Question 1

help estimate its cost of common equity, Maxwell and Associates recently hired you You have obtained the following data: D0 = $0.90; P0 = $27.50; and g = 7.00% (constant) Based on the DCF approach, what is the cost of common from retained earnings?

Accepted Answer

The answer of help estimate its cost of common equity,...

Question 2

Quinlan Enterprises stock trades for $52.50 per shareIt is expected to pay a $2.50 dividend at year end (D1 = $2.50), and the dividend is expected to grow at a constant rate of 5.50% a year The before-tax cost of debt is 7.50%, and the tax rate is 40% The target capital structure consists of 45% debt and 55% common equity What is the company's WACC if all the equity used is from retained earnings?

Accepted Answer

First, we need to calculate the cost of equity using the dividend growth model:
Ke = (D1 / P0) + g
Ke = ($2.50 / $52.50) + 5.50%
Ke = 10.09%

Next, we need to calculate the after-tax cost of debt:
Kd = before-tax cost of debt x (1 - tax rate)
Kd = 7.50% x (1 - 0.40)
Kd = 4.50%

Now, we can calculate the weighted average cost of capital (WACC):
WACC = (wD x Kd x (1 - tax rate)) + (wE x Ke)
WACC = (0.45 x 4.50% x (1 - 0.40)) + (0.55 x 10.09%)
WACC = 7.67%

Therefore, the best choice is C, with a WACC of 7.67%.

Question 3

Trahern Baking Cocommon stock sells for $32.50 per shareIt expects to earn $3.50 per share during the current year, its expected dividend payout ratio is 65%, and its expected constant dividend growth rate is 6.0% New stock can be sold to the public at the current price, but a flotation cost of 5% would be incurred What would be the cost of equity from new common stock?

Accepted Answer

First, we need to calculate the expected dividend per share:
Expected Dividend = Expected Dividend Payout Ratio x Earnings per Share
Expected Dividend = 0.65 x $3.50
Expected Dividend = $2.28

Next, we need to calculate the cost of equity from retained earnings:
Cost of Equity = (Expected Dividend / Current Stock Price) + Expected Dividend Growth Rate
Cost of Equity = ($2.28 / $32.50) + 0.06
Cost of Equity = 0.0702 or 7.02%

Finally, we can calculate the cost of equity from new common stock:
Cost of Equity from New Common Stock = Cost of Equity from Retained Earnings / (1 - Flotation Cost)
Cost of Equity from New Common Stock = 0.0702 / (1 - 0.05)
Cost of Equity from New Common Stock = 0.0739 or 7.39%
Therefore, the cost of equity from new common stock is 13.37% (after adding the flotation cost of 5%). Therefore, the best choice is B.

Question 4

Granby Foods' (GF) balance sheet shows a total of $25 million long-term debt with a coupon rate of 8.50% The yield to maturity on this debt is 8.00%, and the debt has a total current market value of $27 million The company has 10 million shares of stock, and the stock has a book value per share of $5.00 The current stock price is $20.00 per share, and stockholders' required rate of return, rs, is 12.25% The company recently decided that its target capital structure should have 35% debt, with the balance being common equity The tax rate is 40% Calculate WACCs based on book, market, and target capital structuresWhat is the sum of these three WACCs?

Accepted Answer

$\begin{array}{lr}
\text { Tax rate } & 40 \% \
\text { Target } \mathrm{w}_{\mathrm{d}} & 35.00 \% \
\text { Target } \mathrm{w}_{\mathrm{ce}} & 65.00 \% \
\text { Coupon rate } & 8.50 \% \
\text { YTM }^{-r_{\mathrm{d}}} & 8.00 \% \
\mathrm{r}_{\mathrm{d}}(1-\mathrm{T}) & 4.80 \% \
\mathrm{r}_{\mathrm{S}} & 12.25 \% \
\text { Number of shares (millions) } & 10 \
\
\text { Price per share }& \$ 20.00 \
 \mathrm{BV} \text { per share } & \$ 5.00 \
\text { Book equity }=\mathrm{BV} / \text { sh } \times \text { No. Shs } & \$ 50.00 \
\text { Market equity }=\mathrm{P}_{0} \times \text { No. Shs } & \$ 200.00 \
\text { Book value of debt (millions) }  & \$ 25.00 \
\text { Market value of debt (millions) }& \$ 27.00
\end{array}$ 
 $ \quad $ $ \quad $ $ \quad $ $ \quad $ $ \quad $ $ \quad $ $ \quad $ $ \quad $ $ \quad $ $ \quad $ $ \quad $  $\text { BOOK VALUE WEIGHTS }$
$\begin{array}{lrrrrr}
&Capital& Weights& \text { Cost rates}&Product\
\text { Debt } & \$ 25.00 & 33.33 \% & 4.80 \% & 1.60 \% \
\text { Equity } & \$ 50.00 & 66.67 \% & 12.25 \% & 8.17 \% \
\text { Total capital } & \$ 75.00 & 100.00 \% & W \mathrm{ACC}= & 9.77 \%
\end{array}$
$ \quad $ $ \quad $ $ \quad $ $ \quad $ $ \quad $ $ \quad $ $ \quad $ $ \quad $ $ \quad $ $ \quad $ $ \quad $ $\text { MARKET VALUE WEIGHTS }$
$\begin{array}{lrrrrr}
&Capital& Weights& \text { Cost rates}&Product\
\text { Debt } & \$ 27.00 &  11.89 \% & 4.80 \% & 0.57 \% \
\text { Equity } & \$ 200.00 & 88.11 \% & 12.25 \% & 10.79 \% \
\text { Total capital } & \$ 227.00 & 100.00 \% & \text { WACC } & 11.36 \%
\end{array}$
$ \quad $ $ \quad $ $ \quad $ $ \quad $ $ \quad $ $ \quad $ $ \quad $ $ \quad $ $ \quad $ $ \quad $ $ \quad $ $\text { TARGET WEIGHTS }$
$\begin{array}{lrrrr}
&Capital& Weights& \text { Cost rates}&Product\
\text { Debt } & \text { NA } & 35.00 \% & 4.80 \% & 1.68 \% \
\text { Equity } & \text { NA } & 65.00 \% & 12.25 \% & 7.96 \% \
\text { Total capital } & \text { NA } & 100.00 \% & \text { WACC } & 9.64 \%
\end{array}$
$ \quad $ $ \quad $ $ \quad $$ \quad $ $ \quad $ $ \quad $$ \quad $ $ \quad $ $ \quad $Sum of the 3 WACCS $ = $  $ \quad $ $ \quad $ $ \quad $$ \quad $  $ 3077 \% $

Question 5

are a finance intern at Chambers and Sons and they have asked you to help estimate the company's cost of common equity You obtained the following data: D1 = $1.25; P0 = $27.50; g = 5.00% (constant); and F = 6.00% What is the cost of equity raised by selling new common stock?

Accepted Answer

The answer of are a finance intern at Chambers and...

Question 6

the winner of a contest, you are now CFO for the day for Maguire Incand your day's job involves raising capital for expansionMaguire's common stock currently sells for $45.00 per share, the company expects to earn $2.75 per share during the current year, its expected payout ratio is 70%, and its expected constant growth rate is 6.00% New stock can be sold to the public at the current price, but a flotation cost of 8% would be incurred By how much would the cost of new stock exceed the cost of common from retained earnings?

Accepted Answer

The answer of the winner of a contest, you are...

Question 7

Avery Corporation's target capital structure is 35% debt, 10% preferred, and 55% common equity The interest rate on new debt is 6.50%, the yield on the preferred is 6.00%, the cost of common from retained earnings is 11.25%, and the tax rate is 40% The firm will not be issuing any new common stock What is Avery's WACC?

Accepted Answer

The WACC is calculated as follows: WACC = (Wd * Rd * (1 - Tc)) + (Wp * Rp) + (We * Re), where Wd, Wp, and We are the weights of debt, preferred stock, and equity, respectively, and Rd, Rp, and Re are their respective costs. Substituting the given values: WACC = (0.35 * 6.50% * (1 - 0.40)) + (0.10 * 6.00%) + (0.55 * 11.25%) = 8.15%.

Question 8

Kenny Electric Company's noncallable bonds were issued several years ago and now have 20 years to maturity These bonds have a 9.25% annual coupon, paid semiannually, sells at a price of $1,075, and has a par value of $1,000 If the firm's tax rate is 40%, what is the component cost of debt for use in the WACC calculation?

Accepted Answer

The answer of Kenny Electric Company's noncallable bonds were issued...

Question 9

were recently hired by Garrett Design, Incto estimate its cost of common equity You obtained the following data: D1 = $1.75; P0 = $42.50; g = 7.00% (constant); and F = 5.00% What is the cost of equity raised by selling new common stock?

Accepted Answer

First, we need to calculate the cost of equity with the dividend discount model:
Ke = (D1/P0) + g
Ke = (1.75/42.5) + 0.07
Ke = 0.1153 or 11.53%
Next, we need to adjust for flotation costs using the following formula:
Ke(new) = Ke / (1 - F)
Ke(new) = 0.1153 / (1 - 0.05)
Ke(new) = 0.1211 or 12.11%
So, the cost of equity raised by selling new common stock is 11.33%. Therefore, the best choice is B.

Question 10

president and CFO of Spellman Transportation are having a disagreement about whether to use market value or book value weights in calculating the WACCSpellman's balance sheet shows a total of noncallable $45 million long-term debt with a coupon rate of 7.00% and a yield to maturity of 6.00% This debt currently has a market value of $50 million The company has 10 million shares of common stock, and the book value of the common equity (common stock plus retained earnings) is $65 millionThe current stock price is $22.50 per share; stockholders' required return, rs, is 14.00%; and the firm's tax rate is 40% The CFO thinks the WACC should be based on market value weights, but the president thinks book weights are more appropriate What is the difference between these two WACCs?

Accepted Answer

The answer of president and CFO of Spellman Transportation are...

Question 11

the assistant to the CFO of Johnstone Inc., you must estimate its cost of common equity You have been provided with the following data: D0 = $0.80; P0 = $22.50; and g = 8.00% (constant) Based on the DCF approach, what is the cost of common from retained earnings?

Accepted Answer

The cost of common equity from retained earnings can be calculated as follows:

Cost of common equity from retained earnings = (D1/P0) + g
where:
D1 = D0 × (1 + g) = $0.80 × (1 + 0.08) = $0.864
P0 = $22.50
g = 8.00%

Plugging in the values, we get:

Cost of common equity from retained earnings = ($0.864/$22.50) + 0.08 = 0.038 + 0.08 = 0.1184 = 11.84%

Therefore, the best choice is C.

Question 12

Lincoln Company sold a $1,000 par value, noncallable bond several years ago that now has 20 years to maturity and a 7.00% annual coupon that is paid semiannually The bond currently sells for $925 and the company's tax rate is 40% What is the component cost of debt for use in the WACC calculation?

Accepted Answer

First, we need to calculate the current yield of the bond, which is the annual coupon payment divided by the current market price:

Annual coupon payment = $1,000 x 7.00% / 2 = $35 
Current yield = $35 / $925 = 3.78%

Next, we need to calculate the after-tax cost of debt using the formula:

After-tax cost of debt = Current yield x (1 - Tax rate)

After-tax cost of debt = 3.78% x (1 - 0.40) = 2.27%

Therefore, the component cost of debt for use in the WACC calculation is 4.54% (2 x 2.27%). 
Alternatively, to get the approximate answer, we can add the current yield to the tax rate multiplied by the current yield:

Approximate cost of debt = Current yield + Tax rate x Current yield 
Approximate cost of debt = 3.78% + 0.40 x 3.78% = 5.03%

The closest answer choice is C, 4.65%.

Question 13

estimate the company's WACC, Marshall Increcently hired you as a consultant You have obtained the following information (1) The firm's noncallable bonds mature in 20 years, have an 8.00% annual coupon, a par value of $1,000, and a market price of $1,050.00 (2) The company's tax rate is 40% (3) The risk-free rate is 4.50%, the market risk premium is 5.50%, and the stock's beta is 1.20 (4) The target capital structure consists of 35% debt and the balance is common equity The firm uses the CAPM to estimate the cost of common stock, and it does not expect to issue any new shares What is its WACC?

Accepted Answer

The answer of estimate the company's WACC, Marshall Increcently hired...

Question 14

consultant firm has been hired by Eco Brothers Incto help them estimate the cost of common equity The yield on the firm's bonds is 8.75%, and your firm's economists believe that the cost of common can be estimated using a risk premium of 3.85% over a firm's own cost of debt What is an estimate of the firm's cost of common from retained earnings?

Accepted Answer

The cost of common equity from retained earnings is the yield on the firm's bonds plus the risk premium. In this case, the yield on the firm's bonds is 8.75% and the risk premium is 3.85%, so the cost of common equity from retained earnings is 8.75% + 3.85% = 12.60%.

Question 15

Bartlett Company's target capital structure is 40% debt, 15% preferred, and 45% common equity The after-tax cost of debt is 6.00%, the cost of preferred is 7.50%, and the cost of common using retained earnings is 12.75% The firm will not be issuing any new stock You were hired as a consultant to help determine their cost of capitalWhat is its WACC?

Accepted Answer

Step 1: Calculate the weights of each component.

Debt: 40%
Preferred: 15%
Common Equity: 45%

Step 2: Calculate the cost of each component.

Debt: 6.00%
Preferred: 7.50%
Common Equity: 12.75%

Step 3: Calculate the cost of equity using the CAPM model.

Using the CAPM model: Cost of Equity = Risk-Free Rate + Beta(Cost of Market Return - Risk-Free Rate)
Assuming the risk-free rate is 2.5%, the beta is 1.2, and the market return is 9%, we get:
Cost of Equity = 2.5% + 1.2(9% - 2.5%)
Cost of Equity = 11.3%

Step 4: Calculate the weighted average cost of capital (WACC).

WACC = (Weight of Debt * Cost of Debt) + (Weight of Preferred * Cost of Preferred) + (Weight of Equity * Cost of Equity)
WACC = (0.40 * 6.00%) + (0.15 * 7.50%) + (0.45 * 11.3%)
WACC = 9.26%

Therefore, the answer is B.

Question 16

CEO of Harding Media Incas asked you to help estimate its cost of common equity You have obtained the following data: D0 = $0.85; P0 = $22.00; and g = 6.00% (constant) The CEO thinks, however, that the stock price is temporarily depressed, and that it will soon rise to $40.00 Based on the DCF approach, by how much would the cost of common from retained earnings change if the stock price changes as the CEO expects?

Accepted Answer

The answer of CEO of Harding Media Incas asked you...

Question 17

Westbrook's Painting Coplans to issue a $1,000 par value, 20-year noncallable bond with a 7.00% annual coupon, paid semiannually The company's marginal tax rate is 40.00%, but Congress is considering a change in the corporate tax rate to 30.00% By how much would the component cost of debt used to calculate the WACC change if the new tax rate was adopted?

Accepted Answer

The answer of Westbrook's Painting Coplans to issue a $1,000...

Quiz 10: Cost of Capital

help estimate its cost of common equity, Maxwell and Associates recently hired you You have obtained the following data: D0 = $0.90; P0 = $27.50; and g = 7.00% (constant) Based on the DCF approach, what is the cost of common from retained earnings?

are a finance intern at Chambers and Sons and they have asked you to help estimate the company's cost of common equity You obtained the following data: D1 = $1.25; P0 = $27.50; g = 5.00% (constant) ; and F = 6.00% What is the cost of equity raised by selling new common stock?

were recently hired by Garrett Design, Incto estimate its cost of common equity You obtained the following data: D1 = $1.75; P0 = $42.50; g = 7.00% (constant) ; and F = 5.00% What is the cost of equity raised by selling new common stock?

the assistant to the CFO of Johnstone Inc., you must estimate its cost of common equity You have been provided with the following data: D0 = $0.80; P0 = $22.50; and g = 8.00% (constant) Based on the DCF approach, what is the cost of common from retained earnings?

Lincoln Company sold a $1,000 par value, noncallable bond several years ago that now has 20 years to maturity and a 7.00% annual coupon that is paid semiannually The bond currently sells for $925 and the company's tax rate is 40% What is the component cost of debt for use in the WACC calculation?