FIN 325 CH 14 HW

Galvatron Metals has a bond outstanding with a coupon rate of 5.9 percent and semiannual payments. The bond currently sells for $945 and matures in 21 years. The par value is $1,000 and the company's tax rate is 21 percent. What is the company's aftertax cost of debt? A. 5.04% B. 2.98% C. 4.39% D. 3.19% E. 3.83%

A. 5.04% Explanation: $945 = $29.50{1 − [1/(1 + R)^42]}/R + $1,000/R^42 R = .0319, or 3.19% YTM = 3.190% × 2 YTM = 6.38% RD = 6.38%(1 − .21) RD = 5.04%

Phillips Equipment has 6,500 bonds outstanding that are selling at 96.5 percent of par. Bonds with similar characteristics are yielding 6.7 percent, pretax. The company also has 48,000 shares of 5.5 percent preferred stock and 75,000 shares of common stock outstanding. The preferred stock sells for $64 per share. The common stock has a beta of 1.32 and sells for $41 per share. The preferred stock has a stated value of $100. The U.S. Treasury bill is yielding 2.2 percent and the return on the market is 10.6 percent. The corporate tax rate is 21 percent. What is the weighted average cost of capital? A. 8.09% B. 8.64% C. 10.18% D. 9.30% E. 10.56%

A. 8.09% Explanation: RE = .022 + 1.32(.106 − .022) = .13288, or 13.288% RP = (.055)($100)/$64 = .08594, or 8.594% E = 75,000($41) = $3,075,000 P = 48,000($64) = $3,072,000 D = 6,500(.965)($1,000) = $6,272,500 V = $3,075,000 + 3,072,000 + 6,272,500 V = $12,419,500 WACC = ($3,075,000/$12,419,500)(.13288) + ($3,072,000/$12,419,500)(.08594) + ($6,272,500/$12,419,500)(.067)(1 − .21) WACC = .0809, or 8.09%

Take It All Away has a cost of equity of 11.17 percent, a pretax cost of debt of 5.32 percent, and a tax rate of 21 percent. The company's capital structure consists of 65 percent debt on a book value basis, but debt is 31 percent of the company's value on a market value basis. What is the company's WACC? A. 9.01% B. 9.36% C. 8.11% D. 9.98% E. 13.52%

A. 9.01% Explanation: WACC = .69(11.17%) + .31(5.32%)(1 − .21) WACC = 9.01%

Which of the following statements regarding a firm's pretax cost of debt is accurate? A. It is based on the current yield to maturity of the company's outstanding bonds. B. It is equal to the coupon rate on the latest bonds issued by the company. C. It is equivalent to the average current yield on all of a company's outstanding bonds. D. It is based on the original yield to maturity on the latest bonds issued by a company. E. It must be estimated as it cannot be directly observed in the market.

A. It is based on the current yield to maturity of the company's outstanding bonds.

Assume a firm employs debt in its capital structure. Which of the following statements is accurate? A. The WACC would most likely decrease if the firm replaced its preferred stock with debt. B. In the WACC calculation, the weight assigned to preferred stock decreases as the market value of the preferred stock increases. C. The WACC will decrease as the corporate tax rate decreases. D. In the WACC calculation, the weight of equity is based on the number of shares outstanding and the book value per share. E. The WACC will remain constant unless a company retires some of its debt.

A. The WACC would most likely decrease if the firm replaced its preferred stock with debt.

Countess Corporation is expected to pay an annual dividend of $5.17 on its common stock in one year. The current stock price is $78.79 per share. The company announced that it will increase its dividend by 3.50 percent annually. What is the company's cost of equity? A. 10.29% B. 10.06% C. 10.67% D. 9.50% E. 9.78%

B. 10.06% Explanation: RE = ($5.17/$78.79) + .0350 RE = .1006, or 10.06%

Too Young, Incorporated, has a bond outstanding with a coupon rate of 7.2 percent and semiannual payments. The bond currently sells for $1,884 and matures in 18 years. The par value is $2,000. What is the company's pretax cost of debt? A. 8.13% B. 7.81% C. 7.90% D. 8.40% E. 3.84%

B. 7.81% Explanation: $1,884 = $72.00{1 − [1/(1 + R)^36]}/R + $2,000/R^36 R = .0390, or 3.90% YTM = 3.903% × 2 YTM = 7.81%

A firm's aftertax cost of debt will increase if there is a(n): A. decrease in the company's debt-equity ratio. B. decrease in the company's tax rate. C. increase in the credit rating of the company's bonds. D. increase in the company's beta. E. decrease in the market rate of interest.

B. decrease in the company's tax rate

Smathers Corporation stock has a beta of 1.16. The market risk premium is 7.70 percent and the risk-free rate is 3.14 percent annually. What is the company's cost of equity? A. 10.25% B. 8.43% C. 12.07% D. 7.96% E. 8.20%

C. 12.07% Explanation: RE = .0314 + 1.16(.0770) RE = .1207, or 12.07%

Assume Barnes' Boots has a debt-equity ratio of .52. The firm uses the capital asset pricing model to determine its cost of equity. Accordingly, the firm's estimated cost of equity: A. Is affected by the firm's rate of growth projections B. Implies that the firm pays out all of its earnings to shareholders C. is dependent upon a reliable estimate of the market risk premium. D. would be unaffected if the dividend discount model were applied instead E. will be unaffected by changes in overall market risks.

C. is dependent upon a reliable estimate of the market risk premium.

Grill Works has 6 percent preferred stock outstanding that is currently selling for $49 per share. The market rate of return is 14 percent and the tax rate is 21 percent. What is the cost of preferred stock if its stated value is $100 per share? A. 12.77% B. 12.29% C. 12.67% D. 12.24% E. 12.54%

D. 12.24% Explanation: RP = .06($100)/$49 RP = .1224, or 12.24%

Espy Hotels has bonds outstanding that mature in 9 years, pay interest semiannually, and have a coupon rate of 5.5 percent. These bonds have a face value of $1,000 and a current market price of $989.28. What is the company's aftertax cost of debt if its tax rate is 22 percent? A. 5.61% B. 2.19% C. 4.37% D. 5.65% E. 4.41%

E. 4.41% Explanation: $989.28 = [.055($1,000)/2][(1 − {1/[1 + (r/2)]^9(2)})/(r/2)] + $1,000/[1 + (r/2)]^9(2) Using trial and error, a financial calculator, or a computer: r = 5.6536% Aftertax cost of debt = 5.6536%(1 − .22) Aftertax cost of debt = 4.41%

For any given capital project proposal, the discount rate should be based on the: A. Company's overall weighted average cost of capital B. Actual sources of funding used for the project C. Average of the company's overall cost of capital for the past five years D. Current risk level of the overall firm E. Risks associated with the use of the funds required by the project

E. Risks associated with the use of the funds required by the project

Which of the following is the main advantage of using the dividend growth model to estimate a firm's cost of equity? A. The ability to apply either current or future tax rates B. The model's applicability to all corporations. C. The model's consideration of risk. D. The stability of the computed cost of equity over time. E. The simplicity of the model.

E. The simplicity of the model.

When evaluating any capital project proposal, the cost of capital: A. is determined by the overall risk level of the firm. B. is dependent upon the source of the funds obtained to fund that project. C. is dependent upon the firm's overall capital structure. D. should be applied as the discount rate for all other projects considered by the firm. E. depends upon how the funds raised for that project are going to be spent.

E. depends upon how the funds raised for that project are going to be spent.