Final Chapter 9

A firm just announced a new preferred stock issue. The preferred dividend, which will be paid in perpetuity, is expected to be $4.10. The price per share of preferred stock is expected to be $37. Given this information, cost of preferred equity in percent? (Round to the nearest hundredth: .00)

Cost of preferred equity: 4.10/37 = 11.08%

Preferred stock holders have priority in dividends over common stock holders. t/f

True

The cost of debt is denoted in percentage terms. (t/f)

true

A company has 75,000 $1,000 face value bonds outstanding that are currently priced at 95% of face value. These bonds have 15 years until maturity and pay an 8% annual coupon rate. If the company has a marginal tax rate that is 40%, what is the company's after tax cost of debtin percent? (Round to the nearest hundredth: .00)

After-Tax Cost of Debt: FV = -1000, PMT = -80, PV = 950, N = 15, CPT I/Y = 8.61%*(1-.40) = 5.16%

A firm just announced a new preferred stock issue. The preferred dividend, which will be paid in perpetuity, is expected to be $4.10. The return required by shareholders is 10%. What is the cost of preferred equity in percent? (Round to the nearest hundredth: .00)

Answer: 10 Cost of preferred equity: 10%

A firm just announced a new preferred stock issue. The preferred dividend, which will be paid in perpetuity, is expected to be $5.85. The price of the preferred stock is expected to be $49 per share. What is the cost of preferred equity in percent? (Round to the nearest hundredth: .00)

Answer: 11.94 Cost of preferred equity: 5.85/49 = 11.94%

Suppose a firm is looking to calculate the cost of common equity using the dividend growth (Gordon) model. The company has just paid a dividend of $4.50 and anticipates growing its dividend at a constant rate of 4% indefinitely. If the current price of the company is valued at $50, what is the cost of common equity in percent (Round to the nearest hundredth: .00)

Answer: 13.36 Cost of Common Equity: Re = [4.50(1.04)]/50 + .04 = 13.36

A company is planning to issue a new $1,000 face value bond that will mature in 10 years. The price of the bond is expected to be $950 and the annual coupon rate is 7.5%. If flotation costs are $12 per bond, what is the before-tax cost of debt in percent? (Round to the nearest hundredth: .00)

Answer: 8.44 Cost of debt: (FV = -1000, PMT = -75, PV = 950-12=938, N = 10, CPT I/Y= 8.44%) 8.44%

A firm just announced a new preferred stock issue. The preferred dividend, which will be paid in perpetuity, is expected to be $2. The return required by shareholders is 9.5%. What is the cost of preferred equity in percent? (Round to the nearest hundredth: .00)

Answer: 9.5 Cost of preferred equity: 9.5%

According to the survey of nearly 400 Chief Financial Officers discussed in the topic, which of the following methods do firms use as methods of calculating the cost of common equity? Arithmetic Mean Dividend Discount (Gordon) model Capital Asset Pricing Model All of these choices

Answer: All of these choices

Flotation costs are costs that are incurred when management miscalculates the cost of capital. (t/f)

Answer: False Flotation costs are costs associated with the issuance of new equity or debt - often due to underwriting fees.

If a firm has its credit rating downgraded, the cost of debt will increase thus lowering the weighted average cost of capital. (t/f)

Answer: False If the cost of debt increases it will result in an increase in the

Preferred stock carries voting rights. t/f

Answer: False Unlike common stock, preferred stock does not generally have voting rights.

According to the survey of nearly 400 Chief Financial Officers discussed in the topic, which of the following methods do firms NOT use as methods of calculating the cost of common equity? Dividend Discount (Gordon) model Capital Asset Pricing Model Perpetuity Dividend Model All of these choices are used

Answer: Perpetuity Dividend Model

If an already heavily levered firm increases its debt even further, the weighted average cost of capital will likely increase. (t/f)

Answer: True If a highly levered firm takes on more debt, it becomes a riskier investment and investors will likely require a higher return.

A company is planning to issue new equity in order to raise capital. The current share price is $45 and the company is planning to pay a dividend of $2.50 and grow the dividend at a constant rate of 6% per year, indefinitely. If flotation costs are $3 per share, what is the cost of common equity? (Round to the nearest hundredth: .00)

Cost of common equity: 2.50/(45-3) + .06 = 11.95%

A company has 100,000 $1,000 face value bonds outstanding that are currently priced at 95% of face value. What is the market value of the company's debt?

Market Value of Debt = Price*bonds outstanding = $950*100,000 = $95,000,000

A company can lower its WACC by increasing the percentage of total debt made up from long-term debt. (t/f)

false

According to a survey by Graham and Harvey (2001), the dividend discount (Gordon) model is more widely used to calculate the cost of common equity by firms than the Capital Asset Pricing Model. (t/f)

false

As flotation costs become more expensive, using internal equity will become more costly than using external equity. (t/f)

false

Flotation costs are higher when management is more inexperienced. (t/f)

false

If a firm increases the amount of dividends it will pay to shareholders, then the cost of capital will likely decrease. (t/f)

false

The WACC is denoted in dollar terms. (t/f)

false

The cost of debt is usually considered the return required by shareholders. (t/F)

false

If marginal tax rates increase, the after-tax cost of debt will increase. (t/f)

false An increase in the marginal tax rate reduces the after tax cost of debt.

Using internal equity will increase the WACC more than using external equity. (t/f)

false Since the issuance of external equity needs to account for floatation costs, it generally costs more.

Holding all else equal, as the length until maturity increases, the yields on bonds decreases. (t/f)

false A longer length to maturity implies greater risk so yields on bonds will actually increase as time to maturity increases.

If a firm expects it growth rate on its dividends to increase, then the firm's cost of capital is likely to decrease. (t/f)

false If the dividend growth rate is higher, this will increase the CAPM (or cost of common equity) which will result in an overall higher WACC.

Upon bankruptcy, preferred stock holders do not have claim on the assets of the firm. t/f

t

A firm that is financed with both internal and external equity will have a WACC that is higher when flotation costs are higher. (t/f)

true

According to a survey by Graham and Harvey (2001), the Capital Asset Pricing Model is the most widely used method for calculating the cost of common equity. (t/f)

true

Finding the cost of preferred stock requires the use of the perpetuity model. t/f

true

Flotation costs are costs that are incurred when companies issue new securities. (t/f)

true

Flotation costs are paid to firms that underwrite the new security issues. (t/F0

true

If a firm gains greater exposure to systematic risk, then the cost of capital will likely increase. (t/f)

true

Short-term bonds generally have lower yields than long-term bonds, holding everything else constant. (t/f)

true

The after-tax cost of debt is equal to the yield to maturity on a company's bonds multiplied by 1 minus the marginal tax rate. (t/f)

true

The cost of common equity is defined as the return required by common shareholders. (t/f)

true

The reason that using external equity is more costly than using internal equity is because of flotation costs. (t/f)

true

A company's WACC will increase if the company reduces the percentage of its total debt made up from short-term debt. (t/f)

true A company's WACC will increase if the company reduces the percentage of its total debt made up from ST debt." The text states that LT debt will have higher yields to maturity than ST bonds (due to risk from the longer term nature of the debt). So if a firm decreases its use of ST debt and instead uses LT debt... it is actually decreasing its use of a lower YTM and increasing its use of a higher YTM resulting in an overall increase to the WACC.

If a firm refinances its debt and extends the length of maturity on all of its bonds, then the cost of capital will increase. (t/f)

true Since bonds with longer time to maturity have more risk, this will increase the YTM on the bonds resulting in an overall higher WACC.

If market interest rates increase, then a firm's cost of capital will likely increase. (t/f)

tue