Scribd Logo
Upload

Welcome to Scribd!

  • 37 views

    CH 9 Problems-1

    Uploaded by

    Çisem Hakyimez
    This document contains sample end-of-chapter questions from a finance textbook. It includes questions about calculating the cost of debt, preferred stock, common stock, and weighted average cost of capital (WACC) using different capital structures. It also discusses how changes in capital structure can affect the risk and required rates of return for different sources of financing.

    Copyright:

    © All Rights Reserved
    Download as PPTX, PDF, TXT or read online from Scribd

    CH 9 Problems-1

    Uploaded by

    Çisem Hakyimez
    37 views16 pages
    This document contains sample end-of-chapter questions from a finance textbook. It includes questions about calculating the cost of debt, preferred stock, common stock, and weighted average cost of capital (WACC) using different capital structures. It also discusses how changes in capital structure can affect the risk and required rates of return for different sources of financing.

    Original Title

    Ch 9 Problems-1

    Copyright

    © © All Rights Reserved

    Available Formats

    PPTX, PDF, TXT or read online from Scribd

    Did you find this document useful?

    Is this content inappropriate?

    This document contains sample end-of-chapter questions from a finance textbook. It includes questions about calculating the cost of debt, preferred stock, common stock, and weighted average cost of capital (WACC) using different capital structures. It also discusses how changes in capital structure can affect the risk and required rates of return for different sources of financing.

    Copyright:

    © All Rights Reserved
    Download as PPTX, PDF, TXT or read online from Scribd
    Download as pptx, pdf, or txt
    37 views16 pages

    CH 9 Problems-1

    Uploaded by

    Çisem Hakyimez
    This document contains sample end-of-chapter questions from a finance textbook. It includes questions about calculating the cost of debt, preferred stock, common stock, and weighted average cost of capital (WACC) using different capital structures. It also discusses how changes in capital structure can affect the risk and required rates of return for different sources of financing.

    Copyright:

    © All Rights Reserved
    Download as PPTX, PDF, TXT or read online from Scribd
    Download as pptx, pdf, or txt
    of 16

    Ch 09

    End of Chapter Questions


    Cost of debt using both methods
    LG 3; Intermediate
    a. Net proceeds: Nd  $1,010  $30
    Nd $980

    b. Cash flows: T CF
    0 $ 980
    1–15 120
    15 1,000

    c. Cost to maturity:
    N  15, P  980, PMT  120, FV  1,000
    Solve for I: 12.30%
    After-tax cost: 12.30% (1  0.4)  7.38%

    d. Approximate before-tax cost of debt


    ($1,000  $980)
    $120 
    rd  15
    ($980  $1,000)
    2
    rd  $121.33  $990,000
    rd  12.26%
    Approximate after-tax cost of debt  12.26%  (10.4)  7.36%
    e. The advantages of the calculator method are evident. There are fewer keypunching strokes and
    one gets the actual cost of debt financing. However, the approximation formula is fairly
    accurate and expedient in the absence of a financial calculator.
    P9-7. Cost of preferred stock: rp  Dp  Np
    LG 2; Basic
    $12.00
    a. rp   12.63%
    $95.00

    $10.00
    b. rp   11.11%
    $90.00
    P9-9. Cost of common stock equity—capital asset pricing model (CAPM)
    LG 5; Intermediate
    rs  RF  [b  (rm  RF)]
    rs  6%  1.2  (11%  6%)
    rs  6%  6%
    rs  12%
    a. Risk premium  6%
    b. Rate of return  12%
    c. After-tax cost of common equity using the CAPM  12%
    D1  g
    P9-10. Cost of common stock equity: kn  Nn

    LG 5; Intermediate
    a. N  4 (2015  2011), PV (initial value)  $2.12, FV (terminal value)  $3.10
    Solve for I (growth rate): 9.97%
    b. Nn  $52 (given in the problem)
    c. rr  (Next Dividend  Current Price)  growth rate
    rr  ($3.40  $57.50)  0.0997
    rr  0.0591  0.0997  0.1588 or 15.88%
    d. rr  ($3.40  $52)  0.0997
    rr  0.0654  0.0997  0.1651 or 16.51%
    P9-14. WACC—book weights and market weights
    LG 6; Intermediate
    a. Book value weights:
    Type of Capital Book Value Weight Cost Weighted Cost
    Long-term debt $4,000,000 0.784 6.00% 4.704%
    Preferred stock 40,000 0.008 13.00% 0.104%
    Common stock 1,060,000 0.208 17.00% 3.536%
    $5,100,000 8.344%

    b. Market value weights:


    Type of Capital Market Value Weight Cost Weighted Cost
    Long-term debt $3,840,000 0.557 6.00% 3.342%
    Preferred stock 60,000 0.009 13.00% 0.117%
    Common stock 3,000,000 0.435 17.00% 7.395%
    $6,900,000 10.854%

    c. The difference lies in the two different value bases. The market value approach yields the better value
    because the costs of the components of the capital structure are calculated using the prevailing market
    prices. Because the common stock is selling at a higher value than its book value, the cost of capital
    is much higher when using the market value weights. Notice that the book value weights give the
    firm a much greater leverage position than when the market value weights are used.
    P9-19. Calculation of individual costs and WACC
    a. After-tax cost of debt
    Approximate approach
    ($1,000  N d ) c. Retained earnings:
    I D1
    rd  n rr  g
    ( N d  $1,000) P0
    = ($7.00 ÷ $90) + 0.06 = 0.0778 + 0.0600 = 0.1378 or 13.78%
    2
    New common stock:
    ($1,000  $940) D1
    $80  rn  g
    20 $80  $3 Nn
    rd    8.56%
    ($940  $1,000) $970 = [$7.00 ÷ ($90  $7  $5)] + 0.06
    2 = [$7.00 ÷ $78] + 0.06 = 0.0897 + 0.0600 = 0.1497 or 14.97%
    ri  rd  (1t) Target Cost of
    Capital Capital Weighted
    ri  8.56%  (10.40) Type of Capital Structure % Source Cost
    ri  5.14% 2. With retained earnings
    Calculator approach Long-term debt 0.30 5.18% 1.55%
    Preferred stock 0.20 8.44% 1.69%
    N  20, PV  $940, PMT  $80, FV  $1,000
    Common stock equity 0.50 13.78% 6.89%
    Solve for I: 8.64% WACC  10.13%
    After-tax cost of debt: 8.64% (1 0.40)  5.18% 3. With new common stock
    b. Preferred stock: Long-term debt 0.30 5.18% 1.55%
    Dp Preferred stock 0.20 8.44% 1.69%
    rp  Common stock equity 0.50 14.97% 7.48%
    Np WACC  10.72%
    $7.60
    rp   8.44%
    $90
    P9-20. Weighted-average cost of capital
    LG 6; Intermediate
    a. WACC  0.50 (0.06)  0.50 (0.12)  0.03  0.06  0.09 or 9.0%
    b. WACC  0.70 (0.06)  0.30 (0.12)  0.042  0.036  0.078 or 7.8%
    c. They are affected because, under the revised capital structure, there is more debt financing. Bond
    holders represent a prior, legal claim to the firm’s operating income. A larger interest expense must be
    paid prior to any dividend payment. There is also a greater chance of bankruptcy because the firm’s
    operating income may be insufficiently large to accommodate the larger interest expense.
    d. WACC  0.70 (0.06)  0.30 (0.16)  0.042  0.048  0.09, or 9%
    e. Increasing the percentage of debt financing increases the risk of the company not being able to make its
    interest payments. Bankruptcy would have negative consequences to both bondholders and
    stockholders. As shown in part d, if stockholders increase their required rate of return, the cost of capital
    may not decline. In fact, if the bondholders required a higher return also, the cost of capital would
    actually rise in this scenario.

    You might also like