Chapter 11 – Cost of Capital
63. A firm is paying an annual dividend of $2.65 for its preferred stock which is selling for
$57.00. There is a selling cost of $3.30. What is the after-tax cost of preferred stock if the
firm’s tax rate is 33%?
64. Firm X has a tax rate of 30%. The price of its new preferred stock is $75 and its flotation
cost is $3.15. The cost of new preferred stock is 8%. What is the firm’s dividend?
Chapter 11 – Cost of Capital
65. The cost of equity capital in the form of new common stock will be higher than the cost of
retained earnings because of
66. If the flotation cost goes up, the cost of retained earnings will
67. Why is the cost of debt normally lower than the cost of preferred stock?
Chapter 11 – Cost of Capital
68. If flotation costs go down, the cost of new preferred stock will
69. A firm’s preferred stock pays an annual dividend of $2, and the stock sells for $65.
Flotation costs for new issuances of preferred stock are 5% of the stock value. What is the
after-tax cost of preferred stock if the firm’s tax rate is 30%?
Chapter 11 – Cost of Capital
70. Ten years ago, Stigler Company issued $100 par value preferred stock yielding 6 percent.
The preferred stock is now selling for $102 per share. What is the current yield or cost of the
preferred stock? (Disregard flotation costs.)
71. A firm’s debt to equity ratio varies at times because
Chapter 11 – Cost of Capital
72. Using the constant dividend growth model for common stock, if Po goes up
73. New common stock is more expensive than Ke
74. In computing the cost of common equity, if D1 goes downward and Po goes up, Ke will
Chapter 11 – Cost of Capital
75. In determining the cost of retained earnings
76. Within the capital asset pricing model
77. Using the constant growth model, a firm’s expected (D1) dividend yield is 4% of the stock
price, and its growth rate is 5%. If the tax rate is .35%, what is the firm’s cost of equity?
Chapter 11 – Cost of Capital
78. Expected cash dividends are $3.00, the dividend yield is 4%, flotation costs are 4% of
price, and the growth rate is 3%. Compute cost of new common stock.
79. A firm’s stock is selling for $65. The dividend yield is 6%. A 7% growth rate is expected
for the common stock. The firm’s tax rate is 40%. What is the firm’s cost of retained
earnings?
Chapter 11 – Cost of Capital
80. A firm’s stock is selling for $62. The next annual dividend is expected to be $3.00. The
growth rate is 9%. The flotation cost is $5.00. What is the cost of retained earnings?
81. For many firms, the cheapest and most important source of equity capital is in the form of
82. Retained earnings has a cost associated with it because:
Chapter 11 – Cost of Capital
83. There may be a change in the marginal cost of capital curve because
84. The after-tax cost of debt will almost always be below
85. The optimal capital structure for firms in cyclical industries should contain
________________ than firms in stable industries.
Chapter 11 – Cost of Capital
86. The component parts of the cost of capital should be weighted by their proportion in the
firm’s
87. Which is not true about debt financing and the weighted average cost of capital?
88. A firm in a stable industry should use
Chapter 11 – Cost of Capital
89. Although debt financing is usually the cheapest component of capital, it cannot be used in
excess because
90. A firm in a cyclical industry should use
91. Most firms are able to use _____ percent debt in their capital structure without exceeding
norms acceptable to creditors and investors.
Chapter 11 – Cost of Capital
92. Marginal cost of capital
93. The weighted average cost of capital is used as a discount rate because
94. Use of the marginal cost of capital
Chapter 11 – Cost of Capital
95. The general rule for using the weighted average cost of capital (WACC) in capital
budgeting decisions is accept all projects with
96. Oak Enterprises has a beta of 1.2, the market return is 8%, and the T-bill rate is 4%. What
is their expected required return of common equity?
97. All of the following are important considerations for minimizing the cost of capital
except:
Chapter 11 – Cost of Capital
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98. Match the following with the items below:
The distribution expense involved in selling securities to
The result of multiplying the cost of each item in the
capital structure by its corresponding representation in the
Features the best possible mix of debt, preferred stock,
Determines the value of a share of stock by taking the
Relates the risk-return tradeoffs of individual securities
Appears on the balance sheet under long-term liabilities
99. Zinger Corporation manufactures industrial type sewing machines. Zinger Corp. received
a very large order from a few European countries. In order to be able to supply these countries
with its products, Zinger will have to expand its facilities. Of the required expansion, Zinger
feels it can raise $75 million internally, through retained earnings. The firm’s optimum capital
structure has been 35% debt, 10% preferred stock and 55% equity. The company will try to
maintain this capital structure in financing this expansion plan. Currently Zinger’s common
stock is traded at a price of $28 per share. Last year’s dividend was $1.50 per share. The
growth rate is 8%. The company’s preferred stock is selling at $45 and has been yielding 6%
in the current market. Flotation costs have been estimated at 8% of common stock and 3% of
preferred stock. Zinger Corp. has bonds outstanding at 6%, but its investment banker has
informed the company that interest rates for bonds of equal risk are currently yielding 5%.
Zinger’s tax rate is 40%.
a) Compute the cost of Kd, Kp, Ke, Kn.
b) Calculate the initial weighted average cost of capital using Ke.
c) How large a capital budget can the firm support with retained earnings financing?
Chapter 11 – Cost of Capital
Chapter 11 – Cost of Capital
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100. The Accidental Petroleum Company is trying to determine its weighted average cost of
capital for use in making a number of investment decisions. The firm’s bonds were issued 6
years ago and have 14 years left until maturity. They carried an 8% coupon rate, and are
currently selling for $910.00.
The firm’s preferred stock carries a $3.10 dividend and is currently selling at $42.50 per share.
Accidental’s investment banker has stated that issue costs for new preferred will be 50 cents
per share.
The firm has significant retained earnings, but will also need to sell new common stock to
finance the projects it is now considering. Accidental Petroleum common stock is expected to
pay a $1.75 per share dividend next year, and is expected to maintain an 8% growth rate for
the foreseeable future. The stock is currently priced at $50 per share, but new common stock
will have flotation costs of 70 cents per share.
Calculate the costs of the various components of Accidental Petroleum’s capital (Kd, Kp, Ke,
Kn). The firm’s tax rate is 30%.
Chapter 11 – Cost of Capital
Chapter 11 – Cost of Capital
101. Jury Company wants to calculate the component costs in its capital structure. Common
stock currently sells for $33, and is expected to pay a dividend of $.40. Jury’s dividend growth
rate is 8%, and flotation cost is $1.25. Preferred stock sells for $40, pays a dividend of $3.00,
and carries a flotation cost of $1.10. Jury Company bonds yield 7% in the market. Jury is in
the 30% tax bracket.
Calculate cost of debt, cost of new common stock, cost of preferred stock and cost of retained
earnings.
Chapter 11 – Cost of Capital
102. Given the information about Jury Co. in the previous problem, calculate the company’s
weighted average cost of capital assuming that its new financing will consist of 40% debt,
10% preferred stock, and 50% retained earnings.