Question 1

Use the following information to answer the question below.
 
-If the firm decided to finance itself completely with debt, calculate the WACC from the above information.
A) 6%
B) 7.8%
C) 0.06%
D) cannot be determined given this information

Accepted Answer

The answer of Use the following information to answer the...

Question 2

The marginal cost of capital can best be defined as:
A) BP = WACC/limit
B) BP = Proportion of total capital/limit
C) BP = Limit/proportion of total capital
D) BP = Limit/WACC

Accepted Answer

The answer of The marginal cost of capital can best...

Question 3

If a firm has a $500,000 debt limit before AT k_dwill change if taxes are 30% and total debt is 50% of the capital structure, calculate the debt break point in the MCC schedule. A) $500,000 B) $300,000 C) $2,500,000 D) $1,000,000

Accepted Answer

The debt break point is calculated by dividing the debt limit by the proportion of debt in the capital structure. Here, $500,000 / 0.50 = $1,000,000.

Question 4

Which of the following best describes what the financial managers must do to estimate the MCC schedule? A) calculate the cost of capital after the points of change in cost B) assess at what point a firm's k_dor k_ewill change the firm's MCC C) calculate the cost of capital up to the points of change in cost D) calculate the cost of capital up to and after the points of change in cost

Accepted Answer

Financial managers must calculate the cost of capital both up to and after the points of change in cost to accurately estimate the Marginal Cost of Capital (MCC) schedule. This involves understanding how the cost of capital changes as the firm raises more funds.

Question 5

The cost of preferred shares is
A) the rate of return investors require on a company's existing preferred shares.
B) the rate of return investors require on a company's new preferred shares.
C) calculated on an after tax basis.
D) the rate of return investors require on new preferred shares plus the cost of issuing the shares.

Accepted Answer

The cost of preferred shares is the rate of return investors require on new preferred shares plus the cost of issuing the shares.

Question 6

If common equity financing is 60% of the optimal capital structure and the existing limit of internal equity is $500,000. Solve for the equity break poin.
A) $1,000,000
B) $600,000
C) $833,333
D) $666,667

Accepted Answer

The equity break point is calculated by dividing the limit of internal equity by the percentage of equity in the optimal capital structure. Therefore, $500,000 / 0.60 = $833,333.

Question 7

If the new common stock costs are greater than the cost of internal common equity, what will happen as the equity break point is passed?
A) The MCC will rise then fall.
B) The MCC will remain unchanged.
C) The MCC will fall.
D) The MCC will rise.

Accepted Answer

When the equity breakpoint is passed and the company starts using new common stock which costs more than internal common equity, the marginal cost of capital (MCC) will rise due to the higher cost of new equity.

Question 8

The cost of internal common equity is equal to:
A) the cost of debt before taxes.
B) the cost of retained earnings.
C) the cost of preferred stock.
D) the cost of new common stock.

Accepted Answer

The cost of internal common equity is equal to the cost of retained earnings because it represents the return that the company must earn on its existing assets to maintain the value of its stock and satisfy its shareholders.

Question 9

The dividends paid on a preferred stock issue are $4 per share, the tax rate is 40%, the price is $32 and there will be $2/share in flotation costs. Calculate the cost of the preferred stock.
A) 13.3%
B) 12.33%
C) 12%
D) 7.98%

Accepted Answer

The cost of the preferred stock is calculated as follows:Cost of preferred stock = (Dividends / (Price - Flotation costs)) * (1 - Tax rate)= (4 / (32 - 2)) * (1 - 0.40)= 0.1333 or 13.33%

Question 10

If a firm has a $1,500,000 debt limit before AT k_dwill change and if taxes are 40% and total debt is 60% of the capital structure, calculate the debt break point in the MCC schedule. A) $7,500,000 B) $1,000,000 C) $3,750,000 D) $2,500,000

Accepted Answer

The answer of If a firm has a $1,500,000 debt...

Question 11

Use the following information to answer the question below.
CDE Inc.'s current (and optimal) capital structure is 40% debt, 10% preferred stock, and 50% common equity. CDE is in the 40% tax bracket. The company can issue up to $20,000,000 in new bonds at par with a 7% coupon; any subsequent amount must carry a 2% premium to compensate investors for added risk. A new issue of preferred stock would pay an annual dividend of $4.00 and be priced to net the company $50.00 per share after the $3.00 per share floatation cost. The firm has $21,000,000 in retained earnings. CDE's common stock trades at $40.00 per share and the expected dividend on the common stock is 2.00. Floatation costs on common equity issues is $5.00 per share. The company is growing at 7% per year.
-What is the cost of preferred stock?
A) 8.0%
B) 12.5%
C) 20.0%
D) 8.5%

Accepted Answer

The cost of preferred stock is calculated as the dividend divided by the net price per share. Here, the annual dividend is $4.00, and the net price per share is $50.00. Thus, the cost of preferred stock is $4.00 / $50.00 = 8.0%.

Question 12

Use the following information to answer the question below.
CDE Inc.'s current (and optimal) capital structure is 40% debt, 10% preferred stock, and 50% common equity. CDE is in the 40% tax bracket. The company can issue up to $20,000,000 in new bonds at par with a 7% coupon; any subsequent amount must carry a 2% premium to compensate investors for added risk. A new issue of preferred stock would pay an annual dividend of $4.00 and be priced to net the company $50.00 per share after the $3.00 per share floatation cost. The firm has $21,000,000 in retained earnings. CDE's common stock trades at $40.00 per share and the expected dividend on the common stock is 2.00. Floatation costs on common equity issues is $5.00 per share. The company is growing at 7% per year.
-What is the cost of internal common equity?
A) 5.0%
B) 9.0%
C) 12.0%
D) 7.0%

Accepted Answer

The cost of internal common equity can be calculated using the Gordon Growth Model (also known as the Dividend Discount Model for a growing perpetuity), which is given by the formula: Cost of Equity = (D1 / P0) + g, where D1 is the dividend expected next year, P0 is the current price of the stock, and g is the growth rate. Here, D1 = $2.00 (given as the expected dividend), P0 = $40.00 (current stock price), and g = 7% or 0.07. Plugging these values into the formula gives: Cost of Equity = ($2.00 / $40.00) + 0.07 = 0.05 + 0.07 = 0.12 or 12%.

Question 13

Use the following information to answer the question below.
CDE Inc.'s current (and optimal) capital structure is 40% debt, 10% preferred stock, and 50% common equity. CDE is in the 40% tax bracket. The company can issue up to $20,000,000 in new bonds at par with a 7% coupon; any subsequent amount must carry a 2% premium to compensate investors for added risk. A new issue of preferred stock would pay an annual dividend of $4.00 and be priced to net the company $50.00 per share after the $3.00 per share floatation cost. The firm has $21,000,000 in retained earnings. CDE's common stock trades at $40.00 per share and the expected dividend on the common stock is 2.00. Floatation costs on common equity issues is $5.00 per share. The company is growing at 7% per year.
-What is the cost of equity from new common stock?
A) 13.3%
B) 11.4%
C) 12.0%
D) 12.7%

Accepted Answer

The cost of equity from new common stock can be calculated using the dividend discount model (DDM) adjusted for flotation costs: Cost of new equity = (D1 / (P0 - F)) + g, where D1 is the dividend expected next year, P0 is the current price per share, F is the flotation cost per share, and g is the growth rate. Here, D1 = $2.00 * (1 + 0.07) = $2.14, P0 = $40, F = $5, and g = 7% or 0.07. Thus, Cost of new equity = ($2.14 / ($40 - $5)) + 0.07 = 0.071 + 0.07 = 0.141 or 14.1%. However, since this option is not available, the calculation needs to be revisited for accuracy. Correctly, it should be: Cost of new equity = (D1 / (P0 - F)) + g = ($2.14 / ($40 - $5)) + 0.07 = ($2.14 / $35) + 0.07 = 0.0611 + 0.07 = 0.1311 or 13.1%. The closest option provided is 12.7%, indicating a mistake in the initial calculation or in the interpretation of the options. The correct approach involves accurately applying the formula and carefully selecting the closest available option based on the calculated result.

Question 14

Use the following information to answer the question below.
CDE Inc.'s current (and optimal) capital structure is 40% debt, 10% preferred stock, and 50% common equity. CDE is in the 40% tax bracket. The company can issue up to $20,000,000 in new bonds at par with a 7% coupon; any subsequent amount must carry a 2% premium to compensate investors for added risk. A new issue of preferred stock would pay an annual dividend of $4.00 and be priced to net the company $50.00 per share after the $3.00 per share floatation cost. The firm has $21,000,000 in retained earnings. CDE's common stock trades at $40.00 per share and the expected dividend on the common stock is 2.00. Floatation costs on common equity issues is $5.00 per share. The company is growing at 7% per year.
-What is the marginal cost of capital (MCC) break point for debt?
A) $20,000,000
B) $42,000,000
C) $50,000,000
D) $12,000,000

Accepted Answer

The answer of Use the following information to answer the...

Question 15

Use the following information to answer the question below.
CDE Inc.'s current (and optimal) capital structure is 40% debt, 10% preferred stock, and 50% common equity. CDE is in the 40% tax bracket. The company can issue up to $20,000,000 in new bonds at par with a 7% coupon; any subsequent amount must carry a 2% premium to compensate investors for added risk. A new issue of preferred stock would pay an annual dividend of $4.00 and be priced to net the company $50.00 per share after the $3.00 per share floatation cost. The firm has $21,000,000 in retained earnings. CDE's common stock trades at $40.00 per share and the expected dividend on the common stock is 2.00. Floatation costs on common equity issues is $5.00 per share. The company is growing at 7% per year.
-What is the marginal cost of capital (MCC) break point for common equity?
A) $20,000,000
B) $12,000,000
C) $42,000,000
D) $50,000,000

Accepted Answer

The marginal cost of capital (MCC) break point for common equity is calculated based on the amount of retained earnings available, as this is the amount of equity financing that can be used before the company must resort to new equity, which has a higher cost due to flotation costs. The break point for common equity is calculated as the amount of retained earnings divided by the percentage of common equity in the capital structure. In this case, CDE Inc. has $21,000,000 in retained earnings and common equity represents 50% of the capital structure. Therefore, the break point for common equity is $21,000,000 / 0.50 = $42,000,000.

Question 16

If $43,000,000 of projects have already been financed, what is the marginal cost of capital of a $4,000,000 project?
A) 7.92%
B) 7.24%
C) 8.28%
D) 8.83%

Accepted Answer

The answer of If $43,000,000 of projects have already been...

Question 17

If $52,000,000 of projects have already been financed, what is the marginal cost of capital of a $9,000,000 project?
A) 8.28%
B) 8.60%
C) 7.24%
D) 9.31%

Accepted Answer

The answer of If $52,000,000 of projects have already been...

Question 18

If the cost of new common equity is higher than the cost of internal equity, why would a firm choose to issue new common stock?

Accepted Answer

The answer of If the cost of new common equity...

Question 19

Discuss the seven steps for determining the optimal capital budget.

Accepted Answer

The answer of Discuss the seven steps for determining the...

Question 20

Why is it important to use a firm's MCC and not a firm's initial WACC to evaluate investments?

Accepted Answer

The answer of Why is it important to use a...

Quiz 3: Essential Concepts in Finance: Part B

Use the following information to answer the question below. -If the firm decided to finance itself completely with debt, calculate the WACC from the above information.

The marginal cost of capital can best be defined as:

If a firm has a $500,000 debt limit before AT kd will change if taxes are 30% and total debt is 50% of the capital structure, calculate the debt break point in the MCC schedule.

Which of the following best describes what the financial managers must do to estimate the MCC schedule?

The cost of preferred shares is

If common equity financing is 60% of the optimal capital structure and the existing limit of internal equity is $500,000. Solve for the equity break poin.

If the new common stock costs are greater than the cost of internal common equity, what will happen as the equity break point is passed?

The cost of internal common equity is equal to:

The dividends paid on a preferred stock issue are $4 per share, the tax rate is 40%, the price is $32 and there will be $2/share in flotation costs. Calculate the cost of the preferred stock.

If a firm has a $1,500,000 debt limit before AT kd will change and if taxes are 40% and total debt is 60% of the capital structure, calculate the debt break point in the MCC schedule.

If $43,000,000 of projects have already been financed, what is the marginal cost of capital of a $4,000,000 project?

If $52,000,000 of projects have already been financed, what is the marginal cost of capital of a $9,000,000 project?

If the cost of new common equity is higher than the cost of internal equity, why would a firm choose to issue new common stock?

Discuss the seven steps for determining the optimal capital budget.

Why is it important to use a firm's MCC and not a firm's initial WACC to evaluate investments?

If a firm has a $500,000 debt limit before AT k_dwill change if taxes are 30% and total debt is 50% of the capital structure, calculate the debt break point in the MCC schedule.

If a firm has a $1,500,000 debt limit before AT k_dwill change and if taxes are 40% and total debt is 60% of the capital structure, calculate the debt break point in the MCC schedule.