fin final ch 11

Judy's Boutique just paid an annual dividend of $1.65 on its common stock. The firm increases its dividend by 2.5 percent annually. What is the rate of return on this stock if the current stock price is $38.20 a share?

6.93 percent RE = [($1.65(1.025)/$38.2] + .025 RE = 0.06927, or 6.93

Claus Enterprises has 174,000 shares of common stock outstanding at a current price of $46 a share. The firm also has two bond issues outstanding. The first bond issue has a total face value of $250,000, pays 7.7 percent interest annually, and currently sells for 102.5 percent of face value. The second bond issue consists of 5,000 bonds that are selling for $993 each. These bonds pay 6.5 percent interest annually and mature in 8 years. The tax rate is 34 percent. What is the capital structure weight of the firm's common stock?

60.52 percent

Sunshine Cruises issues only common stock and coupon bonds. The firm has a debt-equity ratio of 0.55. The cost of equity is 16.3 percent and the pre-tax cost of debt is 9.9 percent. What is the capital structure weight of the firm's equity if the firm's tax rate is 34 percent?

64.52 percent

Four years ago, the Moore Co. issued 15-year, 7.5 percent semiannual coupon bonds at par. Today, the bonds are quoted at 101.6. What is this firm's pre-tax cost of debt?

7.29 percent

Catnip Stores has a $20 million bond issue outstanding that currently has a market value of $18.6 million. The bonds mature in 6.5 years and pay semiannual interest payments of $30 each. What is the firm's pre-tax cost of debt?

7.37 percent

Katie owns 100 shares of ABC stock. Which one of the following terms is used to refer to the return that Katie and the other shareholders require on their investment in ABC?

Cost of equity

Which one of the following will decrease the aftertax cost of debt for a firm?

Increase in tax rates

Which one of the following will increase the cost of equity, all else held constant?

Increase in the dividend growth rate

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

Jet Setters has a cost of equity of 17.8 percent. The market risk premium is 10.2 percent and the risk-free rate is 4.4 percent. The company is acquiring a competitor, which will increase the company's beta to 1.6. What effect, if any, will the acquisition have on the firm's cost of equity capital?

Increase of 2.92 percent ew cost of equity capital = 4.4% + 1.6*10.2%= 20.72% iNCREASE= 20.72% -17.8%= 2.92%

In an efficient market, the cost of equity for a risky firm does which one of the following according to the security market line?

Increases in direct relation to the stock's systematic risk

A firm has a cost of equity of 13 percent, a cost of preferred of 11 percent, and an aftertax cost of debt of 6 percent. Given this, which one of the following will increase the firm's weighted average cost of capital?

Increasing the firm's beta

Which one of the following is the primary determinant of an investment's cost of capital?

Level of risk

The computation of which one of the following requires assigning every proposed investment to a particular risk class?

Subjective cost of capital

The cost of debt for a firm will decrease for:

an increase in tax rates

The cost of capital depends primarily on:

the use of funds

The minimum rate of return that the firm must earn on a new project with risk levelsimilar to that of the firm is given by:

the weighted average cost of capital

The proportional cost of equity plus the proportional after-tax cost of debt is called the:

weighted average cost of capital

All else constant, an increase in a firm's cost of debt:

will result in an increase in the firm's cost of capital.

Farm Equipment, Inc. announced this morning that its next annual dividend will be decreased to $1.80 a share and that all future dividends will be decreased by an additional 1.5 percent annually. What is the current value per share of this stock if the required return is 16.5 percent?

$10 P= D1/(k+g) = 1.8/(.165+.015) =1.8/.18 =10

A firm wants to create a weighted average cost of capital (WACC) of 10.4 percent. The firm's cost of equity is 14.5 percent and its pre-tax cost of debt is 8.5 percent. The tax rate is 34 percent. What does the debt-equity ratio need to be for the firm to achieve its target WACC?

0.86

Brewster's is considering a project that is equally as risky as the firm's current operations. The firm has a cost of equity of 13.7 percent and a pre-tax cost of debt of 8.4 percent. The debt-equity ratio is .65 and the tax rate is 36 percent. What is the cost of capital for this project?

10.42 percent

The 8.5 percent preferred stock of Deltona, Inc. is selling for $73 a share. What is the firm's cost of preferred if its tax rate is 35 percent and the par value per share is $100?

11.64 percent

Musical Charts just paid an annual dividend of $2.45 per share. This dividend is expected to increase by 3.3 percent annually. Currently, the firm has a beta of 1.09 and a stock price of $36 a share. The risk-free rate is 4.2 percent and the market rate of return is 12.6 percent. What is the cost of equity capital for this firm?

11.84 percent 36= 2.45(1.033)/(r-.033)= 0.1033= 10.33 (Gordon Growth) 4.2 +1.09* (12.6-4.2)= 13.356 (Capital Asset pricing model) Answer is the average of the two methods (10.33+13.356)/2= 11.84%

Fancee Restaurant's cost of equity is 15.3 percent and its aftertax cost of debt is 6.1 percent. What is the firm's weighted average cost of capital if its debt-equity ratio is 0.58 and the tax rate is 30 percent?

11.92 percent

Western Electric has 23,000 shares of common stock outstanding at a price per share of $57 and a rate of return of 14.2 percent. The firm has 6,000 shares of 7 percent preferred stock outstanding at a price of $48 a share. The preferred stock has a par value of $100. The outstanding debt has a total face value of $350,000 and currently sells for 102 percent of face. The yield-to-maturity on the debt is 8.49 percent. What is the firm's weighted average cost of capital if the tax rate is 34 percent?

12.69 percent

The General Store has a cost of equity of 15.8 percent, a pre-tax cost of debt of 7.7 percent, and a tax rate of 32 percent. What is the firm's weighted average cost of capital if the debt-equity ratio is 0.40?

12.78 percent

The preferred stock of Pollard's Pools pays an annual dividend of $5.50 a share and sells for $42 a share. The tax rate is 34 percent. What is the firm's cost of preferred stock?

13.10 percent

The 7.5 percent preferred stock of Tanners Floors is selling for $57 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?

13.16 percent

The market rate of return is 14.8 percent and the risk-free rate is 4.45 percent. Galaxy Co. has 54 percent more systematic risk than the overall market and has a dividend growth rate of 5.5 percent. The firm's stock is currently selling for $39 a share and has a dividend yield of 3.6 percent. What is the firm's cost of equity?

14.73 percent RE = 0.0445 + 1.54(0.148 - 0.0445)] = 0.20389 RE = 0.036 + 0.055 = 0.091 Average RE = (0.20389 + 0.091)/2 = 14.73 percent

High Valley Antiques would like to issue new equity shares if its cost of equity declines to 10.5 percent. The company pays a constant annual dividend of $1.60 per share. What does the market price of the stock need to be for the firm to issue the new shares?

15.24 The price of the share would be calculated as - Price of share = Annual constant dividend / Cost of equity Given, cost of equity = 10.5 % Annual constant dividend = $ 1.60 Price of share = $ 1.60 ÷ 10.50 % Price of share = $ 15.238 or $ 15.24

The common stock of Yanderloft and Sons has a beta that is 25 percent larger than the overall market beta. Currently, the market risk premium is 9.2 percent while the U.S. Treasury bill is yielding 4.7 percent. What is the cost of equity for this firm?

16.20 percent Re = 0.047 + 1.25(0.092) = 16.20 percent

The 7.5 percent preferred stock of Home Town Brews is selling for $43 a share. What is the firm's cost of preferred stock if the tax rate is 34 percent and the par value per share is $100?

17.44 percent

Chesterfield and Weston has 55,000 shares of common stock outstanding at a price of $31 a share. It also has 3,000 shares of preferred stock outstanding at a price of $62 a share. The firm has 8 percent, 12-year bonds outstanding with a total face value of $400,000. The bonds are currently quoted at 101.2 percent of face and pay interest semiannually. What is the capital structure weight of the firm's debt if the tax rate is 35 percent?

17.63 percent

The common stock of Modern Interiors has a beta of 1.61 and a standard deviation of 27.4 percent. The market rate of return is 13.2 percent and the risk-free rate is 4.8 percent. What is the cost of equity for this firm?

18.32 Re=0.048+[.132-.048] (1.61)=18.3%

Appalachian Mountain Goods has paid increasing dividends of $.0.12, $0.18, $0.20, and $0.25 a share over the past four years, respectively. The firm estimates that future increases in its dividends will be equal to the arithmetic average growth rate over these past four years. The stock is currently selling for $12.60 a share. The risk-free rate is 3.2 percent and the market risk premium is 9.1 percent. What is the cost of equity for this firm if its beta is 1.26?

22.96 percent

Christie's Train Shoppe has 15,000 shares of common stock outstanding at a price of $11 a share. It also has 2,000 shares of preferred stock outstanding at a price of $34 a share. There are 50 bonds outstanding that have a 7.5 percent semiannual coupon. The bonds mature in 6 years, have a face value of $1,000, and sell at 96 percent of par. What is the capital structure weight of the preferred stock?

24.20 percent

ABC. Corp has a bond issue outstanding with a quoted price of $ 1,013.00 per bond.The bonds mature in 9 years and carry a 7% coupon rate with semiannual payments.What is the firm's aftertax cost of debt if the tax rate is 34%?Notice that the after-tax cost of debt = Yield to maturity × (1- Tax rate)

4.49 percent

Vineyard Wines issued 15-year bonds, 3 years ago. The bonds have a 6.75 percent coupon and pay interest semiannually. Currently, these bonds are selling at 97.8 percent of face value. What is the after-tax cost of debt if the tax rate is 34 percent?

4.64 percent

Great Lakes Packing has two bond issues outstanding. The first issue has a coupon rate of 9 percent, matures in 3 years, has a total face value of $6 million, and is quoted at 108 percent of face value. The second issue has a 7.5 percent coupon, matures in 16 years, has a total face value of $18 million, and is quoted at 97 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 35 percent?

4.78 percent

The Green Balloon just paid its first annual dividend of $0.12 a share. The firm plans to increase the dividend by 3.5 percent per year indefinitely. What is the firm's cost of equity if the current stock price is $6.50 a share?

5.41 ((0.12*(1+0.035))/6.5 )+0.035 =0.0191+0.035 =0.0541

Major Manufacturing issued 30-year, 8.5 percent semiannual bonds 6 years ago. The bonds currently sell at 101 percent of face value. What is the firm's aftertax cost of debt if the tax rate is 35 percent?

5.46 percent

Hi Tech Products has 35,000 bonds outstanding that are currently quoted at 102.3. The bonds mature in 11 years and carry a 9 percent annual coupon. What is the firm's aftertax cost of debt if the applicable tax rate is 35 percent?

5.63 percent

Winter Wear, Inc. has 6 percent bonds outstanding that mature in 13 years. The bonds pay interest semiannually and have a face value of $1,000. Currently, the bonds are selling for $993 each. What is the firm's pre-tax cost of debt?

6.08 percent

Birds and Yards has 10-year bonds outstanding that carry an annual coupon of 8 percent. The bonds mature in 7 years and are currently priced at 108.4 percent of face value. What is the firm's pre-tax cost of debt?

6.47 percent

Aaron's Rentals has 58,000 shares of common stock outstanding at a market price of $36 a share. The common stock just paid a $1.64 annual dividend and has a dividend growth rate of 2.8 percent. There are 12,000 shares of 6 percent preferred stock outstanding at a market price of $51 a share. The preferred stock has a par value of $100. The outstanding bonds mature in 17 years, have a total face value of $750,000, a face value per bond of $1,000, and a market price of $1,011 each. The bonds pay 8 percent interest, semiannually. The tax rate is 34 percent. What is the firm's weighted average cost of capital?

7.74 percent

ABC. Corp has a bond issue outstanding that currently has a market value of $1,026per bond. The bonds mature in fourteen years. The coupon rate is 9% and the paymentsare semiannually. What is the pre-tax cost of Debt?Notice that the pre-tax cost of debt is the bond Yield to maturity.

8.68 percent

The Cracker Mill has a beta of 0.97, a dividend growth rate of 3.2 percent, a stock price of $33 a share, and an expected annual dividend of $1.06 per share next year. The market rate of return is 11.2 percent and the risk-free rate is 3.7 percent. What is the firm's cost of equity?

8.69 percent

The Bird House just paid its annual dividend of $1.46 a share and will increase all future dividends by 3.5 percent annually. What is the firm's cost of equity if its stock is currently selling for $24.50 a share?

9.67 percent

Which one of the following statements is correct, all else held constant?

A decrease in a firm's WACC will increase the attractiveness of the firm's investment options.

Derek's is a brick-and-mortar toy store. The firm is considering expanding its operations to include Internet sales. Which one of the following would be the best firm to use in a pure play approach to analyzing this proposed expansion?

A toy store that only sells online

Boone Brothers remodels homes and replaces windows. Ace Builders constructs new homes. If Boone Brothers considers expanding into new home construction, it should evaluate the expansion project using which one of the following as the required return for the project?

Ace Builders' cost of capital

A firm has multiple divisions of similar nature, yet varying degrees of risk. Which one of the following would be the most appropriate, yet relatively easy, means of assigning discount rates to each of its proposed investments?

Assign every project a rate equal to the firm's WACC plus or minus a subjective adjustment

Which of the following is a correct statement about the Weighted Average Cost of Capital WACC: I- The WACC uses the after-tax cost of debt II- For a leveraged firm, the higher the tax-rate the lower the WACC III- The cost of debt is the after tax coupon rate for a bond

I and II

Which of the following features are advantages of the dividend growth model? I. easy to understand II. model simplicity III. constant dividend growth rate IV. model's applicability to all common stocks

I and II only

All else constant, which of the following will increase the after-tax cost of debt for a firm? I. increase in the yield to maturity of the firm's outstanding debt II. decrease in the yield to maturity of the firm's outstanding debt III. increase in the firm's tax rate IV. decrease in the firm's tax rate

I and IV only

All else constant, which of the following will increase the aftertax cost of debt for a firm? I. increase in the yield to maturity of the firm's outstanding debt II. decrease in the yield to maturity of the firm's outstanding debt III. increase in the firm's tax rate IV. decrease in the firm's tax rate

I and IV only

The aftertax cost of which of the following are affected by a change in a firm's tax rate? I. preferred stock II. debt III. equity IV. capital

II and IV only

Which of the following are weaknesses of the dividend growth model? I. market risk premium fluctuations II. lack of dividends for some firms III. reliance on historical beta IV. sensitivity of model to dividend growth rate

II and IV only

Which of the following will increase the cost of equity for a firm with a beta of 1.1? I. decrease in the security's beta II. decrease in the market risk premium III. decrease in the risk-free rate IV. increase in the risk-free rate

III only

Farmer's Supply, Inc. is considering opening a clothing store, which would be a new line of business for the firm. Management has decided to use the cost of capital of a similar clothing store as the discount rate that should be used to evaluate this proposed expansion. Which one of the following terms is used to describe the approach Farmer's Supply is taking to establish an appropriate discount rate for the project?

Pure play approach

Kelly's uses the firm's weighted average cost of capital (WACC) as the required return for some of its projects. For other projects, the firms uses a rate equal to WACC plus 1 percent, while another set of projects is assigned rates equal to WACC minus some amount. Which one of the following factors should be the key factor the firm uses to determine the amount of the adjustment it will make when assigning the project a discount rate?

Risk level of project

Ted is trying to decide what cost of capital he should assign to a project. Which one of the following should be his primary consideration in this decision?

Risk level of the project

Which one of the following is most apt to cause a wise manager to increase a project's cost of capital? Assume the firm is levered.

She learns the project is riskier than previously believed.

Kate is the CFO of a major firm and has the job of assigning discount rates to each project that is under consideration. Kate's method of doing this is to assign an incrementally higher rate as the risk level of the project increases over that of the current firm. Likewise, she assigns lower rates as the risk level declines. Which one of the following approaches is Kate using to assign the discount rates?

Subjective approach

Which one of the following statements is correct? A. An increase in the market value of preferred stock will increase a firm's weighted average cost of capital. B. The cost of preferred stock is unaffected by the issuer's tax rate. C. Preferred stock is generally the cheapest source of capital for a firm. D. The cost of preferred stock remains constant from year to year.

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

Which one of the following statements is correct? 1) An increase in the market value of preferred stock will increase a firm's weighted average cost of capital. 2) The cost of preferred stock is unaffected by the issuer's tax rate. 3) Preferred stock is generally the cheapest source of capital for a firm. 4) The cost of preferred stock remains constant from year to year. 5) Preferred stock is valued using the capital asset pricing model.

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

Which one of the following represents the rate of return a firm must earn on its assets if it is to maintain the current value of its securities?

Weighted average cost of capital

Which one of the following is the pre-tax cost of debt?

Weighted average yield-to-maturity on the firm's outstanding debt

Old Town Industries has three divisions. Division X has been in existence the longest and has the most stable sales. Division Y has been in existence for five years and is slightly less risky than the overall firm. Division Z is the research and development side of the business. When allocating funds, the firm should probably:

assign the highest cost of capital to division Z because it is most likely the riskiest of the three divisions.

A firm uses its weighted average cost of capital to evaluate the proposed projects for all of its varying divisions. By doing so, the firm:

automatically gives preferential treatment in the allocation of funds to its riskiest division.

When using the pure play approach for a proposed investment, a firm is primarily seeking a rate of return which:

best matches the risk level of the proposed investment.

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 debt.

The return that stockholders require on their investment in a firm is referred to as the:

cost of equity

The weighted average cost of capital is defined as the weighted average of a firm's:

cost of equity and its aftertax cost of debt.

The cost of debt is based on the:

creditor's required rate on new debt