QUESTION: 19 Topic 1: Part 2 Sec One (1 to 52)

Assume that the after-tax cost of debt is 7% and the cost of equity is 12%. Determine the weighted-average cost of capital to DQZ.

10.50%
850%
950%
6.30%

Answer(s): A

Explanation:

The 7% debt cost and the 12% equity cost should be weighted by the proportions of the total investment represented by each source of capital. The total project costs $50 million, of which debt is $15 million, or 30% of the total. Equity capital is the other 70%,. Consequently, the weighted-average cost of capital is 10.5% [(7%)(30%) + (12%)(70%)].

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QUESTION: 20 Topic 1: Part 2 Sec One (1 to 52)

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The difference between the required rate of return on a given risky investment and that on a risk less investment with the same expected return is the

Risk premium.
Coefficient of variation.
Standard deviation.
Beta coefficient.

Answer(s): A

Explanation:

The required rate of return on equity capital in the capital asset pricing model is me risk- free rate (determined by government securities) plus the product of the market risk premium times the beta coefficient (beta measures the firm's risk). The market risk premium is the amount above the risk-free rate that will induce investment in the market. The beta coefficient of an individual stock is the correlation between the volatility (price variation) of the stock market and that of the price of the individual stock,

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QUESTION: 21 Topic 1: Part 2 Sec One (1 to 52)

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The common stock of the Nicolas Corporation is currently selling at $80 per share. The leadership of the company intends to pay a $4 per share dividend next year With the expectation that the dividend will grow at 5% perpetually, what will the markets required return on investment be for Nicolas common stock'?

5%
6. 5.25%
7.5%
10%

Answer(s): D

Explanation:

The dividend growth model estimates the cost of retained earnings using the dividends per share, the expected growth rate, and the market price. The current dividend yield is 5% ($4 + $80) Adding the growth rate of 5% to the yield o15% results in a required return of 10%.

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QUESTION: 22 Topic 1: Part 2 Sec One (1 to 52)

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A firm's new financing will be in proportion to the market value of its current financing shown below

The firm's bonds are currently selling at 80% of par, generating a current market yield of 9%, and the corporation has a 40% tax rate. The preferred stock is selling at its par value and pays a 6% dividend. The common stock has a current market value of $40 and is expected to pay a $1 20 per share dividend this fiscal year. Dividend growth is expected to be 10% per year, and flotation costs are negligible. The firm's weighted-average cost of capital is (round calculations to tenths of a percent)

130%
83%
9.6%
9.0%

Answer(s): C

Explanation:

The first step is to determine the after-tax cost of the long-term debt. Multiplying the current yield of 9% times one minus the tax rate (1 -- .4 = .6) results in an after-tax cost of debt of 5.4% (9% x .6). The cost of the preferred stock is 6% (the annual dividend rate). The dividend growth model for measuring the cost of equity capital is a frequently used method that combines the dividend yield with the growth rate. Dividing the $1.20 dividend by the $40 market price produces a dividend yield of 3%. Adding the 3% dividend yield and the 10% growth rate gives a 13% cost of common equity capital. Once the costs of the three types of capital have been computed, the next step is to weight them according to the market values of the elements of the current capital structure. The $1 .000.000 of preferred stock is selling at par. The market value of the long-term debt is 80% of its carrying amount, or $5,600,000 ($7,000,000 x 80%). The common stock has a current market price of $8,000,000 (200,000 shares x $40). Thus, the weighted-average cost of capital is 9.6% ($1,402,000 + $14,600,000), as shown below.

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QUESTION: 19 Topic 1: Part 2 Sec One (1 to 52)

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QUESTION: 20 Topic 1: Part 2 Sec One (1 to 52)

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QUESTION: 21 Topic 1: Part 2 Sec One (1 to 52)

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QUESTION: 22 Topic 1: Part 2 Sec One (1 to 52)

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