1. To help finance a major expansion, a company sold a noncallable bond several
ID: 2616814 • Letter: 1
Question
1. To help finance a major expansion, a company sold a noncallable bond several years ago that now has 15 years to maturity. This bond has a 10.25% annual coupon, paid semiannually, it sells at a price of $1,025, and it has a par value of $1,000. If the company’s tax rate is 21%, what component cost of debt should be used in the WACC calculation?
A. 5.96%
B. 7.84%
C. 6.95%
D. 9.93%
2. You were hired as a consultant to a company, whose target capital structure is 40% debt, 10% preferred, and 50% common equity. The before-tax cost of debt is 6.0%, the cost of preferred is 8.0%, and the cost of retained earnings is 13.0%. The corporate tax rate is 21%. The firm will not be issuing any new stock. What is its WACC?
A. 8.72%
B. 9.02%
C. 9.20%
D. 10.15%
3. A firm estimate that its average-risk projects have a WACC of 10%, its below-average risk projects have a WACC of 9%, and its above-average risk projects have a WACC of 12%. Which of the following projects (A, B, and C) should the company accept?
A. None of the projects should be accepted.
B. Project B is of below-average risk and has a return of 9.5%.
C. Project C is of above-average risk and has a return of 11%.
D. Project A is of average risk and has a return of 9%.
4. A stock is selling for $50 in the market. The required rate of return is 9%. The most recent dividend paid is D0 = $2.0 and dividends are expected to grow at a constant rate g. What’s the expected dividend yield for this stock???
A.4.00%
B.4.19%
C.5.0%
D. 9.0%
A. None of the projects should be accepted.
B. Project B is of below-average risk and has a return of 9.5%.
C. Project C is of above-average risk and has a return of 11%.
D. Project A is of average risk and has a return of 9%.
4. A stock is selling for $50 in the market. The required rate of return is 9%. The most recent dividend paid is D0 = $2.0 and dividends are expected to grow at a constant rate g. What’s the expected dividend yield for this stock???
A.4.00%
B.4.19%
C.5.0%
D. 9.0%
Explanation / Answer
QUESTION – 1
The Answer is “B. 7.84% “
Cost of Debt [ Bond YTM ]
YTM = C + [ (Par Value – Bond Price) / Maturity Years ] / [(Par Value + Bond Price)/2]
= $102.50 + [ ($1,000 - $1,025) / 15 ) ] / [($1,000 + $1,025) / 2]
= [$102.50 - $1.67 / $1,012.50] x 100
= 9.93%
After Tax Cost of Bond = 9.93% x [ 1 - 0.21 ] = 7.84%
QUESTION – 2
The Answer is “ C. 9.20% “
Weighted Average Cost of Capital [WACC]
= [ After Tax Cost of Debt x Weight of Debt ] + [ Cost of Preferred stock x Weight of preferred stock ] + [ Cost of equity x Weight of common stock ]
= [ (6% x 0.79) x 0.40 ] + [ 8% x 0.10 ] + [ 13% x 0.50 ]
= 1.90% + 0.80% + 6.50%
= 9.20%
QUESTION – 3
The Answer is “ B. Project B is of below-average risk and has a return of 9.5% “
QUESTION – 4
The Answer is “ A. 4.00% “
Dividend Yield = [ Annual Dividend / Current Market Price ] x 100
= [ $2.00 / $50.00 ] x 100
= 4%
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