Chapter 13 problems (Ch. 12 in the 4th edition)
1. The cost of capital is used primarily in
a. negotiations with banks because it reflects the
company's overall borrowing power.
b. setting the firm's basic risk level.
c. capital budgeting because it reflects what the firm
pays for the money it invests.
d. negotiations with investment bankers because it
establishes an overall return on which the market can
base prices for the firm's securities.
2. A firm's cost of capital is the appropriate rate to use
in the evaluation of
a.
its common stock.
b.
all capital budgeting proposals.
c.
average risk capital budgeting proposals.
d.
none of the above
27. To determine a firm's WACC, it is necessary to
compensate for the effect of:
a.
transaction costs associated with doing business
in financial markets
b.
the tax implications of debt
c.
none of the above
d.
both a and b
29. Flotation costs are administrative fees and expenses
incurred in:
a.
the process of issuing and selling securities
b.
listing the company's stock on a stock exchange
c.
lawsuits alleging fraud in the issue of securities
d.
none of the above
37. Which of the following would increase the WACC?
a.
an increase in flotation costs
b.
a decrease in tax rates
c.
a decrease in preferred dividends
d.
Both a & b
e.
All of the above
42. The cost of retained earnings differs from the cost of
new equity due to:
a.
flotation costs
b.
dividends
c.
capital gains yields
d.
Both a & c
e.
All of the above
55.
Assume a firm’s bonds are currently yielding
new investors 6%. The combined federal and state tax
rate is 40%. What is the firm’s after-tax cost of debt is?
a. 3.6%
b. 4.0%
c. 4.8%
d. 6.0%
56.
Assume the following information about a
firm’s capital components. The firm’s WACC is?
Capital Structure
Cost
Debt
$20,000
8%
Preferred stock
$20,000
11%
Common stock
$60,000
14%
a. 11.00%
b. 11.90%
c. 12.20%
d. 12.05%
57.
Determine the (after-tax) component cost of a
$50 million debt issue that the Mattingly Corporation is
planning to place with a large insurance company.
Assume the company is subject to a 40% tax rate. This
long-term debt issue will yield 12% to the insurance
company.
a. 4.8%
b. 7.2%
c. 12.0%
d. none of the above
58.
Calculate the cost of preferred stock for Ohio
Valley Power Company, which is planning to sell $100
million of $3.25 cumulative preferred stock to the public
at a price of $25 per share. Flotation costs are $1.00 per
share. Ohio Valley has a marginal income tax rate of
40%.
a. 13.0%
b. 7.8%
c. 8.12%
d. 13.54%
71. Donoho Corp. issued 20-year, $1,000 par bonds
eight years ago with a 10% coupon paying semiannually
that are now selling for $1,152.47. Estimate the cost of
retained earnings assuming investors generally demand
a 5% risk premium on equity over the cost of debt.
a.
8%
b.
9%
c.
11%
d.
13%
e.
15%
72. A firm's preferred stock is selling at $83 and pays a
9.5% annual dividend on a $100 par value. What is the
cost of preferred if flotation costs are 12%?
a.
10.64%
b.
13.01%
c.
10.79%
d.
11.45%
1
d. none of the above
59.
Allegheny Valley Power Company common
stock has a beta of 0.80. If the current risk-free rate is
6.5% and the expected return on the stock market as a
whole is 16%, determine the cost of retained earnings
for the firm (using the CAPM).
a. 14.1%
b. 7.6%
c. 6.5%
d. none of the above
60.
The following financial information is available
on Rawls Manufacturing Company:
Current per share market price
$48.00
Most recent per share dividend
$3.50
Expected long-term growth rate
5.0%
Rawls can issue new common stock to net the company
$44 per share. Determine the cost of retained earnings
using the dividend growth model approach. (Compute
answer to the nearest .1%).
a. 12.3%
b. 13.4%
c. 13.0%
d. 12.7%
65.
Northeast Airlines has a current dividend of
$1.80. Dividends are expected to grow at 7% into the
foreseeable future. What is the firm’s cost of equity
from new stock if its shares can be sold to net the
company $46 after administrative expenses (flotation
costs)?
a. 10.9%
b. 11.2%
c. 7.2%
77.
Use the dividend growth or Gordon model to
develop the cost of equity from a new stock issue if last
year’s dividend was $2.25, the anticipated constant
growth rate is 5%, the stock’s selling price today is $36
per share, and flotation costs are estimated to be 11%?
a. 12.4%
b. 11.6%
c. 10.9%
d. 14.9%
85.
Hatter Inc. has the following capital
components and costs. Calculate Hatter’s WACC.
Component
Value
Cost
Debt
15,500
10%
Preferred Stock
7,500
12%
Common Equity
10,000
14%
a. 11.67%
b. 12.41%
c. 13.73%
d. 14.55%
101. Zylon Inc. plans net income of $10 million next
year and typically pays 40% of its earnings in dividends.
Its capital structure is one third equity and two thirds
debt with no preferred stock. Zylon’s MCC curve will
break at:
a. $ 4,000,000
b. $ 6,000,000
c. $12,000,000
d. $18,000,000
Chapter 13 Equations:
n
1.
WACC   wi sourcei ; (weights, w, and cost of source i)
i 1
2.
Cost of debt: Kd × (1 - tax rate)
3.
Cost of preferred stock:
4.
Cost of retained earnings from SML: Kx = KRF + bX (Km - KRF)
5.
Cost of retained earnings from constant growth model:
6.
Cost of new stock: K 
e
K PF 
Dp
(1  f )PP
D 0 (1  g)
g
(1  f )P0
or = kp / (1 - f)
Ke 
D 0 (1  g)
g
P0
2