978-0134083285 Chapter 9 Part 2

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33) Johnson Production Company paid a dividend yesterday of $3.50 per share. The dividend is expected

to grow at a constant rate of 10% per year. The price of KayCee’s common stock today is $40 per share. If

KayCee decides to issue new common stock, flotation costs will equal $4.00 per share. KayCee’s marginal

tax rate is 35%. Based on the above information, the cost of new common stock is

A) 26.41%.

B) 20.09%.

C) 19.63%.

D) 17.55%.

Keywords: Cost of New Common Stock, Flotation Costs

Learning Obj.: L.O. 9.2

AACSB: Analytical Thinking

34) The risk-free rate of return is 3% and the expected return on the market portfolio is 14%. Oklahoma

Oilco has a beta of 2.0 and a standard deviation of returns of 26%. Oilco’s marginal tax rate is 35%.

Analysts expect Oilco’s net income to grow by 12% per year for the next 5 years. Using the capital asset

pricing model, what is Oklahoma Oilco’s cost of retained earnings?

A) 18.6%

B) 21.2%

C) 22.8%

D) 25.0%

Keywords: Capital Asset Pricing Model, Cost of Retained Earnings

Learning Obj.: L.O. 9.2

AACSB: Analytical Thinking

35) Jiffy Co. expects to pay a dividend of $3.00 per share in one year. The current price of Jiffy common

stock is $60 per share. Flotation costs are $3.00 per share when Jiffy issues new stock. What is the cost of

internal common equity (retained earnings) if the long-term growth in dividends is projected to be 8

percent indefinitely?

A) 13 percent

B) 14 percent

C) 15 percent

D) 16 percent

Keywords: Cost of Retained Earnings

Learning Obj.: L.O. 9.2

AACSB: Analytical Thinking

36) JPR Company is financed 75 percent by equity and 25 percent by debt. If the firm expects to earn $30

million in net income next year and retain 40% of it, how large can the capital budget be before common

stock must be sold?

A) $7.5 million

B) $12.0 million

C) $15.5 million

D) $16.0 million

Keywords: Capital Structure, Capital Budget

Learning Obj.: L.O. 9.2

AACSB: Analytical Thinking

37) The cost of new preferred stock is equal to

A) the preferred stock dividend divided by the market price.

B) the preferred stock dividend divided by its par value.

C) (1 – tax rate) times the preferred stock dividend divided by net price.

D) preferred stock dividend divided by the net selling price of preferred.

Keywords: Cost of New Preferred Stock

Learning Obj.: L.O. 9.2

AACSB: Analytical Thinking

38) In general, the least expensive source of capital is

A) debt.

B) new common stock.

C) preferred stock

D) retained earnings.

Keywords: Cost of Capital, Sources of Capital

Learning Obj.: L.O. 9.2

AACSB: Reflective Thinking

39) The cost of external equity capital is greater than the cost of retained earnings because of

A) flotation costs on new equity.

B) increasing marginal tax rates.

C) higher dividends.

D) greater risk for shareholders.

Keywords: Flotation Costs, Cost of New Common Stock, Cost of Retained Earnings

Learning Obj.: L.O. 9.2

AACSB: Reflective Thinking

40) Phillips Enterprises Inc. is expected to pay a dividend of $2.60 next year. Dividends are expected to

grow at a constant rate of 8% per year, and the stock price is currently $20.00. New stock can be sold at

this price subject to flotation costs of 15%. The company’s marginal tax rate is 35%. Compute the cost of

internal equity (retained earnings) and the cost of external equity (new common stock), respectively.

A) 0, 21.00%

B) 8.00%, 23.29%

C) 21.00%, 23.29%

D) 23.00%, 25.48%

Keywords: Cost of Retained Earnings, Cost of New Common Stock

Learning Obj.: L.O. 9.2

AACSB: Analytical Thinking

41) JPR Company‘s preferred stock is currently selling for $28.00, and pays a perpetual annual dividend

of $2.00 per share. Underwriters of a new issue of preferred stock would charge $3 per share in flotation

costs. The firm’s tax rate is 40%. Compute the cost of new preferred stock for JPR.

A) 4.80%

B) 7.14%

C) 8.00%

D) 9.15%

Keywords: Cost of New Preferred Stock, Flotation Costs

Learning Obj.: L.O. 9.2

AACSB: Analytical Thinking

42) GPS Inc. wishes to estimate its cost of retained earnings. The firm’s beta is 1.3. The rate on 6-month T-

bills is 2%, and the return on the S&P 500 index is 15%. What is the appropriate cost for retained earnings

in determining the firm’s cost of capital?

A) 17.0%

B) 19.5%

C) 18.9%

D) 22.1%

Keywords: Capital Asset Pricing Model, Cost of Capital

Learning Obj.: L.O. 9.2

AACSB: Analytical Thinking

43) In capital budgeting analysis, when computing the weighted average cost of capital, the CAPM

approach is typically used to find which of the following?

A) market value weight of equity

B) pretax component cost of debt

C) after-tax component cost of debt

D) component cost of internal equity

Keywords: Capital Asset Pricing Model, Cost of Retained Earnings

Learning Obj.: L.O. 9.2

AACSB: Reflective Thinking

44) The cost of retained earnings is less than the cost of new common stock because

A) marginal tax brackets increase.

B) flotation costs are incurred when new stock is issued.

C) dividends are not tax deductible.

D) accounting rules allow a deduction when using retained earnings.

Keywords: Flotation Costs, Cost of Retained Earnings, Cost of New Common Stock

Learning Obj.: L.O. 9.2

AACSB: Reflective Thinking

45) Which of the following differentiates the cost of retained earnings from the cost of newly-issued

common stock?

A) the cost of the pre-emptive rights held by existing shareholders

B) the greater marginal tax rate faced by the now-larger firm

C) the flotation costs incurred when issuing new securities

D) the larger dividends paid to the new common stockholders

Keywords: Flotation Costs, Cost of Retained Earnings, Cost of New Common Stock

Learning Obj.: L.O. 9.2

AACSB: Reflective Thinking

46) Crandal Dockworks is undergoing a major expansion. The expansion will be financed by issuing new

15-year, $1,000 par, 9% annual coupon bonds. The market price of the bonds is $1,070 each. Five Rivers

flotation expense on the new bonds will be $50 per bond. Crandal‘s marginal tax rate is 35%. What is the

yield to maturity on the newly-issued bonds?

A) 6.95%

B) 7.99%

C) 8.17%

D) 9.82%

Keywords: Yield to Maturity

Learning Obj.: L.O. 9.2

AACSB: Analytical Thinking

47) Crandal Dockworks is undergoing a major expansion. The expansion will be financed by issuing new

15-year, $1,000 par, 9% annual coupon bonds. The market price of the bonds is $1,070 each. Crandal’s

flotation expense on the new bonds will be $50 per bond. Crandal‘s marginal tax rate is 35%. What is the

pre-tax cost of debt for the newly-issued bonds?

A) 8.76%

B) 8.12%

C) 7.49%

D) 10.25%

Keywords: Pre–tax Cost of Debt, Flotation Costs

Learning Obj.: L.O. 9.2

AACSB: Analytical Thinking

48) Tempo Corp. will issue preferred stock to finance a new artillery line. The firm‘s existing preferred

stock pays a dividend of $4.00 per share and is selling for $40 per share. Investment bankers have advised

Tempo that flotation costs on the new preferred issue would be 5% of the selling price. Tempo’s marginal

tax rate is 30%. What is the relevant cost of new preferred stock?

A) 7.00%

B) 7.37%

C) 10.00%

D) 10.53%

E) 15.00%

Keywords: Cost of New Preferred Stock, Flotation Costs

Learning Obj.: L.O. 9.2

AACSB: Analytical Thinking

49) Keystone Corporation will issue new common stock to finance an expansion. The existing common

stock just paid a $1.50 dividend, and dividends are expected to grow at a constant rate 8% indefinitely.

The stock sells for $45, and flotation expenses of 5% of the selling price will be incurred on new shares.

What is the cost of new common stock be for Keystone Corp.?

A) 11.33%

B) 11.51%

C) 11.60%

D) 11.79%

E) 12.53%

Keywords: Cost of New Common Stock, Flotation Costs

Learning Obj.: L.O. 9.2

AACSB: Analytical Thinking

50) Grandview Inc. will issue new common stock to finance an expansion. The existing common stock

just paid a $1.50 dividend, and dividends are expected to grow at a constant rate 8% indefinitely. The

stock sells for $45, and flotation expenses of 5% of the selling price will be incurred on new shares. What

is the cost of retained earnings for Grandview?

A) 11.33%

B) 11.51%

C) 11.60%

D) 11.79%

E) 12.53%

Keywords: Cost of Retained Earnings

Learning Obj.: L.O. 9.2

AACSB: Analytical Thinking

51) All else equal, an increase in beta results in

A) an increase in the cost of retained earnings.

B) an increase in the cost of newly issued common stock.

C) an increase in the after-tax cost of debt.

D) an increase in the cost of common equity, whether or not the funds come from retained earnings or

newly issued common stock.

Keywords: Beta, Cost of Common Equity

Learning Obj.: L.O. 9.2

AACSB: Analytical Thinking

52) Haroldson Inc. common stock is selling for $22 per share. The last dividend was $1.20, and dividends

are expected to grow at a 6% annual rate. Flotation costs on new stock sales are 5% of the selling price.

What is the cost of Haroldson’s retained earnings?

A) 5.73%

B) 11.45%

C) 11.78%

D) 12.09%

Keywords: Cost of Retained Earnings

Learning Obj.: L.O. 9.2

AACSB: Analytical Thinking

53) Haroldson Inc. common stock is selling for $22 per share. The last dividend was $1.20, and dividends

are expected to grow at a 6% annual rate. Flotation costs on new stock sales are 5% of the selling price.

What is the cost of Haroldson Inc.’s new common stock?

A) 5.73%

B) 11.45%

C) 11.78%

D) 12.09%

Keywords: Cost of New Common Stock

Learning Obj.: L.O. 9.2

AACSB: Analytical Thinking

54) Which of the following should NOT be considered when calculating a firm’s WACC?

A) cost of preferred stock

B) after-tax cost of bonds

C) cost of common stock

D) cost of carrying inventory

Keywords: Weighted Average Cost of Capital

Learning Obj.: L.O. 9.2

AACSB: Reflective Thinking

55) Which of the following should NOT be considered when calculating a firm’s WACC?

A) after-tax YTM on a firm’s bonds

B) after-tax cost of accounts payable

C) cost of newly issued preferred stock

D) cost of newly issued common stock

Keywords: Weighted Average Cost of Capital

Learning Obj.: L.O. 9.2

AACSB: Reflective Thinking

56) New Jet Airlines plans to issue 14-year bonds with a par value of $1,000 that will pay $60 every six

months. The bonds have a market price of $1,220. Flotation costs on new debt will be 4% of the selling

price. If the firm has a 35% marginal tax bracket, compute the following:

a. Yield to maturity of debt

b. After-tax cost of existing debt

c. After-tax cost of new debt

Keywords: Yield to Maturity, After-tax Cost of Existing Debt, After-tax Cost of New Debt, Flotation Costs

Learning Obj.: L.O. 9.2

AACSB: Analytical Thinking

57) Alarm Systems Corporation’s preferred stock pays a dividend of $3.60 and sells for $28.00. Alarm

Systems Corporation has a marginal tax rate of 35%. What is the cost of preferred financing?

Keywords: Cost of Preferred Stock

Learning Obj.: L.O. 9.2

AACSB: Analytical Thinking

58) NewLinePhone Corp. is very risky, with a beta equal to 2.8 and a standard deviation of returns of

32%. The risk-free rate of return is 3% and the market risk premium is 8%. NewLinePhone’s marginal tax

rate is 35%. Use the capital asset pricing model to estimate NewLinePhone’s cost of retained earnings.

Keywords: Cost of Retained Earnings, Capital Asset Pricing Model

Learning Obj.: L.O. 9.2

AACSB: Analytical Thinking

59) Dickerson Corporation’s common stock is currently selling for $38. Last year‘s dividend was $4.00 per

share. Investors expect dividends to grow at an annual rate of 7 percent indefinitely. Flotation costs of 4%

will be incurred when new stock is sold.

a. What is the cost of internal common equity?

b. What is the cost of new common equity?

Keywords: Cost of Retained Earnings, Cost of New Common Stock, Flotation Costs

Learning Obj.: L.O. 9.2

AACSB: Analytical Thinking

60) The common stock for El Viss Company currently sells for $20 per share. The firm just paid a

dividend of $1.50, and the dividend three years ago was $1.30. Dividends per share are anticipated to

grow at the same rate in the future as they have over the past three years. Flotation costs for new shares

will be 6% of the selling price. Calculate the following:

a. the cost of retained earnings

b. the cost of external equity capital

Keywords: Cost of Retained Earnings, Cost of New Common Stock

Learning Obj.: L.O. 9.2

AACSB: Analytical Thinking

61) A company is going to issue a $1,000 par value bond that pays a 7% annual coupon. The company

expects investors to pay $942 for the 20-year bond. The expected flotation cost per bond is $42, and the

firm is in the 34% tax bracket. Compute the following:

a. the yield to maturity on the firm‘s bonds

b. the firm’s after-tax cost of existing debt

c. the firm’s after-tax cost of new debt

Keywords: After-tax Cost of Debt, Yield to Maturity, Flotation Costs

Learning Obj.: L.O. 9.2

AACSB: Analytical Thinking

62) Toto and Associates’ preferred stock is selling for $27.50 a share. The firm nets $25.60 after issuance

costs. The stock pays an annual dividend of $3.00 per share. What is the cost of existing, and new,

preferred stock respectively?

Keywords: Cost of Existing Preferred Stock, Cost of New Preferred Stock

Learning Obj.: L.O. 9.2

AACSB: Analytical Thinking

63) Sutter Corporation’s common stock is selling for $16.80 a share. Last year Sutter paid a dividend of

$.80. Investors are expecting Sutter’s dividends to grow at an annual rate of 5% per year. What is the cost

of internal equity?

Keywords: Cost of Retained Earnings

Learning Obj.: L.O. 9.2

AACSB: Analytical Thinking

64) Gibson Industries is issuing a $1,000 par value bond with an 8% annual interest coupon rate that

matures in 11 years. Investors are willing to pay $972, and flotation costs will be 9%. Gibson is in the 34%

tax bracket. What will be the after-tax cost of new debt for the bond?

Keywords: After-tax Cost of Debt, Flotation Costs

Learning Obj.: L.O. 9.2

AACSB: Analytical Thinking

65) The preferred stock of Wells Co. sells for $17 and pays a $1.75 dividend. The net price of the stock

after issuance costs is $15.30. What is the cost of capital for new preferred stock?

Keywords: Cost of Preferred Stock

Learning Obj.: L.O. 9.2

AACSB: Analytical Thinking

66) Glenna Gayle common stock sells for $55, and dividends paid last year were $1.35. Flotation costs on

issuing stock will be 8% of the market price. The dividends are predicted to have a 10% growth rate.

What is the cost of internal equity, and new equity, respectively for Glenna Gayle?

Keywords: Cost of Retained Earnings, Cost of New Common Stock, Flotation Costs

Learning Obj.: L.O. 9.2

AACSB: Analytical Thinking

67) Toombes, Inc. is issuing new common stock at a market price of $55. Dividends last year were $3.30

per share and are expected to grow at a rate of 6%. Flotation costs will be 5% of the market price. What is

Toombes’ cost of retained earnings, and new equity, respectively?

Keywords: Cost of Retained Earnings, Cost of New Common Stock, Flotation Costs

Learning Obj.: L.O. 9.2

AACSB: Analytical Thinking