Management Advisory Services

1) Assume that you are a consultant to Wrong Company and you have been provided with the following data:
D1 = P0.67; P0 = P42.50; and growth rate is 8%.

What is the cost of equity from retained earnings based on the DGM approach?
A. 11.68% C. 9.96%
B. 9.58% D. 11.30%

2) I Feel Inside Company has the following data: RF = 5%; RPM = 6%; and 𝛽 = 1.10. What is the firm’s cost
of equity from retained earnings based on the CAPM?
A. 6.1% C. 11.83%
B. 13.22% D. 8.93%

Numbers 3 – 4

Thief Company is preparing to issue new ordinary shares. Thief’s stock is currently selling in the market for P50.
Very recently, the stock paid a dividend of P2 per share. Dividends are expected to grow 10% per year through
the foreseeable future.

Flotation costs on the new issue will be P3 per share. Thief’s marginal tax rate is 34%. Assume that the new
stock can be sold to investors at the current price of the existing shares.

3) Based on the information above, Thief cost of new ordinary shares is nearest to:
A. 14.40% C. 14.25%
B. 14.68% D. 8.33%

4) Based on the information above, Thief’s cost of retained earnings is nearest to:
A. 14.4% C. 14.0%
B. 4.4% D. 4.7%

5) Sumayaw Company is preparing to float a new issue bonds. The bonds will have the following
characteristics:

Coupon rate: 8.4% Face value: P1,000,000

Term to maturity: 10 years Issue price: 900,300

Sumayaw’s marginal tax rate is 34%. The coupon rate payment must be paid semi-annually. Sumayaw’s
cost of debt for this bond issue will be nearest to:
A. 5.0% C. 3.3%
B. 6.6% D. 7%

6) You were hired as a consultant to Bitaw Company, whose target capital structure is 40% debt, 15%
preferred, and 45% common equity. The after-tax cost of debt is 6%, the cost of preferred is 7.50%, and
the cost of retained earnings is 13%. The firm will not be issuing any new stock.

What is its WACC?

A. 11.44% C. 9.19%
B. 7.22% D. 9.38%

7) Fall Company expect to earn P3.50 per share during the current year, its expected dividend payout ratio is
65%, its expected constant dividend growth rate is 6.0%, and its common stock currently sells for P50.00
per share. New stock can be sold to the public at the current price, but a flotation cost of 5% would be
incurred.

What would be the cost of equity from new common stock?

A. 12.73% C. 10.79%
B. 9.28% D. 10.68%

8) Time Inc.’s perpetual preferred stock sells for P75.00 per share, and it pays an P8.50 annual dividend. If the
company were to sell a new preferred issue, it would incur a flotation cost of 4% of the price paid by the
investor.
FAR by: John Bo S. Cayetano, CPA, MBA Page 1 of 7
 What is the company’s cost of preferred stock for use in calculating the WACC?
A. 14.40% C. 11.81%
B. 13.93% D. 14.28%

9) Sam Corporation is planning to issue 100,000 shares of 10%, P50 par value preferred stocks for P80 per
share. The company pays income tax at a rate of 30%.

What is the cost of capital (preferred stocks)?

A. 10% C. 6.25%
B. P5 D. 4.25%

10) Tanya Corporation issued preferred stocks for P120 per share. The issue price is P20 more than the stock’s
par value. The company incurred underwriting fees of P10 per share. The stock will earn annual dividends
of P12 per share.

If the tax rate is 30%, the cost of capital (preferred stock) is

A. 10% C. 7.42%
B. 12% D. 10.91%

11) Vicky Corporation has preferred stocks that pay dividends of P6.72 per share. If the cost of funds (capita)
coming from preferred stock is 12% and the income tax rate is 30%.

What is the price of the preferred stock?

A. 56 C. 1.79
B. 0.81 D. 38.08

12) Harry Corporation’s common stocks currently sell for P40 per share. The estimated dividend payment at the
end of this year is P4 per share. The expected growth rate is 12%.

Using the dividend growth model, the cost of capital is

A. 22% C. 12%
B. 10% D. 23%

13) Feeling Corporation expects to pay dividends of P5 per share at the end of this year. The expected growth
rate is 10%.

Using the dividend growth model, what is the stock’s market price if the cost of capital (common stock) is
25%
A. 14.29 C. 20
B. 50 D. 33.33

14) Unye Corporation expects to pay dividends of P4.80 per share at the end of the current year. The dividend
growth rate is 10% and the cost of common equity capital is 14%.

If the dividend growth model is used to appraise Unye Corporation’s shares of stocks, the price of the stocks
to the public is
A. 120 C. 14%
B. 5.28 D. 15.4%

15) How You Like That Company has the following target capital structure and costs:

Proportion of capital structure Cost of capital

Debt 30% 10%
Common stock 60% 12%
Preferred stock 10% 10%

The company’s marginal tax rate is 30%. What is the company’s weighted average cost of capital?
A. 9.20% C. 10.30%
B. 9.30% D. 11.20%

16) Danise Corporation believes that it can sell long term bonds with an 8% coupon rate, although the effective
rate is 10%. If such bonds are part of Danise Corporation’s financing plans for next year.

What is the after (30% tax rate) cost of bonds for purposes of calculating the corporation’s cost of capital?
A. 5.44% C. 8%
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 B. 7% D. 10%

Numbers 17– 20

Agor’s CFO is interest in estimating the company’s WACC and has collected the following information
§ The company has bonds outstanding that mature in 26 years with an annual coupon of 7.5 percent. The
bonds have a face value of P1,000 and sell in the market today for P920.
§ The risk free rate is 6%.
§ The market risk premium is 5%.
§ The stock’s beta is 1.20.
§ The company’s tax rate is 40%.
§ The company’s target capital structure consists of 70 percent equity and 30 percent debt.
§ The company uses the CAPM to estimate the cost of equity and does not include flotation costs as part
of its cost of capital

17) What is the after tax cost of debt?

A. 4.92% C. 4.29%
B. 5.00% D. 3.33%

18) What is the cost of common equity?

A. 12% C. 6.6%
B. 15% D. 11%

19) What is Agor’s WACC?

A. 9.75% C. 10.87%
B. 9.39% D. 9.88%

20) An analyst covering Mole Corporation’s common stock estimates the following information for the next year:

Expected return on the market portfolio 12%

Expected returns on treasury securities 5%
Expected beta of Mole Company 2.2

Using the CAPM, the analyst’s estimate for next year’s risk premium (risk premium adjusted by price
variation) for Mole Company’s stock is closest to:
A. 7.0% C. 10.4%
B. 15.4% D. 21.4%

Numbers 21-22
Ricky Ironworks is considering a proposal to sell an existing lathe and purchase a new computer-operated
lathe. Information on the existing lathe and the computer-operated lathe follow:
Computer-operated
Existing Lathe Lathe
Cost P100,000 P300,000
Accumulated depreciation 60,000 0
Salvage value now 20,000
Salvage value in 4 years 0 60,000
Annual depreciation 10,000 75,000
Annual cash operating costs 200,000 50,000
Remaining useful life 4 years 4 years

21) What is the payback period for the computer-operated lathe?

A. 1.87 years
B. 2.00 years
C. 3.53 years
D. 3.29 years

22) If the company uses 10 percent as its discount rate, what is the net present value of the proposed new lathe
purchase? (Round present value factors to four decimal places)

A. 236,465
B. 256,465
C. 195,485
D. 30,422

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23) RPI Corporation bought a piece of machinery. Selected data is presented below:

Useful life 6 years

Yearly net cash inflow P45,000
Salvage value -0-
Internal rate of return 18%
Cost of capital 14%

The initial cost of the machinery was (round present value factor to four decimal places)

A. 157,392
B. 174,992
C. 165,812
D. impossible to determine from the information given

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24) Tanya Corporation issued preferred stocks for P120 per share. The issue price is P20 more than the
stock’s par value. The company incurred underwriting fees of P10 per share. The stocks will earn annual
dividends of P12 per share. If the tax rate is 30%, the cost of capital (preferred stocks) is

A. 10%
B. 12%
C. 7.42%
D. 10.91%

25) At the beginning of the year, Djorn Corporation purchased a new equipment for P360,000. The machine has
an estimated useful life of four (4) years with no salvage value. It is expected to produce cash flows from
operations, net of income taxes of 32%, as follows:
Year 1 P128,000
2 112,000
3 144,000
4 96,000
5 80,000

Djorn Corporation uses the sum-of-the-years-digits method (SYD) in computing depreciation of its
depreciable assets. Using SYD, the new equipment will be depreciated as follows:
Year 1 (P360,000 x 4/10) P144,000
2 (P360,000 x 3/10) 108,000
3 (P360,000 x 2/10) 72,000
4 (P360,000 x 1/10) 36,000

The company’s cost of capital is 10%. The present value factors at 10% are as follows:
End of Year 1 0.909
2 0.826
3 0.751
4 0.683
Total, 4 years 3.170

If Djorn Corporation used the straight-line method of depreciation instead of the SYD method, the net
present value provided by the equipment would increase (decrease) by:

A. 13,464
B. (13,464)
C. ( 4,308.48)
D. 4,308.48

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26) Harry owns a computer reselling business and is expanding his business. Harry is presented with one
proposal, Proposal P1, such that the estimated investment for the expansion project is P85,000 and it is
expected to produce cash flows after taxes of P25,000 for each of the next 6 years. An alternate proposal,
Proposal P2, involves an investment of P32,000 and after-tax cash flows of P10,000 for each of the next 6
years. The present value factors for an annuity of P1 for 1 to 6 years are as follows:

n 10% 12% 14% 16% 18% 20%

1 0.909 0.893 0.877 0.862 0.847 0.833
2 1.736 1.690 1.647 1.605 1.566 1.528
3 2.487 2.402 2.322 2.246 2.174 2.106
4 3.170 3.037 2.914 2.798 2.690 2.589
5 3.791 3.605 3.433 3.274 3.127 2.991
6 4.355 4.111 3.889 3.685 3.498 3.326

The cost of capital that would make Harry indifferent between these two proposals lies between

A. 10% and 12%

B. 14% and 16%
C. 16% and 18%
D. 18% and 20%

27) Harold Co. is considering an investment in a capital project. The sole outlay will be P716,417.90 at the outset
of the project and the annual net after-tax cash inflow will be P216,309.75 for 6 years. The present value
factors at Harold’s 8% cost of capital are:

Year PV Factors

1 0.926
2 0.857
3 0.794
4 0.735
5 0.681
6 0.630

What is the break-even time (BET)?

A. 3.31 years
B. 4.00 years
C. 5.00 years
D. 6.00 years

28) The investment banking firm of M and Associates will use a dividend valuation model to appraise the
shares of the L&L Corporation. Dividends (D) at the end of the current year will be P1.20. The growth rate
(g) is 9% and the discount rate (K) is 13%?

What should be the price of the stock to the public?

A. 28.75
B. 31.50
C. 30.00
D. 29.00

29) BSR Co, has an opportunity to purchase a new conveyor line for P250,000. They can borrow P200,000,
paying P50,000 down with annual payments for five years and an interest of 15%. They also have an
opportunity to lease the line for P65,000 a year. The present value of an annuity of P1 for five years at 9%
and 15% are 3.8897 and 3.3522, respectively. At the end of five years, the estimated salvage value is
P40,000. If owned, the cost of maintenance is expected to be P10,000 per year. Assume straight-line
depreciation, a 40% tax rate, a cost of debt of 15%, and a cost of capital of 9%.

What is the present value of the after-tax cost of leasing for the five-year period?

A. 151,698
B. 98,698
C. 144,000
D. 165,800

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30) For the next two years, a lease is estimated to have an operating net cash inflow of P7,500 per annum, before
adjusting for P5,000 per annum tax basis lease amortization, and a 40% tax rate. The present value of an
ordinary annuity of P1 per year at 10% for two years is 1.74. What is the lease’s after-tax present value using
a 10% discount factor?

A. 2,610
B. 4,350
C. 9,570
D. 11,310

Numbers 31 – 22
A firm, with an 18% cost of capital, is considering the following projects (on January 1, 2018):

Project A Project B

Cash outflow, January 1, 2018 P3,500,000 P4,000,000

Cash inflow, December 31, 2022 7,400,000 9,950,000
Project internal rate of return 15% ?

Present Value of P1 Due at End of “N” Periods

N 12% 14% 15% 16% 18% 20% 22%

4 0.6355 0.5921 0.5718 0.5523 0.5158 0.4823 0.4230
5 0.5674 0.5194 0.4972 0.4761 0.4371 0.4019 0.3411
6 0.5066 0.4556 0.4323 0.4104 0.3704 0.3349 0.2751

31) Using the net present value method, Project A’s net present value is

A. 316,920
B. 0
C. (265,460)
D. ( 316,920)

32) Project B’s internal rate of return is closest to

A. 15%
B. 18%
C. 20%
D. 22%

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