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Chapter 10

Terms in this set (19)

Raymond Co. has $2.3 million of debt, $1 million of preferred stock, and $3.3 million of common equity. What would be its weight on preferred stock?
A. 0.14
B. 0.17
C. 0.12
D. 0.15
D
The _____ is the interest rate that a firm pays on any new debt financing.
A. before-tax cost of debt
B. after-tax cost of debt
A
Perpetualcold Refrigeration Company (PRC) can borrow funds at an interest rate of 7.30% for a period of eight years. Its marginal federal-plus-state tax rate is 25%. PRC's after-tax cost of debt is _____ (rounded to two decimal places).
A. 4.66%
B. 5.21%
C. 6.03%
D. 5.48%
D
At the present time, Perpetualcold Refrigeration Company (PRC) has 10-year noncallable bonds with a face value of $1,000 that are outstanding. These bonds have a current market price of $1,278.41 per bond, carry a coupon rate of 11%, and distribute annual coupon payments. The company incurs a federal-plus-state tax rate of 25%. If PRC wants to issue new debt, what would be a reasonable estimate for its after-tax cost of debt (rounded to two decimal places)? (Note: Round your YTM rate to two decimal place.)
A. 6.32%
B. 4.22%
C. 5.27%
D. 4.74%
C
Usually has no voting rights; debt or equity? (preferred stock)
debt
No tax adjustments are made when calculating the cost of preferred stock; debt or equity?
equity
At the present time, Galbraith Enterprises does not have any preferred stock outstanding but is looking to include preferred stock in its capital structure in the future. Galbraith has found some institutional investors that are willing to purchase its preferred stock issue provided that it pays a perpetual dividend of $15 per share. If the investors pay $142.73 per share for their investment, then Galbraith's cost of preferred stock (rounded to four decimal places) will be _____.
A. 9.4585%
B. 10.5094%
C. 12.0858%
D. 8.9330%
B
If a firm cannot invest retained earnings to earn a rate of return _____ the required rate of return on retained earnings, it should return those funds to its stockholders.
A. less than
B. greater than or equal to
B
The current risk-free rate of return (rRFrRF) is 4.67% while the market risk premium is 5.75%. The Burris Company has a beta of 0.78. Using the capital asset pricing model (CAPM) approach, Burris's cost of equity is _____.
A. 8.244%
B. 9.16%
C. 10.992%
D. 10.076%
B
The Taylor Company is closely held and, therefore, cannot generate reliable inputs with which to use the CAPM method for estimating a company's cost of internal equity. Taylor's bonds yield 11.52%, and the firm's analysts estimate that the firm's risk premium on its stock over its bonds is 3.55%. Based on the bond-yield-plus-risk-premium approach, Taylor's cost of internal equity is:
A. 18.84%
B. 15.07%
C. 14.32%
D. 18.08%
B
Pierce Enterprises's stock is currently selling for $45.56 per share, and the firm expects its per-share dividend to be $1.38 in one year. Analysts project the firm's growth rate to be constant at 7.27%. Estimating the cost of equity using the discounted cash flow (or dividend growth) approach, what is Pierce's cost of internal equity?
A. 13.91%
B. 10.30%
C. 12.88%
D. 9.79%
B
Suppose Pierce is currently distributing 40% of its earnings in the form of cash dividends. It has also historically generated an average return on equity (ROE) of 18%. Pierce's estimated growth rate is _____.
A. 18.6%
B. 10.8%
C. 17.4%
D. 78%
B
The cost of issuing new common stock is calculated the same way as the cost of raising equity capital from retained earnings.

False: Flotation costs need to be taken into account when calculating the cost of issuing new common stock, but they do not need to be taken into account when raising capital from retained earnings.
True: The cost of retained earnings and the cost of new common stock are calculated in the same manner, except that the cost of retained earnings is based on the firm's existing common equity, while the cost of new common stock is based on the value of the firm's share price net of its flotation cost.
false
White Lion Homebuilders is considering investing in a one-year project that requires an initial investment of $500,000. To do so, it will have to issue new common stock and will incur a flotation cost of 2.00%. At the end of the year, the project is expected to produce a cash inflow of $595,000. The rate of return that White Lion expects to earn on its project (net of its flotation costs) is _____(rounded to two decimal places).
A. 13.34%
B. 14.17%
C. 16.67%
D. 10%
C
Alpha Moose Transporters has a current stock price of $22.35 per share, and is expected to pay a per-share dividend of $2.45 at the end of the year. The company's earnings' and dividends' growth rate are expected to grow at the constant rate of 5.20% into the foreseeable future. If Alpha Moose expects to incur flotation costs of 6.50% of the value of its newly-raised equity funds, then the flotation-adjusted (net) cost of its new common stock (rounded to two decimal places) should be _____.
A. 16.92%
B. 13.54%
C. 16.16%
D. 14.38%
A
White Lion Homebuilders Co.'s addition to earnings for this year is expected to be $420,000. Its target capital structure consists of 35% debt, 5% preferred, and 60% equity. Determine White Lion Homebuilders's retained earnings breakpoint:
A. $805,000
B. $700,000
C. $1,200,000
D. $875,000
B
Turnbull Co. has a target capital structure of 58% debt, 6% preferred stock, and 36% common equity. It has a before-tax cost of debt of 11.1%, and its cost of preferred stock is 12.2%.
If Turnbull can raise all of its equity capital from retained earnings, its cost of common equity will be 14.7%. However, if it is necessary to raise new common equity, it will carry a cost of 16.8%.
If its current tax rate is 25%, how much higher will Turnbull's weighted average cost of capital (WACC) be if it has to raise additional common equity capital by issuing new common stock instead of raising the funds through retained earnings? (Note: Round your intermediate calculations to two decimal places.)
A. 1.03%
B. 0.76%
C. 0.99%
D. 0.68%
B
Turnbull Co. is considering a project that requires an initial investment of $1,708,000. The firm will raise the $1,708,000 in capital by issuing $750,000 of debt at a before-tax cost of 8.7%, $78,000 of preferred stock at a cost of 9.9%, and $880,000 of equity at a cost of 13.2%. The firm faces a tax rate of 25%. What will be the WACC for this project? (Note: Round your intermediate calculations to three decimal places.)
A. 6.58%
B. 7.59%
C. 10.12%
D. 11.64%
C
Kuhn Co. is considering a new project that will require an initial investment of $20 million. It has a target capital structure of 35% debt, 2% preferred stock, and 63% common equity. Kuhn has noncallable bonds outstanding that mature in five years with a face value of $1,000, an annual coupon rate of 10%, and a market price of $1,050.76. The yield on the company's current bonds is a good approximation of the yield on any new bonds that it issues. The company can sell shares of preferred stock that pay an annual dividend of $8 at a price of $95.70 per share.
Kuhn does not have any retained earnings available to finance this project, so the firm will have to issue new common stock to help fund it. Its common stock is currently selling for $33.35 per share, and it is expected to pay a dividend of $2.78 at the end of next year. Flotation costs will represent 3% of the funds raised by issuing new common stock. The company is projected to grow at a constant rate of 9.2%, and they face a tax rate of 25%. What will be the WACC for this project? (Note: Round your intermediate calculations to two decimal places.)
A. 10.93%
B. 12.29%
C. 13.66%
D. 16.39%
C
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