Exam 9: The cost of capital

As the winner of a contest, you are now CFO for the day for Maguire Inc.and your day's job involves raising capital for expansion.Maguire's common stock currently sells for $45.00 per share, the company expects to earn $2.75 per share during the current year, its expected payout ratio is 70%, and its expected constant growth rate is 6.00%.New stock can be sold to the public at the current price, but a flotation cost of 8% would be incurred.By how much would the cost of new stock exceed the cost of common from reinvested earnings?

Firm J's earnings and stock price tend to move up and down with other firms in the S&P 500, while Firm F's earnings and stock price move counter cyclically with J and other S&P companies.Both J and F estimate their costs of equity using the CAPM, they have identical market values, their standard deviations of returns are identical, and they both finance only with common equity.Which of the following statements is CORRECT?

Suppose the debt ratio (D/TA)is 50%, the interest rate on new debt is 8%, the current cost of equity is 16%, and the tax rate is 40%.An increase in the debt ratio to 60% would decrease the weighted average cost of capital (WACC).

Which of the following statements is CORRECT? Assume that the firm is a publicly-owned corporation and is seeking to maximize shareholder wealth.

Granby Foods' (GF)balance sheet shows a total of $25 million long-term debt with a coupon rate of 8.50%.The yield to maturity on this debt is 8.00%, and the debt has a total current market value of $27 million.The company has 10 million shares of stock, and the stock has a book value per share of $5.00.The current stock price is $20.00 per share, and stockholders' required rate of return, rs, is 12.25%.The company recently decided that its target capital structure should have 35% debt, with the balance being common equity.The tax rate is 40%.Calculate WACCs based on book, market, and target capital structures.What is the sum of these three WACCs?

Taylor Inc.estimates that its average-risk projects have a WACC of 10%, its below-average risk projects have a WACC of 8%, and its above-average risk projects have a WACC of 12%.Which of the following projects (A, B, and C)should the company accept?

The president and CFO of Spellman Transportation are having a disagreement about whether to use market value or book value weights in calculating the WACC.Spellman's balance sheet shows a total of noncallable $45 million long-term debt with a coupon rate of 7.00% and a yield to maturity of 6.00%.This debt currently has a market value of $50 million.The company has 10 million shares of common stock, and the book value of the common equity (common stock plus retained earnings)is $65 million.The current stock price is $22.50 per share; stockholders' required return, rs, is 14.00%; and the firm's tax rate is 40%.The CFO thinks the WACC should be based on market value weights, but the president thinks book weights are more appropriate.What is the difference between these two WACCs?

You have been hired by the CFO of Lugones Industries to help estimate its cost of common equity.You have obtained the following data: (1)rd = yield on the firm's bonds = 7.00% and the risk premium over its own debt cost = 4.00%.(2)rRF = 5.00%, RPM = 6.00%, and b = 1.25.(3)D? = $1.20, P? = $35.00, and g = 8.00% (constant).You were asked to estimate the cost of common based on the three most commonly used methods and then to indicate the difference between the highest and lowest of these estimates.What is that difference?

Which of the following statements is CORRECT?

Funds acquired by the firm through retaining earnings have no cost because there are no dividend or interest payments associated with them, and no flotation costs are required to raise them, but capital raised by selling new stock or bonds does have a cost.

For capital budgeting and cost of capital purposes, the firm should assume that each dollar of capital is obtained in accordance with its target capital structure, which for many firms means partly as debt, partly as preferred stock, and partly common equity.

As a consultant to Basso Inc., you have been provided with the following data: D? = $0.67; P? = $27.50; and g = 8.00% (constant).What is the cost of common from reinvested earnings based on the DCF approach?