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question:Rivoli Inc. hired you as a consultant to help estimate its cost of capital. You have been provided with the following data: D0 = 0.80; P0 = 72.50; and g = 8.00% (constant). Based on the DCF approach, what is the cost of equity from retained earnings? Do not round your intermediate calculations.

answer:The formula to calculate the cost of equity from retained earnings using the DCF approach is: rs = (D1/P0) + g Where: D1 = the next expected dividend P0 = the current stock price g = the constant growth rate First, we need to calculate the next expected dividend, D1. Assuming that the dividend is expected to grow at a constant rate of 8.00%, we can use the Gordon growth model: D1 = D0 * (1 + g) = 0.80 * (1 + 8.00%) = 0.864 Now we can calculate the cost of equity from retained earnings: rs = (D1/P0) + g = (0.864/72.50) + 8.00% = 0.0119 + 0.0800 = 9.19% Therefore, the cost of equity from retained earnings using the DCF approach is 9.19%.

question:Assume that you are a consultant to Broske Inc., and you have been provided with the following data: D1 = 0.67; P0 = 32.50; and g = 8.00% (constant). What is the cost of equity from retained earnings based on the DCF approach?

answer:The formula to calculate the cost of equity from retained earnings using the DCF approach is: rs = (D1/P0) + g where: D1 = the next expected dividend P0 = the current stock price g = the constant growth rate Substituting the given values: rs = (0.67/32.50) + 8.00% = 0.02062 + 0.0800 = 0.10062 or 10.06% Therefore, the cost of equity from retained earnings based on the DCF approach is 10.06%.

question:Cranberry Corp. has two divisions of equal size: a computer manufacturing division and a data processing division. Its CFO believes that stand-alone data processor companies typically have a WACC of 8%, while stand-alone computer manufacturers typically have a 12% WACC. He also believes that the data processing and manufacturing divisions have the same risk as their typical peers. Consequently, he estimates that the composite, or corporate, WACC is 10%. A consultant has suggested using an 8% hurdle rate for the data processing division and a 12% hurdle rate for the manufacturing division. However, the CFO disagrees, and he has assigned a 10% WACC to all projects in both divisions. Which of the following statements is CORRECT? Group of answer choices While the decision to use just one WACC will result in its accepting more projects in the manufacturing division and fewer projects in its data processing division than if it followed the consultant’s recommendation, this should not affect the firm’s intrinsic value. The decision not to adjust for risk means, in effect, that it is favoring the data processing division. Therefore, that division is likely to become a larger part of the consolidated company over time. The decision not to adjust for risk means that the company will accept too many projects in the manufacturing division and too few in the data processing division. This will lead to a reduction in the firm’s intrinsic value over time. The decision not to risk adjust means that the company will accept too many projects in the data processing business and too few projects in the manufacturing business. This will lead to a reduction in its intrinsic value over time. The decision not to risk adjust means that the company will accept too many projects in the manufacturing business and too few projects in the data processing business. This may affect the firm’s capital structure but it will not affect its intrinsic value.

answer:The correct statement is: The decision not to risk adjust means that the company will accept too many projects in the manufacturing business and too few projects in the data processing business. This may affect the firm’s capital structure but it will not affect its intrinsic value. The CFO's decision to use a 10% WACC for both divisions means that the company is not adjusting for the differences in risk between the two divisions. As a result, the manufacturing division's projects will be evaluated as if they are less risky than they actually are, and the data processing division's projects will be evaluated as if they are more risky than they actually are. This will lead to the acceptance of too many projects in the manufacturing division and too few projects in the data processing division. However, the intrinsic value of the firm will not be affected by this decision because the projects that are accepted will earn the same return as the company's WACC, regardless of which division they are in. Therefore, the value of the firm, based on the present value of its cash flows, will be the same regardless of how many projects are accepted in each division. This decision may affect the company's capital structure because accepting more projects in the manufacturing division may require more financing, which could lead to a higher debt-to-equity ratio or a need to issue more equity to maintain the target capital structure.

question:Which of the following statements is CORRECT? Assume that the firm is a publicly-owned corporation and is seeking to maximize shareholder wealth. Group of answer choices If a firm has a beta that is less than 1.0, say 0.9, this would suggest that the expected returns on its assets are negatively correlated with the returns on most other firms’ assets. If a firm’s managers want to maximize the value of the stock, they should, in theory, concentrate on project risk as measured by the standard deviation of the project’s expected future cash flows. If a firm evaluates all projects using the same cost of capital, and the CAPM is used to help determine that cost, then its risk as measured by beta will probably decline over time. Projects with above-average risk typically have higher-than-average expected returns. Therefore, to maximize a firm’s intrinsic value, its managers should favor high-beta projects over those with lower betas. Project A has a standard deviation of expected returns of 20%, while Project B’s standard deviation is only 10%. A’s returns are negatively correlated with both the firm’s other assets and the returns on most stocks in the economy, while B’s returns are positively correlated. Therefore, Project A is less risky to a firm and should be evaluated with a lower cost of capital.

answer:If a firm evaluates all projects using the same cost of capital, and the CAPM is used to help determine that cost, then its risk as measured by beta will probably decline over time. This statement is incorrect. The correct statement is: Projects with above-average risk typically have higher-than-average expected returns. Therefore, to maximize a firm’s intrinsic value, its managers should favor high-beta projects over those with lower betas. This is because the CAPM assumes that there is a positive relationship between risk and expected returns. Projects that have higher-than-average risk, as measured by their beta, are expected to have higher-than-average returns. Therefore, to maximize the intrinsic value of the firm, managers should select projects with higher betas and higher expected returns. The other statements are incorrect. A beta of less than 1.0 does not suggest negative correlation between the returns on a firm's assets and the returns on other firms' assets. Instead, it indicates that the firm's assets are less risky than the market as a whole. Managers should not concentrate on project risk as measured by the standard deviation of expected future cash flows, as this does not capture the relationship between risk and expected returns. The statement about project A and project B is incorrect because it contradicts the assumption of the CAPM that risk and expected returns are positively related.