Question 1

Cost of debt using the approximation formulaFor the following $1,000-par-value bond, assuming annual interest payment and a 28% taxrate, calculate the after-tax cost to maturity using the approximation formula.

Life Underwriting fee Discount () or premium (+) Coupon interest rate

5 years $40 -$50 12%

Theafter-tax cost of financing using the approximation formula is

___________%. (Round to two decimalplaces.)

Question 2

Before-tax cost of debtGronseth DrywallSystems, Inc., is in discussions with its investment bankers regarding the issuance of new bonds. The investment banker has informed the firm that different maturities will carry different coupon rates and sell at different prices. The firm must choose among several alternatives.

In eachcase, the bonds will have a $1,000 par value and flotation costs will be $30 per bond. Calculate the before-tax cost of financing with the following alternative.

Coupon rate Time to maturity Premium or discount

8% 6 years $180

Thebefore-tax cost of debt is __________%. (Round to two decimalplaces.)

Question 3

Cost of common stock equity Ross Textiles wishes to measure its cost of common stock equity. Thefirm's stock is currently selling for $40.59. The firm just recently paid a dividend of $3.99. The firm has been increasing dividends regularly. Five yearsago, the dividend was just $3.01.

After underpricing and flotationcosts, the firm expects to net $38.15 per share on a new issue.

a. Determine average annual dividend growth rate over the past 5 years. Using that growthrate, what dividend would you expect the company to pay nextyear?

b. Determine the netproceeds, Nn, that the firm will actually receive.

c.Using theconstant-growth valuationmodel, determine the required return on thecompany's stock, rs, which should equal the cost of retainedearnings, rr.

d. Using theconstant-growth valuationmodel, determine the cost of new commonstock, rn.

Question 4

Weighted average cost of capitalAmericanExploration, Inc., a natural gasproducer, is trying to decide whether to revise its target capital structure. Currently it targets a 50-50 mix of debt andequity, but it is considering a target capital structure with 80% debt. American Exploration currently has 6% after-tax cost of debt and a 12% cost of common stock. The company does not have any preferred stock outstanding.

a.What is AmericanExploration's currentWACC?

AmericanExploration's current WACC under the 50-50 mix of debt and equity is ____________%. (Round to two decimalplaces.)

b.Assuming that its cost of debt and equity remainunchanged, what will be AmericanExploration's WACC under the revised target capitalstructure?

c.Do you think shareholders are affected by the increase in debt to 80%? Ifso, how are theyaffected? Are the common stock claims riskiernow?

d.Suppose that in response to the increase indebt, AmericanExploration's shareholders increase their required return so that cost of common equity is 16%. What will its new WACC be in thiscase?

e.What does your answer in part d suggest about the tradeoff between financing with debt versusequity?