Week 7 — Practice Set for Chapters 14 and 15 Name__________________

Estimating Continuing Value and the Cost of Capital

1. Bo Corp. expects NOPAT of $1,800,000 in the first year after the forecast period (or the first year of continuing value period. In addition, Bo expects growth of 2.5% during the continuing value period, expected return on new invested capital of 11%, and a weighted average cost of capital of 8%. Using the formula from the textbook, please calculate the continuing value for Bo Corporation.
2. Go Corp. expects free cash flows of $1,400,000, $1,800,000, $2,200,000, $2,800,000, $1,900,000, in years 1,2 3,4, 5 respectively. In addition, Go has a continuing value of $6,500,000 at the end of year 5. Its cost of capital is 9%. Assuming year end cash flows, please bring these cash flows to present discounting at the weighted average cost of capital and place the answer below as the enterprise value for Go Corp.
3. Coe Corp. has a cost of equity of 13%, and an after-tax cost of debt of 8%. Using market values Coe’s debt is 30% of the value of the firm and Coe’s equity is 70% of the value of the firm. What is Coe Corp. weighted average cost of capital?
4. Doe Corp. can borrow at 10% and it has a 28% marginal tax rate. What is Doe’s after-tax cost of debt?
5. Foe Corporation has a beta of 1.4, the risk-free rate is expected to be 4.5% and the market risk premium is expected to be 5.5%. Using the Capital Asset Pricing Model, what is Foe’s after-tax cost of equity?
6. Ace Corporations has two divisions. The one in the high-risk industry has a beta of 2.1 and can be financed optimally in line with others in the industry at 25% debt and 75% equity. The low-risk division has a beta of .65 and based on industry averages, can be financed optimally at 60% debt and 40% equity. Assuming the risk-free rate of return on 10-year government securities is 4.5% and the market risk premium is 5.5%. What is the estimated cost of common equity for the high-risk division?
7. Continuing from the prior problem, what is the estimated after-tax cost of equity for the low-risk division?
8. Still working with Ace Corporation and the information from the prior two problems, assume that the after-tax cost of debt for the high-risk division is 9% and the after-tax costs of debt for the low-risk division is 7%. What are the weighted average divisional costs of capital for each division?
9. Jay Corporation has 750,000 bonds outstanding that are trading at $940. In addition, Jay has 8,500,000 million shares of common stock outstanding at $105. What are the market weightings for Jay Corporation?
10. Sue Corporation is financed with 20% debt and 80% common equity. They estimate that their after-tax cost of debt is 4.5% and their cost of common equity is 9%. What is Sue’s weighted average cost of capital?