Question 1

Greene Co. is planning a project for which it will issue new bonds. Bonds in the same risk class issued by another firm are currently priced at $954.90, have 25 years remaining to maturity, and pay coupons of $75 every year. If Greene's marginal tax rate is 34%, what is the pre-tax cost of debt for the project?

Accepted Answer

The pre-tax cost of debt can be found using the yield to maturity (YTM) formula, which equates the present value of future cash flows (coupons and principal repayment) to the current price of the bond. Given the bond's price ($954.90), annual coupon ($75), years to maturity (25), and face value (typically $1000 for corporate bonds), the YTM can be calculated. The YTM in this case is approximately 7.92%, which represents the pre-tax cost of debt for Greene Co. This calculation involves solving for the interest rate that equates the present value of the bond's cash flows to its price, which is a common method for determining the cost of debt.

Question 2

The Jackson Co. is currently in the business of making kitchen cabinets. It has $400,000 in outstanding bonds with a coupon rate of 8% and a yield-to-maturity of 7.5%. The company is seeking additional financing so it can start a new venture, which involves the sales and installation of patio rooms, including spas and hot tubs. Its biggest competitor, who specializes solely in patio rooms, has $600,000 in outstanding bonds with a 9% coupon rate and an 11% yield-to-maturity. Jackson's marginal tax rate is 35% and the competitor's marginal tax rate is 34%. What after-tax rate cost of debt should the Jackson Co. use in its WACC calculation?

Accepted Answer

The answer of The Jackson Co. is currently in the...

Question 3

Lagoon Boat Sales has 300,000 shares of common stock outstanding at a market price of $44 a share. Last month, the company paid an annual dividend in the amount of $1 per share. The dividend growth rate is 3.5 %. Lagoon also has 5,000 bonds outstanding with a face value of $1,000 per bond. The bonds carry a 9.5 % coupon, pay interest annually, and mature in 7.5 years. The bonds are selling at 102 % of face value. The company's tax rate is 34 %. What is Lagoon's weighted average cost of capital?

Accepted Answer

The correct answer is A because the weighted average cost of capital is 5.90%.

Question 4

The Jamestown Co. has a capital structure which is based on 40 % debt, 15 % preferred stock, and 45 % common stock. The flotation costs are 8 % for common stock, 9 % for preferred stock, and 4 % for debt. What is the weighted average flotation cost?

Accepted Answer

The weighted average flotation cost is calculated by multiplying the proportion of each type of capital by its respective flotation cost and then summing these products. For Jamestown Co., this calculation is as follows: (0.40 * 4%) + (0.15 * 9%) + (0.45 * 8%) = 1.6% + 1.35% + 3.6% = 6.55%.

Question 5

Gillian's Boutique has 850,000 shares of common stock outstanding at a market price of $16 a share. The company also has 15,000 bonds outstanding that are quoted at 98 % of face value. What weight should be given to the common stock when Gillian's computes their weighted average cost of capital?

Accepted Answer

The weight of the common stock is calculated as follows:Weight of common stock = (Market value of common stock / (Market value of common stock + Market value of bonds))Market value of common stock = 850,000 shares * $16 per share = $13,600,000Market value of bonds = 15,000 bonds * 98% of face value * $1,000 face value = $14,700,000Weight of common stock = $13,600,000 / ($13,600,000 + $14,700,000) = 48%

Question 6

The Wendell Co. uses 40 % common stock, 30 % preferred stock, and 30 % debt as their capital structure. The flotation costs are 5 % for debt, 9 % for preferred stock, and 8 % for common stock. The corporate tax rate is 35 %. What is the weighted average flotation cost?

Accepted Answer

The answer of The Wendell Co. uses 40 % common...

Question 7

Hartley, Inc. needs to purchase equipment for its 2,000 drive-ins nationwide. The total cost of the equipment is $2 million. It is estimated that the after-tax cash inflows from the project will be $210,000 annually in perpetuity. Hartley has a market value debt-to-assets ratio of 40%. The firm's cost of equity is 13%, its pre-tax cost of debt is 8%, and the flotation costs of debt and equity are 2% and 8%, respectively. The tax rate is 34%. Assume the project is of similar risk to the firm's existing operations.

What is the weighted average flotation cost for Hartley?

Accepted Answer

First, calculate the weights of debt and equity based on the market value debt-to-assets ratio. With a 40% debt-to-assets ratio, the weights are 40% debt and 60% equity. Then, apply these weights to the flotation costs: (40% * 2%) + (60% * 8%) = 0.8% + 4.8% = 5.6%.

Question 8

Jake's Sound Systems has 210,000 shares of common stock outstanding at a market price of $36 a share. Last month, Jake's paid an annual dividend in the amount of $1.593 per share. The dividend growth rate is 4 %. Jake's also has 6,000 bonds outstanding with a face value of $1,000 per bond. The bonds carry a 7 % coupon, pay interest annually, and mature in 4.89 years. The bonds are selling at 99 % of face value. The company's tax rate is 34 %. What is Jake's weighted average cost of capital?

Accepted Answer

The answer of Jake's Sound Systems has 210,000 shares of...

Question 9

Danida Inc. has a target debt-equity ratio of 1.15. Its WACC is 7.5%, and the tax rate is 30%. If Danida's cost of equity is 12%, what is its pre-tax cost of debt?

Accepted Answer

The answer of Danida Inc. has a target debt-equity ratio...

Question 10

A firm uses 55% equity and 45% debt for all of its financing needs. Shares of the common stock sell at $43. The company expects to pay $1.30 in dividends next year and increase that amount by 3% annually. The bonds have a 7% coupon rate and a yield-to-maturity of 6.8%. The company has a beta of 1.39 and a 34% marginal tax rate. What is the WACC?

Accepted Answer

The correct answer is A because the WACC is 5.33%. The calculation is as follows:Ke = (D1 / P0) + g = (1.30 / 43) + 0.03 = 0.0605Kd = (C / P) * (1 - T) = (0.07 / 100) * (1 - 0.34) = 0.0459WACC = (E / V) * Ke + (D / V) * Kd = (0.55 * 0.0605) + (0.45 * 0.0459) = 0.0533 or 5.33%

Question 11

Ernst's Electrical has a bond issue outstanding with ten years to maturity. These bonds have a $1,000 face value, a 5 % coupon, and pay interest semi-annually. The bonds are currently quoted at 96 % of face value. What is Ernst's pre-tax cost of debt?

Accepted Answer

The answer of Ernst's Electrical has a bond issue outstanding...

Question 12

Green Yards has a capital structure of 50 % common stock, 15 % preferred stock, and 35 % debt. The flotation costs are 3 % for debt, 6 % for preferred stock, and 8 % for common stock. What is the weighted average flotation cost?

Accepted Answer

The answer of Green Yards has a capital structure of...

Question 13

Wilson's Cabinets has bonds outstanding that mature in eight years, have a 6 % coupon and pay interest annually. These bonds have a face value of $1,000 and a current market price of $1,020. What is the company's pre-tax cost of debt?

Accepted Answer

The pre-tax cost of debt can be calculated using the yield to maturity (YTM) formula, which takes into account the annual coupon payments, the face value, the current market price, and the time to maturity. Given the bond's annual coupon of $60 (6% of $1000), a current price of $1020, a face value of $1000, and 8 years to maturity, the YTM calculation will yield a pre-tax cost of debt of approximately 5.68%. This calculation involves solving for the discount rate that equates the present value of all future cash flows (coupon payments and the repayment of the principal at maturity) to the bond's current price.

Question 14

A firm has 100,000 shares of common stock and 40,000 shares of preferred stock outstanding. The common stock has a market value of $15 a share and the preferred stock is priced at $21 a share. The firm also has 1,000 bonds outstanding with a market price of $989 and a 5% coupon rate. The bonds mature in fifteen years and pay interest semi-annually. The weights for the common stock, the preferred stock, and the debt are _____________, respectively.

Accepted Answer

The market value of the common stock is $15 * 100,000 = $1,500,000. The market value of the preferred stock is $21 * 40,000 = $840,000. The market value of the bonds is $989 * 1,000 = $989,000. The total market value of the firm is $1,500,000 + $840,000 + $989,000 = $3,329,000. The weights for the common stock, the preferred stock, and the debt are $1,500,000/$3,329,000 = 45%, $840,000/$3,329,000 = 25%, and $989,000/$3,329,000 = 30%, respectively.

Question 15

The common stock of a firm is currently priced at $53 a share. The company paid $1.40 in common dividends last year and expects to increase this amount by 3% annually. The stock has a beta of 1.40, which is about equal to its industry average. Given this information, what is the cost of equity financing?

Accepted Answer

The answer of The common stock of a firm is...

Question 16

Spacetech is an all equity company with common and preferred shares. There are 250,000 common shares outstanding. Currently the common shares have a price of $50 per share and have consistently provided a $2 per share dividend. There are 50,000 5% preferred shares outstanding, with a stock price of $90 per share. Given this information, calculated the company's WACC.

Accepted Answer

The answer of Spacetech is an all equity company with...

Question 17

Jefferson Enterprises has 700,000 shares of common stock outstanding at a market price of $18 a share. The company also has 20,000 bonds outstanding that are quoted at 104 % of face value. What weight should be given to the debt when Jefferson Enterprises computes their weighted average cost of capital?

Accepted Answer

The answer of Jefferson Enterprises has 700,000 shares of common...

Question 18

The outstanding bonds of The Purple Fiddle are priced at $898 and mature in nine years. These bonds have a 6 % coupon and pay interest annually. The firm's tax rate is 35 %. What is the firm's after-tax cost of debt?

Accepted Answer

The after-tax cost of debt is calculated using the formula for the yield to maturity (YTM) on a bond, which takes into account the annual interest payment, the face value, the current price, and the number of years until maturity. The after-tax cost of debt is then adjusted for the tax rate. The formula for the after-tax cost of debt is: After-tax cost of debt = YTM * (1 - tax rate). Given the information, the YTM can be approximated or calculated using a financial calculator or software, and then adjusted for the tax rate of 35%. The correct answer, 4.94%, reflects the calculation of the YTM adjusted for the tax benefit of debt.

Question 19

Ausel's Furniture Stores has bonds outstanding that mature in 11 years, have a 7 % coupon, and pay interest annually. These bonds have a face value of $1,000 and a current market price of $1,002. What is the company's pre-tax cost of debt?

Accepted Answer

The pre-tax cost of debt is the yield to maturity (YTM) on the bonds. Using the bond's current price, coupon rate, face value, and time to maturity, the YTM is calculated to be approximately 6.97%.

Question 20

Turner Cement Products has a bond issue outstanding that matures in 12 years. The bonds pay interest semi-annually. Currently, the bonds are quoted at 102.5 % of face value and carry an 8.5 % coupon. The firm's tax rate is 35 %. What is Turner's after-tax cost of debt?

Accepted Answer

The after-tax cost of debt can be calculated using the formula for the yield to maturity (YTM) on a bond, which takes into account the current price, the face value, the coupon rate, and the time to maturity. However, since the exact YTM calculation requires a financial calculator or solving a polynomial equation, we'll focus on the conceptual understanding that the after-tax cost of debt is the YTM adjusted for the tax rate. Given the bond is quoted at 102.5% of its face value, has an 8.5% coupon rate, and considering the tax rate of 35%, the after-tax cost of debt would be lower than the coupon rate due to the tax shield on interest payments. The correct answer (B) 5.31% is the closest approximation to what the after-tax cost of debt would be, considering these factors.

Quiz 14: Cost of Capital