FINANCE 3770 FINAL

Blossom Insurance Ltd. issued a fixed-rate perpetual preferred stock three years ago and placed it privately with institutional investors. The stock was issued at $25 per share with a $1.75 dividend. If the company were to issue preferred stock today, the yield would be 6.2 percent. The stock's current value is:

28.33

Sunland Insurance Ltd. issued a fixed-rate perpetual preferred stock three years ago and placed it privately with institutional investors. The stock was issued at $25 per share with a $1.94 dividend. If the company were to issue preferred stock today, the yield would be 6.4 percent. The stock's current value is:

30.31

The Sunland Company has an after-tax cost of debt capital of 4 percent, a cost of preferred stock of 7 percent, a cost of equity capital of 10 percent, and a weighted average cost of capital of 6 percent. Sunland intends to maintain its current capital structure as it raises additional capital. In making its capital-budgeting decisions for the average-risk project, the relevant cost of capital is:

6 PERCENT

The Wildhorse Company has an after-tax cost of debt capital of 3 percent, a cost of preferred stock of 7 percent, a cost of equity capital of 12 percent, and a weighted average cost of capital of 6 percent. Wildhorse intends to maintain its current capital structure as it raises additional capital. In making its capital-budgeting decisions for the average-risk project, the relevant cost of capital is:

6 percent.

Wally's War Duds has a preferred share issue outstanding with a current price of $26.57. The firm is expected to pay a dividend of $1.86 per share a year from today. What is the firm's cost of preferred equity? Round your final answer to two decimal places.

7.00%

The WACC for a firm is 13.00 percent. You know that the firm's cost of debt capital is 10 percent and the cost of equity capital is 20%. What proportion of the firm is financed with debt? Assume the firm pays no tax.

70%

Turquoise Electronics, Inc. paid a dividend of $1.87 last year. If the firm's growth in dividends is expected to be 10 percent next year and then zero thereafter, what is its cost of equity capital if the price of its common shares is currently $25.71?

8.00%

Bellamee, Inc. has semiannual bonds outstanding with five years to maturity, and the bonds are priced at $920.87. If the bonds have a coupon rate of 7 percent, then what is the YTM for the bonds? Round your final percentage answer to one decimal place.

9%

The cost of equity for a firm is a weighted average of the costs of the different types of stock that the firm has outstanding at a particular point in time.

TRUE

When the discount rate estimated is too low, firms run the risk of accepting a negative NPV project.

TRUE

Which of the following methods is typically used to estimate a firm's cost of equity?

The CAPM

Using a firm's overall cost of capital to evaluate a project's cash flows is problematic in that the firm is a collection of projects, with the possibility that each project has a different level of risk than the other projects.

True

The cost of capital is:

all of the above.

Income taxes have the effect of

decreasing the cost of debt for a firm.

The value of the cash flows that the assets of a firm are expected to generate must equal

the value of the cash flows claimed by both the equity and debt investors.

For firms that issue several types of debt, the correct cost to use when estimating its WACC is _____.

the weighted average after-tax cost of all the debt types

The best method to use when estimating a firm's discount rate is the _____.

weighted average cost of capital approach

The Conservative Corporation has determined its weighted average cost of capital to be 13%. It has a capital structure of 60% debt, and 40% equity, with the before-tax cost of debt estimated at 10%. If the firm's marginal tax rate is 30%, its cost of equity capital is closest to _____. (Do not round intermediate calculations.)

22%

The WACC for a firm is 19.75 percent. You know that the firm is financed with $75 million of equity and $25 million of debt. The cost of debt capital is 7 percent. What is the cost of equity for the firm? Assume the firm pays no tax.

24.00

Suppose the cost of capital of the Oriole Company is 10 percent. If Oriole has a capital structure that is 50 percent debt and 50 percent equity, its before-tax cost of debt is 7 percent, and its marginal tax rate is 20 percent, then its cost of equity capital is closest to:

12.4 percent.

Gangland Water Guns, Inc. is expected to pay a dividend of $2.10 one year from today. If the firm's growth in dividends is expected to remain at a flat 3 percent forever, what is the cost of equity capital for Gangland if the price of its common shares is currently $17.50?

15.00%

You are analyzing the cost of capital for a firm that is financed with 65 percent equity and 35 percent debt. The cost of debt capital is 8 percent, while the cost of equity capital is 20 percent for the firm. What is the overall cost of capital for the firm?

15.8%

If the market risk premium is currently 6 percent and the risk-free rate of return is 4 percent, then what is the expected return on a common share with a beta equal to 2?

16.0%

A situation where a firm would not want to use its own WACC to evaluate a risky project would be when:

the cost of capital of a pure-play comparable that is similar to the project can be found.

When estimating the cost of debt capital for a firm, we are primarily interested in

the cost of long-term debt.

According to the finance balance sheet equation:

the market value of a firm's assets must equal the market value of its liabilities and the market value of its equity.

The market value of a firm's assets must equal

the present value of the cash flows that these assets are expected to generate.

The Capital Asset Pricing Model is an appropriate method of calculating a firm's cost of equity when no dividends are being paid.

TRUE

A bond has a coupon rate of 6 percent and the bond makes semiannual coupon payments. The dollar amount of coupon interest received every six months is

$30.

Stryder, Inc. has 3 million shares outstanding at a current price of $15 per share. The book value of the shares is $10 per share. The firm also has $30 million (based on par value) in bonds outstanding. The bonds are selling at a price equal to 101 percent of par. What is the market value of the firm?

$75.3 million

What is the beta of a firm whose equity has an expected return of 21.3 percent when the risk-free rate of return is 7.0 percent and the expected return on the market is 18.0 percent?

1.30

The Classic Car Co. has a before-tax cost of debt capital of 9%, a cost of preferred stock of 10%, a cost of equity capital of 14%, and a marginal tax rate of 40%. The market values of its debt, preferred stock and common stock are $40 million, $20 million, and $60 million respectively. Therefore, for evaluating average risk projects, the manager should use a discount rate of _____. (Do not round intermediate calculations. Round final answer to two decimal places.)

10.47%.

The cost of capital of a company that uses 45 percent debt that has an after-tax cost of debt of 10 percent and 55 percent equity that has a cost of 15 percent is:

12.75%.

Which of the following is true of the cost of debt?

A firm's interest payments are tax-deductible.

What financial instruments comprise a firm's capital structure?

All of the above

Which of the following capital component costs must be adjusted for taxes?

Cost of debt.

Milton Corp. issued bonds 10 years ago with a coupon rate of 10 percent at a price of $1,000. The current price of the bonds is $980. The before-tax cost of the debt to the firm is still 10 percent.

False

The finance balance sheet is based on market values, just like the accounting balance sheet.

False

The historic cost of long-term debt is the appropriate cost of debt for WACC calculations.

False

When estimating the cost of debt to use in the WACC, which of the following types of debt should be included?

Publicly traded bonds

The cost of equity is equal to the:

Rate of return required by stockholders.

In order to use a firm's WACC to evaluate its future project's cash flows, which of the following must hold?

The project will be financed with the same proportion of debt and equity as the firm, and the systematic risk of the project is the same as the overall systematic risk of the firm.

Systematic risk is the only risk that investors require compensation for bearing.

True

If a company's weighted average cost of capital is less than the required return on equity, then the firm

has debt in its capital structure.

When estimating the risk-free rate to use in the CAPM for determining the firm's cost of equity it is best to use the _____

long-term Treasury bond yield.

Managers should make fairly accurate estimates of their cost of capital so as to_____.

make correct investment decisions.

Maloney's, Inc. has found that its cost of common equity capital is 17 percent and its cost of debt capital is 6 percent. The firm is financed with $3,000,000 of common shares (market value) and $2,000,000 of debt. What is the after-tax weighted average cost of capital for Maloney's, if it is subject to a 40 percent marginal tax rate?

11.64

Melba's Toast has a preferred share issue outstanding with a current price of $19.50. The firm is expected to pay a dividend of $2.34 per share a year from today. What is the firm's cost of preferred equity? (Round your final answer to two decimal places.)

12.00%

The appropriate risk-free rate to use when calculating the cost of equity for a firm is

a long-term Treasury rate.