Question 1

Appalachian Mountain Goods has paid increasing dividends of $.10,$.12,$.15,and $.20 a share over the past four years,respectively.The firm estimates that future increases in its dividends will be equal to the arithmetic average growth rate over these past four years.The stock is currently selling for $12.50 a share.The risk-free rate is 3.4 percent and the market risk premium is 8.1 percent.What is the cost of equity for this firm if its beta is 1.46?

Accepted Answer

The answer of Appalachian Mountain Goods has paid increasing dividends...

Question 2

To value a non-dividend-paying firm,the terminal value used in the valuation calculation will most likely be based on a(n):

Accepted Answer

The terminal value used in the valuation calculation will most likely be based on a target ratio, which is a multiple of the firm's earnings or cash flows.

Question 3

Titans has 7 percent bonds outstanding that mature in 16 years.The bonds pay interest semiannually and have a face value of $1,000.Currently,the bonds are selling for $1,015 each.What is the firm's pretax cost of debt?

Accepted Answer

The pretax cost of debt is the yield to maturity (YTM) on the bonds. Given the bond's price, coupon rate, and maturity, the YTM can be calculated using the formula for bond pricing. The bond pays $35 every six months (7% of $1,000 annually, divided by 2), has 32 periods (16 years * 2), and a face value of $1,000. Solving for YTM using these inputs gives approximately 6.84% annually.

Question 4

Madison Square Stores has a $20 million bond issue outstanding that currently has a market value of $19.4 million.The bonds mature in 6.5 years and pay semiannual interest payments of $35 each.What is the firm's pretax cost of debt?

Accepted Answer

The formula to calculate the pretax cost of debt is:
Pretax Cost of Debt = (Semiannual Interest Payment / Bond Market Value)*2

Semiannual Interest Payment = $35
Bond Market Value = $19.4 million

Pretax Cost of Debt = (35 / 19.4)*2 = 3.603*2 = 7.206

Therefore, the pretax cost of debt is 7.206%, which is closest to option B (7.59%).

Question 5

Birds of a Feather has bonds outstanding that carry an annual coupon of 6 percent.The bonds mature in 11 years and are currently priced at 94 percent of face value.What is the firm's pretax cost of debt?

Accepted Answer

The firm's pretax cost of debt can be calculated using the yield to maturity (YTM) formula for bonds. Given the bond's annual coupon rate of 6%, maturity of 11 years, and current price of 94% of face value, the YTM is approximately 6.79%.

Question 6

USA Manufacturing issued 30-year,7.5 percent semiannual bonds 6 years ago.The bonds currently sell at 101 percent of face value.What is the firm's aftertax cost of debt if the tax rate is 35 percent?

Accepted Answer

The answer of USA Manufacturing issued 30-year,7.5 percent semiannual bonds...

Question 7

The Green Balloon just paid its first annual dividend of $.87 a share.The firm plans to increase the dividend by 3.2 percent per year indefinitely.What is the firm's cost of equity if the current stock price is $4.75 a share?

Accepted Answer

The answer of The Green Balloon just paid its first...

Question 8

Farm Equipment announced this morning that its next annual dividend will be decreased to $1.67 a share and that all future dividends will be decreased by an additional 1.3 percent annually.What is the current value per share if the required return is 15.7 percent?

Accepted Answer

The current value per share can be calculated using the Gordon Growth Model (Dividend Discount Model for a decreasing dividend), which is P = D1 / (r - g). Here, D1 = $1.67, r = 15.7% or 0.157, and g = -1.3% or -0.013. Plugging in these values gives P = $1.67 / (0.157 + 0.013) = $9.82.

Question 9

The common stock of Contemporary Interiors has a beta of 1.13 and a standard deviation of 21.4 percent.The market rate of return is 12.7 percent and the risk-free rate is 4.1 percent.What is the cost of equity for this firm?

Accepted Answer

Using the Capital Asset Pricing Model:
Cost of Equity = Risk-Free Rate + Beta*(Market Rate of Return - Risk-Free Rate)
Cost of Equity = 4.1% + 1.13*(12.7% - 4.1%)
Cost of Equity = 4.1% + 1.13*8.6%
Cost of Equity = 4.1% + 9.74%
Cost of Equity = 13.82% 
Therefore, the cost of equity for the firm is 13.82 percent. Hence, option A is the correct choice.

Question 10

Trendsetters has a cost of equity of 14.6 percent.The market risk premium is 8.4 percent and the risk-free rate is 3.9 percent.The company is acquiring a competitor,which will increase the company's beta to 1.4.What effect,if any,will the acquisition have on the firm's cost of equity capital?

Accepted Answer

The cost of equity can be calculated using the capital asset pricing model (CAPM):
Cost of equity = Risk-free rate + Beta * (Market risk premium)
Before the acquisition, the company had a beta of (unspecified), so we cannot calculate the exact cost of equity. However, we can use the given cost of equity and the CAPM formula to calculate the current beta:
14.6% = 3.9% + Beta * 8.4%
Beta = (14.6% - 3.9%) / 8.4% = 1.0238
After the acquisition, the beta will increase to 1.4. Using the same formula, we can calculate the new cost of equity:
Cost of equity = 3.9% + 1.4 * 8.4% = 15.03%
The new cost of equity is higher than the old cost of equity, so the acquisition will increase the firm's cost of equity capital by 1.06%. Therefore, the correct answer is D.

Question 11

Electronic Products has 22,500 bonds outstanding that are currently quoted at 101.6.The bonds mature in 8 years and pay an annual coupon payment of $90.What is the firm's aftertax cost of debt if the applicable tax rate is 34 percent?

Accepted Answer

The market price of the bond is 101.6% of its face value, which means the bond is sold at a premium. We need to calculate the yield to maturity (YTM) of the bond, which is the internal rate of return of the bond's cash flows:

PV = -$1016 (price of bond)
PMT = $90
FV = $1000
n = 8

Solving for i using a financial calculator or Excel, we get YTM = 3.773%.

However, we need to adjust for the tax shield of the interest expense. Because the interest payments are tax-deductible, the after-tax cost of debt is:

After-tax cost of debt = YTM x (1 - Tax rate)
After-tax cost of debt = 3.773% x (1 - 0.34)
After-tax cost of debt = 2.488%

Therefore, the after-tax cost of debt for Electronic Products is 5.75% (rounded to two decimal places). Therefore, the best choice is C.

Question 12

Judy's Boutique just paid an annual dividend of $1.48 on its common stock and increases its dividend by 2.2 percent annually.What is the rate of return on this stock if the current stock price is $29.60 a share?

Accepted Answer

The answer of Judy's Boutique just paid an annual dividend...

Question 13

The common stock of Mill Stones has a beta that is 8 percent greater than the overall market beta.Currently,the market risk premium is 7.65 percent while the U.S.Treasury bill is yielding 4.3 percent.What is the cost of equity for this firm?

Accepted Answer

The answer of The common stock of Mill Stones has...

Question 14

Three years ago,the Morgan Co.issued 15-year,6.5 percent semiannual coupon bonds at par.Today,the bonds are quoted at 100.6.What is this firm's pretax cost of debt?

Accepted Answer

The firm's pretax cost of debt is the yield to maturity (YTM) on the bonds. Since the bonds are quoted at 100.6, they are trading slightly above par. The YTM can be calculated using the bond's current price, coupon rate, and time to maturity. Given the semiannual coupon and the bond's current price, the YTM is approximately 6.43 percent.

Question 15

Donut Delites has a beta of 1.06,a dividend growth rate of 1.2 percent,a stock price of $12a share,and an expected annual dividend of $.68 per share next year.The market rate of return is 11.4 percent and the risk-free rate is 3.8 percent.What is the firm's cost of equity?

Accepted Answer

The cost of equity can be calculated using the Capital Asset Pricing Model (CAPM): Cost of Equity = Risk-free rate + Beta * (Market rate of return - Risk-free rate). Substituting the given values: Cost of Equity = 3.8% + 1.06 * (11.4% - 3.8%) = 9.36%.

Question 16

A firm has multiple divisions of similar nature,yet varying degrees of risk.Which one of the following would be the most appropriate,yet relatively easy,means of assigning discount rates to each of its numerous proposed investments?

Accepted Answer

Assigning every project a rate equal to the firm's WACC plus or minus a subjective adjustment would be the most appropriate means of assigning discount rates to each of its numerous proposed investments. This approach recognizes that the firm's projects have varying degrees of risk and adjusts for those differences by adding or subtracting a subjective adjustment from the WACC. This approach takes into account the firm's overall cost of capital and its risk profile but allows for flexibility in adjusting for project-specific risks. The other options either do not account for project-specific risks (A and E) or are too arbitrary (B) or complicated (D) to be practical for a firm with numerous proposed investments.

Question 17

Musical Charts just paid an annual dividend of $1.84 per share.This dividend is expected to increase by 2.1 percent annually.Currently,the firm has a beta of 1.12 and a stock price of $31 a share.The risk-free rate is 4.3 percent and the market rate of return is 13.2 percent.What is the cost of equity capital for this firm?

Accepted Answer

The answer of Musical Charts just paid an annual dividend...

Question 18

What is the primary reason why the cash flow from assets (CFA)is adjusted when used to value a firm?

Accepted Answer

The answer of What is the primary reason why the...

Question 19

Tennessee Valley Antiques would like to issue new equity shares if its cost of equity declines to 12.5 percent.The company pays a constant annual dividend of $2.10 per share.What does the market price of the stock need to be for the firm to issue the new shares?

Accepted Answer

We can use the constant growth model to find the market price of the stock:
P0 = D1 / (r-g)
Where:
D1 = the next annual dividend = $2.10
r = the required rate of return (cost of equity) = 12.5%
g = the expected growth rate of dividends = 0% (constant dividend)

Plugging in the values, we get:
P0 = $2.10 / (0.125 - 0) = $16.80

Therefore, the market price of the stock needs to be $16.80 for the firm to issue the new shares.

Question 20

The market rate of return is 11.8 percent and the risk-free rate is 3.45 percent.Galaxy Co.has 36 percent more systematic risk than the overall market and has a dividend growth rate of 3.5 percent.The firm's stock is currently selling for $42 a share and has a dividend yield of 2.8 percent.What is the firm's cost of equity?

Accepted Answer

The answer of The market rate of return is 11.8...

Quiz 12: Cost of Capital

To value a non-dividend-paying firm,the terminal value used in the valuation calculation will most likely be based on a(n) :