Finance 340 – Financial Management I
Summer 2002
Final Exam Sample Problems
Dr. Stanley D. Longhofer
T-Th 1:30-4:30
1) Fernie Mining Corporation 7% semiannual coupon bonds are currently trading at
$1,050; they have 12 years remaining until maturity. Fernie preferred stock has a par
value of $100 with a 8.25% promised dividend, paid quarterly; the preferred stock is
currently trading at $110 per share. Fernie common stock currently sells for $45 per
share. Its latest dividend was $5.19 per share; dividends are expected to grow by 4%
per year for the foreseeable future.
The risk-free rate is currently 4.5% and average return on the market as a whole is
12.5%. Fernie’s beta is 1.31.
When using the bond-yield-plus-risk-premium approach, Fernie assumes that its
common equity requires a 9.1% risk premium over its own bonds.
Fernie’s corporate marginal tax rate is 40%, and its capital structure includes 50%
common equity, 35% debt, and 15% preferred stock.
Fernie is considering two different technologies for a new mine it will be opening
next year. These technologies are mutually exclusive, so one of the two can be
implemented.
Technology A will require an initial investment of $2.5 million, and will generate
annual net revenues of $750,000 for each the first 3 years and $300,000 for each of
the following 7 years.
Technology B is more expensive to implement, but will allow the mine to be more
productive longer. This technology will require an initial investment of $3.3 million,
and will generate revenues of $625,000 for each of the next 10 years.
a) What is Fernie’s weighted average cost of capital (WACC)? Hint: In calculating
the cost of Fernie’s equity, take the average of the values calculated based on the
discounted cash flow, CAPM, and bond-yield-plus-risk-premium approaches.
b) Calculate the payback period for each technology. If Fernie requires any project
to pay back its initial investment within 4 years, which technology will it accept?
c) Calculate the discounted payback period for Technology A only given the WACC
calculated in part a.
d) Calculate the net present value (NPV) of each technology. Based on this method,
which of these two technologies should Fernie choose?
e) Calculate the internal rate of return (IRR) for each technology. Based on this
method, which of these two technologies should Fernie choose?
f) Calculate the modified internal rate of return (MIRR) for each technology. Which
should be chosen based on this method?
