Question 1

Tidewater Fishing has a current beta of 1.21.The market risk premium is 8.9 percent and the risk-free rate of return is 3.2 percent.By how much will the cost of equity increase if the company expands its operations such that the company beta rises to 1.50?

Accepted Answer

Increase in cost of equity = (1.50 - 1.21) × 0.089 = 2.58 percent

Question 2

New York Deli has 7 percent preferred stock outstanding that sells for $34 a share.This stock was originally issued at $45 per share.What is the cost of preferred stock?

Accepted Answer

R_p = (0.07 × $100)/$34 = 20.59 percent

Question 3

The outstanding bonds of Tech Express are priced at $989 and mature in 10 years.These bonds have a 6 percent coupon and pay interest annually.The firm's tax rate is 35 percent.What is the firm's aftertax cost of debt?

Accepted Answer

The answer of The outstanding bonds of Tech Express are...

Question 4

The common stock of Metal Molds has a negative growth rate of 1.5 percent and a required return of 18 percent.The current stock price is $11.40.What was the amount of the last dividend paid?

Accepted Answer

D₁ = [(0.18 - (-0.015)) × $11.40] = $2.223; D₀ = $2.223/(1 - 0.015) = $2.26

Question 5

Simple Foods has a zero coupon bond issue outstanding that matures in 9 years.The bonds are selling at 42 percent of par value.What is the company's aftertax cost of debt if the tax rate is 38 percent?

Accepted Answer

The formula to calculate the aftertax cost of debt is:
Aftertax Cost of Debt = Yield to Maturity * (1 - Tax Rate)

As the bond is a zero coupon bond, we need to calculate the Yield to Maturity (YTM) using the formula below:
YTM = (Face Value/Price)^(1/n) - 1
where n = number of years to maturity

Substituting the given values, we get:
YTM = (100/42)^(1/9) - 1 = 0.1071 or 10.71%

Now substituting these values in the first formula, we get:
Aftertax Cost of Debt = 10.71% * (1 - 0.38) = 6.64%
Therefore, the company's aftertax cost of debt is 6.12% (option C).

Question 6

Handy Man,Inc.has zero coupon bonds outstanding that mature in 8 years.The bonds have a face value of $1,000 and a current market price of $640.What is the company's pre-tax cost of debt?

Accepted Answer

We can use the following formula to calculate the pre-tax cost of debt:
Pre-tax cost of debt = (Face value - Current market price)/Face value * (1/years to maturity)
Substituting the given values, we get: 
Pre-tax cost of debt = (1000 - 640)/1000 * (1/8) = 0.08 or 8%
Therefore, the pre-tax cost of debt for Handy Man, Inc. is 8%. Option C (5.66 percent) is the closest answer choice, so it is the best choice.

Question 7

National Home Rentals has a beta of 1.24,a stock price of $22,and recently paid an annual dividend of $0.94 a share.The dividend growth rate is 4.5 percent.The market has a 10.6 percent rate of return and a risk premium of 7.5 percent.What is the firm's cost of equity?

Accepted Answer

R_e = (0.106 - 0.075) + (1.24 × 0.075) = 0.124R_e = [($0.94 × 1.045)/$22] + 0.045 = 0.08965R_{e Average} = (0.124 + 0.08965)/2 = 10.68 percent

Question 8

Grill Works and More has 7 percent preferred stock outstanding that is currently selling for $49 a share.The market rate of return is 14 percent and the firm's tax rate is 37 percent.What is the firm's cost of preferred stock?

Accepted Answer

R_p = (0.07 × $100)/$49 = 14.29 percent

Question 9

Nelson's Landscaping has 1,200 bonds outstanding that are selling for $990 each.The company also has 2,500 shares of preferred stock at a market price of $28 a share.The common stock is priced at $37 a share and there are 28,000 shares outstanding.What is the weight of the common stock as it relates to the firm's weighted average cost of capital?

Accepted Answer

The answer of Nelson's Landscaping has 1,200 bonds outstanding that...

Question 10

Sweet Treats common stock is currently priced at $18.53 a share.The company just paid $1.25 per share as its annual dividend.The dividends have been increasing by 2.5 percent annually and are expected to continue doing the same.What is this firm's cost of equity?

Accepted Answer

e = [($1.25 × 1.025)/$18.53] + 0.025 = 9.41 percent

Question 11

The Corner Bakery has a bond issue outstanding that matures in 7 years.The bonds pay interest semi-annually.Currently,the bonds are quoted at 101.4 percent of face value and carry a 9 percent coupon.What is the firm's aftertax cost of debt if the tax rate is 30 percent?

Accepted Answer

The answer of The Corner Bakery has a bond issue...

Question 12

Samuelson Plastics has 7.5 percent preferred stock outstanding.Currently,this stock has a market value per share of $52 and a book value per share of $38.What is the cost of preferred stock?

Accepted Answer

R_p = (0.075 × $100)/$52 = 14.42 percent

Question 13

Electronics Galore has 950,000 shares of common stock outstanding at a market price of $38 a share.The company also has 40,000 bonds outstanding that are quoted at 106 percent of face value.What weight should be given to the debt when the firm computes its weighted average cost of capital?

Accepted Answer

To calculate the weight of debt, we need to calculate the total market value of the firm's debt and equity.

Total market value of equity = 950,000 shares × $38 per share = $36,100,000

Total market value of debt = 40,000 bonds × 1.06 × $1,000 (face value) = $42,400,000

Total market value of the firm = $36,100,000 + $42,400,000 = $78,500,000

Weight of debt = ($42,400,000 / $78,500,000) × 100% = 53.98%, which can be rounded to 54%.

Therefore, the answer is D) 54 percent.

Question 14

Dog Gone Good Engines has a bond issue outstanding with 17 years to maturity.These bonds have a $1,000 face value,a 9 percent coupon,and pay interest semi-annually.The bonds are currently quoted at 82 percent of face value.What is the company's pre-tax cost of debt if the tax rate is 38 percent?

Accepted Answer

The answer of Dog Gone Good Engines has a bond...

Question 15

Mangrove Fruit Farms has a $250,000 bond issue outstanding that is selling at 92 percent of face value.The firm also has 1,500 shares of preferred stock and 15,000 shares of common stock outstanding.The preferred stock has a market price of $35 a share compared to a price of $24 a share for the common stock.What is the weight of the preferred stock as it relates to the firm's weighted average cost of capital?

Accepted Answer

The answer of Mangrove Fruit Farms has a $250,000 bond...

Question 16

Wind Power Systems has 20-year,semi-annual bonds outstanding with a 5 percent coupon.The face amount of each bond is $1,000.These bonds are currently selling for 114 percent of face value.What is the company's pre-tax cost of debt?

Accepted Answer

The answer of Wind Power Systems has 20-year,semi-annual bonds outstanding...

Question 17

Henessey Markets has a growth rate of 4.8 percent and is equally as risky as the market.The stock is currently selling for $17 a share.The overall stock market has a 10.6 percent rate of return and a risk premium of 8.7 percent.What is the expected rate of return on this stock?

Accepted Answer

R_e = (0.106 - 0.087) + (1.00 × 0.087) = 10.6 percent

Question 18

Southern Home Cookin' just paid its annual dividend of $0.65 a share.The stock has a market price of $13 and a beta of 1.12.The return on the U.S.Treasury bill is 2.5 percent and the market risk premium is 6.8 percent.What is the cost of equity?

Accepted Answer

R_e = 0.025 + (1.12 × 0.068) = 10.12 percent

Question 19

Highway Express has paid annual dividends of $1.05,$1.20,$1.25,$1.15,and $0.95 over the past five years,respectively.What is the average dividend growth rate?

Accepted Answer

($1.20 - $1.05)/$1.05 = 0.142857($1.25 - $1.20)/$1.20 = 0.041667($1.15 - $1.25)/$1.25 = -0.08($0.95 - $1.15)/$1.15 = -0.17391g = (0.142857 + 0.041667 - 0.08 - 0.17391)/4 = -1.74 percent

Question 20

Boulder Furniture has bonds outstanding that mature in 15 years,have a 6 percent coupon,and pay interest annually.These bonds have a face value of $1,000 and a current market price of $1,075.What is the company's aftertax cost of debt if its tax rate is 32 percent?

Accepted Answer

The answer of Boulder Furniture has bonds outstanding that mature...

Quiz 14: Cost of Capital