bus 320 connect homework 5

Applied Software has $1,000 par value bonds outstanding at 16 percent interest. The bonds will mature in 20 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):

Speedy Delivery Systems can buy a piece of equipment that should provide an 8 percent return and can be financed at 5 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 16 percent return but would cost 18 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.

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

[removed]

(b)

Which project(s) should be accepted?

A brilliant young scientist is killed in a plane crash. It was anticipated that he could have earned $210,000 a year for the next 20 years. The attorney for the plaintiff’s estate argues that the lost income should be discounted back to the present at 4 percent. The lawyer for the defendant’s insurance company argues for a discount rate of 15 percent.

What is the difference between the present value of the settlement at 4 percent and 15 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)

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.)

.75

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 25 percent increase? (Round your answer to 2 decimal places. Omit the “%” sign in your response.)

  Cost of debt

%  

If the receipts of the foundation were found to be taxable by the IRS (at a rate of 35 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

Airbone Airlines, Inc., has a $1,000 par value bond outstanding with 30 years to maturity. The bond carries an annual interest payment of $100 and is currently selling for $880. 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.

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

[removed] %  

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.)

Russell Container Corporation has a $1,800 par value bond outstanding with 20 years to maturity. The bond carries an annual interest payment of $111 and is currently selling for $1,200 per bond. Russell Corp. is in a 20 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 39 percent.

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.)

Has the aftertax cost of debt gone up or down?

KFW is planning to issue debt that will mature in the year 2012. In many respects the issue is similar to currently outstanding debt of the corporation. Using Table 11-2, identify:

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.)

Calculate yield to maturity with an increase of 0.25 percent than the value determined in part a. (Round your answer to 2 decimal places. Omit the “%” sign in your response.)

(c)

If the firm is in a 40 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.)

The Meredith Corporation issued $100 par value preferred stock 10 years ago. The stock provided an 10 percent yield at the time of issue. The preferred stock is now selling for $70. (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.)

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 1 percent less than that for preferred stock.

  Debt

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

  Aftertax cost of debt

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

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

Compute Ke and Kn under the following circumstances:

6.0

D1 = $0.50, P0 = $46, g = 3%, F = $4.50. (Round your intermediate and final answers to 2 decimal places. Omit the “%” sign in your response.)

E1 (earnings at the end of period one) = $13, payout ratio equals 40 percent, P0 = $46, g = 3.5%, F = $2.10. (Round your intermediate and final answers to 2 decimal places. Omit the “%” sign in your response.)

(d)

D0 (dividend at the beginning of the first period) = $6, growth rate for dividends and earnings (g) = 4%, P0= $72, F = $3. (Round your intermediate and final answers to 2 decimal places. Omit the “%” sign in your response.)

United Business Forms’ capital structure is as follows:

  Preferred stock

  Common equity

The aftertax cost of debt is 11 percent, the cost of preferred stock is 14 percent, and the cost of common equity (in the form of retained earnings) is 17 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)

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

Cost (aftertax)

Weights

  Plan A

5.0

10.0

  Plan B

5.2

10.2

15.0

  Plan C

15.7

11.6

  Plan D

12.0

6.6

13.6

(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.)

[removed]      

(a-2)

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

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

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.

1.70

$1.25

1.3

1.54

     The preferred stock is selling at $70 per share and pays a dividend of $6.60 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, 10 percent preferred stock, and 65 percent common equity in the form of retained earnings.

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

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.)

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.)

Aa3

     Historically, the corporation’s earnings and dividends per share have increased about 4.6 percent annually and this should continue in the future. Northwest’s common stock is selling at $69 per share, and the company will pay a $6.20 per share dividend (D1).

     The company’s $106 preferred stock has been yielding 6 percent in the current market. Flotation costs for the company have been estimated by its investment banker to be $4.00 for preferred stock.

     The company’s optimum capital structure is 35 percent debt, 10 percent preferred stock, and 55 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.

Data on Bond Issues

  Issue

Moody’s rating

Yield to maturity

  Utilities:

     Southwest electric power––71/4 2023

Aa2

920.18

8.66

     Pacific bell––73/8 2025

896.25

8.44

     Pennsylvania power & light––81/2 2022

995.66

8.45

  Industrials:

     Johnson & Johnson––63/4 2023

Aaa

850.24

8.35

     Dillard’s Department Stores––71/8 2023

910.92

8.88

     Marriott Corp.––10 2015

1,060.10

9.55

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.)

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

  Cost of preferred stock

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

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

[removed]      

Delta Corporation has the following capital structure:

1.32

11.2

1.12

  Common equity (Ke) (retained earnings)

7.84

10.28

If the firm has $49 million in retained earnings, at what size capital structure will the firm run out of retained earnings? (Enter your answer in millions. Omit the “$” sign in your response.)

  Capital structure size (X)

$ [removed] million  

The 6.6 percent cost of debt referred to above applies only to the first $23 million of debt. After that the cost of debt will go up. At what size capital structure will there be a change in the cost of debt? (Enter your answer in millions. Omit the “$” sign in your response.)

  Capital structure size (Z)

The Nolan Corporation finds that it is necessary to determine its marginal cost of capital. Nolan’s current capital structure calls for 45 percent debt, 15 percent preferred stock, and 40 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, 4.2 percent; preferred stock, 6 percent; retained earning, 14 percent; and new common stock, 15.2 percent.

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.)

If the firm has $26 million in retained earnings, at what size capital structure will the firm run out of retained earnings? (Enter your answer in millions. Omit the “$” sign in your response.)

What will the marginal cost of capital be immediately after that point? (Equity will remain at 40 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

The 4.2 percent cost of debt referred to above applies only to the first $45 million of debt. After that the cost of debt will be 6.5 percent. At what size capital structure will there be a change in the cost of debt?(Enter your answer in millions. Omit the “$” sign in your response.)

(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.)

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).

Assume:

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

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.)

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) 8 percent

$ 

  (b) 1

4

percent

  (c) 

11

percent

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 12 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

 %

Essex Biochemical Co. has a $1,000 par value bond outstanding that pays 14 percent annual interest. The current yield to maturity on such bonds in the market is

9

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):

  (a) 40 years

  (b) 17 years

  (c) 5 years

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 10 percent to 9 percent.

(a)

What was 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

(b)

What is the bond price at 9 percent? (Round “PV Factor” to 3 decimal places, intermediate calculations and final answers to 2 decimal places. Omit the “$” sign in your response.)

(c)

What would be your percentage return on the investment if you bought when rates were 10 percent and sold when rates were 9 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

Refer to 
Table 10-2

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 5-year, a

25

-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

  5 Years

  25 years

  30 years

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 5-year, a 25-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.)

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

Tom Cruise Lines, Inc., issued bonds five years ago at $1,000 per bond. These bonds had a 30-year life when issued and the annual interest payment was then

15

percent. This return was in line with the required returns by bondholders at that point as described below:

  Real rate of return

  Inflation premium

  Risk premium

  Total

return

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 25 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

Find the present value of 3 percent × $1,000 (or $30) for 25 years at 12 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

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.)

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 7 percent annual interest and has 16 years remaining to maturity. The current yield to maturity on similar bonds is 12 percent.

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

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

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

 % 

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 8 percent, which is paid semiannually. The yield to maturity on the bonds is 10 percent annual interest. There are 15 years to maturity. Use 
Appendix B
 and
Appendix D
.

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.)

With 10 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.)

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).

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

  Original price

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

  Current value

Grant Hillside Homes, Inc., has preferred stock outstanding that pays an annual dividend of $14.20. Its price is $139.

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

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.)

Ecology Labs, Inc., will pay a dividend of $3

.75

per share in the next 12 months (D1). The required rate of return (Ke) is 16 percent and the constant growth rate is 6 percent. (Each question is independent of the others.)

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

Assume Ke, the required rate of return, goes up to 19 percent; what will be the new price? (Round your intermediate and final answer to 2 decimal places. Omit the “$” sign in your response.)

Assume the growth rate (g) goes up to 10 percent; what will be the new price? Ke goes back to its original value of 16 percent. (Round your intermediate and final answer to 2 decimal places. Omit the “$” sign in your response.)

Assume D1 is $

5.0

0; what will be the new price? Assume Ke is at its original value of 16 percent and g goes back to its original value of 6 percent. (Round your intermediate and final answer to 2 decimal places. Omit the “$” sign in your response.)

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

  Year

Earnings
per share

  2006

9.00

  2007

9.54

  2008

10.11

  2009

10.72

  2010

1

1.3

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.

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.)

  Earnings

  Dividend

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

A firm pays a $12.80 dividend at the end of year one (D1), has a stock price of $88, 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.)

Beasley Ball Bearings paid a $4 dividend last year. The dividend is expected to grow at a constant rate of 6 percent over the next four years. The required rate of return is 19 percent (this will also serve as the discount rate in this problem). Use 
Appendix B
.

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

Calculate the present value of each of the anticipated dividends at a discount rate of 19 percent.(Round “PV Factor”, intermediate calculations and final answers to 3 decimal places. Omit the “$” sign in your response.)

PV of
dividends

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

Calculate the present value of the year 4 stock price at a discount rate of 19 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.)

(f)

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

=

Ke − g

(g)

If current EPS is equal to $5.700 and the P/E ratio is 1.2 times higher than the industry average of 5, what would the stock price be? (Round your intermediate calculations and final answers to 2 decimal places. Omit the “$” 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

Speedy Delivery Systems can buy a piece of equipment that should provide an 8 percent return and can be financed at 5 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 16 percent return but would cost 18 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.

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

Which project(s) should be accepted?

Piece of equipment should be financed.

New machine should be financed.

A brilliant young scientist is killed in a plane crash. It was anticipated that he could have earned $210,000 a year for the next 20 years. The attorney for the plaintiff’s estate argues that the lost income should be discounted back to the present at 4 percent. The lawyer for the defendant’s insurance company argues for a discount rate of 15 percent.

What is the difference between the present value of the settlement at 4 percent and 15 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)

  PV at 4% rate

  PV at 15% rate

  Difference

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.)

Yield

Corporate
tax rate

Cost of debt

 a.

7.0

 b.

14.0

 c.

15.5

The Goodsmith Charitable Foundation, which is tax-exempt, issued debt last year at 9 percent to help finance a new playground facility in Los Angeles. This year the cost of debt is 25 percent higher; that is, firms that paid 11 percent for debt last year will be paying 13.75 percent this year.

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 25 percent increase? (Round your answer to 2 decimal places. Omit the “%” sign in your response.)

  Cost of debt

If the receipts of the foundation were found to be taxable by the IRS (at a rate of 35 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

Airbone Airlines, Inc., has a $1,000 par value bond outstanding with 30 years to maturity. The bond carries an annual interest payment of $100 and is currently selling for $880. 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.

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

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.)

Russell Container Corporation has a $1,800 par value bond outstanding with 20 years to maturity. The bond carries an annual interest payment of $111 and is currently selling for $1,200 per bond. Russell Corp. is in a 20 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 39 percent.

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.)

Has the aftertax cost of debt gone up or down?

It has gone up.

It has gone down.

KFW is planning to issue debt that will mature in the year 2012. In many respects the issue is similar to currently outstanding debt of the corporation. Using 
Table 11-2
, identify:

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.)

Calculate yield to maturity with an increase of 0.25 percent than the value determined in part a. (Round your answer to 2 decimal places. Omit the “%” sign in your response.)

If the firm is in a 40 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.)

The Meredith Corporation issued $100 par value preferred stock 10 years ago. The stock provided an 10 percent yield at the time of issue. The preferred stock is now selling for $70. (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.)

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 1 percent less than that for preferred stock.

  Debt

can be issued at a yield of 8.6 percent, and the corporate tax rate is 30 percent. Preferred stock will be priced at $54 and pay a dividend of $3.80. The flotation cost on the preferred stock is $2.

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

  Aftertax cost of debt

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

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

No

Yes

Compute Ke and Kn under the following circumstances:

D1 = $8.00, P0 = $82, g = 7%, F = $

6.0

0. (Round your intermediate and final answers to 2 decimal places. Omit the “%” sign in your response.)

  Kn

D1 = $0.50, P0 = $46, g = 3%, F = $4.50. (Round your intermediate and final answers to 2 decimal places. Omit the “%” sign in your response.)

E1 (earnings at the end of period one) = $13, payout ratio equals 40 percent, P0 = $46, g = 3.5%, F = $2.10. (Round your intermediate and final answers to 2 decimal places. Omit the “%” sign in your response.)

D0 (dividend at the beginning of the first period) = $6, growth rate for dividends and earnings (g) = 4%, P0= $72, F = $3. (Round your intermediate and final answers to 2 decimal places. Omit the “%” sign in your response.)

United Business Forms’ capital structure is as follows:

  Preferred stock

  Common equity

The aftertax cost of debt is 11 percent, the cost of preferred stock is 14 percent, and the cost of common equity (in the form of retained earnings) is 17 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)

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

Cost
(aftertax)

Weights

  Plan A

10.0

  Plan B

5.2

10.2

15.0

60

  Plan C

15.7

11.6

  Plan D

12.0

1

6.6

13.6

(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.)

(a-2)

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

Plan A

Plan B

Plan C

Plan D

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

Plan D

Plan C

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 9.6 percent coupon rate and another bond with an 7.2 percent rate. The firm has been informed by its investment banker that bonds of equal risk and credit rating are now selling to yield 10.5 percent. The common stock has a price of $50 and an expected dividend (D1) of $

1.70

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

$1.25

1.39

1.54

     The preferred stock is selling at $70 per share and pays a dividend of $6.60 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, 10 percent preferred stock, and 65 percent common equity in the form of retained earnings.

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

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.)

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.)

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

Aa3

credit rating. The corporate tax rate is 35 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 4.6 percent annually and this should continue in the future. Northwest’s common stock is selling at $69 per share, and the company will pay a $6.20 per share dividend (D1).

     The company’s $106 preferred stock has been yielding 6 percent in the current market. Flotation costs for the company have been estimated by its investment banker to be $4.00 for preferred stock.

     The company’s optimum capital structure is 35 percent debt, 10 percent preferred stock, and 55 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.

Data on Bond Issues

  Issue

Moody’s
rating

Yield to maturity

  Utilities:

     Southwest electric power––71/4 2023

Aa2

920.18

8.66

     Pacific bell––73/8 2025

896.25

8.44

     Pennsylvania power & light––81/2 2022

A2

995.66

8.45

  Industrials:

     Johnson & Johnson––63/4 2023

Aaa

850.24

8.35

     Dillard’s Department Stores––71/8 2023

910.92

8.88

     Marriott Corp.––10 2015

B2

1,060.10

9.55

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.)

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

  Cost of preferred stock

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

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

Delta Corporation has the following capital structure:

Weighted
cost

1.32

11.2

1.12

  Common equity (Ke) (retained earnings)

7.84

10.28

If the firm has $49 million in retained earnings, at what size capital structure will the firm run out of retained earnings? (Enter your answer in millions. Omit the “$” sign in your response.)

  Capital structure size (X)

$  million  

The 6.6 percent cost of debt referred to above applies only to the first $23 million of debt. After that the cost of debt will go up. At what size capital structure will there be a change in the cost of debt? (Enter your answer in millions. Omit the “$” sign in your response.)

  Capital structure size (Z)

The Nolan Corporation finds that it is necessary to determine its marginal cost of capital. Nolan’s current capital structure calls for 45 percent debt, 15 percent preferred stock, and 40 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, 4.2 percent; preferred stock, 6 percent; retained earning, 14 percent; and new common stock, 15.2 percent.

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.)

If the firm has $26 million in retained earnings, at what size capital structure will the firm run out of retained earnings? (Enter your answer in millions. Omit the “$” sign in your response.)

What will the marginal cost of capital be immediately after that point? (Equity will remain at 40 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

The 4.2 percent cost of debt referred to above applies only to the first $45 million of debt. After that the cost of debt will be 6.5 percent. At what size capital structure will there be a change in the cost of debt?(Enter your answer in millions. Omit the “$” sign in your response.)

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.)

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).

Assume:

Rf

Km

β

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

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.)