SU 8
Under frost-free conditions, Cal Cultivators expects its strawberry crop to have a $60,000 market value. An unprotected crop subject to frost has an expected market value of $40,000. If Cal protects the strawberries against frost, then the market value of the crop is still expected to be $60,000 under frost-free conditions and $90,000 if there is a frost. What must be the probability of a frost for Cal to be indifferent to spending $10,000 for frost protection?
.200
The data presented below show actual figures for selected accounts of McKeon Company for the fiscal year ended May 31, Year 1, and selected budget figures for the Year 2 fiscal year. McKeon's controller is in the process of reviewing the Year 1 figures and calculating some key ratios based on the actual figures. (Round all calculations to three decimal places if necessary.) McKeon Company's debt ratio for Year 2 is
0.315
Shank Co. has a debt-to-asset ratio of 0.4 and $6,000,000 equity. Shank is seeking capital to fund a construction project costing $6,500,000 and is considering funding the project by both bank borrowings and additional common stock issuance. The current debt covenant requires Shank to fund any project by incurring a maximum of 30% debt. If Shank funds the project with the maximum permitted debt, the debt-to-equity ratio will be
0.56 ($4,000,000+$1,950,000)÷($6,000,000+$4,550,000)
Southern Corp. has a debt-to-equity ratio of 1.75 and total assets of $275 million. Southern is considering issuing another $20 million of debt and another $20 million of equity. What will be Southern's debt-to-equity ratio after the issuance?
1.63
Which one of the following statements is true when comparing bond financing alternatives?
A call provision is generally considered detrimental to the investor.
The graph above depicts a relationship between the price and the quantity of a good. The movement depicted by the arrow could be caused by
A decrease in the cost of inputs to the production process
Which of the following corporate characteristics would favor debt financing versus equity financing?
A high tax rate.
Joint Products, Inc., a corporation with a 40% marginal tax rate, plans to issue $1,000,000 of 8% preferred stock in exchange for $1,000,000 of its 8% bonds currently outstanding. The firm's total liabilities and equity are equal to $10,000,000. The effect of this exchange on the firm's weighted-average cost of capital is likely to be
An increase, since a portion of the debt payments are tax deductible.
A corporation paid a dividend of $3 per share last year. If investors expected the dividend per share to grow by 5% per year forever, what required return of investors is consistent with a current share price of $63 per share?
10%
A company has income after tax of $5.4 million, interest expense of $1 million for the year, depreciation expense of $1 million, and a 40% tax rate. What is the company's times-interest-earned ratio?
10.0
Debentures are
Bonds secured by the full faith and credit of the issuing firm.
Bander Co. is determining how to finance some long-term projects. Bander has decided it prefers the benefits of no fixed charges, no fixed maturity date, and an increase in the credit-worthiness of the company. Which of the following would best meet Bander's financing requirements?
Common stock.
An analyst expects a company to pay a dividend of $5 with a dividend growth rate of 3%. The inflation rate is expected to fall from 5% per year to 3% per year. As a result of the change in the inflation premium, the company's
Cost of equity will likely decrease.
Unless the shares are specifically restricted, a holder of common stock with a preemptive right may share proportionately in all of the following except
Cumulative dividends.
he following is information about three companies: Which company would be considered least risky from a creditor's viewpoint?
XYZ, because the debt ratio is the lowest. ABC, XYZ, and KLM are 40% ($44,000 ÷ $109,000), 33% ($150,000 ÷ $450,000), and 53% ($450,000 ÷ $850,000)
Which of the following positions best describes the nature of the board of directors of XYZ Co.'s relationship to the company?
Fiduciary.
Which of the following types of bonds is most likely to maintain a constant market value?
Floating-rate.
Which one of the following is not a determinant in valuing a call option?
Forward contract price.
Which of the following components of control contribute most to a strong control environment?
Management adheres to control policies.
A firm's target or optimal capital structure is consistent with which one of the following?
Minimum weighted-average cost of capital.
From an investor's viewpoint, the least risky type of bond in which to invest is a(n)
Mortgage bond.
Sen Corp., a publicly-traded, mid-cap company, wanted to obtain $30 million in new capital to expand its Iowa plant. Cost of capital was a factor in making the decision. Sen Corp. could either issue new preferred stock or new debentures. Sen Corp.'s underwriter estimated that preferred stock should have an annual dividend payout of $6 and an issue price of $103 per share. The debentures should have a coupon interest rate of 9% and an issue price of $101. Sen Corp.'s marginal income tax rate was 40%. Which of the following approaches describes Sen Corp.'s best strategy?
Sen Corp. should issue the debentures since the after-tax cost of debt (5.347%) would be less than the cost of equity (5.825%).
Domestic content rules
Tend to be imposed by capital-intensive countries.
An individual holds a 10-year fixed-rate bond as an investment. Three years of its life remain. When the bond was issued, interest rates were much higher than they are now. Interest rates are expected to be stable for the next 3 years. Which of the following statements is correct regarding the bond?
The bond is currently selling at a premium.
Larson Corp. issued $20 million of long-term debt in the current year. What is a major advantage to Larson with regards to the debt issuance?
The relatively low after-tax cost due to the interest deduction.
Protectionism has been justified using the strategic trade policy argument. Its premise is that
The risk of domestic product development should be reduced.
Future payments must be discounted in a bond valuation in order to take into account the
Time value of money.
What would be the primary reason for a company to agree to a debt covenant limiting the percentage of its long-term debt?
To reduce the interest rate on the bonds being sold.
Each share of nonparticipating, 8%, cumulative preferred stock in a company that meets its dividend obligations has all of the following characteristics except
Voting rights in corporate elections.
If k is the cost of debt and t is the marginal tax rate, the after-tax cost of debt, ki, is best represented by the formula
ki = k(1 - t)
During the year just ended, Deet Corp. experienced the following power outages: Each power outage results in out-of-pocket costs of $400. For $500 per month, Deet can lease an auxiliary generator to provide power during outages. If Deet leases an auxiliary generator for the current year, the estimated savings (or additional expenditures) would be
$1,600
A corporation just paid a dividend of $2.00 per common share. Historical data indicate that dividends grow at a steady rate of 5% per year. The required rate of return for investing in such stock is 18%. The current value of one share of common stock is
$16.15 2.00 dividend × (1 + .05 2.10 next dividend ÷ (18% cost of capital - 5%
The payoff table below reflects the supply of, and demand for, an entity's product in the next year. Without perfect information, the entity chooses the supply level with the highest expected payoff. What is the expected value of perfect information?
$18 (0 × 0.1) + (20 × 0.4) + (40 × 0.3) + (60 × 0.2)=32 (-40 × 0.1) + (20 × 0.4) + (20 × 0.3) + (20 × 0.2)=14 32-14=18
During the past few years, Wilder Company has experienced the following average number of power outages: Each power outage results in out-of-pocket costs of $800. For $1,000 per month, Wilder can lease a generator to provide power during outages. If Wilder leases a generator in the coming year, the estimated savings (or additional expense) for the year will be
$3,200
Scarf Corporation's controller has decided to use a decision model to cope with uncertainty. With a particular proposal, currently under consideration, Scarf has two possible actions, invest or not invest in a joint venture with an international firm. The controller has determined the following. Which one of the following alternatives correctly reflects the respective expected values of investing versus not investing?
$300,000 and $(100,000).
If Tonya used $10,000 from her savings account, which was paying 5% interest annually, to invest in a coffee shop, the opportunity cost of this investment annually would be
$500
How much must the stock be worth at expiration in order for a call holder to break even if the exercise price is $60 and the call premium was $3?
$63.00
Bates Corp. has $100,000 in bonds payable with a fair market value of $120,000. It also has 1,000 shares of common stock issued at $50 per share with a fair market value of $80 per share. What amount represents the corporation's market capitalization?
$80,000 1,000 × 80
A company is conducting a risk analysis on a project. One task has a risk probability estimated to be 0.15. The task has a budget of $35,000. If the risk occurs, it will cost $6,000 to correct the problem caused by the risk event. What is the expected monetary value of the risk event?
$900
A beverage stand can sell either soft drinks or coffee on any given day. If the stand sells soft drinks and the weather is hot, it will make $2,500; if the weather is cold, the profit will be $1,000. If the stand sells coffee and the weather is hot, it will make $1,900; if the weather is cold, the profit will be $2,000. The probability of cold weather on a given day at this time is 60%. The expected payoff for selling coffee is
1,960
The common stock of a company is currently selling at $80 per share. The leadership of the company intends to pay a $4 per share dividend next year. With the expectation that the dividend will grow at 5% perpetually, what will the market's required return on investment be for the common stock?
10% 4 ÷ $80=5% 5%+5%(growth)
Maloney, Inc.'s $1,000 par-value preferred stock paid its $100 per share annual dividend on April 4 of the current year. The preferred stock's current market price is $960 a share on the date of the dividend distribution. Maloney's marginal tax rate (combined federal and state) is 40%, and the firm plans to maintain its current capital structure. The component cost of preferred stock to Maloney would be closest to
10.4 100/960
Thomas Company's capital structure consists of 30% long-term debt, 25% preferred stock, and 45% common equity. The cost of capital for each component is shown below. Long-term debt 8% Preferred stock 11% Common equity 15% If Thomas pays taxes at the rate of 40%, what is the company's after-tax weighted-average cost of capital?
10.94% Long-term debt 30%×4.8%=1.44% Preferred stock 25%×11.0%=2.75% Common equity 45%×15.0%=6.75%
Dividends are equal to $5, and the current share price is $50. Dividends are expected to grow at 2% forever. According to the dividend growth model, what is the investor's required rate of return?
12.2%
Kielly Machines, Inc., is planning an expansion program estimated to cost $100 million. Kielly is going to raise funds according to its target capital structure shown below. Kielly had net income available to common shareholders of $184 million last year of which 75% was paid out in dividends. The company has a marginal tax rate of 40%. What is Kielly's weighted-average cost of capital?
12.22% 11% × (1.0 - .40 tax rate)=6.6 Debt $ 30,000,000 30%×6.6%=1.98% Preferred stock 24,000,000 24%×12.0%=2.88% Common equity 46,000,000 46%×16.0%=7.36%
Global Company Press has $150 par-value preferred stock with a market price of $120 a share. The organization pays a $15 per share annual dividend. Global's current marginal tax rate is 40%. Looking to the future, the company anticipates maintaining its current capital structure. What is the component cost of preferred stock to Global?
12.5% 15 ÷ $120
Following is an excerpt from Albion Corporation's balance sheet. Long-term debt (9% effective interest rate) $30,000,000 Preferred stock (100,000 shares, 12% dividend) 10,000,000 Common stock (5,000,000 shares outstanding) 60,000,000 The market value of Albion's debt and equity is equal to the carrying amount. Albion's treasurer estimates that the firm's cost of common equity is 17% and cost of preferred stock is 12%. If Albion's effective income tax rate is 40%, what is the firm's cost of capital?
13.0%
A company provides the following financial information: Cost of equity 20% Cost of debt 8% Tax rate 40% Debt-to-equity ratio 0.8 What is the company's weighted-average cost of capital?
13.3%
What is the after-tax cost of preferred stock that sells for $5 per share and offers a $0.75 dividend when the tax rate is 35%?
15% .75/5
A manufacturer of printers is attempting to determine its cost of common equity for cost of capital purposes. The manufacturer's long-term debt is rated AA by Standard & Poor's. The manufacturer's common shares trade on the NASDAQ and the current market price is $26.87. The most recent yearly common share dividend paid common shareholders was $1.04. The consensus forecast of security analysts who follow the manufacturer's common shares is that earnings growth will average 12.5% over the long term. The manufacturer's marginal income tax rate is 40%. Using the dividend discount model, what is the manufacturer's cost of equity capital for cost of capital purposes?
16.85%
Current-year earnings are $2.00 per share. Using a discounted cash flow model, the controller determines that the common stock is worth $14 per share. Assuming a 5% long-term growth rate, the required rate of return is which one of the following?
2.10 ÷ (x - .05)=$14 20%
By using the dividend growth model, estimate the cost of equity capital for a firm with a stock price of $30.00, an estimated dividend at the end of the first year of $3.00 per share, and an expected growth rate of 10%.
20.0% 10% + ($3 ÷ $30)
A stock priced at $50 per share is expected to pay $5 in dividends and trade for $60 per share in one year. What is the expected return on this stock?
30%
The College Honor Society sells hot pretzels at the home football games. The pretzels are sold for $1.00 each, and the cost per pretzel is $.30. Any unsold pretzels are discarded because they will be stale before the next home game. The estimated demand for pretzels at the next home football game using an expected value approach is
4,400 pretzels. sum of all (volume*probability)
In the current year, Company A has a degree of total leverage (DTL) of 8 and a degree of financial leverage (DFL) of 2. If sales in dollars are twice that of the previous year, what is the percentage change in EBIT in the current year?
400% 8/2=4
The following information was taken from Culver Co.'s financial statements for the current year ending December 31: Current assets $11,000,000 Noncurrent assets 14,000,000 Total stockholders' equity 10,000,000 Total operating expenses 20,000,000 What was Culver's debt ratio as ofDecember 31?
60%
A company issued a 15-year, $1,000 par value bond. The coupon rate on this bond is 9% annually, with interest being paid each 6 months. The investor who purchased the bond expects to earn a 12% nominal rate of return. The cash proceeds received by the company from the investor totaled
793.43
A company issued common stock and preferred stock. Projected growth rate of the common stock is 5%. The current quarterly dividend on preferred stock is $1.60. The current market price of the preferred stock is $80 and the current market price of the common stock is $95. What is the expected rate of return on the preferred stock?
8%
ABC Co. had debt with a market value of $1 million and an after-tax cost of financing of 8%. ABC also had equity with a market value of $2 million and a cost of equity capital of 9%. ABC's weighted-average cost of capital would be
8.7% 1mil/(2mil+1mil) 33.33%×8%=2.67% 66.67%×9%=6.00%
What is the price of a 10-year, 10% coupon bond with a $1,000 face value if investors require a 12% return? Assume annual coupon payments.
887.00 1,000 × .322) + ($100 × 5.65
Dzyubenko Co. reported these data at year end: The long-term debt has an interest rate of 8%, and its fair value equaled its book value at year-end. The fair value of the equity capital is $2 million greater than its book value. Dzyubenko's income tax rate is 25%, and its cost of equity capital is 10%. What is Dzyubenko's weighted-average cost of capital (WACC)?
9% WACC=(5mil*.06+15mil*.10)/5mil+15mil
A company is trying to determine the cost of capital for a major expansion project. A survey of commercial lenders indicates that cost of debt is currently 8% based on the company's debt ratio of 40%. The company complies with this requirement and has determined that a stock issuance would require a 10% return in order to attract investors. Which of the following is the company's cost of capital?
9.2% 8%×40%+[10% × (1-40%)]
Cox Company has sold 1,000 shares of $100 par, 8% preferred stock at an issue price of $92 per share. Stock issue costs were $5 per share. Cox pays taxes at the rate of 40%. What is Cox's cost of preferred stock capital?
9.20%
Scrunchy-Tech, Inc., has determined that it can minimize its weighted-average cost of capital (WACC) by using a debt-equity ratio of 2/3. If the firm's cost of debt is 9% before taxes, the cost of equity is estimated to be 12% before taxes, and the tax rate is 40%, what is the firm's WACC?
9.36% 9% × (1 - 40%)=5.4 40%×5.4%=2.16% 60%×12.0%=7.20%
The capital structure of a firm includes bonds with a coupon rate of 12% and an effective interest rate is 14%. The corporate tax rate is 30%. What is the firm's net cost of debt?
9.8% 14% × (1.0 - .30)
A curve on a graph with the rate of return on the vertical axis and time on the horizontal axis depicts
A yield curve showing the term structure of interest rates.
The cost of debt most frequently is measured as
Actual interest rate minus tax savings.
Information regarding four aluminum manufacturers is as follows: According to international law, which of the following aluminum producers is dumping?
Alpha
A company currently has 1,000 shares of common stock outstanding with zero debt. It has the choice of raising an additional $100,000 by issuing 9% long-term debt or issuing 500 shares of common stock. The company has a 40% tax rate. What level of earnings before interest and taxes (EBIT) would result in the same earnings per share (EPS) for the two financing options?
An EBIT of $27,000 would result in EPS of $10.80 for both. 100,000 face amount× 9% coupon rate=9000 [(1 - 0.4) × (EBIT - $9,000)] ÷ 1,000 = [EBIT × (1 - 0.4)] ÷ (1,000 + 500)
Which one of the following factors might cause a firm to increase the portion of debt in its financial structure?
An increase in the corporate income tax rate.
All of the following may allow a firm to set a lower coupon rate on a bond issued at par except a
Call provision.
The benefits of debt financing over equity financing are likely to be highest in which of the following situations?
High marginal tax rates and few noninterest tax benefits.
If a $1,000 bond sells for $1,125, which of the following statements are true? 1. The market rate of interest is greater than the coupon rate on the bond. 2. The coupon rate on the bond is greater than the market rate of interest. 3. The bond sells at a premium. 4. The bond sells at a discount.
II and III.
If Brewer Corporation's bonds are currently yielding 8% in the marketplace, why is the firm's cost of debt lower?
Interest is deductible for tax purposes.
The term structure of interest rates is the relationship of
Interest rates over time.
In general, it is more expensive for a company to finance with equity capital than with debt capital because
Investors are exposed to greater risk with equity capital.
The expected monetary value of an event
Is equal to the payoff of the event times the probability the event will occur.
The theory underlying the cost of capital is primarily concerned with the cost of
Long-term funds and new funds.
The yield curve shown implies that the upward slope curve
Long-term interest rates have a higher annualized yield than short-term rates.
A forward contract involves a commitment today to purchase a product
On a specific future date at a price determined today.
According to recent focus sessions, Norton Corporation has a "can't miss" consumer product on its hands. Sales forecasts indicate either excellent or good results, with Norton's sales manager assigning a probability of .6 to a good results outcome. The company is now studying various sales compensation plans for the product and has determined the following contribution margin data: If sales are excellent and Plan 1 is adopted $300,000 Plan 2 is adopted 370,000 If sales are good and Plan 1 is adopted 240,000 Plan 2 is adopted 180,000 On the basis of this information, which of the following statements is correct?
Plan 1 should be adopted because it is $8,000 more attractive than Plan 2.
Which one of the following statements is correct regarding the effect preferred stock has on a company?
Preferred shareholders' claims take precedence over the claims of common shareholders in the event of liquidation.
Preferred and common stock differ in that
Preferred stock has a higher priority than common stock with regard to earnings and assets in the event of bankruptcy.
The following excerpt was taken from a company's financial statements: " . . . 10% convertible participating . . . $10,000,000." What is most likely being referred to?
Preferred stock.
The Sarbanes-Oxley Act of 2002 requires management of publicly-traded corporations to do all of the following except
Provide a statement that the board approves the choice of accounting methods and policies.
All of the following items should be considered when setting an export price except
Repatriation restrictions.
Junk bonds are
Securities rated at less than investment grade.
If the ratio of total liabilities to equity increases, a ratio that must also increase is
Total liabilities to total assets.
Suppose that a stairway manufacturer's price elasticity of demand was relatively inelastic. If this manufacturer decided to increase the price of its stairways, what should have been the result?
Total revenues increased.
The term structure of interest rates is depicted by a yield curve. What variables are plotted on the horizontal axis and on the vertical axis?
Years to maturity and the interest rates, respectively.
