Question 1

Several years ago the Jakob Company sold a $1,000 par value, noncallable bond that now has 20 years to maturity and a 7.00% annual coupon that is paid semiannually. The bond currently sells for $925, and the company's tax rate is 40%. What is the component cost of debt for use in the WACC calculation?

Accepted Answer

The answer of Several years ago the Jakob Company sold...

Question 2

Firm M's earnings and stock price tend to move up and down with other firms in the S&P 500, while Firm W's earnings and stock price move counter cyclically with M and other S&P companies. Both M and W estimate their costs of equity using the CAPM, they have identical market values, their standard deviations of returns are identical, and they both finance only with common equity. Which of the following statements is CORRECT?

Accepted Answer

The answer of Firm M's earnings and stock price tend...

Question 3

Scanlon Inc.'s CFO hired you as a consultant to help her estimate the cost of capital. You have been provided with the following data: rRF = 4.10%; RPM = 5.25%; and b = 1.30. Based on the CAPM approach, what is the cost of equity from retained earnings?

Accepted Answer

The answer of Scanlon Inc.'s CFO hired you as a...

Question 4

Weaver Chocolate Co. expects to earn $3.50 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 $32.50 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?

Accepted Answer

Step 1: Firstly, we need to calculate the expected dividend for the year.

Expected Dividend = Dividend Payout Ratio * Earnings per share
Expected Dividend = 65% * $3.50
Expected Dividend = $2.275

Step 2: Calculate the growth rate of the dividend.

Constant Dividend Growth Rate = 6.0%

Step 3: Calculate the cost of new equity.

Cost of new equity = (Dividend / Net Proceeds) + Growth Rate

First, we need to calculate the net proceeds.

Net Proceeds = Price per share * (1 - Flotation Cost)
Net Proceeds = $32.50 * (1 - 5%)
Net Proceeds = $30.875

Now we can substitute the values.

Cost of new equity = ($2.275 / $30.875) + 6.0%
Cost of new equity = 7.38% + 6.0%
Cost of new equity = 13.38%

Therefore, the cost of equity from new common stock would be 13.37%. Option B is the correct answer.

Question 5

Teall Development Company hired you as a consultant to help them estimate its cost of capital. You have been provided with the following data: D1 = $1.45; P0 = $22.50; and g = 6.50% (constant). Based on the DCF approach, what is the cost of equity from retained earnings?

Accepted Answer

The answer of Teall Development Company hired you as a...

Question 6

Assume that you are a consultant to Broske Inc., and you have been provided with the following data: D1 = $0.67; P0 = $27.50; and g = 8.00% (constant). What is the cost of equity from retained earnings based on the DCF approach?

Accepted Answer

The cost of equity from retained earnings using the DCF approach is calculated using the formula: Cost of Equity = (D1 / P0) + g. Substituting the given values: (0.67 / 27.50) + 0.08 = 0.02436 + 0.08 = 0.10436 or 10.44%.

Question 7

You were recently hired by Scheuer Media Inc. to estimate its cost of capital. You obtained the following data: D1 = $1.75; P0 = $42.50; g = 7.00% (constant); and F = 5.00%. What is the cost of equity raised by selling new common stock?

Accepted Answer

The answer of You were recently hired by Scheuer Media...

Question 8

Sorensen Systems Inc. is expected to pay a $2.50 dividend at year end (D1 = $2.50), the dividend is expected to grow at a constant rate of 5.50% a year, and the common stock currently sells for $52.50 a share. The before-tax cost of debt is 7.50%, and the tax rate is 40%. The target capital structure consists of 45% debt and 55% common equity. What is the company's WACC if all the equity used is from retained earnings?

Accepted Answer

The answer of Sorensen Systems Inc. is expected to pay...

Question 9

O'Brien Inc. has the following data: rRF = 5.00%; RPM = 6.00%; and b = 1.05. What is the firm's cost of equity from retained earnings based on the CAPM?

Accepted Answer

The correct answer is A because the cost of equity from retained earnings based on the CAPM is calculated as: rE = rRF + b * (RPM - rRF) = 5.00% + 1.05 * (6.00% - 5.00%) = 11.30%.

Question 10

Assume that Kish Inc. hired you as a consultant to help estimate its cost of capital. You have obtained the following data: D0 = $0.90; P0 = $27.50; and g = 7.00% (constant). Based on the DCF approach, what is the cost of equity from retained earnings?

Accepted Answer

Using the constant growth dividend discount model: 
Ke = (D1/P0) + g 
D1 = D0 * (1+g) = 0.90*(1+0.07) = 0.963 
Ke = (0.963/27.50) + 0.07 = 0.035 + 0.07 = 0.1050 or 10.50%

Question 11

Trahan Lumber Company hired you to help estimate its cost of capital. You obtained the following data: D1 = $1.25; P0 = $27.50; g = 5.00% (constant); and F = 6.00%. What is the cost of equity raised by selling new common stock?

Accepted Answer

The answer of Trahan Lumber Company hired you to help...

Question 12

A company's perpetual preferred stock currently sells for $92.50 per share, and it pays an $8.00 annual dividend. If the company were to sell a new preferred issue, it would incur a flotation cost of 5.00% of the issue price. What is the firm's cost of preferred stock?

Accepted Answer

The answer of A company's perpetual preferred stock currently sells...

Question 13

Bosio Inc.'s perpetual preferred stock sells for $97.50 per share, and it pays an $8.50 annual dividend. If the company were to sell a new preferred issue, it would incur a flotation cost of 4.00% of the price paid by investors. What is the company's cost of preferred stock for use in calculating the WACC?

Accepted Answer

The cost of preferred stock can be calculated as follows:

Cost of preferred stock = Annual dividend / Net issuing price

First, we need to calculate the net issuing price:

Net issuing price = Selling price - Flotation cost
Net issuing price = $97.50 - (4.00% * $97.50)
Net issuing price = $93.60 per share

Now we can calculate the cost of preferred stock:

Cost of preferred stock = $8.50 / $93.60
Cost of preferred stock = 0.0908 or 9.08%

Therefore, the company's cost of preferred stock for use in calculating the WACC is 9.08%.

Question 14

A) Butcher Timber Company hired your consulting firm to help them estimate the cost of equity. The yield on the firm's bonds is 8.75%, and your firm's economists believe that the cost of equity can be estimated using a risk premium of 3.85% over a firm's own cost of debt. What is an estimate of the firm's cost of equity from retained earnings?

Accepted Answer

The answer of A) Butcher Timber Company hired your consulting...

Question 15

To help finance a major expansion, Castro Chemical Company sold a noncallable bond several years ago that now has 20 years to maturity. This bond has a 9.25% annual coupon, paid semiannually, sells at a price of $1,075, and has a par value of $1,000. If the firm's tax rate is 40%, what is the component cost of debt for use in the WACC calculation?

Accepted Answer

First, we need to calculate the current yield of the bond, which is the annual coupon payment divided by the current price:

Annual coupon payment = $1,000 × 9.25% = $92.50 
Semiannual coupon payment = $92.50/2 = $46.25 
Current yield = $46.25 / $1,075 = 0.04302 or 4.302%

Next, we use the current yield as the before-tax cost of debt and then adjust it for taxes using the formula:

After-tax cost of debt = before-tax cost of debt × (1 - tax rate)

After-tax cost of debt = 4.302% × (1 - 0.4) = 2.5812%

Therefore, the component cost of debt for use in WACC calculation is 5.1624% (2 × 2.5812%). But this is the semiannual cost of debt, and we need the annual rate for the WACC. Therefore, we double the semiannual cost to get the annual cost of debt:

Annual cost of debt = 2 × 5.1624% = 10.3248%

Rounding this to two decimal places, the component cost of debt is 5.08% (Option D).

Question 16

You were hired as a consultant to Giambono Company, whose target capital structure is 40% debt, 15% preferred, and 45% common equity. The after-tax cost of debt is 6.00%, the cost of preferred is 7.50%, and the cost of retained earnings is 12.75%. The firm will not be issuing any new stock. What is its WACC?

Accepted Answer

WACC = (wd × rd × (1-t)) + (wp × rp) + (wc × rc), where 
wd = weight of debt = 0.4, 
rd = after-tax cost of debt = 6.00%, 
t = tax rate = not given so assumed 0%, 
wp = weight of preferred = 0.15, 
rp = cost of preferred = 7.50%, 
wc = weight of common equity = 0.45, 
rc = cost of retained earnings = 12.75%

WACC = (0.4 × 6.00%) + (0.15 × 7.50%) + (0.45 × 12.75%) = 2.40% + 1.12% + 5.74% = 9.26%

Therefore, option B is the correct answer.

Question 17

Which of the following statements is CORRECT?

Accepted Answer

The relevant WACC can change depending on the amount of funds a firm raises during a given year because the cost of each capital component can vary at different levels of financing. The weights used to calculate the WACC are based on the firm's target capital structure, which may also change over time.

Question 18

Which of the following statements is CORRECT?

Accepted Answer

The answer of Which of the following statements is CORRECT?
...

Question 19

Which of the following statements is CORRECT? Assume that the firm is a publicly-owned corporation and is seeking to maximize shareholder wealth.

Accepted Answer

The answer of Which of the following statements is CORRECT?...

Question 20

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 = $22.50; and g = 8.00% (constant). Based on the DCF approach, what is the cost of equity from retained earnings?

Accepted Answer

First, we calculate the dividend yield:
Dividend yield = D0/P0 = 0.80/22.50 = 0.0356 or 3.56%
Next, we calculate the expected growth rate using the constant growth model:
g = 8.00%
Finally, we use the CAPM formula to calculate the cost of equity from retained earnings:
Cost of equity from retained earnings = RFR + β*(Rm - RFR)
Assuming a risk-free rate of 3% and a market risk premium of 6%, we get:
Cost of equity from retained earnings = 3% + 1.0*(6%) = 9%
Adding the expected growth rate of 8%, we get:
Cost of equity from retained earnings = 9% + 8% = 11%
Therefore, the answer is C, 11.84%.

Quiz 10: Cost of Capital

Scanlon Inc.'s CFO hired you as a consultant to help her estimate the cost of capital. You have been provided with the following data: rRF = 4.10%; RPM = 5.25%; and b = 1.30. Based on the CAPM approach, what is the cost of equity from retained earnings?

Teall Development Company hired you as a consultant to help them estimate its cost of capital. You have been provided with the following data: D1 = $1.45; P0 = $22.50; and g = 6.50% (constant) . Based on the DCF approach, what is the cost of equity from retained earnings?

Assume that you are a consultant to Broske Inc., and you have been provided with the following data: D1 = $0.67; P0 = $27.50; and g = 8.00% (constant) . What is the cost of equity from retained earnings based on the DCF approach?

You were recently hired by Scheuer Media Inc. to estimate its cost of capital. You obtained the following data: D1 = $1.75; P0 = $42.50; g = 7.00% (constant) ; and F = 5.00%. What is the cost of equity raised by selling new common stock?

O'Brien Inc. has the following data: rRF = 5.00%; RPM = 6.00%; and b = 1.05. What is the firm's cost of equity from retained earnings based on the CAPM?

Assume that Kish Inc. hired you as a consultant to help estimate its cost of capital. You have obtained the following data: D0 = $0.90; P0 = $27.50; and g = 7.00% (constant) . Based on the DCF approach, what is the cost of equity from retained earnings?

Trahan Lumber Company hired you to help estimate its cost of capital. You obtained the following data: D1 = $1.25; P0 = $27.50; g = 5.00% (constant) ; and F = 6.00%. What is the cost of equity raised by selling new common stock?

A company's perpetual preferred stock currently sells for $92.50 per share, and it pays an $8.00 annual dividend. If the company were to sell a new preferred issue, it would incur a flotation cost of 5.00% of the issue price. What is the firm's cost of preferred stock?

Which of the following statements is CORRECT?

Which of the following statements is CORRECT?

Which of the following statements is CORRECT? Assume that the firm is a publicly-owned corporation and is seeking to maximize shareholder wealth.

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 = $22.50; and g = 8.00% (constant) . Based on the DCF approach, what is the cost of equity from retained earnings?