Question 1

Montreal Trustco expects to pay a dividend of $5 next year.Dividends are expected to grow at 3 percent forever and the market requires a rate of return of 7 percent on its stock.Montreal Trustco can issue new stock at $125 per share with flotation costs of $20 per share.The tax rate is zero.The cost of issuing new equity to Montreal Trustco is:

Accepted Answer

K = 5 / (125 - 20)+ 3% = 7.76%

Question 2

The Third Cup Company has a return on equity of 10 percent and pays out 30 percent of its earnings as dividends.The company is expected to pay a dividend of $2 next year and the current stock price is $20.The cost of equity of The Third Cup Company is:

Accepted Answer

Growth = 10% *(1-30%)= 7%.$20 = 2/(k-.07)k=17%

Question 3

The manager of Montreal Trustco has noticed that as he increases the dividend payout ratio,the value of the firm's equity increases.This is most likely due to:

Accepted Answer

The answer of The manager of Montreal Trustco has noticed...

Question 4

Activa Sports Gyms is considering a project that is virtually risk-free.It has a beta of 1.5 and a D/E ratio of 0.6.The appropriate discount rate to use in analyzing this project is:

Accepted Answer

Given that the project is described as "virtually risk-free," the appropriate discount rate to use would be the risk-free rate, which is best represented by the Treasury-bill rate. The other options involve risk measures (beta, D/E ratio, WACC) that are not relevant for a risk-free project.

Question 5

Use the following statements to answer this question:

Accepted Answer

Both statements are correct. Statement I is true because a firm's ability to grow often depends on its ability to reinvest its earnings into profitable opportunities. Statement II is also true because simply retaining more earnings (increasing the retention ratio) does not guarantee increased firm value; the retained earnings must be invested in projects that yield a return above the firm's cost of capital.

Question 6

The Third Cup Company has just paid a dividend of $3 per share.The dividends are expected to grow at a rate of 4 percent per year forever.The current stock price is $25 per share.The firm faces a tax rate of 40 percent and flotation costs of 5 percent on new stock issues.The cost of equity for internal funds is:

Accepted Answer

25 = 3*(1.04)/(k - .04),K = 16.48%

Question 7

Laurentide Resort has just paid a dividend of $3.The current stock price is $25.The beta of the company is 1.3,the risk-free rate is 2 percent,and the market risk premium is 6 percent.The firm earns a return on equity of 10%.Is this a growth firm?

Accepted Answer

The answer of Laurentide Resort has just paid a dividend...

Question 8

The CFO of Cynergy Inc.decides to recalculate the company's WACC based on higher growth expectations for the firm,thus making the new WACC:

Accepted Answer

If the CFO is recalculating the WACC based on higher growth expectations, it means that there will be higher cash flows in the future, which means a higher cost of equity. This will increase the overall WACC, making D the correct answer.

Question 9

The Third Cup Company has just paid a dividend of $3 per share.The dividends are expected to grow at a rate of 4 percent per year forever.The current stock price is $25 per share.The firm faces a tax rate of 40 percent and flotation costs of 5 percent on new stock issues.The cost of equity for new funds is:

Accepted Answer

NP = 25 *(1-.05*(1-.4))= 24.25,24.25 = 3*(1.04)/(k-.04),K = 16.87%

Question 10

According to The Boston Consulting Group,a cash cow is characterized by:

Accepted Answer

A cash cow is a business unit that has a high market share in a mature, slow-growing industry. It generates significant cash flows and profits, which can be used to support other business units in the company. Since the industry is mature, there are limited growth opportunities, and therefore the present value of growth opportunities is low, while the present value of existing operations is high.

Question 11

The Saguenay Tourism Company has a beta of .80,the risk-free rate is 4 percent,and the market risk premium is 6 percent.The required return on the firm's equity is:

Accepted Answer

4% + .80 * 6% = 8.8%

Question 12

Toronto Skaters Company has a D/E ratio of 1.5.The company has 1,000 shares outstanding and a beta of 1.2.The risk-free rate is 3 percent and the market risk premium is 5 percent.The company has 10-year debt with a face value of $1 million and annual coupons of 4 percent.The debt is currently trading at 105.The tax rate is 35 percent.Calculate the weighted average cost of capital for Toronto Skaters Company.

Accepted Answer

The answer of Toronto Skaters Company has a D/E ratio...

Question 13

The current T-Bill rate is 3%,and the market risk premium is 9%.If Arabica Coffee Company has a beta of 1.75,its required return on equity is:

Accepted Answer

R_e = 3% + 1.75*(9%)= 0.1875 F1S1S1W1F1F1F10 18.75%

Question 14

The Saguenay Tourism Company has a beta of 1.30,the risk-free rate is 3 percent,and the return on the market is 4 percent.The required return on the firm's equity is:

Accepted Answer

3% + 1.3*(4% - 3%)= 4.30%

Question 15

The manager of Montreal Trustco has noticed that as he increases the dividend payout ratio,the value of the firm's equity declines.This is most likely due to:

Accepted Answer

The answer of The manager of Montreal Trustco has noticed...

Question 16

A firm is going to finance a new project 100 percent with debt,through a new bond issue.Since the firm is only using debt to finance the project,the NPV of the project should be calculated using the cost of debt as the discount rate.Is this statement true,false,or uncertain? Explain.

Accepted Answer

The answer of A firm is going to finance a...

Question 17

The Saguenay Tourism Company is an all-equity company and is able to fund a $1 million investment using cash.The company has a beta of 1.4,the risk-free rate is 2 percent,and the return on the market is 8 percent.Flotation costs for new equity are 5 percent.The tax rate is zero.The appropriate cost of capital is:

Accepted Answer

K = 2% + 1.4*(8% - 2%)= 10.40%

Question 18

Use the following statements to answer this question:

Accepted Answer

Both statements I and II are correct. The weighted average cost of capital (WACC) reflects the average risk of the company and is the most appropriate rate to discount future cash flows of average risk. The investment opportunities schedule, on the other hand, shows the available investment opportunities for the company at various rates of return, with the WACC being used as a threshold for investment.

Question 19

The Montreal Film Festival Company has a book value per share of $10 and a current return on equity of 7 percent.The firm expects to invest $100 next year and earn a return of 10 percent on that investment.The market requires a rate of return of 5 percent on the firm's equity.The present value of existing opportunities and the present value of growth opportunities are:

Accepted Answer

PVEO = 7% * $10/.05 = $14.00,PVGO = ($100/1.05)*(.10-.05)/.05 = $95.24

Question 20

Cynergy Inc.currently has a debt-equity ratio of 0.70,an after-tax cost of debt of 7.5%,and a cost of equity of 14%.If the firm changes its debt-equity ratio to 0.40,it will:

Accepted Answer

The answer of Cynergy Inc.currently has a debt-equity ratio of...

Quiz 20: Cost of Capital

The Third Cup Company has a return on equity of 10 percent and pays out 30 percent of its earnings as dividends.The company is expected to pay a dividend of $2 next year and the current stock price is $20.The cost of equity of The Third Cup Company is:

The manager of Montreal Trustco has noticed that as he increases the dividend payout ratio,the value of the firm's equity increases.This is most likely due to:

Activa Sports Gyms is considering a project that is virtually risk-free.It has a beta of 1.5 and a D/E ratio of 0.6.The appropriate discount rate to use in analyzing this project is:

Use the following statements to answer this question:

Laurentide Resort has just paid a dividend of $3.The current stock price is $25.The beta of the company is 1.3,the risk-free rate is 2 percent,and the market risk premium is 6 percent.The firm earns a return on equity of 10%.Is this a growth firm?

The CFO of Cynergy Inc.decides to recalculate the company's WACC based on higher growth expectations for the firm,thus making the new WACC:

According to The Boston Consulting Group,a cash cow is characterized by:

The Saguenay Tourism Company has a beta of .80,the risk-free rate is 4 percent,and the market risk premium is 6 percent.The required return on the firm's equity is:

The current T-Bill rate is 3%,and the market risk premium is 9%.If Arabica Coffee Company has a beta of 1.75,its required return on equity is:

The Saguenay Tourism Company has a beta of 1.30,the risk-free rate is 3 percent,and the return on the market is 4 percent.The required return on the firm's equity is:

The manager of Montreal Trustco has noticed that as he increases the dividend payout ratio,the value of the firm's equity declines.This is most likely due to:

A firm is going to finance a new project 100 percent with debt,through a new bond issue.Since the firm is only using debt to finance the project,the NPV of the project should be calculated using the cost of debt as the discount rate.Is this statement true,false,or uncertain? Explain.

Use the following statements to answer this question:

Cynergy Inc.currently has a debt-equity ratio of 0.70,an after-tax cost of debt of 7.5%,and a cost of equity of 14%.If the firm changes its debt-equity ratio to 0.40,it will: