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Question;[1]. Financial;analysts for Naulls Industries have revealed the following information about;the company;?;Naulls;Industries currently has a capital structure that consists of 75 percent common;equity and 25 percent debt.;?;The risk-free;rate, kRF, is 5 percent.;?;The market;risk premium, kM - kRF, is 6 percent.;?;Naulls?s;common stock has a beta of 1.2.;?;Naulls has;20-year bonds outstanding with an annual coupon rate of 12 percent and a face;value of $1,000. The bonds sell today;for $1,200.;?;The company?s;tax rate is 40 percent.;What is the company?s current WACC?;a. 7.41%;b. 9.17%;c.10.61%;d.10.99%;e.11.57%;[2]. Grateway;Inc. has a weighted average cost of capital of 11.5 percent. Its target capital;structure is 55 percent equity and 45 percent debt. The company has sufficient;retained earnings to fund the equity portion of its capital budget. The before-tax cost of debt is 9 percent, and;the company?s tax rate is 30 percent. If;the expected dividend next period (D1) is $5 and the current stock;price is $45, what is the company?s growth rate?;a.2.68%;b.3.44%;c.4.64%;d.6.75%;e.8.16%;Answer: e;[3]. The;managers of Kenforest Grocers are trying to determine the company?s optimal;capital budget for the upcoming year.;Kenforest is considering the following projects;Rate of;Project Size Return Risk;A $200,000 16% High;B 500,000 14 Average;C 400,000 12 Low;D 300,000 11 High;E 100,000 10 Average;F 200,000 10 Low;G 400,000 7 Low;The company estimates that its WACC is 11;percent. All projects are;independent. The company adjusts for;risk by adding 2 percentage points to the WACC for high-risk projects and;subtracting 2 percentage points from the WACC for low-risk projects. Which of the projects will the company;accept?;a.A, B, C, E, F;b.B, D, F, G;c.A, B, C, E;d,A, B, C, D, E;e.A, B, C, F;[4]. Bradshaw;Steel has a capital structure with 30 percent debt (all long-term bonds) and 70;percent common equity.The;yield to maturity on the company?s long-term bonds is 8 percent, and the firm;estimates that its overall composite WACC is 10 percent.The risk-free rate of interest;is 5.5 percent, the market risk premium is 5 percent, and the company?s tax;rate is 40 percent.Bradshaw;uses the CAPM to determine its cost of equity.What is the beta on Bradshaw?s;stock?;a.1.07;b.1.48;c.1.31;d.0.10;e.1.35;[5]. Arizona;Rock, an all-equity firm, currently has a beta of 1.25. The risk-free rate, kRF, is 7;percent and kM is 14 percent.;Suppose the firm sells 10 percent of its assets with beta equal to 1.25;and purchases the same proportion of new assets with a beta of 1.1. What will be the firm?s new overall required;rate of return, and what rate of return must the new assets produce in order to;leave the stock price unchanged?;a.15.645%;15.645%;b.15.750%;14.700%;c.15.645%;14.700%;d.15.750%;15.645%;e.14.750%;15.750%;[6]. Sun;State Mining Inc., an all-equity firm, is considering the formation of a new;division that will increase the assets of the firm by 50 percent. Sun;State currently has a;required rate of return of 18 percent, U.S. Treasury bonds yield 7 percent, and the;market risk premium is 5 percent. If Sun State;wants to reduce its required rate of return to 16 percent, what is the maximum;beta coefficient the new division could have?;a.2.2;b.1.0;c.1.8;d.1.6;e.2.0;[7]. Heavy;Metal Corp. is a steel manufacturer that finances its operations with 40;percent debt, 10 percent preferred stock, and 50 percent equity. The interest;rate on the company?s debt is 11 percent.;The preferred stock pays an annual dividend of $2 and sells for $20 a;share. The company?s common stock trades;at $30 a share, and its current dividend (D0) of $2 a share is;expected to grow at a constant rate of 8 percent per year. The flotation cost of external equity is 15;percent of the dollar amount issued, while the flotation cost on preferred;stock is 10 percent. The company;estimates that its WACC is 12.30 percent.;Assume that the firm will not have enough retained earnings to fund the;equity portion of its capital budget.;What is the company?s tax rate?;a.30.33%;b.32.86%;c.35.75%;d.38.12%;e.40.98%;[8]. Anderson;Company has four investment opportunities with the following costs (paid at t =;0) and expected returns;Expected;Project Cost Return;A $2,000;16.0%;B 3,000;14.5;C 5,000;11.5;D 3,000;9.5;The company has a target capital structure that;consists of 40 percent common equity, 40 percent debt, and 20 percent preferred;stock. The company has $1,000 in;retained earnings. The company expects;its year-end dividend to be $3.00 per share (D1 = $3.00). The dividend is expected to grow at a;constant rate of 5 percent a year. The;company?s stock price is currently $42.75.;If the company issues new common stock, the company will pay its;investment bankers a 10 percent flotation cost.;The company can issue corporate bonds with a yield;to maturity of 10 percent. The company;is in the 35 percent tax bracket. How;large can the cost of preferred stock be (including flotation costs) and it;still be profitable for the company to invest in all four projects?;a. 7.75%;b. 8.90%;c.10.46%;d.11.54%;e.12.68%;Multiple;Part;(The;following information applies to the next three problems.);The Global Advertising Company has a marginal tax rate of;40 percent. The company can raise debt;at a 12 percent interest rate and the last dividend paid by Global was;$0.90. Global?s common stock is selling;for $8.59 per share, and its expected growth rate in earnings and dividends is;5 percent. If Global issues new common;stock, the flotation cost incurred will be 10 percent. Global plans to finance all capital expenditures;with 30 percent debt and 70 percent equity.;[9]. What is;Global?s cost of retained earnings if it can use retained earnings rather than;issue new common stock?;a.12.22%;b.17.22%;c.10.33%;d. 9.66%;e.16.00%;[10]. What is;the cost of common equity raised by selling new stock?;a.12.22%;b.17.22%;c.10.33%;d. 9.66%;e.16.00%;[11]. What is;the firm?s weighted average cost of capital if the firm has sufficient retained;earnings to fund the equity portion of its capital budget?;a.11.95%;b.12.22%;c.12.88%;d.13.36%;e.14.21%;(The;following information applies to the next two problems.);Byron Corporation?s present capital structure;which is also its target capital structure, is 40 percent debt and 60 percent;common equity. Assume that the firm has;no retained earnings. The company?s;earnings and dividends are growing at a constant rate of 5 percent, the last;dividend (D0) was $2.00, and the current equilibrium stock price is;$21.88. Byron can raise all the debt;financing it needs at 14 percent. If;Byron issues new common stock, a 20 percent flotation cost will be incurred. The firm?s marginal tax rate is 40 percent.;[12]. What is;the component cost of the equity raised by selling new common stock?;a.17.0%;b.16.4%;c.15.0%;d.14.6%;e.12.0%;[13]. What is;the firm?s weighted average cost of capital?;a.10.8%;b.13.6%;c.14.2%;d.16.4%;e.18.0%;(The;following information applies to the next six problems.);Rollins Corporation has a target capital structure;consisting of 20 percent debt, 20 percent preferred stock, and 60 percent;common equity. Assume the firm has;insufficient retained earnings to fund the equity portion of its capital;budget. Its bonds have a 12 percent coupon, paid semiannually, a current;maturity of 20 years, and sell for $1,000.;The firm could sell, at par, $100 preferred stock that pays a 12 percent;annual dividend, but flotation costs of 5 percent would be incurred. Rollins? beta is 1.2, the risk-free rate is;10 percent, and the market risk premium is 5 percent. Rollins is a constant;growth firm that just paid a dividend of $2.00, sells for $27.00 per share, and;has a growth rate of 8 percent. The;firm?s policy is to use a risk premium of 4 percentage points when using the;bond-yield-plus-risk-premium method to find ks. Flotation costs on new common stock total 10;percent, and the firm?s marginal tax rate is 40 percent.;[14]. What is;Rollins? component cost of debt?;a.10.0%;b. 9.1%;c. 8.6%;d. 8.0%;e. 7.2%;[15]. What is;Rollins? cost of preferred stock?;a.10.0%;b.11.0%;c.12.0%;d.12.6%;e.13.2%;[16]. What is;Rollins? cost of retained earnings using the CAPM approach?;a.13.6%;b.14.1%;c.16.0%;d.16.6%;e.16.9%;[17]. What is;the firm?s cost of retained earnings using the DCF approach?;a.13.6%;b.14.1%;c.16.0%;d.16.6%;e.16.9%;[18]. What is;Rollins? cost of retained earnings using the bond-yield-plus-risk-premium;approach?;a.13.6%;b.14.1%;c.16.0%;d.16.6%;e.16.9%;[19]. What is;Rollins? WACC, if the firm has insufficient retained earnings to fund the;equity portion of its capital budget?;a.13.6%;b.14.1%;c.16.0%;d.16.6%;e.16.9%;(The;following information applies to the next two problems.);The Jackson Company has just paid a dividend of;$3.00 per share on its common stock, and it expects this dividend to grow by 10;percent per year, indefinitely. The firm has a beta of 1.50, the risk-free rate;is 10 percent, and the expected return on the market is 14 percent. The firm?s investment bankers believe that;new issues of common stock would have a flotation cost equal to 5 percent of;the current market price.;[20]. How much;should an investor be willing to pay for this stock today?;a.$62.81;b.$70.00;c.$43.75;d.$55.00;e.$30.00;[21]. What will;be Jackson?s;cost of new common stock if it issues new stock in the marketplace today?;a.15.25%;b.16.32%;c.17.00%;d.12.47%;e. 9.85%;(The;following information applies to the next two problems.);Becker Glass Corporation expects to have earnings before;interest and taxes during the coming year of $1,000,000, and it expects its;earnings and dividends to grow indefinitely at a constant annual rate of 12.5;percent. The firm has $5,000,000 of debt;outstanding bearing a coupon interest rate of 8 percent, and it has 100,000;shares of common stock outstanding. Historically, Becker has paid 50 percent of;net earnings to common shareholders in the form of dividends. The current price of Becker?s common stock is;$40, but it would incur a 10 percent flotation cost if it were to sell new;stock. The firm?s tax rate is 40;percent.;[22]. What is;the firm?s cost of retained earnings?;a.15.0%;b.15.5%;c.16.0%;d.16.5%;e.17.0%;[23]. What is;Becker?s cost of newly issued stock?;a.16.0%;b.16.5%;c.17.0%;d.17.5%;e.18.0%;(The;following information applies to the next four problems.);J. Ross and Sons Inc. has a target capital structure;that calls for 40 percent debt, 10 percent preferred stock, and 50 percent;common equity. The firm?s current;after-tax cost of debt is 6 percent, and it can sell as much debt as it wishes;at this rate. The firm?s preferred stock;currently sells for $90 a share and pays a dividend of $10 per share, however;the firm will net only $80 per share from the sale of new preferred stock. Ross? common stock currently sells for $40;per share, but the firm will net only $34 per share from the sale of new common;stock. The firm recently paid a dividend;of $2 per share on its common stock, and investors expect the dividend to grow;indefinitely at a constant rate of 10 percent per year. Assume the firm has sufficient retained;earnings to fund the equity portion of its capital budget.;[24]. What is;the firm?s cost of retained earnings?;a.10.0%;b.12.5%;c.15.5%;d.16.5%;e.18.0%;[25]. What is;the firm?s cost of newly issued common stock?;a.10.0%;b.12.5%;c.15.5%;d.16.5%;e.18.0%;[26]. What is;the firm?s cost of newly issued preferred stock?;a.10.0%;b.12.5%;c.15.5%;d.16.5%;e.18.0%;[27]. What is;the firm?s weighted average cost of capital?;a. 9.5%;b.10.3%;c.10.8%;d.11.4%;e.11.9%;(The following information applies;to the next three problems.);The following information applies to the Coetzer Company;?;Coetzer has a;target capital structure of 40 percent debt and 60 percent common equity.;?;Coetzer has;$1,000 par value bonds outstanding with a 15-year maturity, a 12 percent annual;coupon, and a current price of $1,150.;?;The risk-free;rate is 5 percent. The market risk;premium (kM ? kRF) is also 5 percent.;?;Coetzer?s;common stock has a beta of 1.4.;?;Coetzer?s tax;rate is 40 percent.;[28]. What is;the company?s after-tax cost of debt?;a. 3.6%;b. 6.0%;c. 7.2%;d.10.0%;e.12.0%;[29]. What is;the company?s after-tax cost of common equity?;a. 6.0%;b. 8.4%;c. 9.6%;d.10.0%;e.12.0%;[30]. What is;the company?s WACC?;a. 6.0%;b. 7.4%;c. 9.6%;d.10.8%;e.12.2%;(The;following information applies to the next four problems.);Viduka Construction?s CFO wants to;estimate the company?s WACC. She has;collected the following information;?;The company;currently has 20-year bonds outstanding.;The bonds have an 8.5 percent annual coupon, a face value of $1,000, and;they currently sell for $945.;?;The company?s;stock has a beta = 1.20.;?;The market;risk premium, km? kRF;equals 5 percent.;?;The risk-free;rate is 6 percent.;?;The company;has outstanding preferred stock that pays a $2.00 annual dividend. The preferred;stock sells for $25 a share.;?;The company?s;tax rate is 40 percent.;?;The company?s;capital structure consists of 40 percent long-term debt, 40 percent common;stock, and 20 percent preferred stock.;[31]. What is;the company?s after-tax cost of debt?;a.5.10%;b.5.46%;c.6.46%;d.8.50%;e.9.11%;[32]. What is;the company?s after-tax cost of preferred stock?;a.4.80%;b.5.60%;c.7.10%;d.8.00%;e.8.40%;[33]. What is;the company?s after-tax cost of common equity?;a. 7.20%;b. 7.32%;c. 7.94%;d.12.00%;e.12.20%;[34]. What is;the company?s WACC?;a. 7.95%;b. 8.12%;c. 8.59%;d. 8.67%;e.10.04%;(The following information applies;to the next three problems.);Burlees Inc.?s;CFO is interested in calculating the cost of capital. In order to calculate the cost of capital;the company has collected the following information;?;The company?s;capital structure consists of 40 percent debt and 60 percent common stock.;?;The company;has bonds outstanding with 25 years to maturity. The bonds have a 12 percent annual coupon, a;face value of $1,000, and a current price of $1,252.;?;The company;uses the CAPM to calculate the cost of common stock. Currently, the risk-free rate is 5 percent;and the market risk premium, (kM - kRF), equals 6;percent. The company?s common stock has;a beta of 1.6.;?;The company?s;tax rate is 40 percent.;[35]. What is;the company?s after-tax cost of debt?;a.3.74%;b.4.80%;c.5.62%;d.7.20%;e.8.33%;[36]. What is;the company?s cost of common equity?;a. 9.65%;b.14.00%;c.14.60%;d.17.60%;e.18.91%;[37]. What is;the company?s weighted average cost of capital (WACC)?;a.10.5%;b.11.0%;c.11.5%;d.12.0%;e.12.5%;Web Appendix 9A;Multiple;Choice: Conceptual;9A-[38]. Sunshine Inc. has two divisions. 50 percent of the firm?s capital is invested;in Division A, which has a beta of 0.8.;The other 50 percent of the firm?s capital is invested in Division B;which has a beta of 1.2. The company has;no debt, and it is 100 percent equity financed. The risk-free rate is 6 percent;and the market risk premium is 5 percent.;Sunshine assigns different hurdle rates to each division, and these;hurdle rates are based on each division?s market risk. Which of the following statements is most;correct?;a.Sunshine?s composite WACC is 11 percent.;b.Division B has a lower weighted average cost of;capital than Division A.;c.If Sunshine assigned the same hurdle rate to;each division, this would lead the firm to select too many projects in Division;A and reject too many projects in Division B.;d.Statements a and b are correct.;e.Statements a and c are correct.;9A-[39]. If the firm is being operated so as to;maximize shareholder wealth, and if our basic assumptions concerning the;relationship between risk and return are true, then which of the following;should be true?;a.If the beta of the asset is larger than the;firm?s beta, then the re-quired return on the asset is less than the required;return on the firm.;b.If the beta of the asset is smaller than the;firm?s beta, then the required return on the asset is greater than the required;return on the firm.;c.If the beta of the asset is greater than the;firm?s beta prior to the addition of that asset, then the firm?s beta after the;purchase of the asset will be smaller than the original firm?s beta.;d.If the beta of an asset is larger than the;firm?s beta prior to the addition of that asset, then the required return on;the firm will be greater after the purchase of that asset than prior to its;purchase.;e.None of the statements above is correct.;9A-[40]. Using the Security Market Line concept in;capital budgeting, which of the following is correct?;a.If the expected rate of return on a given;capital project lies above the SML, the project should be accepted even if its;beta is above the beta of the firm?s average project.;b.If a project?s return lies below the SML, it;should be rejected if it has a beta greater than the firm?s existing beta but;accepted if its beta is below the firm?s beta.;c.If two mutually exclusive projects? expected;returns are both above the SML, the project with the lower risk should be;accepted.;d.If a project?s expected rate of return is;greater than the expected rate of return on an average project, it should be;accepted.;e.None of the statements above is correct.;Multiple Choice: Problems;9A-[41]. Louisiana Enterprises, an all-equity firm, is;consider?ing a new capital investment.;Analy?sis has indicated that the proposed investment has a beta of 0.5;and will generate an expected return of 7 percent. The firm currently has a required return of;10.75 percent and a beta of 1.25. The;investment, if undertaken, will double the firm?s total assets. If kRF is 7 percent and the market;return is 10 percent, should the firm undertake the invest?ment? (Choose the best answer.);a.Yes,theexpectedreturnofthe asset(7%)exceedstherequiredreturn (6.5%).;b.Yes, the beta of the asset will reduce the risk;of the firm.;c.No, the expected return of the asset (7%) is;less than the required return (8.5%).;d.No, the risk of the asset (beta) will increase;the firm?s beta.;e.No, the expected return of the asset is less;than the firm?s required return, which is 10.75%.;Medium;9A-[42]. Assume you are the director of capital;budgeting for an all-equity firm. The firm?s current cost of equity is 16;percent, the risk-free rate is 10 percent, and the market risk premium is 5;percent. You are considering a new;project that has 50 percent more beta risk than your firm?s assets currently;have, that is, its beta is 50 percent larger than the firm?s existing;beta. The expected return on the new;project is 18 percent. Should the;project be accepted if beta risk is the appropriate risk measure? Choose the correct statement.;a.Yes, its expected return is greater than the;firm?s cost of capital.;b.Yes, the project?s risk-adjusted required;return is less than its expected return.;c.No, a 50 percent increase in beta risk gives a;risk-adjusted required return of 24 percent.;d.No, the project?s risk-adjusted required return;is 2 percentage points above its expected return.;e.No, the project?s risk-adjusted required return;is 1 percentage point above its expected return.;Web Appendix 9B;Multiple;Choice: Conceptual;9B-[43]. Which of the following methods involves;calculating an average beta for firms in a similar business and then applying;that beta to determine a project?s beta?;a.Risk premium method.;b.Pure play method.;c.Accounting beta method.;d.CAPM method.;e.Statements b and c are correct.;Multiple;Choice: Problems;9B-[44]. Northern Conglomerate has two divisions;Division A and Division B. Northern;looks at competing pure-play firms to estimate the betas of each of the two;divisions. After this analysis, Northern;concludesthat Division A has a beta of 0.8 and Division B has a;beta of 1.5. The twodivisions;are the same size. The risk-free rate is;5 percent and the market risk premium, kM - kRF, is 6;percent. Assume that Northern is 100;percent equity financed. What is the overall composite WACC for Northern;Conglomerate?;a. 9.8%;b.10.2%;c.11.9%;d.13.6%;e.14.0%;9B-[45]. Interstate Transport has a target capital;struc?ture of 50 percent debt and 50 percent common equity. The firm is considering a new independent;project that has a return of 13 percent and is not related to;transportation. However, a pure play;proxy firm has been identified that is exclusively engaged in the new line of;busi?ness. The proxy firm has a beta of;1.38. Both firms have a marginal tax;rate of 40 percent, and Interstate?s before-tax cost of debt is 12;percent. The risk-free rate is 10;percent and the market risk premium is 5 percent. The firm should;a.Reject the project, its return is less than the;firm?s required rate of return on the project of 16.9 percent.;b.Accept the project, its return is greater than;the firm?s required rate of return on the project of 12.05 percent.;c.Reject the project, its return is only 13;percent.;d.Accept the project, its return exceeds the;risk-free rate and the before-tax cost of debt.;e.Be indifferent between accepting or rejecting;the firm?s required rate of return on the project equals its expected return.

 

Paper#45199 | Written in 18-Jul-2015

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