bus 320 connect homework 5 (sep 2013)

bus_320_homework_5_sep_2013 x

1 Problem 10-2 Bond value [LO3]

Applied Software has $1,000 par value bonds outstanding at 20 percent interest. The bonds will mature in 15 years. Use Appendix B and Appendix D.

    

 

Compute the current price of the bonds if the present yield to maturity is (Round “PV Factor” to 3 decimal places, intermediate and final answers to 2 decimal places. Omit the “$” sign in your response):

     

Price of the bond

  

(a)

 10 percent

$   

(2)

  Ke increases

  

(3)

  g increases

  

 

18.

value:

1.00 points

 

Problem 11-2 Cost of capital [LO2]

Speedy Delivery Systems can buy a piece of equipment that should provide an 6 percent return and can be financed at 3 percent with debt. The CEO likes earning more than the cost of debt, and he thinks this would be a good deal. The firm can also buy a machine that would yield a 13 percent return but would cost 15 percent to finance through common equity. Earning less than the cost of equity sounds bad to the CEO. Assume debt and common equity each represent 50 percent of the firm’s capital structure.

 

(a)

Compute the weighted average cost of capital. (Round your intermediate and final answers to 1 decimal place. Omit the “%” sign in your response.)

 

  

(2)  Ke increases  (3)  g increases  

  Weighted average cost of capital

 18.value: 1.00 points Problem 11-2 Cost of capital [LO2]Speedy Delivery Systems can buy a piece of equipment that should provide an 6 percent return and can be financed at 3 percent with debt. The CEO likes earning more than the cost of debt, and he thinks this would be a good deal. The firm can also buy a machine that would yield a 13 percent return but would cost 15 percent to finance through common equity. Earning less than the cost of equity sounds bad to the CEO. Assume debt and common equity each represent 50 percent of the firm’s capital structure. (a)Compute the weighted average cost of capital. (Round your intermediate and final answers to 1 decimal place. Omit the “%” sign in your response.) 

  Weighted average cost of capital

 on investment

 on investment

[removed] 

  

1 Problem

10

-2 Bond value [LO3]

Applied Software has

$

1,000 par value bonds outstandin

g

at

20

percent interest. The bonds will mature in 1

5

years. Use

 

Appendix B
 and 
Appendix D
.

  

  

 

Compute the current price of the bonds if the present yield to maturity is (Round “PV Factor” to 3 decimal places, intermediate and final answers to 2 decimal places. Omit the “$” sign in your response):

   

 

$   

$   

 

Price

of the
bond

  (a) 10 percent

  

  (b) 

15

percent

  (c) 12 percent

2.

value:
1.00 points

 

Problem 10-

4

Bond value [LO3]

Barry’s Steroids Company has $1,000 par value bonds outstanding at

14

percent interest. The bonds will mature in 40 years.

If the percent yield to maturity is 11 percent, what percent of the total bond value does the repayment of principal represent? Use 
Appendix B
 and 
Appendix D
. (Round intermediate calculations to 2 decimal places, “PV Factor” and final answer to 3 decimal places. Omit the “

%

” sign in your response.)

  Principal repayment

 %

 

3.

value:
1.00 points
 

Problem 10-5 Bond value [LO3]

Essex Biochemical Co. has a $1,000 par value bond outstanding that pays 19 percent annual interest. The current yield to maturity on such bonds in the market is 11 percent. Use 
Appendix B
 and 
Appendix D
.

  

Compute the price of the bonds for these maturity dates (Round “PV Factor” to 3 decimal places, intermediate and final answers to 2 decimal places. Omit the “$” sign in your response):

  

 

Price of the
bond

$   

$   

$   

  (a)

25

years

  (b) 15 years

  (c) 4 years

rev: 04_2

7

_2012

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r

5.

value:
1.00 points
 

Problem 10-11 Effect of maturity on bond price [LO3]

Refer to 
Table 10-2

(a)

Assume the interest rate in the market (yield to maturity) goes down to 8 percent for the 10 percent bonds. Using column 2, indicate what the bond price will be with a 10-year, a 20-year, and a 30-year time period. (Round “PV Factor” to 3 decimal places, intermediate calculations and final answers to 2 decimal places. Omit the “$” sign in your response.)

    

$   

  

  

Maturity

Bond price

  10 Years

  20 years

  30 years

    

(b)

Assume the interest rate in the market (yield to maturity) goes up to 12 percent for the 10 percent bonds. Using column 3, indicate what the bond price will be with a 10-year, a 20-year, and a 30-year period. (Round “PV Factor” to 3 decimal places, intermediate calculations and final answers to 2 decimal places. Omit the “$” sign in your response.)

     

Maturity

Bond price

  10 Years

$   

  20 years

  

  30 years

  

    

 

  

 

Longest-term bond

Shortest-term bond

(c)

Assume the interest rate in the market (yield to maturity) goes down to 8 percent for the 10 percent bonds. If interest rates in the market are going down, which bond would you choose to own?

    

 

  

 

(d)

Assume the interest rate in the market (yield to maturity) goes up to 12 percent for the 10 percent bonds. If interest rates in the market are going up, which bond would you choose to own?

Longest-term bond

Shortest-term bond

6.

value:
1.00 points
 

Problem 10-13 Effect of yield to maturity on bond price [LO3]

Tom Cruise Lines, Inc., issued bonds five years ago at $1,000 per bond. These bonds had a 20-year life when issued and the annual interest payment was then 14 percent. This return was in line with the required returns by bondholders at that point as described below:

  

  

 

 

 

5

 

  

%

  

  Real rate of return

4 %

  Inflation premium

5

  Risk premium

   

  Total

return

14

  

Assume that five years later the inflation premium is only 2 percent and is appropriately reflected in the required return (or yield to maturity) of the bonds. The bonds have 15 years remaining until maturity.

  

Compute the new price of the bond. Use 
Appendix B
 and 
Appendix D
. (Round “PV Factor” to 3 decimal places, intermediate and final answer to 2 decimal places. Omit the “$” sign in your response.)

  

$   

  New price

rev: 07-13-

2011

7.

value:
2.00 points

 

Problem 10-14 Analyzing bond price changes [LO3]

(a)

Find the present value of 3 percent × $1,000 (or $30) for 15 years at 11 percent. The $30 is assumed to be an annual payment. Use 
Appendix D
. (Round “PV Factor” to 3 decimal places, intermediate and final answer to 2 decimal places. Omit the “$” sign in your response.)

      

$   

  

Present value

       

     

(b)

Add the answer obtained in part a to 1,000. (Round “PV Factor” to 3 decimal places, intermediate and final answer to 2 decimal places. Omit the “$” sign in your response.)

       

  Present value

$   

 8.

value:
2.00 points
 

Problem 10-17 Deep discount bonds [LO3]

Lance Whittingham IV specializes in buying deep discount bonds. These represent bonds that are trading at well below par value. He has his eye on a bond issued by the Leisure Time Corporation. The $1,000 par value bond pays 8 percent annual interest and has 17 years remaining to maturity. The current yield to maturity on similar bonds is 10 percent.

  

(a)

What is the current price of the bonds? Use 
Appendix B
 and 
Appendix D
. (Round “PV Factor” to 3 decimal places, intermediate and final answers to 2 decimal places. Omit the “$” sign in your response.)

  

$   

  Current price

  

(b)

By what percent will the price of the bonds increase between now and maturity? (Round “PV Factor” to 3 decimal places, intermediate and final answers to 2 decimal places. Omit the “%” sign in your response.)

  

 

%  

  Price

increases by

rev: 07-13-2011

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references

 9.

value:
1.00 points
 

Problem 10-19 Approximate yield to maturity [LO3]

Bonds issued by the Tyler Food Corporation have a par value of $1,000, are selling for $1,410, and have 20 years remaining to maturity. The annual interest payment is

20.

5 percent ($205).

      

Compute the approximate yield to maturity. (Do not round intermediate calculations. Round your answer to 2 decimal places. Omit the “%” sign in your response.)

    

 

  Approximate yield to maturity

10.

value:
2.00 points
 

Problem 10-22 Bond value-semiannual analysis [LO3]

You are called in as a financial analyst to appraise the bonds of Olsen’s Clothing Stores. The $1,000 par value bonds have a quoted annual interest rate of 11 percent, which is paid semiannually. The yield to maturity on the bonds is 14 percent annual interest. There are 20 years to maturity. Use 
Appendix B
 and
Appendix D
.

    

(a)

Compute the price of the bonds based on semiannual interest payments. (Round “PV Factor” to 3 decimal places, intermediate and final answer to 2 decimal places. Omit the “$” sign in your response.)

    

 Price of the bond

s

$   

 

    (b)

With 15 years to maturity, if yield to maturity goes down substantially to 8 percent, what will be the new price of the bonds? (Round “PV Factor” to 3 decimal places, intermediate and final answer to 2 decimal places. Omit the “$” sign in your response.)

    

  New price

$   

 11.

value:
1.00 points
 

Problem 10-24 Preferred stock value [LO4]

Bedford Mattress Company issued preferred stock many years ago. It carries a fixed dividend of $11 per share. With the passage of time, yields have gone down from the original 10 percent to 9 percent (yield is the same as required rate of return).

  

(a)

What was the original issue price? (Round your answer to 2 decimal places. Omit the “$” sign in your response.)

  

$   

  Original price

  

(b)

What is the current value of this preferred stock?(Round your answer to 2 decimal places. Omit the “$” sign in your response.)

  

$   

  Current value

12.

value:
1.00 points
 

Problem 10-26 Preferred stock rate of return [LO4]

Grant Hillside Homes, Inc., has preferred stock outstanding that pays an annual dividend of $10.

30.

Its price is $167.

 

What is the required rate of return (yield) on the preferred stock? (Round your answer to 2 decimal places. Omit the “%” sign in your response.)

   

 %  

  Rate of return

13.

value:
1.00 points
 

Problem 10-28 Common stock value [LO5]

Laser Optics will pay a common stock dividend of $3.20 at the end of the year (

D1

). The required rate of return on common stock (Ke) is 20 percent. The firm has a constant growth rate (g) of 10 percent.

  

Compute the current price of the stock (

P0

). (Round your answer to 2 decimal places. Omit the “$” sign in your response.)

  

  Current price

$   

1

4.

value:
2.00 points
 

Problem 10-29 Common stock value under different market conditions [LO5]

Ecology Labs, Inc., will pay a dividend of $6.80 per share in the next 12 months (D1). The required rate of return (Ke) is 15 percent and the constant growth rate is 5 percent. (Each question is independent of the others.)

   

(a)

Compute the price of Ecology Labs’ common stock. (Round your intermediate and final answer to 2 decimal places. Omit the “$” sign in your response.)

    

$   

  Price

    

(b)

Assume Ke, the required rate of return, goes up to 20 percent; what will be the new price? (Round your intermediate and final answer to 2 decimal places. Omit the “$” sign in your response.)

    

  New price

$   

  

(c)

Assume the growth rate (g) goes up to 7 percent; what will be the new price? Ke goes back to its original value of 15 percent. (Round your intermediate and final answer to 2 decimal places. Omit the “$” sign in your response.)

  

  New price

$   

    

(d)

Assume D1 is $7.50; what will be the new price? Assume Ke is at its original value of 15 percent and g goes back to its original value of 5 percent. (Round your intermediate and final answer to 2 decimal places. Omit the “$” sign in your response.)

    

  New price

$   

15.

value:
2.00 points
 

Problem 10-31 Common stock value based on determining growth rate [LO5]

Justin Cement Company had the following pattern of earnings per share over the last five years:

    

  Year

Earnings
per share

  2006

$

10.00

  2007

10.5

0

  2008

11.03

  2009

11.58

  2010

1

2.1

6

   

The earnings per share have grown at a constant rate (on a rounded basis) and is expected to do so in the future. Dividends represent 40 percent of earnings.

      (a)

Project earnings and dividends for the next year (2011). (Round your intermediate and final answers to 2 decimal places. Omit the “$” sign in your response.)

    

2011

  Earnings

  Dividend

      

(b)

If the required rate of return (Ke) is 13 percent, what is the anticipated stock price (P0) at the beginning of 2011? (Round your intermediate and final answers to 2 decimal places. Omit the “$” sign in your response.)

       

$   

  Anticipated stock price

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16.

value:
1.00 points
 

Problem 10-32 Common stock required rate of return [LO5]

A firm pays a $9.80 dividend at the end of year one (D1), has a stock price of $137, and a constant growth rate (g) of 5 percent.

  

Compute the required rate of return (Ke). (Round your intermediate and final answer to 2 decimal places. Omit the “%” sign in your response.)

  

  Rate of return

 %  

17.

value:

4.0

0 points

 

Problem 10-

35

Common stock value based on PV calculations [LO5]

Beasley Ball Bearings paid a $4 dividend last year. The dividend is expected to grow at a constant rate of 4 percent over the next four years. The required rate of return is 16 percent (this will also serve as the discount rate in this problem). Use 
Appendix B
.

   

(a)

Compute the anticipated value of the dividends for the next four years. (Round your intermediate calculations and final answers to 3 decimal places. Omit the “$” sign in your response.)

    

 

$   

$   

$   

$   

   Anticipated
   value

  D1

  D2

  D3

  D4

    

(b)

Calculate the present value of each of the anticipated dividends at a discount rate of 16 percent.(Round “PV Factor”, intermediate calculations and final answers to 3 decimal places. Omit the “$” sign in your response.)

    

 

  D1

$   

  D2

  

  D3

  

  D4

  

  

$   

  

PV of
dividends

  Total

    

(c)

Compute the price of the stock at the end of the fourth year (P4). (Round “PV Factor”, intermediate calculations and final answer to 3 decimal places. Omit the “$” sign in your response.)

    

$   

  Price of the stock

    

(d)

Calculate the present value of the year 4 stock price at a discount rate of 16 percent. (Round “PV Factor”, intermediate calculations and final answer to 3 decimal places. Omit the “$” sign in your response.)

    

$   

  Price of the stock (discounted)

    

(e)

Compute the current value of the stock. (Round “PV Factor”, intermediate calculations and final answer to 3 decimal places. Omit the “$” sign in your response.)

     

  Current value

$   

    

(f)

Use formula given below to show that it will provide approximately the same answer as part e. (Omit the “$” sign in your response.)

    

P0

=

D1

Ke − g

    

  Current value

$   

    

(g)

If current EPS is equal to $5.329 and the P/E ratio is 1.2 times higher than the industry average of 6, what would the stock price be? (Round your intermediate calculations and final answers to 2 decimal places. Omit the “$” sign in your response.)

    

$   

  Stock price

    

(h)

By what dollar amount is the stock price in part g different from the stock price in part f? (Input the amount as a positive value. Round intermediate calculations and final answer to 2 decimal places. Omit the “$” sign in your response.)

    

$   

  Amount

    

(i)

In regard to the stock price in part f, indicate which direction it would move if

    

  

 

 

  

  

  

(1)

  D1 increases

(2)

  Ke

 increases

(3)

  g increases

18.

value:
1.00 points
 

Problem 11-2

Cost of capital

[LO2]

Speedy Delivery Systems can buy a piece of equipment that should provide an 6 percent return and can be financed at 3 percent with debt. The CEO likes earning more than the cost of debt, and he thinks this would be a good deal. The firm can also buy a machine that would yield a 13 percent return but would cost 15 percent to finance through common equity. Earning less than the cost of equity sounds bad to the CEO. Assume debt and common equity each represent 50 percent of the firm’s capital structure.

(a)

Compute the weighted average cost of capital. (Round your intermediate and final answers to 1 decimal place. Omit the “%” sign in your response.)

 %  

  Weighted average cost of capital

(b)

 

 

 

Which project(s) should be accepted?

Piece of equipment should be financed.

New machine should be financed.

19.

value:
1.00 points
 

Problem 11-3 Effect of discount rate [LO2]

A brilliant young scientist is killed in a plane crash. It was anticipated that he could have earned $260,000 a year for the next 25 years. The attorney for the plaintiff’s estate argues that the lost income should be discounted back to the present at 5 percent. The lawyer for the defendant’s insurance company argues for a discount rate of 10 percent.

What is the difference between the present value of the settlement at 5 percent and 10 percent? Compute each one separately. Use 
Appendix D
. (Round “PV Factor” to 3 decimal places. Round your answers to the nearest dollar amount. Omit the “$” sign in your response)

 

$

  

 

  

 

$

  

 

Present value

  PV at 5% rate

  PV at 10% rate

  Difference

20.
value:
1.00 points
 

Problem 11-5 Aftertax cost of debt [LO3]

Calculate the aftertax cost of debt under each of the following conditions. (Round your answers to 2 decimal places. Omit the “%” sign in your response.)

  

 %

 %

 

 

 

 

 

 

 

    

 

 

 

 

20

 

 

 

 

    

 

Yield

Corporate
tax rate

Cost of debt

 a.

4.0  % 10

 b.

6.6

20

 c.

6.0

21

.

value:
1.00 points
 

Problem 11-7 Aftertax cost of debt [LO3]

The Goodsmith Charitable Foundation, which is tax-exempt, issued debt last year at 5 percent to help finance a new playground facility in Los Angeles. This year the cost of debt is 5 percent higher; that is, firms that paid 7 percent for debt last year will be paying 7.35 percent this year.

  

(a)

If the Goodsmith Charitable Foundation borrowed money this year, what would the aftertax cost of debt be, based on its cost last year and the 5 percent increase? (Round your answer to 2 decimal places. Omit the “%” sign in your response.)

  

 %  

  Cost of debt

  

(b)

If the receipts of the foundation were found to be taxable by the IRS (at a rate of 15 percent because of involvement in political activities), what would the aftertax cost of the debt be? (Round your answer to 2 decimal places. Omit the “%” sign in your response.)

  

  Cost of debt

 % 

22.

value:
1.00 points
 

Problem 11-9 Approximate yield to maturity and cost of debt [LO3]

Airbone Airlines, Inc., has a $1,000 par value bond outstanding with 15 years to maturity. The bond carries an annual interest payment of $82 and is currently selling for $850. Airbone is in the 25 percent tax bracket. The firm wishes to know what the aftertax cost of a new bond issue is likely to be. The yield to maturity on the new issue will be the same as the yield to maturity on the old issue because the risk and maturity date will be similar.

 

(a)

Compute the approximate yield to maturity on the old issue and use this as the yield for the new issue.(Do not round intermediate calculations. Round your answer to 2 decimal places. Omit the “%” sign in your response.)

 %  

  Yield

on new issue

 

(b)

Make the appropriate tax adjustment to determine the aftertax cost of debt. (Do not round intermediate calculations. Round your answer to 2 decimal places. Omit the “%” sign in your response.)

  Cost of debt

 %  

23.

value:
1.00 points
 

Problem 11-11 Changing rates and cost of debt [LO3]

Russell Container Corporation has a $1,900 par value bond outstanding with 30 years to maturity. The bond carries an annual interest payment of $113 and is currently selling for $1,210 per bond. Russell Corp. is in a 25 percent tax bracket. The firm wishes to know what the aftertax cost of a new bond issue is likely to be. The yield to maturity on the new issue will be the same as the yield to maturity on the old issue because the risk and maturity date will be similar.
Assume that the yield on the bonds goes up by 1 percentage point and that the tax rate is now 35 percent.

 

(a)

What is the new after-tax cost of debt? (Hint: Use the approximate yield to maturity to compute after-tax cost of debt) (Round your answer to 2 decimal places. Omit the “%” sign in your response.)

 

  Cost of debt

 %  

 

(b)

 

 

 

Has the aftertax cost of debt gone up or down?

It has gone down.

It has gone up.

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24.

value:
2.00 points
 

Problem 11-12 Real-world example and cost of debt [LO3]

KFW is planning to issue debt that will mature in the year 2017. In many respects the issue is similar to currently outstanding debt of the corporation. Using 
Table 11-2
, identify:

(a)

The yield to maturity on similarly outstanding debt for the firm, in terms of maturity. (Round your answer to 2 decimal places. Omit the “%” sign in your response.)

 %  

  Yield
(b)

Calculate yield to maturity with an increase of 0.10 percent than the value determined in part a. (Round your answer to 2 decimal places. Omit the “%” sign in your response.)

  Yield

 %  

(c)

If the firm is in a 30 percent tax bracket, what is the aftertax cost of debt for yield determined in part b?(Round your answer to 2 decimal places. Omit the “%” sign in your response.)

  Cost of debt

 %  

25.

value:
1.00 points
 

Problem 11-14 Cost of preferred stock [LO3]

The Meredith Corporation issued $100 par value preferred stock 10 years ago. The stock provided an 9 percent yield at the time of issue. The preferred stock is now selling for $84. (Disregard flotation costs.)

  

What is the current yield or cost of preferred stock? (Round your answer to 2 decimal places. Omit the “%” sign in your response.)

  

  Yield

 %  

26.

value:
2.00 points
 

Problem 11-15 Comparison of the costs of debt and preferred stock [LO3]

The treasurer of Riley Coal Co. is asked to compute the cost of fixed income securities for her corporation. Even before making the calculations, she assumes the aftertax cost of debt is at least 6 percent less than that for preferred stock.

   

  Debt

can be issued at a yield of

13.0

percent, and the corporate tax rate is 30 percent. Preferred stock will be priced at $64 and pay a dividend of $8.40. The flotation cost on the preferred stock is $8.

 

(a)

Compute the aftertax cost of debt. (Round your answer to 2 decimal places. Omit the “%” sign in your response.)

 %  

  Aftertax cost of debt

 

(b)

Compute the aftertax cost of preferred stock. (Round your answer to 2 decimal places. Omit the “%” sign in your response.)

 %  

  Aftertax cost of preferred stock

 

(c)

 

 

 

Based on the facts given above, is the treasurer correct?

No

Yes

27.

value:
2.00 points
 

Problem 11-17 Costs of retained earnings and new common stock [LO3]

Compute Ke and Kn under the following circumstances:

(a)

D1 = $8.80, P0 = $96, g = 6%, F = $7.00. (Round your intermediate and final answers to 2 decimal places. Omit the “%” sign in your response.)

 

 

 %  

 %  

  Ke

  Kn

(b)

D1 = $0.38, P0 = $25, g = 8%, F = $2.00. (Round your intermediate and final answers to 2 decimal places. Omit the “%” sign in your response.)

 

 

  Ke

 %  

  Kn

 %  

(c)

E1 (earnings at the end of period one) = $7, payout ratio equals 20 percent, P0 = $38, g = 10.5%, F = $1.40. (Round your intermediate and final answers to 2 decimal places. Omit the “%” sign in your response.)

 

 

  Ke

 %  

  Kn

 %  

(d)

D0 (dividend at the beginning of the first period) = $5, growth rate for dividends and earnings (g) = 5%, P0= $59, F = $5. (Round your intermediate and final answers to 2 decimal places. Omit the “%” sign in your response.)

 

 

  Ke

 %  

  Kn

 %  

28.

value:
1.00 points
 

Problem 11-19 Weighted average cost of capital [LO1]

United Business Forms’ capital structure is as follows:

  

  

 

%

20

 

 

  Debt 25

  Preferred stock

  Common equity

55

  

The aftertax cost of debt is 6 percent, the cost of preferred stock is 9 percent, and the cost of common equity (in the form of retained earnings) is 12 percent.

  

Calculate United Business Forms’ weighted cost of each source of capital and the weighted average cost of capital. (Round your answers to 2 decimal places. Omit the “%” sign in your response.)

  

  

 

 

  

%  

  

Weighted cost

  Debt (Kd)

%  

  Preferred stock (Kp)

  Common equity (Ke)

  Weighted average cost of capital (Ka)

29.

value:
2.00 points
 

Problem 11-21 Weighted average cost of capital [LO1]

Sauer Milk, Inc., wants to determine the minimum cost of capital point for the firm. Assume it is considering the following financial plans:

 

 

 

 

 

 

 

 

  Debt

 

4.0

%

 

%

  Preferred stock

 

 

 

10

 

  Common equity

 

 

 

 

 

 

 

 

 

 

  Debt

 

%

 

25

%

  Preferred stock

 

 

 

10

 

  Common equity

 

 

 

 

 

 

 

 

 

 

  Debt

 

%

 

%

  Preferred stock

 

 

 

10

 

  Common equity

 

 

 

55

 

 

 

 

 

 

 

  Debt

 

%

 

%

  Preferred stock

 

 

 

10

 

  Common equity

 

 

 

45

 

Cost
(aftertax)

Weights

  Plan A

15

8.0

16.0

75

  Plan B

4.8

8.6

13.0

65

  Plan C

5.0

35

17.7

10.5

  Plan D

15.0

45

18.4

12.6

(a-1)

Compute the weighted average cost for four plans. (Round your intermediate and final answers to 2 decimal places. Omit the “%” sign in your response.)

 

 

Weighted cost

  Plan A

 %  

  Plan B

  Plan C

      

  Plan D

      

      

 

 

 

(a-2)

Which of the four plans has the lowest weighted average cost of capital?

Plan A

Plan B

Plan C

Plan D

 

(b)

 

Among Plan C and Plan D, which has higher weighted average cost of capital.

 

Plan C

Plan D

30.
value:
2.00 points
 

Problem 11-25 Changes in cost and weighted average cost of capital [LO1]

   

A-Rod Manufacturing Company is trying to calculate its cost of capital for use in making a capital budgeting decision. Mr. Jeter, the vice-president of finance, has given you the following information and has asked you to compute the weighted average cost of capital.

     The company currently has outstanding a bond with a 10.2 percent coupon rate and another bond with an 7.8 percent rate. The firm has been informed by its investment banker that bonds of equal risk and credit rating are now selling to yield 11.1 percent. The common stock has a price of $56 and an expected dividend (D1) of $

1.76

per share. The historical growth pattern (g) for dividends is as follows:

     

 

 

 

 

$1.31

1.45

1.60

1.76

    

     The preferred stock is selling at $76 per share and pays a dividend of $7.20 per share. The corporate tax rate is 30 percent. The flotation cost is 2.0 percent of the selling price for preferred stock. The optimum capital structure for the firm is 25 percent debt, 20 percent preferred stock, and 55 percent common equity in the form of retained earnings.

     

(a)

Compute the historical growth rate. (Round your intermediate calculations and your final answer to 2 decimal Places. Omit the “%” sign in your response.)

    

 %  

  Growth rate

   

(b)

Compute the cost of capital for the individual components in the capital structure. (Round growth rate to nearest whole percent. Round your answers to 2 decimal places. Omit the “%” sign in your response.)

     

 

  Debt (Kd)

 %  

  Preferred stock (Kp)

      

  Common equity (Ke)

      

Cost of capital

      

(c)

Calculate the weighted cost of each source of capital and the weighted average cost of capital. (Round your intermediate calculations and  final answers to 2 decimal places. Omit the “%” sign in your response.)

     

 

Weighted cost

  Debt (Kd)

 %  

  Preferred stock (Kp)

      

  Common equity (Ke)

      

 

  Weighted average cost of capital (Ka)

 %  

 

31.

value:
2.00 points
 

Problem 11-26 Impact of credit ratings on cost of capital [LO3]

   

   

   

Northwest Utility Company faces increasing needs for capital. Fortunately, it has an

Aa3

credit rating. The corporate tax rate is 40 percent. Northwest’s treasurer is trying to determine the corporation’s current weighted average cost of capital in order to assess the profitability of capital budgeting projects.

     Historically, the corporation’s earnings and dividends per share have increased about 6.6 percent annually and this should continue in the future. Northwest’s common stock is selling at $67 per share, and the company will pay a $4.20 per share dividend (D1).

     The company’s $102 preferred stock has been yielding 4 percent in the current market. Flotation costs for the company have been estimated by its investment banker to be $3.00 for preferred stock.

     The company’s optimum capital structure is 40 percent debt, 20 percent preferred stock, and 40 percent common equity in the form of retained earnings. Refer to the table below on bond issues for comparative yields on bonds of equal risk to Northwest.

   

 

 

 

 

 

 

 

$

 

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

%

A2

 

 

 

 

Data on Bond Issues

  Issue

Moody’s
rating

Price

Yield to maturity

  Utilities:

     Southwest electric power––71/4 2023

Aa2

910.18

8.44

     Pacific bell––73/8 2025

Aa3

894.25

8.22

     Pennsylvania power & light––81/2 2022

A2

985.66

8.56

  Industrials:

     Johnson & Johnson––63/4 2023

Aaa

830.24

8.46

     Dillard’s Department Stores––71/8 2023

990.92

8.66

     Marriott Corp.––10 2015

B2

1,050.10

9.44

   

(a)

Compute the cost of debt, Kd (use the accompanying table—relate to the utility bond credit rating for yield.) (Round your answer to 2 decimal places. Omit the “%” sign in your response.)

   

  Cost of debt

 %  

   

(b)

Compute the cost of preferred stock, Kp. (Round your answer to 2 decimal places. Omit the “%” sign in your response.)

   

 %  

  Cost of preferred stock

   

(c)

Compute the cost of common equity in the form of retained earnings, Ke. (Round your answer to 2 decimal places. Omit the “%” sign in your response.)

   

 %  

  Cost of common equity

   

(d)

Compute the weighted average cost of capital. (Round your intermediate and final answers to 2 decimal places. Omit the “%” sign in your response.)

   

 

Weighted cost

  Debt (Kd)

 %  

  Preferred stock (Kp)

     

  Common equity (Ke)

 

  Weighted average cost of capital (Ka)

 %  

 

      

32.

value:
2.00 points
 

Problem 11-27 Marginal cost of capital [LO5]

Delta Corporation has the following capital structure:

  

 

Cost
(aftertax)

Weights

  Debt (Kd)

 

%

 

10

%

 

%

  Preferred stock (Kp)

 

 

 

20

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

  Weighted average cost of capital (Ka)

 

 

 

 

 

 

 

%

 

 

 

 

 

 

 

Weighted
cost

5.2

.52

12.2

2.44

  Common equity (Ke) (retained earnings)

7.1

70

4.97

7.93

  

(a)

If the firm has $28 million in retained earnings, at what size capital structure will the firm run out of retained earnings? (Enter your answer in millions. Omit the “$” sign in your response.)

  

  Capital structure size (X)

$  million  

 

(b)

The 5.2 percent cost of debt referred to above applies only to the first $15 million of debt. After that the cost of debt will go up. At what size capital structure will there be a change in the cost of debt? (Enter your answer in millions. Omit the “$” sign in your response.)

  

$  million  

  Capital structure size (Z)

33.

value:
2.00 points
 

Problem 11-28 Marginal cost of capital [LO5]

The Nolan Corporation finds that it is necessary to determine its marginal cost of capital. Nolan’s current capital structure calls for 30 percent debt, 20 percent preferred stock, and 50 percent common equity. Initially common equity will be in the form of retained earnings (Ke) and then new common stock (Kn). The costs of the various sources of financing are as follows: debt, 5.2 percent; preferred stock, 7 percent; retained earning, 10 percent; and new common stock, 11.2 percent.

(a)

What is the initial weighted average cost of capital? (Round your intermediate calculations and final answer to 2 decimal places. Omit the “%” sign in your response.)

 

  Weighted average cost of capital

 %  

(b)

If the firm has $27 million in retained earnings, at what size capital structure will the firm run out of retained earnings? (Enter your answer in millions. Omit the “$” sign in your response.)

 

  Capital structure size (X)

$  million  

 

(c)

What will the marginal cost of capital be immediately after that point? (Equity will remain at 50 percent of the capital structure, but will all be in the form of new common stock, Kn.)(Round your intermediate calculations and final answer to 2 decimal places. Omit the “%” sign in your response.)

 

 %  

  Marginal cost of capital

(d)

The 5.2 percent cost of debt referred to above applies only to the first $42 million of debt. After that the cost of debt will be 7.2 percent. At what size capital structure will there be a change in the cost of debt?(Enter your answer in millions. Omit the “$” sign in your response.)

 

  Capital structure size (Z)

$  million  

(e)

What will the marginal cost of capital be immediately after that point? (Consider the facts in both parts cand d.) (Round your intermediate calculations and final answer to 2 decimal places. Omit the “%” sign in your response.)

 

  Marginal cost of capital

 %  

34.

value:
2.00 points
 

Problem 11-30 Capital asset pricing model and dividend valuation model [LO3]

Eaton Electronic Company’s treasurer uses  both the capital asset pricing model and the dividend valuation model to compute the cost of common equity (also referred to as the required rate of return for common equity).

   

=

 

5

%

=

 

%

=

 

 

D1

=

$

 

P0

=

$

 

=

 

5

%

Assume:

Rf

Km

7

β

2.1

.95

21
g

   

(a)

Compute Ki (required rate of return on common equity based on the capital asset pricing model).(Round your final answers to 2 decimal places. Omit the “%” sign in your response.)

   

 %  

  Ki

   

(b)

Compute Ke (required rate of return on common equity based on the dividend valuation model). (Round your intermediate and final answers to 2 decimal places. Omit the “%” sign in your response.)

   

  Ke

 %  

4.
value:
2.00 points
 

Problem 10-8 Interest rate effect [LO3]

Refer to 
Table 10-1
, which is based on bonds paying 10 percent interest for 20 years. Assume interest rates in the market (yield to maturity) go from 20 percent to 10 percent.

 

(a)

What was the bond price at 20 percent? (Round “PV Factor” to 3 decimal places, intermediate calculations and final answers to 2 decimal places. Omit the “$” sign in your response.)

   

$   

  Bond price

    

(b)

What is the bond price at 10 percent? (Round “PV Factor” to 3 decimal places, intermediate calculations and final answers to 2 decimal places. Omit the “$” sign in your response.)

   

  Bond price

$   

 

(c)

What would be your percentage return on the investment if you bought when rates were 20 percent and sold when rates were 10 percent? (Round “PV Factor” to 3 decimal places, intermediate calculations and final answers to 2 decimal places. Enter the value as positive value. Omit the “%” sign in your response.)

  

 

   on investment

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