Question

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13. Absolute Corporation has a capital structure that consists of 65% equity and 35% debt. The company expects to report P100 million in net income this year, and 67.5% of the net income will be paid out as dividends. How large can the firm's capital budget be this year without it having to include the cost of new common stock in its cost of capital analysis?

a. P100.0 million

b. P 67.5 million                                            

c. P 50.0 million

d. P 32.5 million

14. The Salvage Company projects the following for the upcoming year:

Earnings before interest and taxes                                                           P40 million

Interest expense                                                                                                P 5 million

Preferred stock dividends                                                                            P 4 million

Common stock dividend payout ratio                                                                  20%

Average number of common shares outstanding                                   2 million

Effective corporate income tax rate                                                                      40%

The expected dividend per share of common stock is

a. P1.70

b. P1.86

c. P2.10

d. P1.00

15. How much will a firm need in cash flow before tax and interest to satisfy debt holders and equity holders if the tax rate is 40%, there is P10 million in common stock requiring a 12% return, and P6 million in bonds requiring an 8% return?

a. P1,392,000

b. P1,488,000

c. P2,480,000

d. P2,800,000

16. The Dumaguete Co. has an equity cost of capital of 17%. The debt to equity ratio is 1.5 and a cost of debt is 11%. What is the weighted average cost of capital of the firm? (Assume a tax rate of 33%)

a. 3.06%                                                          

b. 13.40%

c. 16.97%

d. 15.52%

17. During the past five years, Pena Company had consistently paid 50% of earnings available to common as dividends. Next year, the Pena Company projects its net income, before the P1.2 million preferred dividends, at P6 million.

The capital structure for the company is maintained at:

Debt                                                                        25.5%

Preferred stock                                                  15.0%

Common equity                                                 60.0%

What is the retained earnings break-point next year?

a. P5,760,000

b. P4,800,000

c. P4,000,000

Answer 1

13.Capital Budget without new stock = Net Income*(1-Payout ratio)/% of Equity in Capital Structure

= P100 million*(1-67.5%)/65%

= P50 million

i.e. c

14.Net Income = (EBIT – Interest)(1-Tax rate)

= (40 million – 5million)*(1-40%) = 21 million

Dividend per share = (Net Income – Preferred Dividends)*Payout ratio/Number of common shares

= (21 million – 4 million)*20%/2 million

= P1.70

i.e. a

15.Required cash flow = Amount to equity/(1-tax rate) + Interest

= 10 million*12%/(1-40%) + 6 million*8%

= P2,480,000

i.e. c

16. WACC = After tax cost of debt*weight of debt + Cost of Equity*Weight of Equity

= 11%*1.5/2.5 + 17%*1/2.5

= 13.40%

i.e. b

17.Retained earnings break point = Income retained/% of Equity

= (6 million – 1.2 million)*50%/60%

= P4,000,000

I.e. c