Question 1

The outstanding bonds of The Purple Fiddle are priced at $898 and mature in nine years.These bonds have a 6 percent coupon and pay interest annually.The firm's tax rate is 35 percent.What is the firm's after-tax cost of debt?

Accepted Answer

Step 1 - Use a financial calculator to solve for the pre-tax cost of debt. PV = -898, FV = 1,000, PMT = 60, N = 9, CPT I/Y = 7.61% Step 2 - Account for taxes. k_d(1 - T) 7.61% (1 - .35) = 4.94%

Question 2

The dividend just paid on Thompson Industry stock was $2 per share and it is expected to grow 8% each year.If the stock is currently selling at $30 per share,what is Thompson's cost of equity? (Round to the nearest percent.)

Accepted Answer

Step 1 - Compute D₁. D₁ = D₀(1 + g) D₁ = $2(1.08) = $2.16 Step 2 - Use the constant growth model to estimate the cost of equity. k_e = 11ea7fdb_fc6b_a5bc_a768_c35769aed4cf_TB2902_11 + g k_e = 11ea7fdb_fc6b_a5bd_a768_8fffc48d09a6_TB2902_11 + .08 k_e = 0.152 or 15%

Question 3

A $1,000 par bond is currently selling for $1,100.It has a 9% coupon rate,fifteen years remaining to maturity,and pays interest semi-annually.If the firm's tax rate is 35%,what is the after-tax cost of debt?

Accepted Answer

Step 1 - Use a financial calculator to solve for the pre-tax cost of debt. PV = -1,100, FV = 1,000, PMT = 45, N = 30, CPT I/Y = 3.927 × 2 = 7.85% Step 2 - Account for taxes. k_d 11ea7fdb_fc6a_1f06_a768_7f808f576271_TB2902_11 7.85%(1 - .35) = 5.10%

Question 4

Ray Stokes is raising capital for a new company called NO Balloons Inc.NO Balloons will manufacture and sell festive balloons.Because of the shortage of helium,the balloons will be filled with nitrous oxide instead.NO Balloons plans to finance the business with common equity and long-term debt.It plans to sell 12 million shares of common stock and 200,000 bonds.Each bond will have a coupon rate of 5%,will pay its coupons semi-annually and will have a face value of $1,000.The common stock will be issued at a price of $19.5 a share and has a beta of 1.1.The bonds will sell for 89% of face value and have a 6.25% yield to maturity.The market risk premium is 5.25%,T-bills are yielding 3.5%,and NO Balloons' tax rate is 36%.What is NO Balloons' cost of debt (after tax)?

Accepted Answer

The pre-tax cost of debt is the yield to maturity on the company's bonds, or 6.25%. After-tax cost of debt = k_d(1 - T) 0.0625(1 - 0.36) = 0.04 or 4%

Question 5

Tom's Ventures has a zero coupon bond issue outstanding that matures in thirteen years.The bonds are selling at 48 percent of par value.The company's tax rate is 34 percent.What is the company's after-tax cost of debt?

Accepted Answer

Step 1 - Use a financial calculator to solve for the pre-tax cost of debt. PV = -480, FV = 1,000, PMT = 0, N = 13, CPT I/Y = 5.81% Step 2 - Account for taxes. k_d(1 - T) 5.81% (1 - .34) = 3.83%

Question 6

Donnelly and Son pay $8 as the annual dividend on their preferred stock.Currently,this stock is selling for $72 a share.What is Donnelly's cost of preferred stock?

Accepted Answer

k_p = 11ea7fdb_fc6a_9439_a768_477dc16b46b0_TB2902_11 k_p = 11ea7fdb_fc6a_bb4a_a768_8d2b7bc268fa_TB2902_11 = 11.11%

Question 7

Swiss Cheeses,Inc.has paid annual dividends of $1.00,$1.04,$1.09,and $1.15 per share over the last four years,respectively.The stock is currently selling for $42 a share.What is this firm's cost of equity?

Accepted Answer

Step 1 - Compute the growth rate of dividends. g = 11ea7fdb_fc6b_3084_a768_67f0c4f9fb35_TB2902_11 - 1 g = 11ea7fdb_fc6b_3085_a768_cf92f45d707b_TB2902_11 - 1 g = .04769 Step 2 - Use the constant growth model to estimate the cost of equity. k_e = 11ea7fdb_fc6b_5796_a768_a930d54f199a_TB2902_11 + g k_e = 11ea7fdb_fc6b_5797_a768_23efd6440774_TB2902_11 + .04769 k_e = 7.64%

Question 8

Blackwater Adventures has a bond issue outstanding that matures in sixteen years.The bonds pay interest semi-annually.Currently,the bonds are quoted at 103 percent of face value and carry a 9 percent coupon.The firm's tax rate is 34 percent.What is the firm's after-tax cost of debt?

Accepted Answer

Step 1 - Use a financial calculator to solve for the pre-tax cost of debt. PV = -1,030, FV = 1,000, PMT = 45, N = 32, CPT I/Y = 4.325 × 2 = 8.65% Step 2 - Account for taxes k_d 11ea7fdb_fc69_f7f5_a768_a59f30872377_TB2902_11 8.65% (1 - .34) = 5.71%

Question 9

What is the after-tax cost of preferred stock if its price is $25 per share and it pays a $1 per share dividend? Assume the firm's marginal tax rate is 25% and there are no flotation costs.

Accepted Answer

k_p = 11ea7fdb_fc6a_e25d_a768_9f26185f70e2_TB2902_11 k_p = 11ea7fdb_fc6a_e25e_a768_5d4b61810bbd_TB2902_11 = 4%

Question 10

If investors require a 10% after-tax return from a firm's preferred stock and its dividend is $5.00 per share,what is the price per share assuming a marginal tax rate of 25% and no flotation costs?

Accepted Answer

k_p = 11ea7fdb_fc6b_096f_a768_7df68fe9c78e_TB2902_11 11ea7fdb_fc6b_0970_a768_05dcde0abfb1_TB2902_11 = 11ea7fdb_fc6b_0971_a768_4b067edfc26a_TB2902_11 11ea7fdb_fc6b_0972_a768_cd88a5273294_TB2902_11 = 11ea7fdb_fc6b_0973_a768_8319c7a61831_TB2902_11 = $50

Question 11

Jensen's Travel Agency has a 7 percent preferred stock outstanding that is currently selling for $48 a share.The preferred stock has a $100 par value.The market rate of return is 10 percent and the firm's tax rate is 34 percent.What is the Jensen's cost of preferred stock?

Accepted Answer

k_p = 11ea7fdb_fc6a_6d27_a768_a7350dc09858_TB2902_11 k_p = 11ea7fdb_fc6a_9438_a768_931ba9adcbaf_TB2902_11 = 14.58%

Question 12

If Fluppy Dog Grooming shareholders require a 20% return,what is the dividend growth rate if the dividend yield is 12%?

Accepted Answer

k_e = 11ea7fdb_fc6c_1af2_a768_6743d0421e33_TB2902_11 + g 0.20 = 0.12 + g g = 0.08 or 8%

Question 13

Rekall Inc.,the memory implant company,has 7 million shares of common stock outstanding and 100,000 semi-annual bonds.The bonds have 6 years to maturity,a 9.05% coupon rate and a face value of $1,000 each.The common stock currently sells for $29.94 and just paid a dividend of $2.50.Dividends are paid annually and are expected to grow in perpetuity at 3%.The bonds sell for 94% of face value and have a 10.42% yield to maturity.The market risk premium is 5.5%,T-bills are yielding 5% and the tax rate is 30%.What is Rekall's cost of debt (after-tax)? Round to one decimal place.

Accepted Answer

After-tax cost of debt = k_d(1 - T) 0.1042(1 - 0.30) = 0.07294 or 7.3%

Question 14

Gaunt Computer Displays plans to issue bonds to finance research and development for computer monitors that can be read while sleeping.The firm's investment bankers report that the bonds should be sold to yield 10%.What is Gaunt's cost of debt if its marginal tax rate is 30%?

Accepted Answer

After-tax cost of debt = k_d(1 - T) 0.10(1 - .30) = 0.07 or 7%

Question 15

Neeson Co.paid dividends in the last three years of $3.00,$3.15,and $3.31,respectively.The current stock price of Neeson is $30.00.Assuming the next dividend will grow at the same rate as the last three years,what is Neeson's cost of equity?

Accepted Answer

Step 1 - Compute the growth rate of dividends. g = 11ea7fdb_fc6b_7ea8_a768_8bb43f056538_TB2902_11 - 1 g = 11ea7fdb_fc6b_7ea9_a768_3d4ecf0e4c29_TB2902_11 - 1 g = .050397 Step 2 - Compute D₁. D₁ = D₀(1 + g) D₁ = $3.31(1.050397) = $3.4765 Step 3 - Use the constant growth model to estimate the cost of equity. k_e = 11ea7fdb_fc6b_7eaa_a768_d357d7d4c2d4_TB2902_11 + g k_e = 11ea7fdb_fc6b_7eab_a768_7f435bf90bff_TB2902_11 + .050397 k_e= 0.1662 or 16.62%

Question 16

Rekall Inc.,the memory implant company,has 7 million shares of common stock outstanding and 100,000 semi-annual bonds.The bonds have 6 years to maturity,a 9.05% coupon rate and a face value of $1,000 each.The common stock currently sells for $29.94 and just paid a dividend of $2.50.Dividends are paid annually and are expected to grow in perpetuity at 3%.The bonds sell for 94% of face value and have a 10.42% yield to maturity.The market risk premium is 5.5%,T-bills are yielding 5% and the tax rate is 30%.What is Rekall's cost of equity?

Accepted Answer

k_e = 11ea7fdb_fc6b_f3e0_a768_f913b7f85542_TB2902_11 + g k_e = 11ea7fdb_fc6b_f3e1_a768_d52755c0e85c_TB2902_11 + .03 k_e = 11.6%

Question 17

Neal Enterprises common stock is currently priced at $36.80 a share.The company is expected to pay $1.20 per share next month as their annual dividend.The dividends have been increasing by 2 percent annually and are expected to continue doing so.What is the cost of equity for Neal Enterprises?

Accepted Answer

k_e = 11ea7fdb_fc6b_ccce_a768_65f92f940ab1_TB2902_11 + g k_e = 11ea7fdb_fc6b_cccf_a768_57491dbc150f_TB2902_11 + .02 k_e = 5.26%

Question 18

Ben's Ice Cream just paid their annual dividend of $.75 a share.The stock has a market price of $32 and a beta of .90.The return on the U.S.Treasury bill is 4 percent and the market has a 12 percent rate of return.What is the cost of equity?

Accepted Answer

k_e = k_F + β(k_M - k_F) k_e= .04 + 0.90(.12 - .04) k_e = 11.2%

Question 19

Teri's Tires has 7 percent preferred stock outstanding that sells for $68 a share.The preferred stock has a $100 par value.What is Teri's cost of preferred stock?

Accepted Answer

k_p = 11ea7fdb_fc6a_bb4b_a768_19bac978eeda_TB2902_11 k_p = 11ea7fdb_fc6a_bb4c_a768_47a4ada34c0c_TB2902_11 = 10.29%

Question 20

The common stock of Big Birds Unlimited has a required return of 8 percent and a growth rate of 4 percent.The last annual dividend was $.60 a share.What is the current price of this stock?

Accepted Answer

k_e = 11ea7fdb_fc6c_4203_a768_b5be61f1b99b_TB2902_11 + g .08 = 11ea7fdb_fc6c_4204_a768_f1d089bceb07_TB2902_11 + .04 .04(P₀₎ = .624 P₀ = 11ea7fdb_fc6c_4205_a768_41de26e889b1_TB2902_11 = $15.60

Quiz 11: Cost of Capital