Chapter 11 CFIN5
Chapter 11 Solutions
11-1 a. Equation solution (set up):
é ù
–é ù
ê ú
+
= + ê ú
ê ú +
ë û
ê ú
ë û
10
10
1
11
(1 YTM)
$1,077 $60 $1,000
YTM (1 YTM)
Calculator solution for YTM:
N = 10
PV = -1,077
PMT = 60
FV = 1,000
I/Y = ? = 5.0% = YTM = rd
The coupon rate of interest on the new bond should be equal to the yield to maturity on the
company’s existing bonds, which is 5 percent.
11-2 Interest payment = [0.056($1,000)]/2 = $28
N = 12 x 2 = 24
a. Equation solution (set up):
24
24
1
11
[1 (YTM / 2)]
$918 $28 $1,000
(YTM / 2) [1 (YTM / 2)]
é ù
–é ù
ê ú
+
= + ê ú
ê ú +
ë û
ê ú
ë û
Calculator solution for YTM:
N = 24
PV = -918
PMT = 28
FV = 1,000
I/Y = ? = 3.3% = YTM/2 = rd/2 = six-month rate
b. Equation solution (set up):
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accessible website, in whole or in part.
Chapter 11 CFIN5
24
24
1
11
[1 (YTM / 2)]
$730 $28 $1,000
(YTM / 2) [1 (YTM / 2)]
é ù
–é ù
ê ú
+
= + ê ú
ê ú +
ë û
ê ú
ë û
Calculator solution for YTM:
N = 24
PV = -730
11-3 Dividend = 0.05($120) = $6
ps
0
D $6
r = 0.08 8.0%
NP $75
= = =
There is no adjustment for taxes, because dividends payment are not a tax-deductible expense.
11-4 a. Net proceeds to the firm = $50(10,000)(1 – 0.05) = $500,000(0.95) = $475,000
b.
ps
0
D $4.75 $4.75
r = 0.10 10.0%
NP $50(1 0.05) $47.50
= = = =
–
There is no adjustment for taxes, because dividends payment are not a tax-deductible expense.
11-7 Equation solution (set up) for rd:
12
12
1
11
[1 (YTM / 2)]
$900 $20 $1,000
(YTM / 2) [1 (YTM / 2)]
é ù
–é ù
ê ú
+
= + ê ú
ê ú +
ë û
ê ú
ë û
Calculator solution for YTM:
N = 12
PV = -900
PMT = 20
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accessible website, in whole or in part.
Chapter 11 CFIN5
11-8 g = 4%
P0 = $34
D0 = $4.25
F = 8.5%
a. Cost of retained earnings, rs
1
s
0
ˆ
D
r g
P
$4.25(1.04) $4.42
0.04 0.04 0.17 17.0%
$34 $34
= +
= + = + = =
b. Cost of new equity, re
1
e
0
ˆ
D
r g
NP
$4.25(1.04) $4.42
0.04 0.04 0.182 18.2%
$34(1 0.085) $31.11
= +
= + = + = =
–
11-9 g = 0%
P0 = $50
D0 = $6
F = 7%
β = 0.75 (irrelevant information for this problem)
a. Cost of retained earnings, rs
1
s
0
ˆ
D
r g
P
$6(1.0) $6
0.0 0.12 12.0%
$50 $50
= +
= + = = =
b. Cost of new equity, re
Chapter 11 CFIN5
1
s
0
ˆ
D$3.36
r g g 0.155
P $32
g 0.155 0.105 0.05
= + = + =
= – =
Cost of new equity, re:
1 1
e
0 0
ˆ ˆ
D D
r g g
NP P (1 F)
$3.36 $3.36
0.05 0.05 0.162 16.2%
$32(1 0.065) $29.92
= + = +
–
= + = + = =
–
11-12 Break points associated with the debt:
1
$450,000
BP $750,000
0.6
= =
2
$750,000
BP $1,250,000
0.6
= =
11-13 There are two break points associated with the new funds—(1) when more than $240,000 in debt is
issued and (2) when new common equity must be issued.
Debt
$240,000
BP $800,000
0.3
= =
RE
$560,000
BP $800,000
0.7
= =
According to this information, Western’s WACC will increase when it raises more than $800,000 in total
funds because both the cost of debt and the cost of equity will increase beyond this point. In other
words, the break point for debt and the break point for equity occur at the same level of funds.
11-14 a. WACC1 = wd(rdT) + ws(rs) = 0.4[5%(1 – 0.35)] + 0.6(8%) = 6.1%
11-15 wd = 20% rdT = 3.5% re = 12.4%
wps = 30% rps = 6.0% Retained earnings = $100,000
ws = 50% rs= 10.2% Funding needs = $220,000
Chapter 11 CFIN5
RE
$100,000
BP $200,000
0.5
= =
Killer Burgers needs to raise $220,000, but it can only raise a total of $200,000 before new common
stock must be issued. As a result, the firm must issue new stock.
Alternative solution: If Killer Burgers raises $220,000, following is the breakdown of how the funds will
be raised:
Debt = $220,000(0.2) = $44,000
Preferred stock = $220,000(0.3) = $66,000
Common equity = $220,000(0.5) = $110 ,000
Total amount = $220,000
Because the amount of funds that will be raised using common equity is greater than the $100,000
expected increase in retained earnings, new common stock must be issued.
When new common stock must be issued, Killer’s WACC is:
WACC = 3.5%(0.2) + 6.0%(0.3) + 12.4%(0.5) = 8.7%
11-16 wd = 60% rd= 5.0% re = 13.0%
wps = 10% rps = 7.0% Retained earnings = $27,000
ws = 30% rs= 11.0% Funding needs = $85,000
Marginal tax rate = T = 30%
The retained earnings break point must be computed to determine whether a new common stock issue
is required to raise the $85,000 in total funds that FC needs.
RE
$27,000
BP $90,000
0.3
= =
FC needs to raise $85,000, and it can raise up to a total of $90,000 before new common stock must be
issued. As a result, the firm does not need to issue new stock.
Alternative solution: If FC raises $85,000, following is the breakdown of how the funds will be raised:
Because the amount of funds that will be raised using common equity is less than the $27,000 expected
increase in retained earnings, new common stock does not need to be issued.
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accessible website, in whole or in part.
Chapter 11 CFIN5
11-17 The retained earnings break point must be computed to determine at what point new common stock
must be issued:.
RE
$24,000
BP $40,000
(1 0.4)
= =
–
Based on this information, we know that WACC = 14 percent as long as the total capital budget is less
than $40,000. If the capital budget is greater than $40,000, WACC = 17 percent. The following table
applies this information to the three projects Lazy Loungers is evaluating:
Project Cost Costs IRR WACC Acceptable?*
A $10,000 $10,000 21.0% 14.0% Yes, IRR > WACC
B 15,000 $25,000 20.0 14.0 Yes, IRR > WACC
C 25,000 $50,000 16.0 17.0 No, IRR < WACC
* Indicates whether the project in the row is acceptable.
Projects A and B should be purchased.
11-18 The retained earnings break point must be computed to determine at what point new common stock
must be issued:.
RE
$230,000
BP $287,500
0.8
= =
As a result, following are the WACCs when no new stock must be issued and when new common stock
must be issued:
Capital budget < $287,500; no new stock is needed: WACC = 0.2(4.0%) + 0.8(10.0%) = 8.8%
Capital budget > $287,500; new stock must be issued: WACC = 0.2(4.0%) + 0.8(12.5%) = 10.8%
. The following table applies this information to the projects OTC is evaluating:
Project Cost Costs IRR WACC Acceptable?*
S $150,000 $150,000 12.0% 8.8% Yes, IRR > WACC
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accessible website, in whole or in part.
Chapter 11 CFIN5
11-19 The WACCs are:
Total Amount Raised WACC
$1 – $520,000 11.0%
Using these WACCs, the following table summarizes the capital budgeting decision:
Project Cost Costs IRR WACC Acceptable?*
1 $214,000 $214,000 19.0% 11.0% Yes, IRR > WACC
* Indicates whether the project in the row is acceptable.
11-20 (1) Compute the break points:
RE
$1,300,000
BP $2,000,000
0.65
= =
Debt
$420,000
BP $1,200,000
0.35
= =
(2) Compute the WACC for each interval of funds:
Total Funds: $1 to $1,200,000 (first break point); at the maximum amount of this interval,
Total Funds: $1,200,001 to $2,000,000 (second break point); at the maximum amount of this
interval,
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accessible website, in whole or in part.
Chapter 11 CFIN5
Total Funds: Greater than 2,000,000; if the entire project is funded at $2.6 million,
(3) Determine how much of the project should be purchased.
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accessible website, in whole or in part.