FRL301 Ch.14 Test Bank
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?
$2.26 D1 = [(0.18 - (-0.015)) $11.40] = $2.223; D0 = $2.223/(1 - 0.015) = $2.26
The Bakery is considering a new project it considers to be a little riskier than its current operations. Thus, management has decided to add an additional 1.5 percent to the company's overall cost of capital when evaluating this project. The project has an initial cash outlay of $62,000 and projected cash inflows of $17,000 in year one, $28,000 in year two, and $30,000 in year three. The firm uses 25 percent debt and 75 percent common stock as its capital structure. The company's cost of equity is 15.5 percent while the aftertax cost of debt for the firm is 6.1 percent. What is the projected net present value of the new project?
-$5,964 WACCFirm = (0.75 0.155) + (0.25 0.061) = 0.1315 WACCProject = 0.1315 + 0.015 = 0.1465 NPV = -$62,000 + ($17,000/1.1465) + ($28,000/1.14652) + ($30,000/1.14653) = -$5,964
Fama's Llamas has a weighted average cost of capital of 10.5 percent. The company's cost of equity is 15.5 percent, and its pretax cost of debt is 8.5 percent. The tax rate is 34 percent. What is the company's target debt-equity ratio?
1.02 WACC = 0.105 = 0.155(E/V) + (0.085) (D/V) (1 - 0.34) 0.105(V/E) = 0.155 + 0.085(0.66) (D/E) 0.105(1 + D/E) = 0.155 + 0.0561(D/E) D/E = 1.02
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?
10.6 percent Re = (0.106 - 0.087) + (1.00 0.087) = 10.6 percent
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?
10.67 percent N 17x2 IY /2 PV -870 PMT 90/2 FV 1000 Solve for IY: 10.67
Decker's is a chain of furniture retail stores. Furniture Fashions is a furniture maker and a supplier to Decker's. Decker's has a beta of 1.38 as compared to Furniture Fashion's beta of 1.12. The risk-free rate of return is 3.5 percent and the market risk premium is 8 percent. What discount rate should Decker's use if it considers a project that involves the manufacturing of furniture?
12.46 percent Re = 0.035 + 1.12(0.08) = 12.46 percent
Cookie Dough Manufacturing has a target debt-equity ratio of 0.5. Its cost of equity is 15 percent, and its cost of debt is 11 percent. What is the firm's WACC given a tax rate of 31 percent?
12.53 percent WACC = (1/1.5)(0.15) + (0.5/1.5)(0.11)(1 - 0.31) = 12.53 percent
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?
19.44 percent Rp = (0.07 $100)/$36 = 19.44 percent
Jiminy's Cricket Farm issued a 30-year, 8 percent, semiannual bond 6 years ago. The bond currently sells for 114 percent of its face value. What is the aftertax cost of debt if the company's tax rate is 31 percent?
4.70 percent ENTER N: 24x2 IY /2 PV -1140 PMT 80/2 FV 1000 Solve for IY 6.81 0.0681(1-0.31)= 4.7%
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?
45.16 percent
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?
6.11 percent N 7x2 IY /2 PV -1014 PMT 90/2 FV 1000 Solve for IY: 8.7285 Aftertax R(d)= 0.087285x(1-0.30)=6.11%
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?
6.12 percent N 9x2 IY /2 PV -420 FV 1000 Solve for IY: 9.8749 Aftertax R(d): 0.0998749x(1-0.38)=6.12
Decline, Inc. is trying to determine its cost of debt. The firm has a debt issue outstanding with 15 years to maturity that is quoted at 107 percent of face value. The issue makes semiannual payments and has an embedded cost of 11 percent annually. What is the aftertax cost of debt if the tax rate is 33 percent?
6.76 percent Enter: N 15x2 IY /2 PV -1070 PMT 110/2 FV 1000 Solve for IY 10.085 R(D Aftertax) 0.10085(1-0.33)= 6.76%
Chelsea Fashions is expected to pay an annual dividend of $0.80 a share next year. The market price of the stock is $22.40 and the growth rate is 5 percent. What is the firm's cost of equity?
8.57 percent R(e)= ($0.8/$22.4) + 0.5 = 8.57%
Which one of the following statements is correct? A. Firms should accept low risk projects prior to funding high risk projects. B. Making subjective adjustments to a firm's WACC when determining project discount rates unfairly punishes low-risk divisions within a firm. C. A project that is unacceptable today might be acceptable tomorrow given a change in market returns. D. The pure play method is most frequently used for projects involving the expansion of a firm's current operations. E. Firms that elect to use the pure play method for determining a discount rate for a project cannot subjectively adjust the pure play rate.
A project that is unacceptable today might be acceptable tomorrow given a change in market returns.
If a firm uses its WACC as the discount rate for all of the projects it undertakes then the firm will tend to: I. reject some positive net present value projects. II. accept some negative net present value projects. III. favor high risk projects over low risk projects. IV. increase its overall level of risk over time.
I, II, III, and IV
The weighted average cost of capital for a firm may be dependent upon the firm's: I. rate of growth. II. debt-equity ratio. III. preferred dividend payment. IV. retention ratio.
I, II, III, and IV
The dividend growth model can be used to compute the cost of equity for a firm in which of the following situations? I. firms that have a 100 percent retention ratio II. firms that pay a constant dividend III. firms that pay an increasing dividend IV. firms that pay a decreasing dividend
II, III, and IV only
Which one of the following statements is correct for a firm that uses debt in its capital structure?
The WACC should decrease as the firm's debt-equity ratio increases.
Morris Industries has a capital structure of 55 percent common stock, 10 percent preferred stock, and 45 percent debt. The firm has a 60 percent dividend payout ratio, a beta of 0.89, and a tax rate of 38 percent. Given this, which one of the following statements is correct?
The firm's cost of equity is unaffected by a change in the firm's tax rate.
Which one of the following statements related to the SML approach to equity valuation is correct? Assume the firm uses debt in its capital structure.
The model is dependent upon a reliable estimate of the market risk premium.
All else constant, which one of the following will increase a firm's cost of equity if the firm computes that cost using the security market line approach? Assume the firm currently pays an annual dividend of $1 a share and has a beta of 1.2.
a reduction in the risk-free rate
The capital structure weights used in computing the weighted average cost of capital:
are based on the market value of the firm's debt and equity securities.
Preston Industries has two separate divisions. Each division is in a separate line of business. Division A is the largest division and represents 70 percent of the firm's overall sales. Division A is also the riskier of the two divisions. Division B is the smaller and least risky of the two. When management is deciding which of the various divisional projects should be accepted, the managers should:
assign appropriate, but differing, discount rates to each project and then select the projects with the highest net present values.
The subjective approach to project analysis:
assigns discount rates to projects based on the discretion of the senior managers of a firm.
Flotation costs for a levered firm should:
be weighted and included in the initial cash flow.
Scholastic Toys is considering developing and distributing a new board game for children. The project is similar in risk to the firm's current operations. The firm maintains a debt-equity ratio of 0.40 and retains all profits to fund the firm's rapid growth. How should the firm determine its cost of equity?
by using the capital asset pricing model
Textile Mills borrows money at a rate of 13.5 percent. This interest rate is referred to as the:
cost of debt.
A group of individuals got together and purchased all of the outstanding shares of common stock of DL Smith, Inc. What is the return that these individuals require on this investment called?
cost of equity
A firm's cost of capital:
depends upon how the funds raised are going to be spent.
The aftertax cost of debt:
has a greater effect on a firm's cost of capital when the debt-equity ratio increases.
A firm's overall cost of equity is:
highly dependent upon the growth rate and risk level of the firm.
The cost of equity for a firm:
ignores the firm's risks when that cost is based on the dividend growth model.
Incorporating flotation costs into the analysis of a project will:
increase the initial cash outflow of the project.
When a firm has flotation costs equal to 7 percent of the funding need, project analysts should:
increase the initial project cost by dividing that cost by (1 - 0.07).
The cost of preferred stock:
is equal to the dividend yield.
The dividend growth model:
is only as reliable as the estimated rate of growth.
The weighted average cost of capital for a wholesaler:
is the return investors require on the total assets of the firm.
Assigning discount rates to individual projects based on the risk level of each project:
may cause the firm's overall weighted average cost of capital to either increase or decrease over time.
When a manager develops a cost of capital for a specific project based on the cost of capital for another firm which has a similar line of business as the project, the manager is utilizing the _____ approach.
pure play
The weighted average cost of capital for a firm is the:
rate of return a firm must earn on its existing assets to maintain the current value of its stock.
The cost of preferred stock is computed the same as the:
return on a perpetuity.
The discount rate assigned to an individual project should be based on:
the risks associated with the use of the funds required by the project.
The flotation cost for a firm is computed as:
the weighted average of the flotation costs associated with each form of financing.
Which one of the following is the primary determinant of a firm's cost of capital?
use of the funds
The average of a firm's cost of equity and aftertax cost of debt that is weighted based on the firm's capital structure is called the:
weighted average cost of capital
Yesteryear Productions is considering a project with an initial start up cost of $960,000. The firm maintains a debt-equity ratio of 0.50 and has a flotation cost of debt of 6.8 percent and a flotation cost of equity of 11.4 percent. The firm has sufficient internally generated equity to cover the equity cost of this project. What is the initial cost of the project including the flotation costs?
$982,265 Average flotation cost = (1/1.5) (0.0) + (0.5/1.5) (0.068) = 0.0226667 Initial cost = $960,000/(1 - 0.0226667) = $982,265
Sister Pools sells outdoor swimming pools and currently has an aftertax cost of capital of 11.6 percent. Al's Construction builds and sells water features and fountains and has an aftertax cost of capital of 10.8 percent. Sister Pools is considering building and selling its own water features and fountains. The sales manager of Sister Pools estimates that the water features and fountains would produce 20 percent of the firm's future total sales. The initial cash outlay for this project would be $85,000. The expected net cash inflows are $16,000 a year for 7 years. What is the net present value of the Sister Pools project?
-$9,115
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?
-4.51 percent ($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 = -0.136364 g = (0.034483 + 0.041667 - 0.12 - 0.136364)/4 = -4.51 percent
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?
1.07 percent Increase in cost of equity = (1.60 - 1.48) 0.089 = 1.07 percent
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?
10.12 percent Re = 0.025 + (1.12 0.068) = 10.12 percent
Mullineaux Corporation has a target capital structure of 41 percent common stock, 4 percent preferred stock, and 55 percent debt. Its cost of equity is 19 percent, the cost of preferred stock is 6.5 percent, and the pre-tax cost of debt is 7.5 percent. What is the firm's WACC given a tax rate of 34 percent?
10.77 percent WACC = 0.41(0.19) + (0.04)(.065) + (0.55)(.075)(1 - 0.34) = 10.77 percent
Granite Works maintains a debt-equity ratio of 0.65 and has a tax rate of 32 percent. The firm does not issue preferred stock. The pre-tax cost of debt is 9.8 percent. There are 25,000 shares of stock outstanding with a beta of 1.2 and a market price of $19 a share. The current market risk premium is 8.5 percent and the current risk-free rate is 3.6 percent. This year, the firm paid an annual dividend of $1.10 a share and expects to increase that amount by 2 percent each year. Using an average expected cost of equity, what is the weighted average cost of capital?
9.20 percent Re = 0.036 + 1.2(0.085) = 0.138 Re = [($1.10 1.02)/$19] + 0.02 = 0.0790526 Re Average = (0.138 + 0.0790526)/2 = 0.108526 WACC = (1/1.65) (0.108526) + (0.65/1.65) (0.098) (1 - 0.32) = 9.20 percent
Which of the following statements are correct? I. The SML approach is dependent upon a reliable measure of a firm's unsystematic risk. II. The SML approach can be applied to firms that retain all of their earnings. III. The SML approach assumes a firm's future risks are similar to its past risks. IV. The SML approach assumes the reward-to-risk ratio is constant.
II, III, and IV only
Phil's is a sit-down restaurant that specializes in home-cooked meals. Theresa's is a walk-in deli that specializes in specialty soups and sandwiches. Both firms are currently considering expanding their operations during the summer months by offering pre-wrapped donuts, sandwiches, and wraps at a local beach. Phil's currently has a WACC of 14 percent while Theresa's WACC is 10 percent. The expansion project has a projected net present value of $12,600 at a 10 percent discount rate and a net present value of -$2,080 at a 14 percent discount rate. Which firm or firms should expand and offer food at the local beach during the summer months?
both Phil's and Theresa's
Markley and Stearns is a multi-divisional firm that uses its WACC as the discount rate for all proposed projects. Each division is in a separate line of business and each presents risks unique to those lines. Given this, a division within the firm will tend to:
prefer higher risk projects over lower risk projects.
You are evaluating a project which requires $230,000 in external financing. The flotation cost of equity is 11.6 percent and the flotation cost of debt is 5.4 percent. What is the initial cost of the project including the flotation costs if you maintain a debt-equity ratio of 0.45?
$254,638 Average flotation cost = (1/1.45) (0.116) + (0.45/1.45) (0.054) = 0.0967586 Initial cost = $230,000/(1 - 0.0967586) = $254,638
Western Wear is considering a project that requires an initial investment of $274,000. The firm maintains a debt-equity ratio of 0.40 and has a flotation cost of debt of 7 percent and a flotation cost of equity of 10.5 percent. The firm has sufficient internally generated equity to cover the equity portion of this project. What is the initial cost of the project including the flotation costs?
$279,592 Average flotation cost = (1/1.40) (0) + (0.40/1.40) (0.07) = 0.02 Initial cost = $274,000/(1 - 0.02) = $279,592
Carson Electronics uses 70 percent common stock and 30 percent debt to finance its operations. The aftertax cost of debt is 5.4 percent and the cost of equity is 15.4 percent. Management is considering a project that will produce a cash inflow of $36,000 in the first year. The cash inflows will then grow at 3 percent per year forever. What is the maximum amount the firm can initially invest in this project to avoid a negative net present value for the project?
$382,979 WACC = 0.70(0.154) + 0.30(0.054) = 0.124 PV = $36,000/(0.124 - 0.03) = $382,979
The Daily Brew has a debt-equity ratio of 0.72. The firm is analyzing a new project which requires an initial cash outlay of $420,000 for equipment. The flotation cost is 9.6 percent for equity and 5.4 percent for debt. What is the initial cost of the project including the flotation costs?
$455,738 Average flotation cost = (1/1.72) (0.096) + (0.72/1.72) (0.054) = 0.0784186 Initial cost = $420,000/(1 - 0.0784186) = $455,738
Kelso's has a debt-equity ratio of 0.55 and a tax rate of 35 percent. The firm does not issue preferred stock. The cost of equity is 14.5 percent and the aftertax cost of debt is 4.8 percent. What is the weighted average cost of capital?
11.06 percent WACC = (1/1.55) (0.145) + (0.55/1.55) (0.048) = 11.06 percent
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?
11.56 percent Re = (0.106 - 0.075) + (1.38 0.075) = 0.1345 Re = [($0.94 1.045)/$19] + 0.045 = 0.0967 Re Average = (0.1345 + 0.0967)/2 = 11.56 percent
Central Systems, Inc. desires a weighted average cost of capital of 8 percent. The firm has an aftertax cost of debt of 4.8 percent and a cost of equity of 15.2 percent. What debt-equity ratio is needed for the firm to achieve its targeted weighted average cost of capital?
2.25 WACC = 0.08 = [We 0.152] + [(1 - We) 0.048)] We = 0.3077; Wd = 1 - We = 0.6923 Debt-equity ratio = 0.6923/0.3077 = 2.25
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
3.77 percent N 8 PV -989 PMT 60 FV 1000 Solve for IY: 6.1784 Aftertax R(d)= 0.061784x(1-0.39)=3.77
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?
5.66 percent N 8x2 IY /2 PV -640 FV 1000 Solve for IY: 5.66
Which one of the following statements is correct? A. The subjective approach assesses the risks of each project and assigns an adjustment factor that is unique just for that project. B. Overall, a firm makes better decisions when it uses the subjective approach than when it uses its WACC as the discount rate for all projects. C. Firms will correctly accept or reject every project if they adopt the subjective approach. D. Mandatory projects should only be accepted if they produce a positive NPV when the firm's WACC is used as the discount rate. E. The pure play approach should only be used with low-risk projects.
Overall, a firm makes better decisions when it uses the subjective approach than when it uses its WACC as the discount rate for all projects.
The pre-tax cost of debt:
is based on the current yield to maturity of the firm's outstanding bonds.
Panelli's is analyzing a project with an initial cost of $102,000 and cash inflows of $65,000 in year one and $74,000 in year two. This project is an extension of the firm's current operations and thus is equally as risky as the current firm. The firm uses only debt and common stock to finance its operations and maintains a debt-equity ratio of 0.45. The aftertax cost of debt is 4.8 percent, the cost of equity is 12.7 percent, and the tax rate is 35 percent. What is the projected net present value of this project?
$17,840 WACC = (1/1.45) (0.127) + (0.45/1.45) (0.048) = 0.102483 NPV = -$102,000 + ($65,000/1.102483) + ($74,000/1.1024832) = $17,840
Travis & Sons has a capital structure which is based on 40 percent debt, 5 percent preferred stock, and 55 percent common stock. The pre-tax cost of debt is 7.5 percent, the cost of preferred is 9 percent, and the cost of common stock is 13 percent. The company's tax rate is 39 percent. The company is considering a project that is equally as risky as the overall firm. This project has initial costs of $325,000 and annual cash inflows of $87,000, $279,000, and $116,000 over the next three years, respectively. What is the projected net present value of this project?
$76,011.23 WACC = (0.55 0.13) + (0.05 0.09) + [0.40 0.075 (1 - 0.39)] =0.0943 NPV -$325,000 + ($87,000/1.0943) + ($279,000/1.09432) + ($116,000/1.09433) = $76,011.23
Phillips Equipment has 80,000 bonds outstanding that are selling at par. Bonds with similar characteristics are yielding 6.75 percent. The company also has 750,000 shares of 7 percent preferred stock and 2.5 million shares of common stock outstanding. The preferred stock sells for $53 a share. The common stock has a beta of 1.34 and sells for $42 a share. The U.S. Treasury bill is yielding 2.8 percent and the return on the market is 11.2 percent. The corporate tax rate is 38 percent. What is the firm's weighted average cost of capital?
10.39 percent Re = 0.028 + 1.34 (0.112 - 0.028) = 0.14056 Rp = (0.07 $100)/$53 = 0.13208 Debt: .028 + 1.34(.112-.028) = 0.14056 Preferred: 75000 x 53= 39.75m Common 2.5m x 42= 105m Total: 224.75m WACC= (105m/224.75m)(0.14056) = (39.75m/224.75m)(-.13208) + (80m/224.75m)(0.0675)(1-0.38)= 10.39%
The Oil Derrick has an overall cost of equity of 13.6 percent and a beta of 1.28. The firm is financed solely with common stock. The risk-free rate of return is 3.4 percent. What is an appropriate cost of capital for a division within the firm that has an estimated beta of 1.18?
12.80 percent 0.136 = 0.034 + 1.28mrp; mrp = 0.0796875 ReDivision = 0.034 + 1.18(0.0796875) = 12.80 percent
Wayco Industrial Supply has a pre-tax cost of debt of 7.6 percent, a cost of equity of 14.3 percent, and a cost of preferred stock of 8.5 percent. The firm has 220,000 shares of common stock outstanding at a market price of $27 a share. There are 25,000 shares of preferred stock outstanding at a market price of $41 a share. The bond issue has a face value of $550,000 and a market quote of 101.2. The company's tax rate is 37 percent. What is the firm's weighted average cost of capital?
12.81 percent
Delta Lighting has 30,000 shares of common stock outstanding at a market price of $17.50 a share. This stock was originally issued at $31 per share. The firm also has a bond issue outstanding with a total face value of $280,000 which is selling for 86 percent of par. The cost of equity is 16 percent while the aftertax cost of debt is 6.9 percent. The firm has a beta of 1.48 and a tax rate of 30 percent. What is the weighted average cost of capital?
13.14 percent Common: 30000 x 17.5= 525000 Debt: 280000 x 0.86= 240000 Total= 756800
Silo Mills has a beta of 0.87 and a cost of equity of 11.9 percent. The risk-free rate of return is 2.8 percent. The firm is currently considering a project that has a beta of 1.03 and a project life of 6 years. What discount rate should be assigned to this project?
13.57 percent. RE = 0.119 = 0.028 + (0.87 mrp); mrp = 0.1046 RProject = 0.028 + (1.03 0.1046) = 13.57 percent
Stock in Country Road Industries has a beta of 0.97. The market risk premium is 10 percent while T-bills are currently yielding 5.5 percent. Country Road's most recent dividend was $1.70 per share, and dividends are expected to grow at a 7 percent annual rate indefinitely. The stock sells for $32 a share. What is the estimated cost of equity using the average of the CAPM approach and the dividend discount approach?
13.94 percent RE = 0.055 + 0.97(0.10) = 0.152 RE = [($1.70 1.07)/$32] + 0.07 = 0.12684375 RE Average = (0.152 + 0.12684375)/2 = 13.94 percent
The Market Outlet has a beta of 1.38 and a cost of equity of 14.945 percent. The risk-free rate of return is 4.25 percent. What discount rate should the firm assign to a new project that has a beta of 1.25?
13.94 percent. RE = 0.14945 = 0.0425 + (1.38 mrp); mrp = 0.0775 RProject = 0.0425 + (1.25 0.0775) = 13.94 percent
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?
14.42 percent Rp = (0.075 $100)/$52 = 14.42 percent
The City Street Corporation's common stock has a beta of 1.2. The risk-free rate is 3.5 percent and the expected return on the market is 13 percent. What is the firm's cost of equity?
14.9 percent RE = 0.035 + 1.2(0.13 - 0.035) = 14.9 percent
Suppose your company needs $14 million to build a new assembly line. Your target debt-equity ratio is 0.84. The flotation cost for new equity is 9.5 percent, but the floatation cost for debt is only 2.5 percent. What is the true cost of building the new assembly line after taking flotation costs into account?
14.94 million fA = (1/1.84)(0.095) + (0.84/1.84) (0.025) = 0.063043 Amount raised = $14m/(1 - 0.063043) = $14.94 million
Miller Sisters has an overall beta of 0.64 and a cost of equity of 11.2 percent for the firm overall. The firm is 100 percent financed with common stock. Division A within the firm has an estimated beta of 1.08 and is the riskiest of all of the firm's operations. What is an appropriate cost of capital for division A if the market risk premium is 9.5 percent?
15.38 percent 0.112 = rf + 0.64(0.095); rf = 0.0512 ReDivision = 0.0512 + 1.08(0.095) = 15.38 percent
Jungle, Inc. has a target debt-equity ratio of 0.72. Its WACC is 11.5 percent and the tax rate is 34 percent. What is the cost of equity if the aftertax cost of debt is 5.5 percent?
15.82 percent WACC = 0.115 = (1/1.72) RE + (0.72/1.72)(0.055); RE = 15.82 percent
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?
16.33 percent Rp = (0.08 $100)/$49 = 16.33 percent
Titan Mining Corporation has 14 million shares of common stock outstanding, 900,000 shares of 9 percent preferred stock outstanding and 210,000 ten percent semiannual bonds outstanding, par value $1,000 each. The common stock currently sells for $34 per share and has a beta of 1.15, the preferred stock currently sells for $80 per share, and the bonds have 17 years to maturity and sell for 91 percent of par. The market risk premium is 11.5 percent, T-bills are yielding 7.5 percent, and the firm's tax rate is 32 percent. What discount rate should the firm apply to a new project's cash flows if the project has the same risk as the firm's typical project?
16.41 percent MVD = 210,000 ($1,000) (0.91) = $191,100,000 MVE = 14,000,000 ($34) = $476,000,000 MVP = 900,000 ($80) = $72,000,000 V = $191,100,000 + $476,000,000 + $72,000,000 = $739,100,000 D/V = $191,100,000/$739,100,000 = 0.258558 E/V = $476,000,000/$739,100,000 = 0.644027 P/V = $72,000,000/$739,100,000 = 0.097416 RE = 0.075 + 1.15(0.115) = 0.20725 RP = $9/$80 = 0.1125 Enter N 17x2 IY /2 PV -910 PMT 100/2 FV 1000 Solve for IY: 11.19514 R(Aftertax): 0.1119514(1-0.32)= 0.076127 WACC= 0.644027(0.20725) + 0.097416(0.1125) + 0.258558(0.076127)= 16.14%
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?
3.78 percent N 13 PV -1040 PMT 60 FV 1000 Solve for IY: 5.5597 Aftertax R(d)= 0.055597 x (1-0.32) = 3.78
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?
3.98 percent Enter N 20x2 IY /2 PV -1,140 PMT 50/2 FV 1000 Solve for IY: 3.98
Holdup Bank has an issue of preferred stock with a $5 stated dividend that just sold for $92 per share. What is the bank's cost of preferred?
5.43 percent RP = $5/$92 = 5.43 percent
Electronics Galore has 950,000 shares of common stock outstanding at a market price of $38 a share. The company also has 40,000 bonds outstanding that are quoted at 106 percent of face value. What weight should be given to the debt when the firm computes its weighted average cost of capital?
54 percent Debt: 40000 x 1000 x 1.06 = 42.4M Common: 950000 x 38 = 36.1M Total: 42.4M + 36.1M = 78.5M Weight(Debt): 42.4M/78.5M
R.S. Green has 250,000 shares of common stock outstanding at a market price of $28 a share. Next year's annual dividend is expected to be $1.55 a share. The dividend growth rate is 2 percent. The firm also has 7,500 bonds outstanding with a face value of $1,000 per bond. The bonds carry a 7 percent coupon, pay interest semiannually, and mature in 7.5 years. The bonds are selling at 98 percent of face value. The company's tax rate is 34 percent. What is the firm's weighted average cost of capital?
6.2 percent Debt: 7500 x .98= 7.35m Common: 250000 x 28= 7m Total: 14.35m R(e)= (1.55/28) + 0.02= 0.075357 Enter: N 7.5x2 IY /2 PV -980 PMT 70/2 FV 1000 Solve for IY: 7.35166 WACC: (7m/14.35m)(0.075457) + (7.35m/14.35m)(0.0735166)(1-0.34)= 6.2%
Bleakly Enterprises has a capital structure of 55 percent common stock, 10 percent preferred stock, and 35 percent debt. The flotation costs are 4.5 percent for debt, 7 percent for preferred stock, and 9.5 percent for common stock. The corporate tax rate is 34 percent. What is the weighted average flotation cost?
7.5 percent Average flotation cost = (0.55 0.095) + (0.10 0.07) + (0.35 0.045) = 7.5 percent
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?
7.93 percent ($0.70 - $0.65)/$0.65 = 0.076923 ($0.72 - $0.70)/$0.70 = 0.028571 ($0.75 - $0.72)/$0.72 = 0.041667 g = (0.076923 + 0.028571 + 0.041667)/3 = .049054 Re = [($0.75 1.049054)/$26] + .049054 = 7.93 percent
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?
8.68 percent e = [($1.15 1.025)/$19.06] + 0.025 = 8.68 percent
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?
8.80 percent
Justice, Inc. has a capital structure which is based on 30 percent debt, 5 percent preferred stock, and 65 percent common stock. The flotation costs are 11 percent for common stock, 10 percent for preferred stock, and 7 percent for debt. The corporate tax rate is 37 percent. What is the weighted average flotation cost?
9.75 percent Average flotation cost = (0.65 0.11) + (0.05 0.10) + (0.30 0.07) = 9.75 percent
The aftertax cost of debt generally increases when: I. a firm's bond rating increases. II. the market rate of interest increases. III. tax rates decrease. IV. bond prices rise.
II and III only
Deep Mining and Precious Metals are separate firms that are both considering a silver exploration project. Deep Mining is in the actual mining business and has an aftertax cost of capital of 12.8 percent. Precious Metals is in the precious gem retail business and has an aftertax cost of capital of 10.6 percent. The project under consideration has initial costs of $575,000 and anticipated annual cash inflows of $102,000 a year for ten years. Which firm(s), if either, should accept this project?
neither Company A or Company B NPV= -575000 + 1022000 x (1-[1/(1+0.128)^10]/0.128)= 17071 Neither company should accept this project as the applicable discount rate for both firms is 12.8 percent and the NPV is negative at this discount rate.
Wilderness Adventures specializes in back-country tours and resort management. Travel Excitement specializes in making travel reservations and promoting vacation travel. Wilderness Adventures has an aftertax cost of capital of 13 percent and Travel Excitement has an aftertax cost of capital of 11 percent. Both firms are considering building wilderness campgrounds complete with man-made lakes and hiking trails. The estimated net present value of such a project is estimated at $87,000 at a discount rate of 11 percent and -$12,500 at a 13 percent discount rate. Which firm or firms, if either, should accept this project?
neither Wilderness Adventures nor Travel Excitement
