FiltersDone

Question type

Essay

Multiple Choice

Short Answer

True False

Matching

Exam 9: The Cost of Capital

Show Answer

Share

---

All types

Filters

Study FlashcardsPractice ExamLearn

Question 41

Multiple Choice

Review LaterAdd Note

Review Later

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 25%, what is the component cost of debt for use in the WACC calculation?

A) 5.44%
B) 5.73%
C) 6.03%
D) 6.35%
E) 6.67%

F) A) and D)
G) C) and E)

Correct Answer

verified

Show Answer

Question 42

Multiple Choice

Review LaterAdd Note

Review Later

Trahern Baking Co.common stock sells for $32.50 per share.It 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?

A) 12.70%
B) 13.37%
C) 14.04%
D) 14.74%
E) 15.48%

F) B) and D)
G) B) and E)

Correct Answer

verified

Show Answer

Question 43

Multiple Choice

Review LaterAdd Note

As the winner of a contest, you are now CFO for the day for Maguire Inc.and your day's job involves raising capital for expansion.Maguire'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 reinvested earnings?

Which of the following statements is CORRECT?

The cost of equity raised by retaining earnings can be less than, equal to, or greater than the cost of external equity raised by selling new issues of common stock, depending on tax rates, flotation costs, the attitude of investors, and other factors.

Which of the following statements is CORRECT?

Firms raise capital at the total corporate level by retaining earnings and by obtaining funds in the capital markets.They then provide funds to their different divisions for investment in capital projects.The divisions may vary in risk, and the projects within the divisions may also vary in risk.Therefore, it is conceptually correct to use different risk-adjusted costs of capital for different capital budgeting projects.

Careco Company and Audaco Inc are identical in size and capital structure.However, the riskiness of their assets and cash flows are somewhat different, resulting in Careco having a WACC of 10% and Audaco a WACC of 12%.Careco is considering Project X, which has an IRR of 10.5% and is of the same risk as a typical Careco project.Audaco is considering Project Y, which has an IRR of 11.5% and is of the same risk as a typical Audaco project. Now assume that the two companies merge and form a new company, Careco/Audaco Inc.Moreover, the new company's market risk is an average of the pre-merger companies' market risks, and the merger has no impact on either the cash flows or the risks of Projects X and Y.Which of the following statements is CORRECT?

Adams Inc.has the following data: r_RF = 5.00%; RP_M = 6.00%; and b = 1.05.What is the firm's cost of common from reinvested earnings based on the CAPM?

If investors' aversion to risk rose, causing the slope of the SML to increase, this would have a greater impact on the required rate of return on equity, r_s, than on the interest rate on long-term debt, r_d, for most firms.Other things held constant, this would lead to an increase in the use of debt and a decrease in the use of equity.However, other things would not stay constant if firms used a lot more debt, as that would increase the riskiness of both debt and equity and thus limit the shift toward debt.

If the expected dividend growth rate is zero, then the cost of external equity capital raised by issuing new common stock (r_e) is equal to the cost of equity capital from retaining earnings (r_s) divided by one minus the percentage flotation cost required to sell the new stock, (1 − F).If the expected growth rate is not zero, then the cost of external equity must be found using a different formula.

When estimating the cost of equity by use of the bond-yield-plus-risk-premium method, we can generally get a good idea of the interest rate on new long-term debt, but we cannot be sure that the risk premium we add is appropriate.This problem leaves us unsure of the true value of r_s.

Collins Group The Collins Group, a leading producer of custom automobile accessories, has hired you to estimate the firm's weighted average cost of capital.The balance sheet and some other information are provided below. $\begin{array}{lr}\text { Assets } \\\text { Current assets } & \$ 38,000,000 \\\text { Net plant, property, and equipment } & 101,000,000 \\\text { Total assets } & \$ 139,000,000\\\\\text { Liabilities and Equity }\\\text { Accounts payable } & \$ 10,000,000 \\\text { Accruals } & 9,000,000 \\\text { Current liabilities } & \$ 19,000,000 \\\text { Long-term debt ( } 40,000 \text { bonds, } \$ 1,000 \text { par value) } & 40,000,000 \\\text { Total liabilities } & \$ 59,000,000 \\\text { Common stock (10,000,000 shares) } & 30,000,000 \\\text { Retained earnings } & 50,000,000 \\\text { Total shareholders' equity } & \$ 0,000,000 \\\text { Total liabilities and shareholders' equity } & \$ 139,000,000\end{array}$ The stock is currently selling for $15.25 per share, and its noncallable $1,000 par value, 20-year, 7.25% bonds with semiannual payments are selling for $875.00.The beta is 1.25, the yield on a 6-month Treasury bill is 3.50%, and the yield on a 20-year Treasury bond is 5.50%.The required return on the stock market is 11.50%, but the market has had an average annual return of 14.50% during the past 5 years.The firm's tax rate is 25%. -The cost of external equity capital raised by issuing new common stock (r_e) is defined as follows, in words: "The cost of external equity equals the cost of equity capital from retaining earnings (r_s), divided by one minus the percentage flotation cost required to sell the new stock, (1 ? F)."

Because 50% of the preferred dividends received by a corporation are excluded from taxable income, the component cost of equity for a company that pays half of its earnings out as common dividends and half as preferred dividends should, theoretically, be ​ Cost of equity = r_s(0.30)(0.50) + r_ps(1 − T)(0.50)(0.50).

The cost of capital used in capital budgeting should reflect the average after-tax cost of providing required returns to investors.

For a typical firm, which of the following sequences is CORRECT? All rates are after taxes, and assume that the firm operates at its target capital structure.

If a firm's marginal tax rate is increased, this would, other things held constant, lower the cost of debt used to calculate its WACC.

For capital budgeting and cost of capital purposes, the firm should always consider reinvested earnings as the first source of capital⎯i.e., use these funds first⎯because reinvested earnings have no cost to the firm.

To 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_L = 7.00% (constant) .Based on the dividend growth model, what is the cost of common from reinvested earnings?

Which of the following statements is CORRECT?