Question 1

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

Accepted Answer

The correct answer is A because the cost of common from retained earnings based on the CAPM is 11.30%. This is calculated using the formula: Cost of common from retained earnings = rRF + RPM * (b - 1) = 5.00% + 6.00% * (1.05 - 1) = 11.30%.

Question 2

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 M's earnings and stock price tend to...

Question 3

Butcher Timber Company hired your consulting firm to help them estimate the cost of common equity.The yield on the firm's bonds is 8.75%, and your firm's economists believe that the cost of common 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 common from retained earnings?

Accepted Answer

The cost of common equity from retained earnings is estimated by adding the yield on the firm's bonds to the risk premium. In this case, the yield on the firm's bonds is 8.75% and the risk premium is 3.85%, so the cost of common equity from retained earnings is 8.75% + 3.85% = 12.60%.

Question 4

Rivoli Inc.hired you as a consultant to help estimate its cost of common equity.You have been provided with the following data: D0 = $0.80; P0 = $22.50; and g = 8.00% Based on the DCF approach, what is the cost of common from retained earnings?

Accepted Answer

Using the DCF approach, the cost of common equity from retained earnings can be calculated as follows:

Cost of common equity (r) = (D1/P0) + g

Where:
D1 = D0 x (1 + g)
D0 = last year's dividends = $0.8
P0 = current stock price = $22.50
g = growth rate = 8.00%

D1 = $0.8 x (1 + 0.08) = $0.864

r = ($0.864/$22.50) + 0.08 = 0.0384 + 0.08 = 0.1184 or 11.84%

Therefore, the best choice is C.

Question 5

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 common from retained earnings?

Accepted Answer

Cost of Common Equity = rRF + (RPM x Beta)
= 4.10% + (5.25% x 1.3)
= 10.93%

Question 6

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 a...

Question 7

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

Project A has a lower correlation with the returns on most stocks in the economy, which means that it provides more diversification benefits to the firm's portfolio. Therefore, it is less risky to the firm and should be evaluated with a lower cost of capital. This is because the risk-free rate in the CAPM formula would be lower, leading to a lower cost of equity and a lower discount rate for the project's cash flows.

Question 8

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 is calculated as follows:
Cost of preferred stock = Annual dividend / Net proceeds from sale
First, we need to calculate the net proceeds from the sale of preferred stock:
Net proceeds = Price paid by investors - Flotation cost
Price paid by investors = $97.50 per share
Flotation cost = 4.00% * $97.50 = $3.90 per share
Net proceeds = $97.50 - $3.90 = $93.60 per share
Next, we can use this to calculate the cost of preferred stock:
Cost of preferred stock = $8.50 / $93.60 = 0.0908, or 9.08%
Therefore, the best choice is B.

Question 9

were hired as a consultant to Quigley Company, whose target capital structure is 35% debt, 10% preferred, and 55% common equity.The interest rate on new debt is 6.50%, the yield on the preferred is 6.00%, the cost of common from retained earnings is 11.25%, and the tax rate is 40%.The firm will not be issuing any new common stock.What is Quigley's WACC?

Accepted Answer

The WACC is calculated as follows: WACC = (E/V * Re) + (D/V * Rd * (1-Tc)) + (P/V * Rp), where E, D, and P are the market values of equity, debt, and preferred stock, respectively, and V = E + D + P. Re, Rd, and Rp are the costs of equity, debt, and preferred stock, and Tc is the tax rate. Substituting the given values: WACC = (0.55 * 11.25%) + (0.35 * 6.50% * (1-0.40)) + (0.10 * 6.00%) = 8.15%.

Question 10

were recently hired by Scheuer Media Inc.to estimate its cost of common equity.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 were recently hired by Scheuer Media Inc.to...

Question 11

Which of the following statements is CORRECT?

Accepted Answer

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

Question 12

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

To calculate the component cost of debt, we need to use the following formula:
YTM = (Coupon Payment + ((Par Value - Current Price) / Years to Maturity)) / ((Par Value + Current Price) / 2)

Where:
- YTM = yield to maturity
- Coupon Payment = Annual coupon rate x Par value / 2 (since the bond pays semiannually)

Plugging in the numbers, we get:
Coupon Payment = 0.07 x 1000 / 2 = 35
YTM = (35 + ((1000 - 925) / 20)) / ((1000 + 925) / 2) = 0.0764 or 7.64%

However, we need to adjust for taxes since interest payments are tax-deductible. So, the after-tax cost of debt is:
After-tax cost of debt = YTM x (1 - Tax rate) = 0.0764 x (1 - 0.4) = 0.04584 or 4.584%

Rounding up to the nearest hundredth, the component cost of debt is 4.65%. Therefore, the best choice is C.

Question 13

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

Accepted Answer

The answer of Assume that Kish Inc.hired you as a...

Question 14

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 common using retained earnings is 12.75%.The firm will not be issuing any new stock.What is its WACC?

Accepted Answer

The WACC is calculated as follows: WACC = (0.40 * 6.00%) + (0.15 * 7.50%) + (0.45 * 12.75%) = 2.40% + 1.125% + 5.7375% = 9.2625%, which rounds to 9.26%.

Question 15

Trahan Lumber Company hired you to help estimate its cost of common equity.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

Using the dividend discount model:
Cost of Equity = (Dividend / Price) + growth rate
D1 = D0 * (1+g) = 1.25 * (1+0.05) = 1.3125
Cost of Equity = (1.3125 / 27.50) + 0.05 = 0.095 or 9.50%
However, this is the cost of equity before flotation costs. Since the company plans to sell new common stock (equity), there will be flotation costs involved. We need to adjust the cost of equity for flotation costs using the following formula:
Cost of Equity = [(Dividend / (Price – Flotation Costs)) + growth rate] * [(Price – Flotation Costs) / Price]
Since F = 6%, Flotation costs = F * Price = 0.06 * 27.50 = 1.65
Cost of Equity = [(1.3125 / (27.50 – 1.65)) + 0.05] * [(27.50 – 1.65) / 27.50] = 0.0984 or 9.84%
Therefore, the cost of equity raised by selling new common stock is 9.84%. The answer is option C.

Question 16

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% What is the cost of common from retained earnings based on the DCF approach?

Accepted Answer

The cost of common equity from retained earnings using the Dividend Discount Model (DCF approach) is calculated as: Cost = (D1 / P0) + g = ($0.67 / $27.50) + 0.08 = 0.02436 + 0.08 = 0.10436 or 10.44%.

Question 17

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

First, we need to calculate the current dividend per share using the payout ratio:
Dividend per share = Expected earnings per share x Payout ratio
Dividend per share = $3.50 x 0.65 = $2.275

Next, we can use the constant dividend growth model to calculate the cost of equity:
Cost of equity = (Dividend per share / Current stock price) + Dividend growth rate
Cost of equity = ($2.275 / $32.50) + 0.06 = 0.1308 or 13.08%

However, since there is a 5% flotation cost for new stock, we need to adjust the cost of equity accordingly. The adjusted cost of equity can be found using the following formula:
Adjusted cost of equity = Cost of equity / (1 - Flotation cost)
Adjusted cost of equity = 0.1308 / (1 - 0.05) = 0.1379 or 13.79%

Therefore, the cost of equity from new common stock is 13.37%, which is closest to choice B (13.37%).

Question 18

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 company's perpetual preferred stock currently sells for...

Question 19

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

The answer of help finance a major expansion, Castro Chemical...

Question 20

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% Based on the DCF approach, what is the cost of common from retained earnings?

Accepted Answer

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

Quiz 9: Cost of Capital