Finance Homework 11

Which one of the following will affect the capital structure weights used to compute a firm's weighted average cost of capital? Increase in the market value of the firm's common stock Increase in the firm's beta Increase in the market risk premium Decrease in a firm's tax rate Decrease in the book value of a firm's equity

Increase in the market value of the firm's common stock

Which statement is true? Preferred stock is generally the cheapest source of capital for a firm. An increase in the market value of preferred stock will increase a firm's weighted average cost of capital. The cost of preferred stock is unaffected by the issuer's tax rate. The cost of preferred stock remains constant from year to year. Preferred stock is valued using the capital asset pricing model.

the cost of preferred stock is unaffected by the issuer's tax rate

The Green Balloon just paid its first annual dividend of $.87 a share. The firm plans to increase the dividend by 3.2 percent per year indefinitely. What is the firm's cost of equity if the current stock price is $4.75 a share? 19.98 percent 20.35 percent 24.42 percent 22.10 percent 18.79 percent

22.10 percent Re = ($.87× 1.032) / $4.75 + .032 = .2210, or 22.10 percent

The 7.5 percent preferred stock of Rock Bottom Floors is selling for $84 a share. What is the firm's cost of preferred stock if the tax rate is 35 percent and the par value per share is $100? 10.79 percent 8.13 percent 8.93 percent 7.50 percent 9.14 percent

8.93 percent Rp = (.075 ×$100)/$84 = .0893, or 8.93 percent

The cost of preferred stock: increases when a firm's tax rate decreases. increases as the price of the stock increases. is unaffected by changes in the market price of the stock. is constant over time. is equal to the stock's dividend yield.

is equal to the stock's dividend yield.

Tennessee Valley Antiques would like to issue new equity shares if its cost of equity declines to 12.5 percent. The company pays a constant annual dividend of $2.10 per share. What does the market price of the stock need to be for the firm to issue the new shares? $16.80 $15.60 $15.10 $17.90 $18.40

$16.80 P0 = $2.10 /.125 = $16.80

Musical Charts just paid an annual dividend of $1.84 per share. This dividend is expected to increase by 2.1 percent annually. Currently, the firm has a beta of 1.12 and a stock price of $31 a share. The risk-free rate is 4.3 percent and the market rate of return is 13.2 percent. What is the cost of equity capital for this firm? 11.95 percent 11.21 percent 13.28 percent 12.29 percent 13.42 percent

11.21 percent RE= .043 + 1.12(.132-.043)] = .14268 RE = [($1.84× 1.021) / $31] + .021 = .08160 Average RE = (.14268 + .08160)/2 = .1121, or 11.21 percent

S&W has 21,000 shares of common stock outstanding at a price of $29 a share. It also has 2,000 shares of preferred stock outstanding at a price of $71 a share. The firm has 7 percent, 12-year bonds outstanding with a total market value of $386,000. The bonds are currently quoted at 100.6 percent of face and pay interest semiannually. What is the capital structure weight of the firm's preferred stock if the tax rate is 34 percent? 1.84 percent 12.49 percent 8.24 percent 9.00 percent 13.63 percent

12.49 percent Common stock = 21,000 × $29 = $609,000 Preferred stock = 2,000 × $71 = $142,000 Debt = $386,000 Value = $609,000 + 142,000 + 386,000 = $1,137,000 Weight of preferred= $142,000/$1,137,000 = .1249, or 12.49 percent

The common stock of Contemporary Interiors has a beta of 1.13 and a standard deviation of 21.4 percent. The market rate of return is 12.7 percent and the risk-free rate is 4.1 percent. What is the cost of equity for this firm? 11.76 percent 13.82 percent 14.40 percent 12.08 percent 13.05 percent

13.82 percent RE= .041 + 1.13 ×(.127-.041) = .1382, or 13.82 percent

K's Bridal Shoppe has 4,000 shares of common stock outstanding at a price of $13 a share. It also has 500 shares of preferred stock outstanding at a price of $22 a share. There are 50 bonds outstanding that have a semiannual coupon payment of $25. The bonds mature in four years, have a face value of $1,000, and sell at 98 percent of par. What is the capital structure weight of the common stock? 48.20 percent 48.15 percent 50.08 percent 49.68 percent 46.43 percent

46.43 percent Common stock = 4,000 × $13 = $52,000 Preferred stock = 500 × $22 = $11,000 Debt = 50 × (.98 × $1,000) = $49,000 Value = $52,000 + 11,000 + 49,000 = $112,000 Weight of common stock = $52,000/$112,000 = .4643, or 46.43 percent

K's Bridal Shoppe has 4,000 shares of common stock outstanding at a price of $13 a share. It also has 500 shares of preferred stock outstanding at a price of $22 a share. There are 50 bonds outstanding that have a semiannual coupon payment of $25. The bonds mature in four years, have a face value of $1,000, and sell at 98 percent of par. What is the capital structure weight of the common stock? 50.08 percent 48.20 percent 49.68 percent 46.43 percent 48.15 percent

46.43% Common stock = 4,000 × $13 = $52,000 Preferred stock = 500 × $22 = $11,000 Debt = 50 × (.98 × $1,000) = $49,000 Value = $52,000 + 11,000 + 49,000 = $112,000 Weight of common stock = $52,000/$112,000 = .4643, or 46.43 percent

Great Lakes Packing has two bond issues outstanding. The first issue has a coupon rate of8 percent, matures in 6 years, has a total face value of $5 million, and is quoted at 101.2 percent of face value. The second issue has a 7.5 percent coupon, matures in 13 years, has a total face value of $18 million, and is quoted at 99 percent of face value. Both bonds pay interest semiannually. What is the firm's weighted average aftertax cost of debt if the tax rate is 34 percent? 5.12 percent 5.05 percent 6.08 percent 5.63 percent 5.95 percent

5.05 percent $1,012 = ([(.08× $1,000) / 2] × ({1 - 1 / [1 + (RD / 2)]12} / (RD / 2))+ $1,000 / [1 + (RD/ 2)]12 RD =7.7462 percent $990 = ([(.075 × $1,000) / 2] × ({1 - 1 / [1 + (RD / 2)]26} / (RD / 2))+ $1,000 / [1 + (RD/ 2)]26 RD = 7.6226 percent Market values: ($5m × 1.012) + ($18m × .99) = $5.06 + 17.82m = $22.88m Aftertax cost of debt = [($5.06/$22.88)(.077462) + ($17.82m /$22.88m)(.076226] × (1 -.34) = .0505, or 5.05 percent

Electronic Products has 22,500 bonds outstanding that are currently quoted at 101.6. The bonds mature in 8 years and pay an annual coupon payment of $90. What is the firm's aftertax cost of debt if the applicable tax rate is 34 percent? 5.47 percent 6.98 percent 6.67 percent 4.79 percent 5.75 percent

5.75 percent $1,016 = $90 ×({1 - [1 / (1 + RD )8]} / RD) + $1,000 / (1 + RD)8 RD = 8.714 percent Aftertax cost of debt = 8.714 percent ×(1 -.34) = .0575, or 5.75 percent

Three years ago, the Morgan Co. issued 15-year, 6.5 percent semiannual coupon bonds at par. Today, the bonds are quoted at 100.6. What is this firm's pretax cost of debt? 6.29 percent 6.83 percent 6.43 percent 6.08 percent 6.27 percent

6.43 percent $1,006= [(.065 ×$1,000) / 2] ×({1 - 1 / [1 + (RD / 2)]24} / (RD / 2))+ $1,000 / [1 + (RD / 2)]24 RD = 6.43 percent

Which one of the following statements is correct? Assume the pretax cost of debt is less than the cost of equity. A decrease in a firm's debt-equity ratio will decrease the firm's cost of capital. The cost of preferred stock decreases when the tax rate increases. A firm may change its capital structure if the government changes its tax policies. A decrease in the dividend growth rate increases the cost of equity. A decrease in the systematic risk of a firm will increase the firm's cost of capital.

A firm may change its capital structure if the government changes its tax policies.

Which one of the following represents the minimum rate of return a firm must earn on its assets if it is to maintain the current value of its securities? Aftertax cost of debt Weighted average cost of capital Weighted average cost of preferred and common stock Pretax cost of debt Cost of equity

Weighted average cost of capital

Lester lent money to The Corner Store by purchasing bonds issued by the store. The rate of return that he and the other lenders require is referred to as the: cost of equity. pure play cost. weighted average cost of capital. subjective cost. cost of debt.

cost of debt.

Trendsetters has a cost of equity of 14.6 percent. The market risk premium is 8.4 percent and the risk-free rate is 3.9 percent. The company is acquiring a competitor, which will increase the company's beta to 1.4. What effect, if any, will the acquisition have on the firm's cost of equity capital? Increase of 1.06 percent Decrease of .84 percent Decrease of .62 percent No effect Increase of .13 percent

increase of 1.06% RE= .039 + 1.4(.084) = .1566, or 15.66 percent Increase in cost of equity = 15.66 percent -14.6 percent = 1.06 percent

Assume a firm has a beta of 1.2. All else held constant, the cost of equity for this firm will increase if the: beta decreases. either the risk-free rate or the market rate of return decreases. risk-free rate decreases. market rate of return decreases. market risk premium decreases.

risk-free rate decreases.

Which one of the following is used as the pretax cost of debt? Average current yield on the firm's outstanding debt Weighted average yield to maturity on the firm's outstanding debt Coupon rate on the firm's latest bond issue Average coupon rate on the firm's outstanding bonds Annual interest divided by the market price per bond for the latest bond issue

weighted average yield to maturity on the firm's outstanding debt