Cost of Capital Practice Questions
Cost of Capital Practice Questions
Cost of Capital Practice Questions
Calculating Cost of Equity [LO1] The Muse Co. just issued a dividend of
$2.75 per share on its common stock. The company is expected to maintain a
constant
5.8 percent growth rate in its dividends indefinitely. If the stock sells for $59 a
share, what is the company’s cost of equity?
2. Calculating Cost of Equity [LO1] The Zombie Corporation’s common stock
has a beta of 1.2. If the risk-free rate is 4.8 percent and the expected return on
the market is 11 percent, what is the company’s cost of equity capital?
3. Calculating Cost of Equity [LO1] Stock in Dragula Industries has a beta of
1.1.The market risk premium is 7 percent, and T-bills are currently yielding 4.5
percent. The company’s most recent dividend was $1.70 per share, and
dividends are expected to grow at a 6 percent annual rate indefinitely. If the
stock sells for
$39 per share, what is your best estimate of the company is cost of equity?
4. Estimating the DCF Growth Rate [LO1] Suppose in a Found, Ltd., just
issued a dividend of $1.69 per share on its common stock. The company paid
dividends of $1.35, $1.43, $1.50, and $1.61 per share in the last four years. If
the stock currently sells for $50, what is your best estimate of the company’s
cost of equity capital using the arithmetic average growth rate in dividends?
What if you use the geometric average growth rate?
5. Calculating Cost of Preferred Stock [LO1] Holdup Bank has an issue of
preferred stock with a $4.25 stated dividend that just sold for $92 per share.
What is the bank’s cost of preferred stock?
6. Calculating Cost of Debt [LO2] Mudvayne, Inc., is trying to determine its
cost of debt. The firm has a debt issue outstanding with 18 years to maturity that
is quoted at 107 percent of face value. The issue makes semiannual payments
and has an embedded cost of 6 percent annually. What is the company’s pretax
cost of debt? If the tax rate is 35 percent, what is the aftertax cost of debt?
7. Calculating Cost of Debt [LO2] Jiminy’s Cricket Farm issued a 30-year, 8
percent semiannual bond 3 years ago. The bond currently sells for 93 percent of
its face value. The company’s tax rate is 35 percent.
a. What is the pretax cost of debt?
b. What is the aftertax cost of debt?
c. Which is more relevant, the pretax or the aftertax cost of debt? Why?
8. Calculating Cost of Debt [LO2] For the firm in Problem 7, suppose the book
value of the debt issue is $60 million. In addition, the company has a second
debt
issue on the market, a zero coupon bond with 10 years left to maturity; the book
value of this issue is $35 million, and the bonds sell for 57 percent of par. What
is the company’s total book value of debt? The total market value? What is your
best estimate of the aftertax cost of debt now?
9. Calculating WACC [LO3] Mullineaux Corporation has a target capital
structure of 60 percent common stock, 5 percent preferred stock, and 35 percent
debt. Its cost of equity is 12 percent, the cost of preferred stock is 5 percent, and
the pretax cost of debt is 7 percent. The relevant tax rate is 35 percent.
a. What is Mullineaux’s WACC?
b. The company president has approached you about Mullineaux’s capital
structure. He wants to know why the company doesn’t use more preferred stock
financing because it costs less than debt. What would you tell the president?
10. Taxes and WACC [LO3] Sixx AM Manufacturing has a target debt−equity
ratio of .45. Its cost of equity is 13 percent, and its cost of debt is 6 percent. If
the tax rate is 35 percent, what is the company’s WACC?