Question 1

Tangshan Mining is considering issuing long-term debt.The debt would have a 30 year maturity and a 6 percent coupon rate and make semiannual coupon payments.In order to sell the issue,the bonds must be underpriced at a discount of 1 percent of face value.In addition,the firm would have to pay flotation costs of 1 percent of face value.The firm's tax rate is 21 percent.Given this information,the after-tax cost of debt for Tangshan Mining would be ________.

Accepted Answer

The after-tax cost of debt is calculated using the formula: (Coupon Rate * (1 - Tax Rate)) / (1 - Discount - Flotation Costs). Here, the coupon rate is 6%, the tax rate is 21%, and the total discount and flotation costs are 2% (1% each). The after-tax cost of debt is approximately 4.86%.

Question 2

What is the dividend on an 8 percent preferred stock that currently sells for $45 and has a face value of $50 per share?

Accepted Answer

The dividend on an 8 percent preferred stock with a face value of $50 per share is calculated as 8% of $50, which equals $4.00.

Question 3

Debt is generally the least expensive source of capital.This is primarily due to ________.

Accepted Answer

Debt is less risky than equity because it usually has a fixed interest rate and a finite maturity date, making it easier to plan for and manage cash flows. Additionally, interest payments on debt are tax deductible, making it a more cost-effective financing option than equity. This leads to debt generally being the least expensive source of capital.

Question 4

A firm has issued preferred stock at its $125 per share par value.The stock will pay a $15 annual dividend.The cost of issuing and selling the stock was $4 per share.The cost of the preferred stock is ________.

Accepted Answer

The cost of preferred stock is calculated using the formula:

Cost of Preferred Stock = Annual Dividend / Net Proceeds from the Sale of the Stock

Net Proceeds from the sale of stock = Par Value – Issuance Cost 
= $125 – $4 
= $121

Therefore,

Cost of Preferred Stock = $15 / $121 
= 0.1239 or 12.39% (rounded to nearest tenth)

Hence, the answer is choice C (12.4 percent).

Question 5

Preferred stockholders must receive their stated dividends prior to the distribution of any earnings to common stockholders and bondholders.

Accepted Answer

Preferred stockholders must receive their stated dividends before common stockholders, but bondholders are paid before both as they are creditors, not equity holders.

Question 6

A firm has issued 10 percent preferred stock,which sold for $100 per share par value.The cost of issuing and selling the stock was $2 per share.The firm's marginal tax rate is 40 percent.The cost of the preferred stock is ________.

Accepted Answer

The answer of A firm has issued 10 percent preferred...

Question 7

If a corporation pays a tax rate of 21 percent,the after-tax cost of debt for a 10-year,8 percent,$1,000 par value bond selling at $1,150 is ________.

Accepted Answer

The after-tax cost of debt is calculated using the formula: After-tax cost of debt = Yield to Maturity (YTM) * (1 - Tax Rate). First, calculate the YTM for the bond, which is approximately 5.96%. Then, apply the tax rate: 5.96% * (1 - 0.21) = 4.71%.

Question 8

A firm has determined it can issue preferred stock at $115 per share par value.The stock will pay a $12 annual dividend.The cost of issuing and selling the stock is $3 per share.The cost of the preferred stock is ________.

Accepted Answer

The cost of preferred stock can be calculated using the formula:

Cost of Preferred Stock = Annual Dividend / Net Proceeds

Net Proceeds = Par Value - Cost of Issuing and Selling
Net Proceeds = $115 - $3
Net Proceeds = $112

Now, plug in the values:

Cost of Preferred Stock = $12 / $112
Cost of Preferred Stock = 0.107, or 10.7%

Therefore, the cost of the preferred stock is 10.7%, which is option C.

Question 9

Since preferred stock is a form of ownership,it has no maturity date.

Accepted Answer

Preferred stock has no maturity date because it represents a perpetual ownership interest in a company. Unlike bonds or other debt securities, preferred stock does not have a set date on which it must be redeemed or repaid. Instead, it generally pays a fixed dividend to investors for as long as they hold the shares.

Question 10

The amount of preferred stock dividends that must be paid each year may be stated in dollars or as a percentage of the firm's earnings.

Accepted Answer

Preferred stock dividends are typically stated as a fixed amount per share or as a percentage of the par value, not as a percentage of the firm's earnings.

Question 11

The cost of preferred stock is typically higher than the cost of long-term debt (bonds)because the cost of long-term debt (interest)is tax deductible.

Accepted Answer

The cost of long-term debt is tax-deductible, which reduces its effective cost to the company. This makes it a cheaper form of financing compared to preferred stock, which does not have tax-deductible payments. Therefore, the cost of preferred stock is typically higher than the cost of long-term debt.

Question 12

The cost of preferred stock is the ratio of the preferred stock dividend to a firm's net proceeds from the sale of the preferred stock.

Accepted Answer

The cost of preferred stock is calculated by dividing the preferred stock dividend by the net proceeds from the sale of the preferred stock.

Question 13

Recently the corporate tax law in the U.S.changed so that firms that previously faced a marginal tax rate of close to 40% now pay tax at a flat rate of 21%.Holding everything else constant,this reduction in the tax rate faced by corporations ________.

Accepted Answer

The answer of Recently the corporate tax law in the...

Question 14

The after-tax cost of debt for a 20-year,7 percent,$1,000 par value bond selling at $960 (assume a marginal tax rate of 40 percent)is ________.

Accepted Answer

The after-tax cost of debt is calculated using the formula: After-tax cost of debt = Yield to Maturity (YTM) * (1 - Tax Rate). First, calculate the YTM for the bond, which is approximately 9.73%. Then, apply the tax adjustment: 9.73% * (1 - 0.40) = 5.84%.

Question 15

The specific cost of each source of long-term financing is based on ________ and ________ costs.

Accepted Answer

The specific cost of each source of long-term financing is based on after-tax and current costs. After-tax costs are used because interest payments on debt are tax-deductible, and current costs are used because the cost of financing changes over time due to factors such as interest rates and market conditions. The other options (A, B, and C) include incorrect factors such as before-tax, historical, or book value costs, which are not relevant in determining the cost of long-term financing.

Question 16

If a corporation faces a tax rate of 21 percent,the after-tax cost of debt for a 15-year,12 percent,$1,000 par value bond,selling at $950 is ________.

Accepted Answer

The first step in calculating the after-tax cost of debt is to determine the annual interest payment by multiplying the coupon rate by the par value of the bond: 
$1,000 x 0.12 = $120

Next, we need to calculate the pre-tax cost of debt, which is the yield to maturity of the bond. We can use a financial calculator or spreadsheet function to find that the yield to maturity is approximately 13.47 percent.

Then, we can calculate the after-tax cost of debt using the following formula:

After-Tax Cost of Debt = Pre-Tax Cost of Debt x (1 - Tax Rate)

After-Tax Cost of Debt = 0.1347 x (1 - 0.21) = 0.10608 or 10.61 percent

Therefore, choice C is the best answer.

Question 17

Tangshan Mining is considering issuing preferred stock.The preferred stock would have a par value of $75 and a 5.50 percent dividend.What is the cost of preferred stock for Tangshan if flotation costs would amount to 5.5 percent of par value?

Accepted Answer

The cost of preferred stock can be calculated using the following formula:
Cost of preferred stock = Dividend/Net Proceeds
Here, the dividend is 5.50% of the par value which is $75, so the dividend is $4.125 per share.
The net proceeds are the par value minus the flotation cost, which is 75 - (0.055 x 75) = $70.875 per share.
Therefore, the cost of preferred stock = 4.125/70.875 = 0.0582 or 5.82%.

Question 18

Nico Trading Corporation is considering issuing long-term debt.The debt would have a 30-year maturity and a 10 percent coupon rate.In order to sell the issue,the bonds must be underpriced at a discount of 5 percent of face value.In addition,the firm would have to pay flotation costs of 5 percent of face value.The firm's tax rate is 21 percent.Given this information,the after-tax cost of debt for Nico Trading would be ________.

Accepted Answer

The after-tax cost of debt is the yield to maturity (YTM) of the bond, which is the annual interest payment divided by the present value of the bond. The present value of the bond is the sum of the present values of the coupon payments and the present value of the face value. The present value of the coupon payments is the sum of the present values of each coupon payment, which is the coupon payment divided by the discount factor. The discount factor is the present value of $1 received at the end of the year, which is 1 / (1 + r)^n, where r is the YTM and n is the number of years until the coupon payment is received. The present value of the face value is the face value divided by the discount factor for the number of years until the face value is received.In this case, the coupon rate is 10%, the maturity is 30 years, the discount rate is 5%, and the flotation costs are 5%. The after-tax cost of debt is:YTM = (Coupon payment + (Face value - Issue price) * YTM * (1 - Tax rate)) / (Issue price)YTM = (0.10 * Face value + (Face value - 0.95 * Face value) * YTM * (1 - 0.21)) / (0.95 * Face value)YTM = (0.10 * Face value + 0.049 * Face value * YTM) / (0.95 * Face value)YTM = 0.1049 / 0.95YTM = 0.1104 or 11.04%Therefore, the after-tax cost of debt for Nico Trading would be 11.04%.

Question 19

When determining the after-tax cost of a bond,the face value of the issue must be adjusted to the net proceeds amounts by considering ________.

Accepted Answer

Flotation costs refer to the expenses associated with issuing new securities, such as underwriting fees, legal fees, and registration fees. These costs reduce the net proceeds received by the issuer and must be taken into account when calculating the after-tax cost of a bond.

Question 20

The cost of preferred stock is the ratio of the preferred stock dividend to a firm's total earnings.

Accepted Answer

The cost of preferred stock is the dividend payment divided by the market value of the preferred stock. It does not take into account a firm's total earnings.

Quiz 9: The Cost of Capital