Question Details

Which of the following projects should Conglomerate accept


1.       You must estimate the intrinsic value of Gallovits Technologies’ stock.  Gallovits- end-of-year free cash flow (FCF) is expected to be $25 million, and it is expected to grow at a constant rate of 8.5% a year thereafter.  The company- WACC is 11%.  Gallovits has $200 million of long-term debt plus preferred stock, and there are 30 million shares of common stock outstanding.  What is Gallovits' estimated intrinsic value per share of common stock?

a.	$22.67
b.	$24.00
c.	$25.33
d.	$26.67  

2.  Campbell Co. is trying to estimate its weighted average cost of capital (WACC).  Which of the following statements is most correct?

a.	The after-tax cost of debt is generally cheaper than the after-tax cost of equity.   
b.	Since retained earnings are readily available, the cost of retained earnings is generally lower than the cost of debt.
c.	The after-tax cost of debt is generally more expensive than the before-tax cost of debt. 
d.	Statements a and c are correct. 

3.	Wyden Brothers has no retained earnings.  The company uses the CAPM to calculate the cost of equity capital.  The company- capital structure consists of common stock, preferred stock, and debt.  Which of the following events will reduce the company- WACC?

a.	A reduction in the market risk premium.  
b.	An increase in the flotation costs associated with issuing new common stock.
c.	An increase in the company- beta.
d.	An increase in expected inflation.



4.	Dick Boe Enterprises, an all-equity firm, has a corpor¬ate beta coefficient of 1.5.  The financial manager is evaluating a proj¬ect with an expected return of 21 percent, before any risk adjustment.  The risk-free rate is 10 percent, and the required rate of return on the market is 16 percent.  The project being evaluated is risk¬ier than Boe- average project, in terms of both beta risk and total risk.  Which of the following statements is most correct?

a.	The project should be accepted since its expected return (before risk adjustment) is greater than its required return.
b.	The project should be rejected since its expected return (before risk adjustment) is less than its re¬quired return.
c.	The accept/reject decision depends on the risk-adjustment policy of the firm.  If the firm- policy were to reduce a riskier-than-average project- expected return by 1 percentage point, then the project should be accepted.   
d.	Riskier-than-average projects should have their expected returns increased to reflect their added riskiness.  Clearly, this would make the project acceptable regardless of the amount of the adjustment.


5.	Conglomerate Inc. consists of 2 divisions of equal size, and Conglomerate is 100 percent equity financed.  Division A- cost of equity capital is 9.8 percent, while Division B- cost of equity capital is 14 percent.  Conglomerate- composite WACC is 11.9 percent.  Assume that all Division A projects have the same risk and that all Division B projects have the same risk.  However, the projects in Division A are not the same risk as those in Division B.  Which of the following projects should Conglomerate accept?

a.	Division A project with an 11 percent return. 
b.	Division B project with a 12 percent return.
c.	Division B project with a 13 percent return.
d.	Statements a and c are correct.




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