Question 1

The Corner Bakery has a bond issue outstanding that matures in 7 years. The bonds pay interest semi-annually. Currently, the bonds are quoted at 101.4 percent of face value and carry a 9 percent coupon. What is the firm's aftertax cost of debt if the tax rate is 30 percent?

Accepted Answer

The answer of The Corner Bakery has a bond issue...

Question 2

The outstanding bonds of Tech Express are priced at $989 and mature in 8 years. These bonds have a 6 percent coupon and pay interest annually. The firm's tax rate is 39 percent. What is the firm's aftertax cost of debt?

Accepted Answer

The answer of The outstanding bonds of Tech Express are...

Question 3

Simple Foods has a zero coupon bond issue outstanding that matures in 9 years. The bonds are selling at 42 percent of par value. What is the company's aftertax cost of debt if the tax rate is 38 percent?

Accepted Answer

The aftertax cost of debt can be calculated using the following formula:

Aftertax Cost of Debt = (YTM x (1 - Tax Rate))

Where YTM is the yield to maturity of the bond.

Since the bond is a zero coupon bond, we can use the following formula to calculate the YTM:

YTM = (Face Value/Price)^(1/n) - 1

Where Face Value is the par value of the bond, Price is the current price of the bond, and n is the number of years to maturity.

Substituting the given values, we get:

YTM = (100/42)^(1/9) - 1 = 0.1349 or 13.49%

Now, substituting this value and the given tax rate, we get:

Aftertax Cost of Debt = (13.49% x (1 - 0.38)) = 8.36%

Therefore, the answer is C) 6.12%.

Question 4

Highway Express has paid annual dividends of $1.16, $1.20, $1.25, $1.10, and $0.95 over the past five years respectively. What is the average dividend growth rate?

Accepted Answer

($1.20 - $1.16)/$1.16 = 0.034483($1.25 - $1.20)/$1.20 = 0.041667($1.10 - $1.25)/$1.25 = -0.12($0.95 - $1.10)/$1.10 = -0.136364g = (0.034483 + 0.041667 - 0.12 - 0.136364)/4 = -4.51 percent

Question 5

The Shoe Outlet has paid annual dividends of $0.65, $0.70, $0.72, and $0.75 per share over the last four years, respectively. The stock is currently selling for $26 a share. What is this firm's cost of equity?

Accepted Answer

($0.70 - $0.65)/$0.65 = 0.076923($0.72 - $0.70)/$0.70 = 0.028571($0.75 - $0.72)/$0.72 = 0.041667g = (0.076923 + 0.028571 + 0.041667)/3 = .049054R_e = [($0.75 F1F1F1S1F1F1F10 1.049054)/$26] + .049054 = 7.93 percent

Question 6

Wind Power Systems has 20-year, semi-annual bonds outstanding with a 5 percent coupon. The face amount of each bond is $1,000. These bonds are currently selling for 114 percent of face value. What is the company's pre-tax cost of debt?

Accepted Answer

The answer of Wind Power Systems has 20-year, semi-annual bonds...

Question 7

Henessey Markets has a growth rate of 4.8 percent and is equally as risky as the market. The stock is currently selling for $17 a share. The overall stock market has a 10.6 percent rate of return and a risk premium of 8.7 percent. What is the expected rate of return on this stock?

Accepted Answer

R_e = (0.106 - 0.087) + (1.00 F1F1F1S1F1F1F10 0.087) = 10.6 percent

Question 8

Boulder Furniture has bonds outstanding that mature in 13 years, have a 6 percent coupon, and pay interest annually. These bonds have a face value of $1,000 and a current market price of $1,040. What is the company's aftertax cost of debt if its tax rate is 32 percent?

Accepted Answer

The answer of Boulder Furniture has bonds outstanding that mature...

Question 9

Samuelson Plastics has 7.5 percent preferred stock outstanding. Currently, this stock has a market value per share of $52 and a book value per share of $38. What is the cost of preferred stock?

Accepted Answer

R_p = (0.075 F1F1F1S1F1F1F10 $100)/$52 = 14.42 percent

Question 10

The common stock of Metal Molds has a negative growth rate of 1.5 percent and a required return of 18 percent. The current stock price is $11.40. What was the amount of the last dividend paid?

Accepted Answer

D₁ = [(0.18 - (-0.015)) F1F1F1S1F1F1F10 $11.40] = $2.223; D₀ = $2.223/(1 - 0.015) = $2.26

Question 11

Dog Gone Good Engines has a bond issue outstanding with 17 years to maturity. These bonds have a $1,000 face value, a 9 percent coupon, and pay interest semi-annually. The bonds are currently quoted at 87 percent of face value. What is the company's pre-tax cost of debt if the tax rate is 38 percent?

Accepted Answer

The answer of Dog Gone Good Engines has a bond...

Question 12

Tidewater Fishing has a current beta of 1.48. The market risk premium is 8.9 percent and the risk-free rate of return is 3.2 percent. By how much will the cost of equity increase if the company expands its operations such that the company beta rises to 1.60?

Accepted Answer

Increase in cost of equity = (1.60 - 1.48) F1F1F1S1F1F1F10 0.089 = 1.07 percent

Question 13

Handy Man, Inc. has zero coupon bonds outstanding that mature in 8 years. The bonds have a face value of $1,000 and a current market price of $640. What is the company's pre-tax cost of debt?

Accepted Answer

The pre-tax cost of debt can be computed using the formula:

Pre-tax Cost of Debt = (Face Value - Current Market Price) / Face Value x (1 / Years to Maturity)

Plugging in the given values:

Pre-tax Cost of Debt = ($1,000 - $640) / $1,000 x (1 / 8) = 0.36 x 0.125 = 0.045

Converting to a percentage:

Pre-tax Cost of Debt = 4.5%

Therefore, the best choice is C. 5.66 percent, which is the closest option to 4.5%.

Question 14

New York Deli's has 7 percent preferred stock outstanding that sells for $36 a share. This stock was originally issued at $50 per share. What is the cost of preferred stock?

Accepted Answer

R_p = (0.07 F1F1F1S1F1F1F10 $100)/$36 = 19.44 percent

Question 15

Grill Works and More has 8 percent preferred stock outstanding that is currently selling for $49 a share. The market rate of return is 14 percent and the firm's tax rate is 37 percent. What is the firm's cost of preferred stock?

Accepted Answer

R_p = (0.08 F1F1F1S1F1F1F10 $100)/$49 = 16.33 percent

Question 16

National Home Rentals has a beta of 1.38, a stock price of $19, and recently paid an annual dividend of $0.94 a share. The dividend growth rate is 4.5 percent. The market has a 10.6 percent rate of return and a risk premium of 7.5 percent. What is the firm's cost of equity?

Accepted Answer

R_e = (0.106 - 0.075) + (1.38 F1F1F1S1F1F1F10 0.075) = 0.1345R_e = [($0.94 F1F1F1S1F1F1F10 1.045)/$19] + 0.045 = 0.0967R_{e Average} = (0.1345 + 0.0967)/2 = 11.56 percent

Question 17

Sweet Treats common stock is currently priced at $19.06 a share. The company just paid $1.15 per share as its annual dividend. The dividends have been increasing by 2.5 percent annually and are expected to continue doing the same. What is this firm's cost of equity?

Accepted Answer

e = [($1.15 F1F1F1S1F1F1F10 1.025)/$19.06] + 0.025 = 8.68 percent

Question 18

Southern Home Cookin' just paid its annual dividend of $0.65 a share. The stock has a market price of $13 and a beta of 1.12. The return on the U.S. Treasury bill is 2.5 percent and the market risk premium is 6.8 percent. What is the cost of equity?

Accepted Answer

R_e = 0.025 + (1.12 F1F1F1S1F1F1F10 0.068) = 10.12 percent

Question 19

Mangrove Fruit Farms has a $200,000 bond issue outstanding that is selling at 92 percent of face value. The firm also has 1,500 shares of preferred stock and 15,000 shares of common stock outstanding. The preferred stock has a market price of $35 a share compared to a price of $24 a share for the common stock. What is the weight of the preferred stock as it relates to the firm's weighted average cost of capital?

Accepted Answer

The answer of Mangrove Fruit Farms has a $200,000 bond...

Question 20

Nelson's Landscaping has 1,200 bonds outstanding that are selling for $990 each. The company also has 2,500 shares of preferred stock at a market price of $28 a share. The common stock is priced at $37 a share and there are 28,000 shares outstanding. What is the weight of the common stock as it relates to the firm's weighted average cost of capital?

Accepted Answer

First, let's calculate the market value of each component of the capital structure:

Market value of bonds = 1,200 x $990 = $1,188,000
Market value of preferred stock = 2,500 x $28 = $70,000
Market value of common stock = 28,000 x $37 = $1,036,000

Total market value of the firm's capital structure = $2,294,000

Next, we need to calculate the weight of each component relative to the total capital structure:

Weight of bonds = $1,188,000/$2,294,000 = 0.518 or 51.80%
Weight of preferred stock = $70,000/$2,294,000 = 0.031 or 3.10%
Weight of common stock = $1,036,000/$2,294,000 = 0.451 or 45.16%

Therefore, the weight of the common stock is 45.16%, which is answer choice B.

Quiz 14: Cost of Capital