3) If the before tax R D equals 8% and the firms’ tax rate equals 25%, how much

Question

3)   If the before tax RD equals 8% and the firms’ tax rate equals 25%, how much is the Rre using the Bond-Yield-plus-Risk-Premium method?

6%

9%

10%

12%

5)   Calculate WACC1 if the following is known:

Wd = 45%

R for Debt before Tax = 7.5%

T = 25%

Wps = 10%

R for Preferred stock = 8.25%

R for Retained Earnings = 9.25%

R for newly issued stocks = 9.75%

A.    8.36%

B.    7.52%

C.    8.59%

D.   7.74%

8)   Based on the so-called Bird-in-Hand theory it can be concluded that:

a. Shareholders prefer that companies have high retained earnings.

b. Managers should invest in projects that promise a high return.

c. Companies should pay out dividends.

d. Shareholders do not pay attention to the WACC.

Explanation / Answer

1.Cost of Equity = After tax cst of Debt + Bond Premium = 8%*(1-25%) + Bond premium = 6% + Bond Premium
SInce Bond premium not given in question please add bon dpremium to 6% to get the answer.

2.Weight of Equity = 1 - Weight of debt - Weight of Preferred Stock = 1 - 45% - 10% = 45%
WACC = Cost of Equity * Weight of Equity + Cost of Preferred Stock *Weight of preferred Stock + Cost of Debt *(1-Tax rate)* Weight of Debt = 9.75% * 45% + 8.25% * 10% + 7.5% *(1- 25%) * 45% = 7.74%

3.Based on the so-called Bird-in-Hand theory it can be concluded that:
Option b Companies should pay out dividends.

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