Question 1

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 2

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 3

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 can be calculated as follows:
Cost of preferred stock = Annual dividend / Net proceeds of preferred stock
Net proceeds = Price paid by investors * (1 - Flotation cost percentage)
Net proceeds = $97.50 * (1 - 4%) = $93.60
Cost of preferred stock = $8.50 / $93.60 = 0.0908 or 9.08% (rounded to two decimal places). Therefore, the correct answer is choice B.

Question 4

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

The answer of Several years ago the Jakob Company sold...

Question 5

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

The answer of A company's perpetual preferred stock currently sells...

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

First, we need to calculate the cost of equity using the constant growth model:

Ke = (D1 / P0) + g

Ke = ($2.50 / $52.50) + 0.055 = 0.1024 or 10.24%

Next, we need to calculate the after-tax cost of debt:

Kd = 7.50% * (1 - 0.40) = 4.50%

Then, we can calculate the WACC:

WACC = (E/V) * Ke + (D/V) * Kd

Since we're using only retained earnings for equity, we don't need to adjust for flotation costs or other expenses.

WACC = (0.55 * 10.24%) + (0.45 * 4.50%) = 7.67%

Therefore, the best choice is C, 7.67%.

Question 7

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 8

Which of the following statements is CORRECT?

Accepted Answer

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

Question 9

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?

Accepted Answer

WACC = (wd * rd * (1 - t)) + (wp * rp) + (wc * rc)

where
wd = weight of debt
rd = cost of debt
t = tax rate
wp = weight of preferred stock
rp = cost of preferred stock
wc = weight of common equity
rc = cost of common equity

Given, 
wd = 0.4
rd = 6.00%
t = Not given, so assumed as 0%
wp = 0.15
rp = 7.50%
wc = 0.45
rc = 12.75%

Plugging in the values, we get:

WACC = (0.4 * 0.06 * (1 - 0)) + (0.15 * 0.075) + (0.45 * 0.1275)
WACC = 0.024 + 0.01125 + 0.057375
WACC = 0.092625 or 9.26%

Therefore, the correct answer is B.

Question 10

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 11

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

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

Question 12

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:

Cost of Equity = (Dividends per Share Next Year / Current Market Price per Share) + Growth Rate

Dividends per Share Next Year = (Dividends per Share This Year) x (1 + Growth Rate)
= $0.80 x (1+0.08)
= $0.86

Cost of Equity = ($0.86 / $22.50) + 0.08
= 0.038 + 0.08
= 0.1184 or 11.84%

Question 13

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, calculate the expected dividend per share:
Expected dividend payout ratio = 65%
Expected earnings per share = $3.50
Expected dividend per share = $3.50 x 65% = $2.275

Next, calculate the cost of equity using the constant growth model:
Cost of equity = (Expected dividend per share / Current stock price) + Expected constant dividend growth rate
Cost of equity = ($2.275 / $32.50) + 6.0% = 13.37%

Finally, adjust for flotation costs:
Cost of equity from new common stock = Cost of equity / (1 - Flotation cost)
Flotation cost = 5%
Cost of equity from new common stock = 13.37% / (1 - 5%) = 14.04%

Therefore, the best choice is B, as it represents the cost of equity from new common stock, adjusted for flotation costs.

Question 14

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 answer of Assume that you are a consultant to...

Question 15

Which of the following statements is CORRECT?

Accepted Answer

The relevant WACC can change depending on the amount of funds a firm raises during a given year. Moreover, the WACC at each level of funds raised is a weighted average of the marginal costs of each capital component, with the weights based on the firm's target capital structure. This statement correctly outlines the calculation and variability of WACC. The other statements are incorrect.

Question 16

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 17

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...

Question 18

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 19

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?

Accepted Answer

The answer of O'Brien Inc. has the following data: rRF...

Question 20

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%

Quiz 10: Cost of Capital

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?

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?

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?

Which of the following statements is CORRECT?

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

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?

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?

Which of the following statements is CORRECT?

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?

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?

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?