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Finance Homework

Finance Homework
Use the following information for questions 1-7.  A corporation has 8,000,000 shares
of stock outstanding at a price of $50 per share.  They just paid a dividend of $2
and the dividend is expected to grow by 7% per year forever.  The stock has a beta
of 1.2, the current risk free rate is 5%, and the market risk premium is 6%. The
corporation also has 500,000 bonds outstanding with a price of $1,100 per bond.  The
bond has a coupon rate of 11% with semiannual interest payments, a face value of
$1,000, and 13 years to go until maturity. The company plans on adding debt until
they reach their target debt ratio of 70%. They expect their cost of debt to be 10%
and their cost of equity to be 15% under this new capital structure. The tax rate is
40%
1.  What is the required return on the corporation’s stock?
a)  9.4%          b)  10.6%         c)  11.3%         d)  12.2%
12.  What is the expected return on the corporation’s stock?
a)  9.4%           b)  10.6%         c)  11.3%         d)  12.2%
3.  What is the yield to maturity on the company’s debt?
a)  9.2%      b) 9.4%            c) 9.6%            d)  9.8%
4.  What percent of their current market value capital structure is made up of debt?
a)  35%       b) 42%             c) 55%             d)  58%
5.  What is their WACC using their target capital structure and expected costs of
debt and equity?
a)  7.7%      b) 8.7%            c) 9.1%            d)  9.8%
6.  Given the new cost of debt, what should be the new price of the bond?
a)  $920      b) $960                        c) $1,072         d)  $1,172
7.  Given the new cost of equity, what should be the new price of the stock?
a)  $26.75   b) $37.25         c) $43.50         d)  $56.67
8. A company that just paid a dividend of $2 per share and expects dividends to grow
by 6% per year. Their current stock price is $50 per share. If flotation costs are
10%, then what is their cost of new equity?
a)  10.2%         b) 10.7%          c)  11.2%         d)  11.9%
9. Which statement is CORRECT?
a)      The cost of equity is adjusted for taxes because dividends are tax
deductible
b)      One method of determining the cost of debt is by adding a risk premium to
the cost of equity
c)      The WACC acts as a Required Return for evaluating a firm’s average risk
projects.
d)      All of the above are correct
10. If a firm plans on reducing the level of debt in their capital structure, then
this should cause the cost of debt to ___________ and the cost of equity to
___________.
a)      Fall; Fall
b)      Fall; Rise
c)      Rise; Rise
d)      Rise; Fall
11. A firm had Net Income of $1,000,000 and a payout ratio of 40%. If they are 70%
equity financed, how much can they spend on capital expenditures before needing
external equity (the Retained Earnings Breakpoint)?
a) $420,000                 b) $571,429     c) $857,143     d) $1,333,333
12. Preferred Stock has a dividend of 5% and a par value of $100. If the price is
$80 and the tax rate is 40%, then what is the Cost of Preferred Stock?
a) 4.8%                        b) 6.25%          c) 7.33%          d) 8%
13. What are the consequences if a firm doesn’t pay the dividend on their preferred
stock?
a)      They may be forced into bankruptcy
b)      It is more difficult for them to raise additional funds
c)      The common shareholders receive the dividend
d)      All of the above
14. The risk free rate is 3%, the firm’s Cost of Debt is 5%, and the firm’s Cost of
Equity is 9%. What is the Risk Premium in the Bond-Yield plus Risk Premium approach?
a) 2%               b) 4%               c) 6%               d) 8%
15. A bond has a price of $1,100, a coupon rate of 9%, and a face value of $1,000.
It matures in 12 years, but can be called in four years for a call premium of
$1,050. What is the appropriate Before Tax Cost of Debt?
a) 7.2%                        b) 7.4%                        c) 7.7%
d) 8%
16. A firm has Equity of $1,000,000, Net Income of $300,000, and paid dividends of
$200,000. What is their sustainable growth rate?
a) 6%               b) 8%               c) 10%             d) 12%
17. Just put A
18. Suppose a company is considering a project that is riskier than their current
business. They should _____________.
a)      Automatically reject the project because it is too risky
b)      Accept the project as long as the return on the project is higher than the
firm’s WACC
c)      Use a required return that is higher than the firm’s WACC as a hurdle rate
for the project
d)      All of the Above
19.  Which of these is the highest for a firm?
a)      Cost of New Equity
b)      Cost of Debt
c)      Cost of Retained Earnings
d)      Cost of Preferred Stock
20. Which statement about Preferred Stock is True?
a)      When a company pays dividends, it can deduct 70% of the cost from taxes
b)      If a company misses a dividend payment, they can be forced into bankruptcy
c)      The cost of preferred stock is higher than the cost of common stock
d)      None of the above statements are true
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