Chapter
9 - Study Problems

1. Bouchard Company's stock sells for $20 per share, its
last dividend (D™) was $1.00, its growth rate is a constant 6 percent, and the company
would incur a flotation cost of 20 percent if it sold new common stock.
Retained earnings for the coming year are expected to be $1,000,000, and the
common equity ratio is 60 percent. If Bouchard has a capital budget of
$2,000,000, what component cost of common equity will be built into the WACC
for the last dollar of capital the company raises?

a. 11.30%

b. 11.45%

c. 11.80%

d. 12.15%

e. 12.63%

2. Your company's stock sells for $50 per share, its last
dividend (D™) was $2.00, its growth rate is a constant 5 percent, and the
company would incur a flotation cost of 15 percent if it sold new common stock.
Net income for the coming year is expected to be $500,000, the firm's payout
ratio is 60 percent, and its common equity ratio is 30 percent. If the firm has
a capital budget of $1,000,000, what component cost of common equity will be
built into the WACC for the last dollar of capital the company raises?

a. 9.20%

b. 9.94%

c. 10.50%

d. 11.75%

e. 12.30%

3. Santorum Co. has a capital structure which consists of 50
percent debt, 30 percent common stock, and 20 percent preferred stock. The
company's net income was just reported to be $1,000,000. The company pays out
40 percent of its net income as dividends. How large of a capital budget can
the company have without having to issue additional common stock or change its
capital structure?

a. $
180,000

b. $
200,000

c. $
600,000

d. $1,200,000

e. $2,000,000

*The information below applies to the following
problems.*

Byron Corporation's present capital structure, which
is also its target capital structure, is 40 percent debt and 60 percent common
equity. Next year's net income is projected to be $21,000, and Byron's payout
ratio is 30 percent. The company's earnings and dividends are growing at a
constant rate of 5 percent; the last dividend (D™) 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.

4. What is the maximum amount of new capital that can be
raised at the lowest component cost of *equity*? (In other words, what is
the retained earnings break point?)

a. $12,600

b. $14,700

c. $17,400

d. $21,000

e. $24,500

5. 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%

6. Assume (contrary to the situation in the question just
above) that at one point along the marginal cost of capital schedule the
component cost of equity is 18 percent. What is the weighted average cost of
capital at that point?

a. 10.8%

b. 13.6%

c. 14.2%

d. 16.4%

e. 18.0%

*The information below applies to the following
problems.*

Rollins Corporation is constructing its MCC schedule.
Its target capital structure is 20 percent debt, 20 percent preferred stock,
and 60 percent common equity. 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 which 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 which 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 k_{s}. The firm's net
income is expected to be $1 million, and its dividend payout ratio is 40
percent. Flotation costs on new common stock total 10 percent, and the firm's
marginal tax rate is 40 percent.

7. 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%

8. 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%

9. What is Rollins' lowest WACC?

a. 13.6%

b. 14.1%

c. 16.0%

d. 16.6%

e. 16.9%

*The information below applies to the following
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.

10. 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

*The information below applies to the following
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.

11. 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 information below applies to the following
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 expects to retain $15,000 in earnings over the next year. Ross's
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.

12. 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%

13. 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%

14. Where will a break in the MCC schedule occur?

a. $30,000

b. $20,000

c. $10,000

d. $42,000

e. There will be no breaks in the MCC schedule.

15. What will be the WACC above this break point?

a. 12.5%

b. 8.3%

c. 10.6%

d. 11.9%

e. 14.1%

1. e. 12.63%

2. b. 9.94%

3. e. $2,000,000

4. e. $24,500

5. a. 17.0%

6. c. 14.2%

7. c. 16.0%

8. c. 16.0%

9. a. 13.6%

10. d. $55.00

11. d. 17.5%

12. d. 16.5%

13. b. 12.5%

14. a. $30,000

15. d. 11.9%