Steps for Net of Tax Proceeds:

1. Find depreciation per year [(initial price-salvage

value)/assumed life]
2. Multiply depreciation/yr. by number of years used
3. Old selling price total depreciation (=BV)
4. New selling price BV (= capital gain)
5. Capital gain * capital gain tax % (= capital gain tax amnt)
6. New selling price capital gain tax amnt (= net of tax
proceeds)
* only input net of tax proceeds the year you sell it

PRACTICE FINAL T/F

DEBT/EQUITY
1. If one portfolios variance exceeds that of another portfolio, its standard deviation will also be greater than that
E=#
of of
the
shares
other *portfolio.
price per share (total bv for common stock/bv per share * current
2. Market risk can not be eliminated in a stock portfolio through diversification
stock price(ddm))
3. The capital asset pricing model (CAPM) assumes that the stock market is dominated by well-diversified investors
Re = who
CAPM
are only concerned
with market risk.
D = bonds = find PV on calc
4.
If a lowr risk company invests in a high-risk project, those cash flows should be discounted at a high cost of capital.
Rd = YTM = 1/Y
WACC=
*
rd
always
<
re
(bonds
are
less risky than stocks and provide higher return)
* new proj. riskier (less risky) than firm r will be higher (lower) than
* debt < wacc < equity
firms wacc
* new proj. same risk as firm r = firms wacc
PRACTICE FINAL EX 2
* WACC = I for NPV
STOCK A:
PRACTICE FINAL EX 1
Expected return = (.25 -4%) + (.40 8%) + (.35 20%) = 9.2%
Considering purchasing a new machine. The old machine was bought 2 years ago for $30,000, with an assume life of 5 years
2 + .4(8% - 9.2%)2 + .35(20% - 9.2%)2
and an assume salvage value of $5,000. The firm uses straight-line depreciation. The old machine can be sold for $25,000.
Variance = .25
The new machine can be purchased today for $40,000. The new machine will have a 5-year life and will be depreciated to
= 43.56 + .58 + 40.82 = 84.96
$5,000 using straight-line depreciation. With the new sewing machine, the firm is expected to have additional revenue of
Standard deviation = (84.92)0.5 = 9.22%
$15,000 for each of the next five years. The variable cost is 40% of the revenue, and the fixed cost is $3,000 each year.
Talias Tutus allows customers to pay with an average 3-month delay, and its inventories are 15% of next years expense.
PORTFOLIO:
Opportunity cost of capital is 12%, corporate tax rate is 35%, and capital gain tax is 15%, what are the projects NPV and
Expected return = (.5 9.2%) + (.5 2.45%) = 5.83%
IRR? What happens to NPV when all your estimates go up by 10% because of a good economy? (NPV goes up by 6,430)
Variance = .25(((-4% + 9%) 0.5) - 5.83%)2 + .4(((8% + 4%) 0.5) - 5.83%)2

(4 9.2 )

Cost of new
machine
Net-of-tax
proceeds
WC
in WC
in CF due to
WC
Revenue
Expense
Depreciation +

0
40,00
0
24250
1350
1350
-1350

+ .35 ((20% - 4%) 5) - 5.83%)2

= 2.77 + .01 + 1.65 = 4.43
Standard deviation = 4.430.5 = 2.1%

5100
3750

5100
0

5100
0

5100
0

3750
-1350

-3750
15,00
0
-9000
-7000

0
15,00
0
-9000
-7000

0
15,00
0
-9000
-7000

0
15,00
0
-9000
-7000

1350
15,00
0
-9000
-7000

PRACTICE FINAL EX 3:
A firm issued $20 million in long-term bonds that now have 10 years until maturity. The bonds carry an 8% annual coupon
but are selling in the market for $877.10. The firm also has $45 million in market value of common stock (EQUITY). For
cost of capital purposes, what portion of the firm is debt financed and what is the after-tax cost of debt (rd*(1-T)), if the tax
rate is 35%? If the risk-free rate is 3%, the firms beta is 1.3, and market premium is 10%, what is the firms WACC?

Pre-tax profits
-1,000
-1,000
-1,000
-1,000
-1,000
Tax
-350
-350
-350
-350
-350
Profits (pretaxPRACTICE
FINAL EX 4:
tax)
-650
-650
The
project requires initial investment of $1 -650
million, and it-650
will generate
$250,000 in-650
revenue in the
first year. The
Salvage value
5000
revenue is expected to grow at a constant rate of 6% for 5 years till the project expires. The working capital is 20% of the
revenue it generated. The project has the same risk as the firm. The company has common stock with a market value of
17,10
12,70
$100
outstanding. The
bond has6,350
a 6% coupon6,350
rate with a total face
CF million, and it has one issue of0bond 2,600
6,350
0 value of $75
million, and a maturity of 20 years, and YTM of 12%. The coupons are paid semiannually. The current 3-month T-bill
rate is 4%, and the expected market premium is 10%. The beta of the firm is 1.3. Will you take the project? Why?

EXAMPLE 7:
Company SIGMA has one type of common stocks and one type of bond outstanding.
The total BV for the stock is $10M and the BV per share is $2. The common stock just
paid a dividend (Div0) of $2. The dividend is expected to grow at 10% for the next
three years, and it will then slow down to 3% forever. The bond has a 10% coupon rate
with a total face value of $10 million, a maturity of 20 years, and a yield to maturity of
8%. The coupons are paid semi-annually. The current T-bill rate is 3%. S&P has a rate of
return of 12%. The Beta of SIGMAs equity is 1.2. assume 35% corporate tax rate.
A.) What is SIGMAs current stock price per share? (equity/PV)
B.) Whats SIGMAs WACC?
C.) Should they invest in project that costs $10M and will pay annual CFs of $2M?
D.) How will A), B), and C) change if SIGMAs equity beta changed to 1.5 after 3 years?