Question 1

A firm is paying an annual dividend of $2.65 for its preferred stock that is selling for $57.00. There is a selling cost of $3.30. What is the after-tax cost of preferred stock if the firm's tax rate is 33%?

Accepted Answer

The after-tax cost of preferred stock can be calculated using the formula:

After-tax cost of preferred stock = (annual dividend / net proceeds) x (1 - tax rate)

First, we need to calculate the net proceeds, which is the selling price minus the selling cost:

Net proceeds = selling price - selling cost
Net proceeds = $57.00 - $3.30
Net proceeds = $53.70

Now we can plug in the values and solve for the after-tax cost:

After-tax cost of preferred stock = ($2.65 / $53.70) x (1 - 0.33)
After-tax cost of preferred stock = 0.0493 or 4.93%

Therefore, the best choice is B.

Question 2

Firm X has a tax rate of 30%. The price of its new preferred stock is $75 and its flotation cost is $3.15. The cost of new preferred stock is 8%. What is the firm's dividend?

Accepted Answer

The answer of Firm X has a tax rate of...

Question 3

If the flotation cost goes up, the cost of retained earnings will

Accepted Answer

Flotation costs are associated with issuing new securities and do not affect the cost of retained earnings, which are profits reinvested in the company rather than distributed to shareholders.

Question 4

Ten years ago, Stigler Company issued $100 par value preferred stock yielding 6%. The preferred stock is now selling for $102 per share. What is the approximate current yield or cost of the preferred stock? (Disregard flotation costs.)

Accepted Answer

The current yield of the preferred stock is calculated by dividing the annual dividend by the current market price of the stock. The annual dividend is $6 (6% of $100 par value). The current market price is $102 per share. Therefore, the current yield is $6 / $102 = 0.0588 or 5.9%.

Question 5

Within the capital asset pricing model

Accepted Answer

Beta measures the volatility of an individual stock relative to a stock market index, such as the S&P 500. It does not determine the required rate of return, which is influenced by the risk-free rate and the return on the market. Dividends may be considered in some valuation models, but they are not specifically included in the CAPM. Additionally, the higher the beta, the higher the required rate of return, not the lower.

Question 6

The pre-tax cost of debt for a new issue of debt is determined by

Accepted Answer

The pre-tax cost of debt for a new issue of debt is determined by the yield to maturity of outstanding or comparable bonds. The coupon rate of existing debt and the investor's required rate of return on issued stock may be used as a reference point, but ultimately the yield to maturity of comparable bonds is the most relevant factor in determining the cost of debt.

Question 7

The after-tax cost of preferred stock to the issuing corporation

Accepted Answer

The after-tax cost of preferred stock to the issuing corporation is the same as the before-tax cost because dividends on preferred stock are not tax-deductible.

Question 8

If flotation costs go down, the cost of new preferred stock will

Accepted Answer

If flotation costs go down, the cost of new preferred stock will also go down. This is because flotation costs are the expenses that a company incurs in order to issue new securities, and if these costs go down, the overall cost of issuing new securities will decrease, leading to a lower cost of new preferred stock.

Question 9

Tobin's Barbeque has a bank loan at 8% interest and an after-tax cost of debt of 6%. What will the after-tax cost of debt be if a new loan is taken out yielding 11%.

Accepted Answer

The after-tax cost of debt formula is: 
After-tax cost of debt = (1 - Tax rate) x Cost of debt

Using the current loan:
After-tax cost of debt = (1 - 0.40) x 0.08 = 0.048, or 4.8%

Using the new loan:
After-tax cost of debt = (1 - 0.40) x 0.11 = 0.066, or 6.6%

Therefore, the after-tax cost of debt with the new loan at 11% interest is 6.6%, which is closest to option B, 8.25%.

Question 10

A firm's preferred stock pays an annual dividend of $2, and the stock sells for $65. Flotation costs for new issuances of preferred stock are 5% of the stock value. What is the after-tax cost of preferred stock if the firm's tax rate is 30%?

Accepted Answer

The cost of preferred stock can be calculated using the following formula:

Cost of preferred stock = Preferred stock dividend / Net issuing price

Net issuing price = Stock price - Flotation costs

Flotation costs = 5% x $65 = $3.25

Net issuing price = $65 - $3.25 = $61.75

Cost of preferred stock = $2 / $61.75 = 3.23%

After-tax cost of preferred stock = Cost of preferred stock x (1 - Tax rate)

After-tax cost of preferred stock = 3.23% x (1 - 0.30) = 2.26%

Therefore, the after-tax cost of preferred stock is 2.26%, which is closest to option C (3.20%).

Question 11

The cost of equity capital in the form of new common stock will be higher than the cost of retained earnings because of

Accepted Answer

Flotation costs associated with issuing new common stock can include underwriting fees, legal fees, and printing expenses. These costs increase the cost of equity capital compared to retained earnings, which do not involve any direct expenses.

Question 12

New common stock is more expensive than required rate of return (K_e)because new common stock has to

Accepted Answer

The answer of New common stock is more expensive than...

Question 13

Why is the cost of debt normally lower than the cost of preferred stock?

Accepted Answer

Interest on debt is tax deductible, making the after-tax cost of debt lower than the cost of preferred stock.

Question 14

In determining the cost of retained earnings

Accepted Answer

The capital asset pricing model (CAPM) can be used to determine the cost of retained earnings by estimating the expected return required by equity investors. This model takes into account the risk-free rate, the stock's beta (which measures its volatility relative to the market), and the market risk premium.

Question 15

Flotation cost is the

Accepted Answer

Flotation cost is the cost incurred by a company when issuing new securities, such as stocks or bonds. Specifically, it refers to the cost of issuing and selling new stocks, including underwriting fees, legal fees, and other expenses. Therefore, the correct choice is C.

Question 16

In computing the cost of common equity, if the dividend (D₁) goes downward and market price (P₀) goes up, required rate of return (K_e) will

Accepted Answer

The answer of In computing the cost of common equity,...

Question 17

Using the constant dividend growth model for common stock, if the market price of stock (P₀) goes up,

Accepted Answer

According to the constant dividend growth model, as the market price of the stock goes up, the expected rate of return (and thus the assumed cost) decreases. This is because the dividend yield (annual dividend divided by the current market price) decreases, but the expected capital gains yield (the assumed growth rate of the stock's price) remains the same. Therefore, the cost of equity capital (the rate of return required by investors) decreases.

Question 18

Lewis, Schultz, and Nobel Development Corp. has an after-tax cost of debt of 4.5%. With a tax rate of 30%, what is the yield on the debt?

Accepted Answer

The after-tax cost of debt is calculated as the yield on the debt multiplied by (1 - tax rate). Given the after-tax cost of debt is 4.5% and the tax rate is 30%, the yield on the debt is 4.5% / (1 - 0.30) = 6.43%.

Question 19

A firm has $50 million in assets and its optimal capital structure is 60% equity. If the firm has $12 million in retained earnings available to invest, at what asset level will the firm need to issue additional stock? (Assume no growth in retained earnings.)

Accepted Answer

Since the optimal capital structure is 60% equity, the firm's equity value should be $30 million (60% of $50 million). If the firm has $12 million in retained earnings available to invest, the remaining funding required is $18 million ($30 million - $12 million). Therefore, the firm will need to issue additional stock when it wants to increase its assets beyond $20 million ($18 million / 0.9, where 0.9 is the remaining equity value after deducting $12 million from $30 million). Therefore, the correct answer is C.

Question 20

A firm's debt-to-equity ratio varies at times because

Accepted Answer

All of these factors can influence a firm's decision to vary its debt-to-equity ratio. Selling common stock when prices are high and issuing bonds when interest rates are low can help the firm raise funds at a lower cost of capital. Timing the fund-raising allows a firm to take advantage of market conditions and minimize costs over the long run. Additionally, there is some flexibility in the debt-to-equity ratio that the market will allow before penalizing the firm with a higher cost of capital, allowing the firm to adjust its financing mix as necessary.

Quiz 11: Cost of Capital

A firm is paying an annual dividend of $2.65 for its preferred stock that is selling for $57.00. There is a selling cost of $3.30. What is the after-tax cost of preferred stock if the firm's tax rate is 33%?

Firm X has a tax rate of 30%. The price of its new preferred stock is $75 and its flotation cost is $3.15. The cost of new preferred stock is 8%. What is the firm's dividend?

If the flotation cost goes up, the cost of retained earnings will

Ten years ago, Stigler Company issued $100 par value preferred stock yielding 6%. The preferred stock is now selling for $102 per share. What is the approximate current yield or cost of the preferred stock? (Disregard flotation costs.)

Within the capital asset pricing model

The pre-tax cost of debt for a new issue of debt is determined by

The after-tax cost of preferred stock to the issuing corporation

If flotation costs go down, the cost of new preferred stock will

Tobin's Barbeque has a bank loan at 8% interest and an after-tax cost of debt of 6%. What will the after-tax cost of debt be if a new loan is taken out yielding 11%.

A firm's preferred stock pays an annual dividend of $2, and the stock sells for $65. Flotation costs for new issuances of preferred stock are 5% of the stock value. What is the after-tax cost of preferred stock if the firm's tax rate is 30%?

The cost of equity capital in the form of new common stock will be higher than the cost of retained earnings because of

New common stock is more expensive than required rate of return (K_e) because new common stock has to

Why is the cost of debt normally lower than the cost of preferred stock?

In determining the cost of retained earnings

Flotation cost is the

In computing the cost of common equity, if the dividend (D₁) goes downward and market price (P₀) goes up, required rate of return (K_e) will

Using the constant dividend growth model for common stock, if the market price of stock (P₀) goes up,

Lewis, Schultz, and Nobel Development Corp. has an after-tax cost of debt of 4.5%. With a tax rate of 30%, what is the yield on the debt?

A firm has $50 million in assets and its optimal capital structure is 60% equity. If the firm has $12 million in retained earnings available to invest, at what asset level will the firm need to issue additional stock? (Assume no growth in retained earnings.)

A firm's debt-to-equity ratio varies at times because

Quiz 11: Cost of Capital

A firm is paying an annual dividend of $2.65 for its preferred stock that is selling for $57.00. There is a selling cost of $3.30. What is the after-tax cost of preferred stock if the firm's tax rate is 33%?

Firm X has a tax rate of 30%. The price of its new preferred stock is $75 and its flotation cost is $3.15. The cost of new preferred stock is 8%. What is the firm's dividend?

If the flotation cost goes up, the cost of retained earnings will

Ten years ago, Stigler Company issued $100 par value preferred stock yielding 6%. The preferred stock is now selling for $102 per share. What is the approximate current yield or cost of the preferred stock? (Disregard flotation costs.)

Within the capital asset pricing model

The pre-tax cost of debt for a new issue of debt is determined by

The after-tax cost of preferred stock to the issuing corporation

If flotation costs go down, the cost of new preferred stock will

Tobin's Barbeque has a bank loan at 8% interest and an after-tax cost of debt of 6%. What will the after-tax cost of debt be if a new loan is taken out yielding 11%.

A firm's preferred stock pays an annual dividend of $2, and the stock sells for $65. Flotation costs for new issuances of preferred stock are 5% of the stock value. What is the after-tax cost of preferred stock if the firm's tax rate is 30%?

The cost of equity capital in the form of new common stock will be higher than the cost of retained earnings because of

New common stock is more expensive than required rate of return (Ke) because new common stock has to

Why is the cost of debt normally lower than the cost of preferred stock?

In determining the cost of retained earnings

Flotation cost is the

In computing the cost of common equity, if the dividend (D1) goes downward and market price (P0) goes up, required rate of return (Ke) will

Using the constant dividend growth model for common stock, if the market price of stock (P0) goes up,

Lewis, Schultz, and Nobel Development Corp. has an after-tax cost of debt of 4.5%. With a tax rate of 30%, what is the yield on the debt?

A firm has $50 million in assets and its optimal capital structure is 60% equity. If the firm has $12 million in retained earnings available to invest, at what asset level will the firm need to issue additional stock? (Assume no growth in retained earnings.)

A firm's debt-to-equity ratio varies at times because

New common stock is more expensive than required rate of return (K_e) because new common stock has to

In computing the cost of common equity, if the dividend (D₁) goes downward and market price (P₀) goes up, required rate of return (K_e) will

Using the constant dividend growth model for common stock, if the market price of stock (P₀) goes up,