Jack’s Construction Co. has 100,000 bonds outstanding that are selling at par value. The bonds yield 9.5 percent. The company also has 4.0 million shares of common stock outstanding. The stock has a beta of 1.2 and sells for $55 a share. The U.S. Treasury bill is yielding 5 percent and the market risk premium is 8 percent. Jack’s tax rate is 35 percent. What is Jack’s weighted average cost of capitalQuestion 2. The Auto Group has 1,000 bonds outstanding that are selling for $950 each. The company also has 9,400 shares of preferred stock at a market price of $70 each. The common stock is priced at $65 a share and there are 40,000 shares outstanding. What is the weight of the preferred stock as it relates to the firm’s weighted average cost of capital

Tillamook Farms invests in a new kind of frozen dessert called polar cream that becomes very popular. So many new customers come to the store that the sales of existing ice cream products are increased. The extra sales revenue

should not be counted as incremental revenue for the polar cream project because the sales come from existing products.

are synergistic effects that should be counted as incremental revenues for the polar cream project.

are cannibalized sales that should be excluded from the analysis.

should be included in the analysis, but not the cost of the ice cream that is sold as that is a recurring expense.

CFA Examination Level II

Westfield Capital Management Company’s equity investment strategy is to invest in companies with low price-to-book ratios, while taking into account differences in solvency and asset utilization. Westfield is considering investing in the shares of either Jerry’s Department Stores (JDS) or Miller Stores (MLS).

a. Calculate each of the following ratios for both JDS and MLS. Use only the financial data in Table 8. Show your work.

(1) Price-to-book ratio

(2) Total-debt-to-equity ratio

(3) Fixed-asset utilization (turnover)

Litchfield Chemical (LCC)

Aminochem (AOC)

Current stock price

$50

$30

Shares outstanding (millions)

10

20

Projected earnings per share (fiscal 1996)

$4.00

$3.20

Projected dividend per share (fiscal 1996)

$0.90

$1.60

Projected dividend growth rate

8%

7%

Stock beta

1.2

1.4

Investors’ required rate of return

10%

11%

Balance sheet data (millions)

Long-term debt

$100

$130

Stockholders’ equity

$300

$320

JERRY’S DEPARTMENT STORES AND MILLER STORES: SELECTED FINANCIAL DATA
AT MARCH 31, 1997 (IN MILLIONS EXCEPT PER-SHARE DATA)

JDS

MLS

Sales

$21,250

$18,500

PP&E

$5,700

$5,500

Short-term debt

$0

$1,000

Long-term debt

$2,700

$2,500

Common equity

$6,000

$7,500

Issued and outstanding shares as of 3/31/97

250

400

Per-share market price on 5/30/97

$51.50

$49.50

JERRY’S DEPARTMENT STORES: DATA EXTRACTED FROM MARCH 31, 1997, FINANCIAL STATEMENT FOOTNOTES

A. Calculate the Future Value of Annuity of investing $6,000 each year starting now for 9 years at 5% interest rate.B. Calculate the Present Value of Annuity of receiving $3,000 each year for the next 12 years with interest rate of 6%.C. Suppose you win a small lottery. You can receive $9,000 now or you can receive $2,200 a year for the next 6 years. Assume 6% interest rate. Which money would you choose?