Question 1

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 using the formula: Cost of preferred stock = Dividend / Net issuance proceeds
First, we need to calculate the net issuance proceeds: 
Net issuance proceeds = Price paid by investors - Flotation cost 
Price paid by investors = $97.50 per share 
Flotation cost = 4.00% x $97.50 = $3.90 per share 
Net issuance proceeds = $97.50 - $3.90 = $93.60 per share

Now, we can calculate the cost of preferred stock: 
Cost of preferred stock = $8.50 / $93.60 = 0.0908 or 9.08% 
Therefore, the answer is B.

Question 2

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 correct answer is A.The WACC is calculated as follows:WACC = (E/V) * Re + (D/V) * Rd * (1 - Tc) + (P/V) * Rpwhere:E = market value of common equityV = total market value of the firmRe = cost of common equityD = market value of debtRd = cost of debtTc = corporate tax rateP = market value of preferred stockRp = cost of preferred stockIn this case, we have:E/V = 55%D/V = 35%P/V = 10%Re = 11.25%Rd = 6.50%Tc = 40%Rp = 6.00%Plugging these values into the formula, we get:WACC = (0.55) * 0.1125 + (0.35) * 0.065 * (1 - 0.4) + (0.10) * 0.06WACC = 0.0619 + 0.0228 + 0.006WACC = 0.0815Therefore, the WACC is 8.15%.

Question 3

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 4

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 as follows:Cost of common from retained earnings = rRF + RPM * (b - 1)= 5.00% + 6.00% * (1.05 - 1)= 5.00% + 6.00% * 0.05= 5.00% + 0.30%= 11.30%

Question 5

A. 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 6

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

Question 7

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 current after-tax cost of debt is:

Current cost of debt = 3.5% * (1 - 0.4) = 2.1%

If the tax rate changes to 30%, the after-tax cost of debt would be:

New cost of debt = 3.5% * (1 - 0.3) = 2.45%

The change in the cost of debt would be:

Delta cost of debt = 2.45% - 2.1% = 0.35%

Therefore, the component cost of debt used to calculate the WACC would increase by 0.35%, or 0.70% on an annualized basis (0.35% * 2). The closest answer choice is C.

Question 8

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 DCF approach is calculated using the formula: Cost = (D1 / P0) + g. Substituting the given values: Cost = ($0.67 / $27.50) + 0.08 = 0.02436 + 0.08 = 0.10436 or 10.44%.

Question 9

Eakins Inc.'s common stock currently sells for $45.00 per share, the company expects to earn $2.75 per share during the current year, its expected payout ratio is 70%, and its expected constant growth rate is 6.00%. New stock can be sold to the public at the current price, but a flotation cost of 8% would be incurred. By how much would the cost of new stock exceed the cost of common from retained earnings?

Accepted Answer

The answer of Eakins Inc.'s common stock currently sells for...

Question 10

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 11

Bolster Foods' (BF) balance sheet shows a total of $25 million long- term debt with a coupon rate of 8.50%. The yield to maturity on this debt is 8.00%, and the debt has a total current market value of $27 million. The balance sheet also shows that the company has 10 million shares of stock, and the stock has a book value per share of $5.00. The current stock price is $20.00 per share, and stockholders' required rate of return, rs, is 12.25%. The company recently decided that its target capital structure should have 35% debt, with the balance being common equity. The tax rate is 40%. Calculate WACCs based on book, market, and target capital structures. What is the sum of these three WACCs?

Accepted Answer

The WACC based on book value is 9.90%, based on market value is 9.93%, and based on target capital structure is 10.94%. The sum of these three WACCs is 30.77%.

Question 12

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 13

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 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 14

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 15

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 per share:
Expected Dividend = Expected Dividend Payout Ratio * Expected Earnings per share
Expected Dividend = 0.65 * $3.50 = $2.275
Next, we need to calculate the cost of new equity:
Cost of New Equity = (Expected Dividend / Net Proceeds) + Growth Rate
Net Proceeds = Price per share * (1 - Flotation Cost)
Net Proceeds = $32.50 * (1 - 0.05) = $30.875
Cost of New Equity = ($2.275 / $30.875) + 0.06
Cost of New Equity = 0.1337 or 13.37%

Question 16

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...

Question 17

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 18

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...

Question 19

S. Bouchard and Company hired you as a consultant to help estimate its cost of common equity. You have obtained the following data: D0 =
$0)85; P0 = $22.00; and g = 6.00% (constant). The CEO thinks, however, that the stock price is temporarily depressed, and that it will soon rise to $40.00. Based on the DCF approach, by how much would the cost of common from retained earnings change if the stock price changes as the CEO expects?

Accepted Answer

The answer of S. Bouchard and Company hired you as...

Question 20

Sapp Trucking's balance sheet shows a total of noncallable $45 million long-term debt with a coupon rate of 7.00% and a yield to maturity of 6.00%. This debt currently has a market value of $50 million. The balance sheet also shows that the company has 10 million shares of common stock, and the book value of the common equity (common stock plus retained earnings) is $65 million. The current stock price is
$22)50 per share; stockholders' required return, rs, is 14.00%; and the firm's tax rate is 40%. The CFO thinks the WACC should be based on market value weights, but the president thinks book weights are more appropriate. What is the difference between these two WACCs?

Accepted Answer

The answer of Sapp Trucking's balance sheet shows a total...

Quiz 9: The Cost of Capital

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?

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?

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?

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?

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?