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TitleManagerial Accounting - Garrison TestBank_Cost of Cap.
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Table of Contents
                            ke = D1/(P0 - F) + g
	Multiple Choice: Problems
	Cost of retained earnings Answer: d Diff: E
	WACC Answer: a Diff: E
	WACC Answer: b Diff: E
		WACC Answer: a Diff: M
		WACC Answer: b Diff: M
		WACC Answer: d Diff: M
		WACC Answer: a Diff: M
	c. 7.91%
		WACC Answer: d Diff: M
		WACC Answer: c Diff: M N
			Cost of retained earnings Answer: e Diff: E
		Cost of debt Answer: b Diff: E N
		Cost of common equity: CAPM Answer: e Diff: E N
		WACC Answer: c Diff: E N
		WACC Answer: c Diff: E N
	After-tax cost of debt Answer: c Diff: E N
	Cost of common equity: CAPM Answer: c Diff: E N
                        
Document Text Contents
Page 1

Multiple Choice: Problems

Easy:

Cost of new equity Answer: b Diff: E

i. Your company’s stock sells for $50 per share, its last dividend (D0) was $2.00, its
growth rate is a constant 5 percent, and the company will incur a flotation cost of 15
percent if it sells new common stock. What is the firm’s cost of new equity, ke?

a. 9.20%

b. 9.94%

c. 10.50%

d. 11.75%

e. 12.30%

Cost of new equity Answer: d Diff: E

ii. Blair Brothers’ stock currently has a price of $50 per share and is expected to pay a
year-end dividend of $2.50 per share (D1 = $2.50). The dividend is expected to grow
at a constant rate of 4 percent per year. The company has insufficient retained
earnings to fund capital projects and must, therefore, issue new common stock. The
new stock has an estimated flotation cost of $3 per share. What is the company’s
cost of equity capital?

a. 10.14%

b. 9.21%

c. 9.45%

d. 9.32%

e. 9.00%

Cost of retained earnings Answer: d Diff: E
iii. Allison Engines Corporation has established a target capital structure of 40 percent

debt and 60 percent common equity. The current market price of the firm’s stock is P0
= $28; its last dividend was D0 = $2.20, and its expected dividend growth rate is 6
percent. What will Allison’s marginal cost of retained earnings, ks, be?

Page 2

a. 15.8%

b. 13.9%

c. 7.9%

d. 14.3%

e. 9.7%

WACC Answer: a Diff: E

iv. An analyst has collected the following information regarding Christopher Co.:

 The company’s capital structure is 70 percent equity and 30 percent debt.
 The yield to maturity on the company’s bonds is 9 percent.
 The company’s year-end dividend is forecasted to be $0.80 a share.
 The company expects that its dividend will grow at a constant rate of 9 percent a

year.
 The company’s stock price is $25.
 The company’s tax rate is 40 percent.
 The company anticipates that it will need to raise new common stock this year,

and total flotation costs will equal 10 percent of the amount issued.

Assume the company accounts for flotation costs by adjusting the cost of
capital. Given this information, calculate the company’s WACC.

a. 10.41%
b. 12.56%
c. 10.78%
d. 13.55%
e. 9.29%

WACCAnswer: a Diff: E
v.Flaherty Electric has a capital structure that consists of 70 percent equity and 30 percent
debt. The company’s long-term bonds have a before-tax yield to maturity of 8.4 percent. The
company uses the DCF approach to determine the cost of equity. Flaherty’s common stock
currently trades at $45 per share. The year-end dividend (D1) is expected to be $2.50 per
share, and the dividend is expected to grow forever at a constant rate of 7 percent a year. The
company estimates that it will have to issue new common stock to help fund this year’s
projects. The flotation cost on new common stock issued is 10 percent, and the company’s tax
rate is 40 percent. What is the company’s weighted average cost of capital, WACC?

a. 10.73%

b. 10.30%

c. 11.31%

d. 7.48%

e. 9.89%

Page 18

WACC and cost of preferred stock Answer: b Diff: T

xxx.Anderson Company has four investment opportunities with the following costs (paid at t =
0) and expected returns:

Expected

Project Cost Return

A $2,000 16.0%

B 3,000 14.5

C 5,000 11.5

D 3,000 9.5

The company has a target capital structure that consists of 40 percent common
equity, 40 percent debt, and 20 percent preferred stock. The company has $1,000 in
retained earnings. The company expects its year-end dividend to be $3.00 per share
(D1 = $3.00). The dividend is expected to grow at a constant rate of 5 percent a year.
The company’s stock price is currently $42.75. If the company issues new common
stock, the company will pay its investment bankers a 10 percent flotation cost.

The company can issue corporate bonds with a yield to maturity of 10 percent. The
company is in the 35 percent tax bracket. How large can the cost of preferred stock
be (including flotation costs) and it still be profitable for the company to invest in all
four projects?

a. 7.75%

b. 8.90%

c. 10.46%

d. 11.54%

e. 12.68%

Multiple Part:

(The following information applies to the next three problems.)

The Global Advertising Company has a marginal tax rate of 40 percent. The company can
raise debt at a 12 percent interest rate and the last dividend paid by Global was $0.90.
Global’s common stock is selling for $8.59 per share, and its expected growth rate in

Page 19

earnings and dividends is 5 percent. If Global issues new common stock, the flotation
cost incurred will be 10 percent. Global plans to finance all capital expenditures with 30
percent debt and 70 percent equity.

Cost of retained earnings Answer: e Diff: E
xxxi.What is Global’s cost of retained earnings if it can use retained earnings rather than issue
new common stock?

a. 12.22%

b. 17.22%

c. 10.33%

d. 9.66%

e. 16.00%

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