Chapter 11 CFIN6
Chapter 11 Solutions
11-1 a. Equation solution (set up):
−
+
=+
+
10
10
1
11
(1 YTM)
$1,077 $60 $1,000
YTM (1 YTM)
Calculator solution for YTM:
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)]
−
+
=+
+
b. Equation solution (set up):
24
24
1
11
[1 (YTM / 2)]
$730 $28 $1,000
(YTM / 2) [1 (YTM / 2)]
−
+
=+
+
Chapter 11 CFIN6
Calculator solution for YTM:
N = 24
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 dividend payments are not a tax-deductible expense.
11-5 rs = rRF + (rM – rRF)βs = 3.5% + (9.0% – 3.5%)1.4 = 11.2%
11-6 rs = rRF + (rM – rRF)βs = = rRF + (RPM)βs = 5% + (7%)2.0 = 19.0%
rd = 3% x 2 = 6%
rs = 6% + Risk premium = 6% + 4% = 10% (using the mid-point risk premium)
Chapter 11 CFIN6
11-8 g = 4%
P0 = $34
D0 = $4.25
F = 8.5%
a. Cost of retained earnings, rs
1
s0
ˆ
D
rg
P
=+
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
s0
ˆ
D
rg
P
=+
Chapter 11 CFIN6
11–10 g = 5%
P0 = $28
D0 = $2.40
re = 15%
F = ?
11
e00
ˆˆ
DD
r g g
NP P (1 F)
= + = +
−
Check: If flotation costs equal 10 percent, the cost of new equity, re, is:
1
e0
ˆ
D
rg
P (1 F)
=+
−
11–11 g = ?
P0 = $32
1
ˆ
D
= $3.36
re = 15.5%
F = 6.5%
Chapter 11 CFIN6
Cost of new equity, re:
11–12 There are two break points associated with new debt—(1) when greater than $450,000 in debt is issued
and (2) when greater than $750,000 in debt is issued. These break points are:
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
==
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
Killer Burgers needs to raise $220,000, but it can only raise a total of $200,000 before new common
Chapter 11 CFIN6
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
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
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:
Debt = $85,000(0.6) = $51,000
Preferred stock = $85,000(0.1) = $8,500
11–17 The retained earnings break point must be computed to determine at what point new common stock
must be issued:.
Chapter 11 CFIN6
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
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 OTC should use to evaluate the projects:
Capital budget < $287,500; no new stock is needed: WACC1 = 0.2(4.0%) + 0.8(10.0%) = 8.8%
11–19 The WACCs are:
Total Amount Raised WACC
$1 – $520,000 11.0%
Chapter 11 CFIN6
Project Cost Costs IRR WACC Acceptable?*
1 $214,000 $214,000 19.0% 11.0% Yes, IRR > WACC
11–20 (1) Compute the break points:
RE $1,300,000
BP $2,000,000
0.65
==
(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,
Debt = 0.35($1,200,000) = $420,000
Equity = 0.65($1,200,000) = $780,000
Total Funds: Greater than 2,000,000; if the entire project is funded at $2.6 million,
Debt = 0.35($2,600,000) = $910,000
Equity = 0.65($2,600,000) = $1,690,000
WACC3 = [7%(1 – 0.4)](0.35) + 14%(0.65) = 10.57%
(3) Determine how much of the project should be purchased.
Chapter 11 CFIN6
Following is a graph that shows the MCC and IOS Schedules:
WACC1 = 8.85%
WACC2 = 9.27%
WACC3 = 10.57%
Rate (%)