Financial Management Ch. 14

A​ firm's capital structure consists of which of the​ following? A. Common stock B. Bonds C. Preferred stock D. All of the above

D. All of the above

A company has a capital structure that consists of​ 50% debt and​ 50% equity. Which of the following is generally​ true? A. The cost of equity financing is greater than the cost of debt financing. B. The weighted average cost of capital is less than the cost of equity financing. C. The weighted average cost of capital is calculated on a before−tax basis. D. Both A and B.

D. Both A and B.

Calculate: A firm has an issue of preferred stock that pays an annual dividend of​ $2.00 per share and currently is selling for​ $18.50 per share.​ Finally, the​ firm's marginal tax rate is​ 34%. This​ firm's cost of financing with new preferred stock is

10.81%

Calculate: Sonderson Corporation is undertaking a capital budgeting analysis. The​ firm's beta is 1.5. The rate on 10 year T−Bonds is​ 1.6% and the return on the​ S&P 500 index is​ 8%. What is the appropriate cost of common equity in determining the​ firm's cost of​ capital?

11.2%

Calculate: Metals Corp. has​ $2,575,000 of​ debt, $550,000 of preferred​ stock, and​ $18,125,000 of common equity. Metals​ Corp.'s after−tax cost of debt is​ 5.25%, preferred stock has a cost of​ 6.35%, and newly issued common stock has a cost of​ 14.05%. What is Metals​ Corp.'s weighted average cost of​ capital?

12.78%

Calculate: The expected dividend is​ $2.50 for a share of stock priced at​ $25. What is the cost of common equity if the long−term growth in dividends is projected to be​ 4%?

14%

Calculate: Pony Corporation is undertaking a capital budgeting analysis. The​ firm's beta is 1.5. The rate on 10−year U.S. Treasury bonds is​ 5%, and the return on the S​ & P 500 index is​ 12%. What is the cost of​ Pony's common​ equity?

15.5%

Calculate: ​Alpha's beta is​ 1.06, the present T−bond rate is​ 6%, and the return on the S​ & P 500 is​ 15.25%. What is​ Alpha's cost of common equity using the CAPM​ approach?

15.81%

Calculate: ​Welch's Lawn Care products just paid a dividend of​ $1.85. This dividend is expected to grow at a constant rate of​ 3% per​ year, so the next expected dividend is​ $1.90. The stock price is currently​ $12.50. The​ company's marginal tax rate is​ 35%. Compute the cost of common equity.

18.2%

Calculate: The last paid dividend is​ $2 for a share of common stock that is currently selling for​ $20. What is the cost of common equity if the long−term growth rate in dividends for the firm is expected to be​ 8%?

18.8%

Calculate: Sola Cola Corporation is undertaking a capital budgeting analysis. The rate on 10−year U.S. Treasury bonds is​ 3.60%, and the return on the S​ & P 500 index is​ 11.6%. If the cost of Sola​ Cola's common equity is​ 19.6%, calculate their beta.

2.0

Calculate: Given the following​ information, determine the risk−free rate. Cost of equity​ = 12% Beta​ = 1.50 Market risk premium​ = 6%

3.0%

Calculate: DIY Building Supplies has the following record of paying dividends 2013 --> $1.10 2014 --> $1.15 2015 --> $1.21 2016 --> $1.25 2017 --> $1.28 What are the arithmetic and geometric average growth rates of​ DIY's dividend​ payments?

3.87%, 3.86%

Calculate: ​PVE, Inc. has​ $15 million of debt outstanding with a coupon rate of​ 9%. Currently, the yield to maturity on these bonds is​ 7%. If the​ firm's tax rate is​ 35%, what is the after−tax cost of debt to​ PVE?

4.55%

Calculate: Alpha has an outstanding bond issue that has a​ 7.75% semiannual​ coupon, a current maturity of 20​ years, and sells for​ $967.97. The​ firm's income tax rate is​ 40%. What should Alpha use as an after−tax cost of debt for cost of capital​ purposes?

4.85%

Calculate: Bender and Co. is issuing a​ $1,000 par value bond that pays​ 9% interest annually. Investors are expected to pay​ $918 for the 10−year bond. What is the after−tax cost of debt if the firm is in the​ 34% tax​ bracket?

6.83%

​$ millions Book Values Market Values Accounts Payable ​& Accruals ​$300 (BV) Short−term notes ​$150 (BV) ​$150 (MV) Long−term debt ​$450 (BV) ​$600 (MV) Preferred Stock ​$75 (BV) ​$150 (MV) Common Stock ​$600 (BV) ​$1500 (MV) Total ​$1575 (BV) ​$2400 (MV) Calculate the percentage of common stock in​ Spencer's weighted average cost of capital

62.5%

T/F: The weighted average cost of capital is computed using before−tax costs of each of the sources of financing that a firm uses to finance a project.

False

T/F: The​ firm's weighted average cost of capital includes the cost of common​ stock, preferred stock and retained​ earnings, but not debt.

False

Tropical Fruit Drinks issued​ $10,000,000 in bonds to expand its production facilities. After issuing the​ bonds, the company was​ 60% debt financed and​ 40% common equity financed. Tropical intends to retire​ 20% of the bonds each year for the next 5 years and not to issue any new debt. A. All things​ equal, we would expect Tropical Fruit Drinks cost of capital to increase gradually over the next 5 years. B. All things​ equal, we would expect Tropical Fruit Drinks cost of capital to decrease gradually over the next 5 years. C. All things​ equal, we would expect Tropical Fruit Drinks cost of capital to stay the same for the next five​ years, then increase rapidly. D. All things​ equal, we would expect Tropical Fruit Drinks cost of capital to stay the same for the next 5​ years, then decrease rapidly.

A. All things​ equal, we would expect Tropical Fruit Drinks cost of capital to increase gradually over the next 5 years.

Which of the following best describes a​ firm's cost of​ capital? A. The rate of return that must be earned on its investments in order to satisfy the​ firm's investors B. The coupon rate on preferred stock C. The average cost of the​ firm's assets D. The average yield to maturity on debt

A. The rate of return that must be earned on its investments in order to satisfy the​ firm's investors

Berlioz Inc. is trying to estimate its cost of common​ equity, and it has the following information. The firm has a beta of​ 0.90, the before−tax cost of the​ firm's debt is​ 7.75%, and the firm estimates that the risk−free rate is​ 4% while the current market return is​ 12%. Berlioz stock currently sells for​ $35.00 per share. The firm pays dividends annually and expects dividends to grow at a constant rate of​ 5% indefinitely. The most recent dividend per​ share, paid​ yesterday, is​ $2.00. Finally, the firm has a marginal tax rate of​ 34%. The best estimate of the cost of new common equity is: A. between​ 11.0%. and​ 11.2% B. 11.00%. C. 11.50%. D. between​ 10%. and​ 12%

A. between​ 11.0%. and​ 11.2%

Which of the following reasons causes investors to require a lower rate of return on the​ firm's bonds than on its​ stock? A. Investors pay a lower tax rate on bond interest B. Bondholders bear less risk than common stockholders bear. C. Bondholders have prior voting rights over common stockholders. D. Bondholders receive greater returns than common stockholders.

B. Bondholders bear less risk than common stockholders bear.

Which of the following must be adjusted for the​ firm's tax rate when estimating the weighted average cost of capital​ WACC? A. Cost of preferred stock B. Cost of debt C. Cost of common equity D. All of the above

B. Cost of debt

When calculating the weighted average cost of​ capital, which of the following has to be adjusted for​ taxes? A. Common stock B. Preferred stock C. Debt D. Retained earnings

C. Debt

T/F: No adjustment is made in the cost of preferred stock for taxes since preferred stock dividends are not tax−deductible.

True

The CAPM approach is used to determine the cost of

common equity.

In order to maximize firm​ value, management should invest in new assets when cash flows from the assets are discounted at the​ firm's ________ and result in a positive NPV.

cost of capital

The weights used to determine the relative importance of the​ firm's sources of capital should reflect

current market values

For tax​ purposes, interest on corporate debt is

deductible for the borrower, but not for the investor

The cost of newly issued common stock is greater than the current cost common equity because of

flotation costs on newly issued common stock.

The most expensive source of capital is usually

new common stock.

Calculate: Spencer​ Bioengineering's preferred stock has a par value of​ $100 and pays a dividend of​ $4.50. The current price of​ Spencer's preferred is​ $75. ​ Spencer's tax rate is​ 34%. The before tax and after tax cost of preferred equity to Spencer is

​6.00% ,​ 6.00%