Question 1

Spartans has 6.5 percent bonds outstanding that mature in 18 years.The bonds pay interest semiannually and have a face value of $1,000.Currently, the bonds are selling for $985 each.What is the firm's pretax cost of debt?

Accepted Answer

The answer of Spartans has 6.5 percent bonds outstanding that...

Question 2

Appalachian Mountain Goods has paid increasing dividends of $10, $.12, $.15, and $.20 a share over the past four years, respectively.The firm estimates that future increases in its dividends will be equal to the arithmetic average growth rate over these past four years.The stock is currently selling for $12.50 a share.The risk-free rate is 3.4 percent and the market risk premium is 8.1 percent.What is the cost of equity for this firm if its beta is 1.46?

Accepted Answer

The answer of Appalachian Mountain Goods has paid increasing dividends...

Question 3

Three years ago, the Fairchildress Co.issued 20-year, 7.75 percent semiannual coupon bonds at par.Today, the bonds are quoted at 102.6.What is this firm's pretax cost of debt?

Accepted Answer

The pretax cost of debt is the yield to maturity, which is calculated as follows:YTM = (C + (FV - PV) / N) / ((FV + PV) / 2)where:C = coupon paymentFV = face valuePV = present valueN = number of periods to maturityIn this case, the coupon payment is $77.50, the face value is $1,000, the present value is $1,026, and the number of periods to maturity is 40 (20 years * 2 semiannual periods per year).Plugging these values into the formula, we get:YTM = (77.50 + (1,000 - 1,026) / 40) / ((1,000 + 1,026) / 2)= 7.48%

Question 4

The common stock of Silent Motors has a beta that is 5 percent greater than the overall market beta.Currently, the market risk premium is 8.25 percent while the U.S.Treasury bill is yielding 2.8 percent.What is the cost of equity for this firm?

Accepted Answer

The answer of The common stock of Silent Motors has...

Question 5

The common stock of Serenity Homescapes has a beta of 1.21 and a standard deviation of 17.8 percent.The market rate of return is 13.5 percent and the risk-free rate is 3.2 percent.What is the cost of equity for this firm?

Accepted Answer

The correct answer is A because the cost of equity is 15.66 percent, which is calculated using the Capital Asset Pricing Model (CAPM): Cost of Equity = Risk-Free Rate + Beta * (Market Rate of Return - Risk-Free Rate) = 3.2% + 1.21 * (13.5% - 3.2%) = 15.66%.

Question 6

USA Manufacturing issued 30-year, 7.5 percent semiannual bonds 6 years ago.The bonds currently sell at 101 percent of face value.What is the firm's aftertax cost of debt if the tax rate is 35 percent?

Accepted Answer

The aftertax cost of debt is the yield to maturity multiplied by (1 - tax rate). The yield to maturity is the annual interest payment divided by the bond price plus the annual change in the bond price. The annual interest payment is $75 (7.5% of $1,000) and the bond price is $1,010 (101% of $1,000). The annual change in the bond price is -$10 ($1,000 - $1,010). Therefore, the yield to maturity is 7.43% ($75 / $1,010 - $10). The aftertax cost of debt is 4.82% (7.43% * (1 - 35%)).

Question 7

City Equipment announced this morning that its next annual dividend will be decreased to $1.90 a share and that all future dividends will be decreased by an additional 1.9 percent annually.What is the current value per share if the required return is 16.8 percent?

Accepted Answer

The answer of City Equipment announced this morning that its...

Question 8

Pride of Lions has bonds outstanding that carry an annual coupon of 5.75 percent.The bonds mature in 9 years and are currently priced at 98 percent of face value.What is the firm's pretax cost of debt?

Accepted Answer

The firm's pretax cost of debt is the yield to maturity (YTM) on the bonds. Since the bonds are priced at 98% of face value, we calculate the YTM using the formula for bond pricing, which involves solving for the interest rate that equates the present value of the bond's future cash flows (coupon payments and face value at maturity) to its current price. The YTM is approximately 6.04 percent.

Question 9

Commercial Construction Builders has a beta of 1.34, a dividend growth rate of 2.1 percent for the foreseeable future, a stock price of $15 per share, and an expected annual dividend of $0.45 per share next year.The market rate of return is 12.8 percent and the risk-free rate is 4.2 percent.What is the firm's average cost of equity?

Accepted Answer

The answer of Commercial Construction Builders has a beta of...

Question 10

Mississippi Mud Products would like to issue new equity shares if its cost of equity declines to 9.5 percent.The company pays a constant annual dividend of $4.80 per share.What does the market price of the stock need to be for the firm to issue the new shares?

Accepted Answer

The answer of Mississippi Mud Products would like to issue...

Question 11

The market rate of return is 12.65 percent and the risk-free rate is 3.1 percent.Galaxy Co.has 15 percent more systematic risk than the overall market and has a dividend growth rate of 3.75 percent.The firm's stock is currently selling for $53 a share and has a dividend yield of 4.53 percent.What is the firm's average cost of equity?

Accepted Answer

The correct answer is A because the average cost of equity is 11.18 percent. The formula for the average cost of equity is:r = rf + β * (rm - rf) + gwhere:r = average cost of equityrf = risk-free rateβ = betarm = market rate of returng = dividend growth rateIn this case, the risk-free rate is 3.1 percent, the beta is 1.15 (15 percent more systematic risk than the overall market), the market rate of return is 12.65 percent, and the dividend growth rate is 3.75 percent. Plugging these values into the formula, we get:r = 3.1% + 1.15 * (12.65% - 3.1%) + 3.75%r = 3.1% + 1.15 * 9.55% + 3.75%r = 3.1% + 10.98% + 3.75%r = 17.83%However, we need to adjust this value for the dividend yield. The dividend yield is 4.53 percent, so the average cost of equity is:r = 17.83% - 4.53%r = 11.18%

Question 12

KellyAnne Public Relations just paid an annual dividend of $1.27 on its common stock and increases its dividend by 3.4 percent annually.What is the rate of return on this stock if the current stock price is $38.56 a share?

Accepted Answer

The rate of return on a stock is calculated by dividing the annual dividend by the current stock price. In this case, the annual dividend is $1.27 and the current stock price is $38.56, so the rate of return is $1.27/$38.56 = 0.0681, or 6.81%.

Question 13

Musical Charts just paid an annual dividend of $1.84 per share.This dividend is expected to increase by 2.1 percent annually.Currently, the firm has a beta of 1.12 and a stock price of $31 a share.The risk-free rate is 4.3 percent and the market rate of return is 13.2 percent.What is the cost of equity capital for this firm?

Accepted Answer

The answer of Musical Charts just paid an annual dividend...

Question 14

Fire Hydrant Pet Supply just paid its first annual dividend of $0.75 a share.The firm plans to increase the dividend by 2.9 percent per year indefinitely.What is the firm's cost of equity if the current stock price is $16.90 per share?

Accepted Answer

The answer of Fire Hydrant Pet Supply just paid its...

Question 15

To value a non-dividend-paying firm, the terminal value used in the valuation calculation will most likely be based on a(n):

Accepted Answer

The terminal value for a non-dividend-paying firm is often based on a target ratio, such as a price-to-earnings or price-to-sales ratio, which reflects the firm's expected future financial performance.

Question 16

What is the primary reason why the cash flow from assets (CFA) is adjusted when used to value a firm?

Accepted Answer

Interest expense is a financing cost, and when valuing a firm, the focus is on the cash flows generated by the firm's operations, not its financing decisions. Therefore, the tax benefit of interest expense is removed to reflect the firm's operational cash flows accurately.

Question 17

Trendsetters has a cost of equity of 14.6 percent.The market risk premium is 8.4 percent and the risk-free rate is 3.9 percent.The company is acquiring a competitor, which will increase the company's beta to 1.4.What effect, if any, will the acquisition have on the firm's cost of equity capital?

Accepted Answer

The acquisition increases the company's beta, which in turn increases the cost of equity. The new cost of equity can be calculated using the CAPM formula: Cost of Equity = Risk-free rate + Beta * Market risk premium. The increase in beta from the acquisition results in an increase of 1.06 percent in the cost of equity.

Question 18

Madison Square Stores has a $20 million bond issue outstanding that currently has a market value of $19.4 million.The bonds mature in 6.5 years and pay semiannual interest payments of $35 each.What is the firm's pretax cost of debt?

Accepted Answer

The answer of Madison Square Stores has a $20 million...

Question 19

A firm has multiple divisions of similar nature, yet varying degrees of risk.Which one of the following would be the most appropriate, yet relatively easy, means of assigning discount rates to each of its numerous proposed investments?

Accepted Answer

Assigning every project a rate equal to the firm's WACC plus or minus a subjective adjustment allows for a relatively easy and practical way to account for the varying degrees of risk across different divisions while still using a consistent base rate.

Question 20

Electronic Products has 22,500 bonds outstanding that are currently quoted at 101.6.The bonds mature in 8 years and pay an annual coupon payment of $90.What is the firm's aftertax cost of debt if the applicable tax rate is 34 percent?

Accepted Answer

The answer of Electronic Products has 22,500 bonds outstanding that...

Quiz 12: Cost of Capital