Cost of new equity Answer: b Diff: E
i
. Your company’s stock sells for $50 per share, its last dividend (D0) was $2.00, its
growth rate is a constant 5 percent, and the company will incur a flotation cost of 15
percent if it sells new common stock. What is the firm’s cost of new equity, ke...
managerialaccountinggarrison cost of cap questions amp answers
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Management Accounting
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Multiple Choice: Problems
Easy:
Cost of new equity Answer: b Diff: E
i
. Your company’s stock sells for $50 per share, its last dividend (D 0) was $2.00, its
growth rate is a constant 5 percent, and the company will incur a flotation cost of 15
percent if it sells new common stock. What is the firm’s cost of new equity, ke?
a. 9.20%
b. 9.94%
c. 10.50%
d. 11.75%
e. 12.30%
Cost of new equity Answer: d Diff: E
ii
. Blair Brothers’ stock currently has a price of $50 per share and is expected to pay a
year-end dividend of $2.50 per share (D 1 = $2.50). The dividend is expected to grow
at a constant rate of 4 percent per year. The company has insufficient retained
earnings to fund capital projects and must, therefore, issue new common stock. The
new stock has an estimated flotation cost of $3 per share. What is the company’s
cost of equity capital?
a. 10.14%
b. 9.21%
c. 9.45%
d. 9.32%
e. 9.00%
Cost of retained earnings Answer: d Diff: E
iii
. Allison Engines Corporation has established a target capital structure of 40 percent
debt and 60 percent common equity. The current market price of the firm’s stock is P0
= $28; its last dividend was D0 = $2.20, and its expected dividend growth rate is 6
percent. What will Allison’s marginal cost of retained earnings, ks, be?
, a. 15.8%
b. 13.9%
c. 7.9%
d. 14.3%
e. 9.7%
WACC Answer: a Diff: E
iv
. An analyst has collected the following information regarding Christopher Co.:
The company’s capital structure is 70 percent equity and 30 percent debt.
The yield to maturity on the company’s bonds is 9 percent.
The company’s year-end dividend is forecasted to be $0.80 a share.
The company expects that its dividend will grow at a constant rate of 9 percent a
year.
The company’s stock price is $25.
The company’s tax rate is 40 percent.
The company anticipates that it will need to raise new common stock this year,
and total flotation costs will equal 10 percent of the amount issued.
Assume the company accounts for flotation costs by adjusting the cost of
capital. Given this information, calculate the company’s WACC.
a. 10.41%
b. 12.56%
c. 10.78%
d. 13.55%
e. 9.29%
WACCAnswer: a Diff: E
v
.Flaherty Electric has a capital structure that consists of 70 percent equity and 30 percent
debt. The company’s long-term bonds have a before-tax yield to maturity of 8.4 percent. The
company uses the DCF approach to determine the cost of equity. Flaherty’s common stock
currently trades at $45 per share. The year-end dividend (D 1) is expected to be $2.50 per
share, and the dividend is expected to grow forever at a constant rate of 7 percent a year. The
company estimates that it will have to issue new common stock to help fund this year’s
projects. The flotation cost on new common stock issued is 10 percent, and the company’s tax
rate is 40 percent. What is the company’s weighted average cost of capital, WACC?
a. 10.73%
b. 10.30%
c. 11.31%
d. 7.48%
e. 9.89%
,WACCAnswer: b Diff: E
vi
.Billick Brothers is estimating its WACC. The company has collected the following
information:
Its capital structure consists of 40 percent debt and 60 percent common equity.
The company has 20-year bonds outstanding with a 9 percent annual coupon that
are trading at par.
The company’s tax rate is 40 percent.
The risk-free rate is 5.5 percent.
The market risk premium is 5 percent.
The stock’s beta is 1.4.
What is the company’s WACC?
a. 9.71%
b. 9.66%
c. 8.31%
d. 11.18%
e. 11.10%
Divisional risk Answer: c Diff: E
vii
.Dandy Product’s overall weighted average required rate of return is 10 percent. Its yogurt
division is riskier than average, its fresh produce division has average risk, and its
institutional foods division has below-average risk. Dandy adjusts for both divisional and
project risk by adding or subtracting 2 percentage points. Thus, the maximum adjustment is
4 percentage points. What is the risk-adjusted required rate of return for a low-risk project in
the yogurt division?
a. 6%
b. 8%
c. 10%
d. 12%
e. 14%
Retained earnings break point Answer: e Diff: E
viii
.Stephenson & Sons has a capital structure that consists of 20 percent equity and 80
percent debt. The company expects to report $3 million in net income this year, and 60
, percent of the net income will be paid out as dividends. How large must the firm’s capital
budget be this year without it having to issue any new common stock?
a. $ 1.20 million
b. $13.00 million
c. $ 1.50 million
d. $ 0.24 million
e. $ 6.00 million
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