Question

*Please show work/formulas and financial calculator steps, if
used. Answer as much as you can*

*(The following information applies to Problems 1-4)*

The Collins Group, a leading producer of custom automobile accessories, has hired you to estimate the firm's weighted average cost of capital. The balance sheet and some other information are provided below.

Assets

Current assets $ 38,000,000

Net plant, property, and equipment 101,000,000

Total assets $139,000,000

Liabilities and Equity

Accounts payable $ 10,000,000

Accruals 9,000,000

Current liabilities $ 19,000,000

**Long-term debt (40,000 bonds, $1,000 par
value) 40,000,000**

Total liabilities $ 59,000,000

**Common stock (10,000,000
shares)
30,000,000**

Retained earnings 50,000,000

Total shareholders' equity 80,000,000

Total liabilities and shareholders' equity $139,000,000

1. The Collins Group’s bond with $1,000 par value 20-year, 7.25% annual

coupon rate with semiannual coupon payment is selling or $875. What is the best estimate of the after-tax cost of debt if the firm’s tax rate is 40%?

a. 4.64%

b. 4.88%

c. 5.14%

d. 5.40%

e. 5.67%

2. The stock’s beta is 1.25, and the yield on a 20-year Treasury bond is 5.50%.

The required return on the stock market is 11.50%. Based on the CAPM,

what is the firm's cost of common stock?

a. 11.15%

b. 11.73%

c. 12.35%

d. 13.00%

e. 13.65%

3. Which of the following is the best estimate for the weight of debt for use in calculating the firm’s WACC? The debt is selling for $875 per bond and the stock is selling or 15.25 per share

a. 18.67%

b. 19.60%

c. 20.58%

d. 21.61%

e. 22.69%

4. What is the best estimate of the firm's WACC?

a. 10.85%

b. 11.19%

c. 11.53%

d. 11.88%

e. 12.24%

5. Quinlan
Enterprises stock trades for $52.50 per share. It is expected to
pay a $2.50 dividend at year end (D_{1} = $2.50), and the
dividend is expected to grow at a constant rate of 5.50% a year.
The before-tax cost of debt is 7.50%, and the tax rate is 40%. The
target capital structure consists of 45% debt and 55% common
equity. What is the company’s WACC if all the equity used is from
retained earnings?

a. 7.07%

b. 7.36%

c. 7.67%

d. 7.98%

e. 8.29%

6. A company’s perpetual preferred stock currently sells for $92.50 per share, and it pays an $8.00 annual dividend. If the company were to sell a new preferred issue, it would incur a flotation cost of 5.00% of the issue price. What is the firm's cost of preferred stock?

a. 7.81%

b. 8.22%

c. 8.65%

d. 9.10%

e. 9.56%

7. The management of
California Fluoride Industries (CFI) is planning next year’s
capital budget. The company’s earnings and dividends are growing at
a constant rate of 4 percent. The last dividend, D_{0}, was
$0.80; and the current equilibrium stock price is $8.73. CFI can
raise new debt at a 12 percent before‑tax cost. CFI is at its
optimal capital structure, which is 35 percent debt and 65 percent
equity, and the firm’s marginal tax rate is 40 percent. CFI has the
following independent, indivisible, and equally risky investment
opportunities:

Project Cost Rate of Return

A $ 18,000 9%

B 16,000 11%

C 13,000 15%

D 23,000 13%

What is CFI’s optimal capital budget?

**
a.** $70,000 b.
$36,000 **c.**
$34,000 **d.**
$47,000 **e.** $0

8. Radiator Products Company (RPC) is at its optimal capital structure of 75 percent common equity and 25 percent debt. RPC’s WACC is 12.50 percent. RPC has a marginal tax rate of 40 percent. Next year’s dividend is expected to be $2.50 per share, and RPC has a constant growth in earnings and dividends of 5 percent. The cost of common equity used in the WACC is based on retained earnings, while the before‑tax cost of debt is 10 percent. What is RPC’s current equilibrium stock price?

**
a.** $12.73
**b.** $17.23 c.
$25.83 **d.**
$20.37 **e.** $23.70

9. Which of the following statements is CORRECT?

a. When calculating the cost of preferred stock, companies must adjust for taxes, because dividends paid on preferred stock are deductible by the paying corporation.

b. Because of tax effects, an increase in the risk-free rate will have a greater effect on the after-tax cost of debt than on the cost of common stock as measured by the CAPM.

c. If a company’s beta increases, this will increase the cost of equity used to calculate the WACC, but only if the company does not have enough retained earnings to take care of its equity financing and hence must issue new stock.

d. Higher flotation costs reduce investors' expected returns, and that leads to a reduction in a company’s WACC.

e. When calculating the cost of debt, a company needs to adjust for taxes, because interest payments are deductible by the paying corporation.

10. Which of the following statements is CORRECT?

a. WACC calculations should be based on the before-tax costs of all the individual capital components.

b. Flotation costs associated with issuing new common stock normally reduce the WACC.

c. If a company’s tax rate increases, then, all else equal, its weighted average cost of capital will decline.

d. An increase in the risk-free rate will normally lower the marginal costs of both debt and equity financing.

e. A change in a company’s target capital structure cannot affect its WACC.

Answer #1

1) C, 2) d, 3) a, 4) c, 5) c, 6) d, 7) b, 8) c, 9) e, 10) c

PLEASE SHOW YOUR WORK
Assuming a target capital structure of:
40% debt
20% preferred
stock
40% common
equity
What would be the WACC given the following: all debt will be
from the sale of bonds with a coupon of 10% (assume no flotation
costs), preferred stock's associated cost will be 13%, and common
equity will be from retained earnings with an associated cost of
15%. The tax rate for this corporation is 30%.

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Dividend, preferred stock……………………….......... …………..$6.00
Dividend, next expected, Common Stock……….......... ………..$1.10
Price, Preferred Stock (ignore any flotation cost)…..........
……$48.00
Price, Common Stock………………………………….......... …..$25.00
Flotation cost per share, common........................ 20% of
stock price
Growth rate…………………………………………….......... ………10%
Bond yield........... …………………………………………………….11%
Bond face .......... ………………………………………………$1,000.00
Net income…………………………………………….... …….$25 million
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