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:
N = 10
PV = -1,077
b. rdT = 5%(1 – 0.4) = 3%
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)]
−
+
=+
+
Calculator solution for YTM:
N = 24
PV = -918
b. Equation solution (set up):
Chapter 11 CFIN6
Calculator solution for YTM:
N = 24
PV = -730
11-3 Dividend = 0.05($120) = $6
11-4 a. Net proceeds to the firm = $50(10,000)(1 – 0.05) = $500,000(0.95) = $475,000
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%
Calculator solution for YTM:
N = 12
PV = -900
PMT = 20
FV = 1,000
Chapter 11 CFIN6
11-8 g = 4%
P0 = $34
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 = ?
0.09 0.10(1 F) 0.10 0.10F
= − = −
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:
1$450,000
BP $750,000
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
==
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 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:
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%
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:
When new common stock must be issued, FC’s WACC is:
WACC = [5%(1 – 0.3)](0.6) + 7.0%(0.1) + 11%(0.3) = 6.1%
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
==
. The following table applies this information to the projects OTC is evaluating:
Project Cost Costs IRR WACC Acceptable?*
11–19 The WACCs are:
Total Amount Raised WACC
$1 – $520,000 11.0%
520,001 – 745,000 12.5
Over 745,000 15.2
Using these WACCs, the following table summarizes the capital budgeting decision:
Chapter 11 CFIN6
Project Cost Costs IRR WACC Acceptable?*
1 $214,000 $214,000 19.0% 11.0% Yes, IRR > WACC
3 $214,000 $428,000 18.0 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 (%)