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

Dp
3. Cost of preferred stock: K PF  or = kp / (1 - f)
(1  f ) PP

4. Cost of retained earnings from SML: Kx = KRF + bX (Km - KRF)

D 0 (1  g )
5. Cost of retained earnings from constant growth model: K e  g
P0
D 0 (1  g )
6. Cost of new stock: K e  g
(1  f )P0