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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 ks. 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%