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essentials managerial finance
Principles Of Managerial Finance 15th Global Edition Chad J. Zutter, Scott Smart - Solutions
=+P9–6 After-tax cost of debt Bill William intends to purchase a new racing car. He has decided to borrow money to pay the $500,000 purchase price of the car. He is in the 40% federal income tax bracket. He can either borrow the money at an interest rate of 10% from the car dealer, or he could
=+a. Calculate the after-tax cost of borrowing from the car dealership.
=+b. Calculate the after-tax cost of borrowing through a second mortgage on Bill’s home.
=+c. Which source of borrowing is less costly for Bill?
=+d. Should Bill consider any other factors when deciding which loan to take out to pay for the racing car?
=+LG 4 P9–7 Cost of preferred stock Mavis Taylor Corporation has just issued preferred stock.The stock has a 6% annual dividend and a $100 par value, and was sold at $98.5 per share. Flotation costs were an additional $3 per share.
=+a. Calculate the cost of the preferred stock.
=+b. If the firm sells the preferred stock with a 10% annual dividend and net $93.00 after flotation costs, what is its cost?
=+LG 4 P9–8 Cost of preferred stock Determine the cost for each of the following preferred stocks.
=+P9–9 Cost of common stock equity: CAPM Brigham Jewellery Corporation common stock has a beta,b, of 1.8. The risk-free rate is 5%, and the market return is 16%.
=+a. Determine the risk premium on Brigham common stock.
=+b. Determine the required return that Brigham common stock should provide.
=+c. Determine Brigham’s cost of common stock equity using the CAPM.
=+LG 5 P9–10 Cost of common stock equity Ross Textiles wishes to measure its cost of common stock equity. The firm’s stock is currently selling for $70.67. The firm just recently paid a dividend of $4. The firm has been increasing dividends regularly. Five years ago, the dividend was just
=+a. Determine average annual dividend growth rate over the past 5 years. Report your answer to the nearest whole percentage. Using that growth rate, what dividend would you expect the company to pay next year?
=+b. Determine the net proceeds, Nn, that the firm will actually receive.
=+c. Using the constant-growth valuation model, determine the required return on the company’s stock, rs, which should equal the cost of retained earnings, rr.
=+d. Using the constant-growth valuation model, determine the cost of new common stock, rn.
=+LG 5 P9–11 Retained earnings versus new common stock Using the data for each firm shown in the following table, calculate the cost of retained earnings and the cost of new common stock using the constant-growth valuation model.
=+P9–12 The effect of tax rate on WACC K. Bell Jewelers wishes to explore the effect on its cost of capital of the rate at which the company pays taxes. The firm wishes to maintain a capital structure of 40% debt, 10% preferred stock, and 50% common stock.The cost of financing with retained
=+LG 6 P9–13 WACC: Market value weights Boots Mechanics is based in Manchester, United Kingdom. The market values and after-tax costs of various sources of capital used by the company are shown in the following table.
=+a. Calculate the WACC for Boots Mechanics.
=+b. Explain how the company can use the WACC if it wants to invest in a new project.
=+LG 6 P9–14 WACC: Book weights and market weights Webster Company has compiled the information shown in the following table.
=+a. Calculate the WACC using book value weights.
=+b. Calculate the WACC using market value weights.
=+c. Compare the answers obtained in parts a andb. Explain the differences.
=+P9–15 WACC and target weights After careful analysis, Dexter Brothers has determined that its optimal capital structure is composed of the sources and target market value weights shown in the following table.Source of capital Target market value weight Long-term debt 30%Preferred stock 15
=+a. Calculate the WACC on the basis of historical market value weights.
=+b. Calculate the WACC on the basis of target market value weights.
=+c. Compare the answers obtained in parts a andb. Explain the differences.
=+LG 3 LG 4 P9–16 Cost of capital GB Timbers GmbH, based in Germany, supplies timber products to construction and manufacturing industries. The company reported after-tax earnings available to common stock of €3,200,000. From these earnings, the management decided to pay a dividend of €0.80
=+a. If the market price of the common stock is €3.60 and dividends are expected to grow at a rate of 8% per year for the foreseeable future, what is the required return on the company’s common stock?
=+b. If underpricing and flotation costs on new shares of common stock amount to €0.40 per share, what is the company’s cost of new common stock financing?
=+c. The company can issue a €1.00 dividend preferred stock for a market price of€10.00 per share. Flotation costs would amount to €0.60 per share. What is the cost of preferred stock financing?
=+d. In addition, the company can issue €100-par-value, 8% coupon, 10-year bonds that can be sold for €110 each. Flotation costs would amount to €2 per bond.Use the estimation formula to figure the approximate cost of debt financing.
=+e. What is the WACC?
=+LG 3 LG 4 P9–17 Calculation of individual costs and WACC Dillon Labs has asked its financial manager to measure the cost of each specific type of capital as well as the weighted average cost of capital (WACC). The WACC is to be measured by using the following weights:40% long-term debt, 10%
=+Debt The firm can sell for $1,020 a 10-year, $1,000-par-value bond paying annual interest at a 7% coupon rate. A flotation cost of 3% of the par value is required.Preferred stock An 8% (annual dividend) preferred stock having a par value of$100 can be sold for $98. An additional fee of $2 per
=+a. Calculate the after-tax cost of debt.
=+b. Calculate the cost of preferred stock.
=+c. Calculate the cost of common stock (both retained earnings and new common stock).
=+d. Calculate the WACC for Dillon Labs.Personal Finance Problem
=+LG 6 P9–18 Weighted average cost of capital (WACC) Mandy Robertson has just bought a new house and wants to consolidate her finances. She has three loans outstanding. They all mature in 5 years, and she can repay them without penalty any time before maturity. The following table shows the
=+LG 3 LG 4 P9–19 Calculation of individual costs and WACC Lang Enterprises is interested in measuring its overall cost of capital. Current investigation has gathered the following data.The firm is in the 21% tax bracket.Debt The firm can raise debt by selling $1,000-par-value, 8% coupon
=+Common stock The firm’s common stock is currently selling for $90 per share.The firm expects to pay cash dividends of $7 per share next year. The firm’s dividends have been growing at an annual rate of 6%, and this growth is expected to continue into the future. The stock must be underpriced
=+a. Calculate the after-tax cost of debt.
=+b. Calculate the cost of preferred stock.
=+c. Calculate the cost of common stock.
=+d. Calculate the firm’s WACC using the capital structure weights shown in the following table. (Round answer to the nearest 0.1%.)Source of capital Weight Long-term debt 30%Preferred stock 20 Common stock equity 50 Total 100%
=+LG 6 P9–20 Weighted average cost of capital (WACC) Tack Laser Ltd., a high-end medical equipment manufacturer, is trying to decide whether to revise its target capital structure. Currently, it targets a structure with 40% debt, but it is considering a target capital structure with 60% debt.
=+a. What is Tack Laser’s current WACC?
=+b. Assuming that its cost of debt and equity remain unchanged, what will be Laser Tack’s WACC under the revised target capital structure?
=+c. Do you think that shareholders are affected by the increase in debt to 60%? If so, how are they affected? Are their common stock claims riskier now?
=+d. Suppose that in response to the increase in debt, Tack Laser’s shareholders increase their required return so that the cost of common equity is 18%. What will its new WACC be in this case? Is it still advisable for management to revise the target capital structure?
=+e. Based on your answers to parts a tod, explain the tradeoff between financing with debt versus equity.
=+LG 1 P9–21 ETHICS PROBLEM During the 1990s, General Electric put together a long string of consecutive quarters in which the firm managed to meet or beat the earnings forecasts of Wall Street stock analysts. Some skeptics wondered if GE “managed” earnings to meet Wall Street’s
=+a. Calculate the after-tax cost of debt.
=+b. Calculate the cost of preferred stock.
=+c. Calculate the cost of retained earnings.
=+d. Calculate the cost of new common stock.
=+e. Calculate the firm’s WACC using retained earnings and the capital structure weights shown in the table above.
=+f. Calculate the firm’s WACC using new common stock and the capital structure weights shown in the table above.
=+The tax rate of the firm is currently 21%. The needed financial information and data are as follows:Debt Nova can raise debt by selling $1,000-par-value, 6.5% coupon interest rate, 10-year bonds on which annual interest payments will be made. To sell the issue, an average discount of $20 per bond
=+Retained earnings The firm expects to have available $100,000 of retained earnings in the coming year. Once these retained earnings are exhausted, the firm will use new common stock as the form of common stock equity financing. (Note:When measuring this cost, the firm does not concern itself
=+a. Calculate Eco’s current after-tax cost of long-term debt.
=+b. Calculate Eco’s current cost of preferred stock.
=+c. Calculate Eco’s current cost of common stock.
=+d. Calculate Eco’s current weighted average cost capital (WACC).
=+e. (1) Assuming that the debt financing costs do not change, what effect would a shift to a more highly leveraged capital structure consisting of 50% longterm debt, 0% preferred stock, and 50% common stock have on the risk premium for Eco’s common stock? What would be Eco’s new cost of
=+6–1 What is the real rate of interest? Differentiate it from the nominal rate of interest.
=+6–6 What are typical maturities, denominations, and interest payments of a corporate bond?
=+What mechanisms protect bondholders?
=+6–7 Differentiate between standard debt provisions and restrictive covenants included in a bond indenture.
=+What are the consequences if a bond issuer violates any of these covenants?
=+6–10 What is the current yield for a bond? How are bond prices quoted?
=+How are bonds rated, and why?
=+6–17 What relationship between the required return and the coupon rate will cause a bond to sell at a discount? At a premium? At its par value?
=+6–18 If the required return on a bond differs from its coupon rate, describe the behavior of the bond price over time as the bond moves toward maturity.
=+ST6–1 Bond valuation Lahey Industries has outstanding a $1,000 par-value bond with an 8% coupon rate. The bond has 12 years remaining to its maturity date.
=+a. If interest is paid annually, find the value of the bond when the required return is(1) 7%, (2) 8%, and (3) 10%.
=+b. Indicate for each case in part a whether the bond is selling at a discount, at a premium, or at its par value.
=+c. Using the 10% required return, find the bond’s value when interest is paid semiannually.
=+LG 3 LG 6 ST6–2 Bond yields Elliot Enterprises’ bonds currently sell for $1,026.57, have a 6.5% coupon rate and a $1,000 par value, pay interest annually, and have 18 years to maturity.
=+a. Calculate the bonds’ current yield.
=+b. Calculate the bonds’ yield to maturity (YTM).
=+c. Compare the YTM calculated in part b to the bonds’ coupon rate and current yield (calculated in part a). Use a comparison of the bonds’ current price and par value to explain these differences.
=+E6–1 Suppose that the real rate of return on T-bills is 5% and the inflation rate is 2.4%.What is the nominal rate of return on T-bills?
=+LG 1 E6–2 The yields for Treasuries with differing maturities on a recent day are shown in the following table.Maturity Yield 3 months 0.50%6 months 0.62 1 years 0.75 2 years 1.50 3 years 1.80 5 years 3.80 10 years 4.51 30 years 4.62
=+a. Use this information to plot a yield curve for this date.
=+b. If the expectations hypothesis is true, approximately what rate of return do investors expect a 5-year Treasury note to pay 5 years from now?
=+c. If the expectations hypothesis is true, approximately what rate of return do investors expect a 1-year Treasury security to pay starting 2 years from now?
=+d. Is it possible that even though the yield curve slopes up in this problem, investors will not be expecting rising interest rates? Explain.
=+LG 1 E6–3 The YTMs for Treasuries with differing maturities (with each rate expressed as an annual rate) on a recent day were as shown in the following table.Maturity YTM 3 months 1.41%6 months 1.71 2 years 2.68 3 years 3.01 5 years 3.70 10 years 4.51 30 years 5.25
=+The real rate of interest is 0.8% per year. Use the information in the preceding table to calculate the approximate inflation expectation for each maturity.
=+LG 1 E6–4 Assume that the rate of inflation expected over the coming financial year in India is 6.5%. Explain how a 1-year T- bill could earn a negative real rate of return over the next year. How could it have a zero real rate of return? What minimum nominal rate of return must the T-bill earn
=+LG 1 E6–5 Calculate the risk premium for each of the following companies offering long-term bonds, assuming that the yield to maturity (YTM) for comparable Treasuries is 4%.
=+E6–6 Jennifer has invested in two schemes. The first scheme has a required return of 12%and will produce a stream of £300 at the end of each year indefinitely. The second has a required return of 8% and will produce an end-of-year cash flow of £500 in the first year, £800 in the second and
=+LG 5 E6–7 A bond with 5 years to maturity and a coupon rate of 6% has a par, or face, value of $20,000. Interest is paid annually. If the required return on this bond is 8%, what is the price of the bond?
=+E6–8 Assume a 5-year Treasury bond has a coupon rate of 4.5%.
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