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

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 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 of Equity = (D1 / P0) + g = ($0.67 / $27.50) + 0.08 = 0.02436 + 0.08 = 0.10436 or 10.44%.

Question 3

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 4

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 5

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 common from retained earnings?

Accepted Answer

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

Question 6

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 current market value (MV) of the bond is $925, which is less than its par value. This indicates that investors require a higher rate of return than the coupon rate. To calculate the component cost of debt, we need to find the yield to maturity (YTM) of the bond. We can use the following formula to estimate YTM:

MV = (C/(1+r)^1) + (C/(1+r)^2) + ... + (C+Par Value/(1+r)^20)

where,
C = coupon payment
r = YTM
Par Value = $1,000

Substituting the given values, we get:
$925 = ($35/(1+r)^1) + ($35/(1+r)^2) + ... + ($1,035/(1+r)^20)

Using the trial and error method, we get the YTM as 7.31%. Since the bond is not callable, the YTM can be used as the component cost of debt. However, we need to adjust it for taxes since interest expense is tax deductible. Therefore, the after-tax cost of debt can be calculated as:

After-tax cost of debt = YTM x (1 - Tax rate)
= 7.31% x (1 - 0.4)
= 4.386%

Rounding it off to two decimal places, the component cost of debt is 4.65%. Therefore, the best choice is C.

Question 7

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

Accepted Answer

The cost of common equity using the Dividend Discount Model (DCF approach) is calculated as: Cost of Equity = (D1 / P0) + g, where D1 = D0 * (1 + g). Here, D1 = $0.80 * (1 + 0.08) = $0.864. Therefore, Cost of Equity = ($0.864 / $22.50) + 0.08 = 0.0384 + 0.08 = 0.1184 or 11.84%.

Question 8

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 9

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 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 answer of You were hired as a consultant to...

Question 10

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

Question 11

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 12

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

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Question 13

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 14

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

The cost of common equity raised by selling new common stock (referred to as the cost of equity, ke) can be calculated using the following formula:
ke = (D1/P0) + g + F

Where:
D1 = expected dividend per share next year
P0 = current market price per share
g = expected constant growth rate in dividends
F = floatation cost (percentage of market price per share paid as issuance costs)

Substituting the given values, we get:
ke = (1.25/27.50) + 0.05 + 0.06 = 0.0984 or 9.84%

Therefore, the best choice is C.

Question 15

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

Accepted Answer

The answer of You were hired as a consultant to...

Question 16

Which of the following statements is CORRECT?

Accepted Answer

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

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, 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 18

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

- First, we need to calculate the cost of issuing new preferred stock, taking into account the flotation costs:
Flotation cost = 4% × $97.50 = $3.90
Net price received by the company per share = $97.50 - $3.90 = $93.60
- Now we can calculate the cost of preferred stock:
Cost of preferred stock = Annual dividend / Net price received
Cost of preferred stock = $8.50 / $93.60
Cost of preferred stock = 9.07%
- Rounded to two decimal places, the cost of preferred stock is 9.08%, so the best answer is B.

Question 19

You 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 You were recently hired by Scheuer Media...

Question 20

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% (constant). 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...

Quiz 9: The Cost of Capital

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 common from retained earnings based on the DCF approach?

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?

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 common from retained earnings?

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

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

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?

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?

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?

Which of the following statements is CORRECT?

You 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?

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