Question 1

The outstanding debt of Berstin Corp.has eight years to maturity,a current yield of 8%,and a price of $95.Assume the debt has a face value of $100.What is the pretax cost of debt if the tax rate is 30%?

Accepted Answer

The answer of The outstanding debt of Berstin Corp.has eight...

Question 2

A firm has $3 million market value and it sells preferred stock with a par value of $100.If the coupon rate on the preferred stock is 9% and the preferred stock trades at $95,what is the cost of preferred stock financing?

Accepted Answer

The cost of preferred stock financing is calculated as the dividend divided by the current price of the stock. Here, the dividend is 9% of the $100 par value, which is $9. The stock trades at $95, so the cost of preferred stock financing is $9 / $95 = 0.0947 or 9.47%.

Question 3

What is the difference between the effective cost of debt and the cost of debt?

Accepted Answer

The answer of What is the difference between the effective...

Question 4

The after-tax cost of debt ________ the before-tax cost of debt for a firm that has a positive marginal tax rate.

Accepted Answer

The after-tax cost of debt is always less than the before-tax cost of debt for a firm that has a positive marginal tax rate. This is because the interest payments on debt are tax-deductible, thereby reducing the firm's tax liability and effectively reducing the cost of the debt. The extent of the reduction in the after-tax cost of debt depends on the marginal tax rate of the firm.

Question 5

A firm has $2 million market value and it sells preferred stock with a par value of $100.If the coupon rate on the preferred stock is 8% and the preferred stock trades at $90,what is the cost of preferred stock financing?

Accepted Answer

The cost of preferred stock financing is calculated as the dividend payment divided by the net proceeds from issuing the preferred stock.

First, we need to calculate the dividend payment per share of preferred stock:

Dividend payment = Coupon rate x Par value = 8% x $100 = $8

Next, we need to calculate the net proceeds from issuing the preferred stock:

Net proceeds = Market value per share - Issue cost per share = $90 - $0 = $90

Finally, we can calculate the cost of preferred stock financing:

Cost of preferred stock financing = Dividend payment / Net proceeds = $8 / $90 = 0.0889 or 8.89%

Therefore, the best choice is B.

Question 6

An all-equity firm produced a dividend flow of $20,000 last year.The market value of the firm is $650,000 and the dividend is expected to increase at 4% each year.What is the cost of equity capital for this firm?

Accepted Answer

Using the Gordon Growth Model, we can calculate the cost of equity capital:
r = (D1 / P0) + g
Where:
D1 = expected dividend for next year = D0(1+g) = $20,800
P0 = market value of the firm = $650,000
g = dividend growth rate = 4%
r = cost of equity capital

Putting in the numbers, we get:
r = ($20,800 / $650,000) + 4% = 7.2%

Therefore, the answer is choice C) 7.2%.

Question 7

Your estimate of the market risk premium is 7%.The risk-free rate of return is 4% and General Motors has a beta of 1.5.What is General Motors' cost of equity capital?

Accepted Answer

The cost of equity capital can be calculated using the Capital Asset Pricing Model (CAPM) formula: Cost of Equity = Risk-Free Rate + Beta * Market Risk Premium. Plugging in the values: 4% + 1.5 * 7% = 14.5%.

Question 8

Is it incorrect to use the coupon rate of debt toward cost of debt?

Accepted Answer

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Question 9

A firm has outstanding debt paying annual coupons,with a coupon rate of 5%,and 10 years to maturity.The firm's bonds are currently trading at a price of $950 per $1000 face value.What is the firm's cost of debt if it has a tax rate of 15%?

Accepted Answer

The first step is to calculate the yield to maturity (YTM) of the bond using the current market price.

$950 = $50/(1+r)^1 + $50/(1+r)^2 + ... + $50/(1+r)^10 + $1000/(1+r)^10

Using a financial calculator or Excel, we can find that the YTM is approximately 5.07%.

Next, we need to adjust for taxes since interest expenses are tax-deductible.

After-tax cost of debt = YTM x (1 - tax rate) 
= 5.07% x (1 - 0.15) 
= 4.31%

Therefore, the firm's cost of debt is approximately 4.31%.

The closest answer choice is C) 4.8%, which is the best choice.

Question 10

Your estimate of the market risk premium is 6%.The risk-free rate of return is 4.5% and General Motors has a beta of 1.6.What is General Motors' cost of equity capital?

Accepted Answer

The cost of equity capital can be calculated using the Capital Asset Pricing Model (CAPM), which is given by the formula: Cost of Equity = Risk-Free Rate + Beta * (Market Risk Premium). Plugging in the given values: Cost of Equity = 4.5% + 1.6 * 6% = 4.5% + 9.6% = 14.1%.

Question 11

A firm has $1 million market value and it sells preferred stock with a par value of $100.If the coupon rate on the preferred stock is 7% and the preferred stock trades at $95,what is the cost of preferred stock financing?

Accepted Answer

The cost of preferred stock financing is calculated as the dividend divided by the current price of the stock. Here, the dividend is 7% of the $100 par value, which is $7. The stock trades at $95, so the cost of preferred stock financing is $7 / $95 = 0.0737 or 7.37%.

Question 12

An all-equity firm produced a dividend flow of $40,000 last year.The market value of the firm is $800,000 and the dividend is expected to increase at 5% each year.What is the cost of equity capital for this firm?

Accepted Answer

The cost of equity capital can be calculated using the Gordon Growth Model (Dividend Discount Model): Cost of Equity = (Dividend per share / Current market value per share) + Growth rate. Here, the dividend is $40,000, the market value is $800,000, and the growth rate is 5%. So, Cost of Equity = ($40,000 / $800,000) + 0.05 = 0.05 + 0.05 = 0.10 or 10%. The closest option is 10.25%.

Question 13

A firm has a pre-tax cost of debt of 8.5%.If the firm has a marginal tax rate of 40%,what is its effective cost of debt?

Accepted Answer

The effective cost of debt is calculated by taking the pre-tax cost of debt and adjusting it for taxes, using the formula: Effective Cost of Debt = Pre-Tax Cost of Debt * (1 - Tax Rate). Therefore, 8.5% * (1 - 0.40) = 5.1%.

Question 14

The outstanding debt of Berstin Corp.has five years to maturity,a current yield of 6%,and a price of $95.Assume the debt has a face value of $100.What is the pretax cost of debt if the tax rate is 30%?

Accepted Answer

The answer of The outstanding debt of Berstin Corp.has five...

Question 15

An all-equity firm produced a dividend flow of $30,000 last year.The market value of the firm is $875,000 and the dividend is expected to increase at 3% each year.What is the cost of equity capital for this firm?

Accepted Answer

The cost of equity capital can be calculated using the Gordon Growth Model (Dividend Discount Model): Cost of Equity = (Dividend/Market Value) + Growth Rate. Here, Cost of Equity = ($30,000/$875,000) + 3% = 6.53%.

Question 16

A firm has outstanding debt paying annual coupons,with a coupon rate of 10%,and 8 years to maturity.The firm's bonds are currently trading at a price of $875.50 per $1000 face value.What is the firm's cost of debt if it has a tax rate of 25%?

Accepted Answer

First, calculate the annual coupon payment:

Annual coupon payment = 10% * $1000 = $100

Next, calculate the yield to maturity (YTM) using the bond price:

$875.50 = $100 / (1 + YTM)^1 + $100 / (1 + YTM)^2 + ... + $100 / (1 + YTM)^8 + $1000 / (1 + YTM)^8

Using financial calculator or excel function, the YTM is found to be 12%.

Finally, adjust the YTM for the tax rate:

Cost of debt = YTM * (1 - tax rate)

Cost of debt = 12% * (1 - 0.25) = 9.4%

Therefore, the answer is choice C (9.4%).

Question 17

Should a firm with high retained earnings have a lower cost of equity?

Accepted Answer

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Question 18

A firm has outstanding debt with a coupon rate of 7%,seven years maturity,and a price of $1000 per $1000 face value.What is the after-tax cost of debt if the marginal tax rate of the firm is 30%?

Accepted Answer

The after-tax cost of debt is calculated as the coupon rate (7%) multiplied by (1 - tax rate), which is 1 - 0.30 = 0.70. So, 7% * 0.70 = 4.9%.

Question 19

Between the two models Constant Dividend Growth Model (CDGM)and Capital Asset Pricing Model (CAPM),which is a better method for computation of the cost of equity?

Accepted Answer

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Question 20

The outstanding debt of Berstin Corp.has ten years to maturity,a current yield of 7%,and a price of $95.Assume the debt has a face value of $100.What is the pretax cost of debt if the tax rate is 30%.

Accepted Answer

Using the formula for calculating the pretax cost of debt:
Pretax cost of debt = Current yield * (1 - Tax rate)
Pretax cost of debt = 7% * (1 - 0.3)
Pretax cost of debt = 4.9%
Therefore, the correct answer is D) 4.9%.

Quiz 12: Determining the Cost of Capital