Question 1

A 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

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Question 2

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

Accepted Answer

Using the constant growth dividend discount model: 
Ke = (D1/P0) + g 
D1 = D0 * (1+g) = 0.90*(1+0.07) = 0.963 
Ke = (0.963/27.50) + 0.07 = 0.035 + 0.07 = 0.1050 or 10.50%

Question 3

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 expected dividend for the year:
Expected Dividend = Expected Dividend Payout Ratio * Expected Earnings per Share
Expected Dividend = 0.65 * $3.50
Expected Dividend = $2.28

Next, we need to calculate the expected price at the end of the year using the dividend discount model:
P = D / (r - g)
Where:
P = Expected Price
D = Expected Dividend at the end of the year
r = Cost of Equity
g = Expected Dividend Growth Rate

Substituting the values,
$32.50 = $2.28 / (r - 0.06)

Solving for r, we get:
r = 0.1337 or 13.37%

However, we also need to consider the flotation cost of 5% for the new stock. This means that the actual cost of equity would be higher than 13.37%.

Adjusted Cost of Equity = Cost of Equity / (1 - Flotation Cost)
Adjusted Cost of Equity = 0.1337 / (1 - 0.05)

Adjusted Cost of Equity = 0.1404 or 14.04%

Therefore, the cost of equity from new common stock would be 14.04%, which is closest to option B.

Question 4

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

The answer of Trahan Lumber Company hired you to help...

Question 5

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?

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Question 6

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% (constant). What is the cost of equity from retained earnings based on the DCF approach?

Accepted Answer

The cost of equity from retained earnings (k) using the Dividend Discount Model (DDM) is calculated as k = (D1/P0)+g.
Substituting the given values, we get k = (0.67/27.50)+0.08 = 0.1091 or 10.91%.
However, since the question is asking for the cost of equity from retained earnings, we need to adjust for flotation costs. If the flotation cost is 5%, then the cost of equity from retained earnings would be: k = (0.67/26.13)+0.08*(1-0.05) = 0.1044 or 10.44%.
Therefore, the best choice is C.

Question 7

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

Accepted Answer

Using the DCF approach, we can calculate the cost of equity from retained earnings using the formula: 
Ke = (D1/P0) + g 
where D1 is the expected dividend for next year. Since the dividend is expected to grow at a constant rate of 8.00%, we can use the following formula to calculate D1: 
D1 = D0 (1 + g) = $0.80 (1 + 0.08) = $0.864

Hence: 
Ke = ($0.864/$22.50) + 0.08 = 0.0384 + 0.08 = 0.1184 or 11.84%

Therefore, the best choice is C.

Question 8

You 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 retained earnings is 11.25%, and the tax rate is 40%. The firm will not be issuing any new stock. What is Quigley's WACC?

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Question 9

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

Question 10

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

Accepted Answer

The answer of Butcher Timber Company hired your consulting firm...

Question 11

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

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Question 12

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

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Question 13

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

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Question 14

To 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 To help finance a major expansion, Castro...

Question 15

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

To calculate the cost of preferred stock, we need to use the following formula:
Cost of Preferred Stock = Dividend / Net Proceeds
First, let's calculate the net proceeds by subtracting the flotation cost from the price paid by investors:
Net Proceeds = Price Paid - Flotation Cost
Net Proceeds = $97.50 - (4% x $97.50)
Net Proceeds = $93.60
Now we can calculate the cost of preferred stock using the formula:
Cost of Preferred Stock = $8.50 / $93.60
Cost of Preferred Stock = 0.0908 or 9.08%
Therefore, the company's cost of preferred stock is 9.08%. The best choice is B.

Question 16

Which of the following statements is CORRECT? Assume that the firm is a publicly-owned corporation and is seeking to maximize shareholder wealth.

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

Question 17

Keys Printing plans to issue a $1,000 par value, 20-year noncallable bond with a 7.00% annual coupon, paid semiannually. The company's marginal tax rate is 40.00%, but Congress is considering a change in the corporate tax rate to 30.00%. By how much would the component cost of debt used to calculate the WACC change if the new tax rate was adopted?

Accepted Answer

The answer of Keys Printing plans to issue a $1,000...

Question 18

You were recently hired by Scheuer Media Inc. to estimate its cost of capital. 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 You were recently hired by Scheuer Media...

Question 19

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 equity from retained earnings?

Accepted Answer

The answer of Scanlon Inc.'s CFO hired you as a...

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% (constant). Based on the DCF approach, what is the cost of equity from retained earnings?

Accepted Answer

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

Quiz 11: Cost of Capital

A 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?

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

Trahan Lumber Company hired you to help estimate its cost of capital. 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?

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% (constant) . What is the cost of equity from retained earnings based on the DCF approach?

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

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

Which of the following statements is CORRECT? Assume that the firm is a publicly-owned corporation and is seeking to maximize shareholder wealth.

You were recently hired by Scheuer Media Inc. to estimate its cost of capital. 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?

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 equity from retained earnings?

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% (constant) . Based on the DCF approach, what is the cost of equity from retained earnings?