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Chapter 4: 4-9-34BP (page 284)
Question: C. D. Rom has just given an insurance company \(35,000. In return, he will receive an annuity of \)3,700 for 20 years. At what rate of return must the insurance company invest this $35,000 in order to make the annual payments?
Answer
The required rate of return is 8.51%.
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The treasurer of Riley Coal Co. is asked to compute the cost of fixed income securities for her corporation. Even before making the calculations, she assumes the aftertax cost of debt is at least 3 percent less than that for preferred stock. Based on the following facts, is she correct?
Debt can be issued at a yield of 11.0 percent, and the corporate tax rate is 20 percent. Preferred stock will be priced at \(60 and pay a dividend of \)6.40. The flotation cost on the preferred stock is $6.
Question: Sherwin Williams will receive \(18,500 a year for the next 25 years as a result of a picture he has painted. If a discount rate of 12 percent is applied, should he be willing to sell out his future rights now for \)165,000?
Rapid corporate growth in sales and profits can cause financing problems. Elaborate on this statement
Question:Stagnant Iron and Steel currently pays a $12.25 annual cash dividend (D0). The company plans to maintain the dividend at this level for the foreseeable future as no future growth is anticipated. If the required rate of return by common stockholders (Ke) is 18 percent, what is the price of the common stock?
The Woodruff Corporation purchased a piece of equipment three years ago for \(230,000. It has an asset depreciation range (ADR) midpoint of eight years. The old equipment can be sold for \)90,000.
A new piece of equipment can be purchased for \(320,000. It also has an ADR of eight years.
Assume the old and new equipment would provide the following operating gains (or losses) over the next six years:
Year New Equipment Old Equipment
1 .................... \)80,000 $25,000
2 .................... 76,000 16,000
3 .................... 70,000 9,000
4 .................... 60,000 8,000
5 .................... 50,000 6,000
6 .................... 45,000 (7,000)
The firm has a 36 percent tax rate and a 9 percent cost of capital. Should the new equipment be purchased to replace the old equipment?
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