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BUSI 320 Homework 5 Valuation and Cost of Capital Assignment solutions complete answers
BUSI 320 Homework 5 Valuation and Cost of Capital Assignment solutions complete answers
The Nolan Corporation finds it is necessary to determine its marginal cost of capital. Nolan’s current capital structure calls for 40 percent debt, 10 percent preferred stock, and 50 percent common equity. Initially, common equity will be in the form of retained earnings (Ke) and then new common stock (Kn). The costs of the various sources of financing are as follows: debt (after-tax), 6.4 percent; preferred stock, 11 percent; retained earnings, 11 percent; and new common stock, 12.2 percent.
a. What is the initial weighted average cost of capital? (Include debt, preferred stock, and common equity in the form of retained earnings, Ke.) (Do not round intermediate calculations. Input your answers as a percent rounded to 2 decimal places.)
b. If the firm has $32 million in retained earnings, at what size capital structure will the firm run out of retained earnings? (Enter your answer in millions of dollars (e.g., $10 million should be entered as "10").)
c. What will the marginal cost of capital be immediately after that point? (Equity will remain at 50 percent of the capital structure, but will all be in the form of new common stock, Kn.) (Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places.)
d. The 6.4 percent cost of debt referred to earlier applies only to the first $58 million of debt. After that, the cost of debt will be 8.4 percent. At what size capital structure will there be a change in the cost of debt? (Enter your answer in millions of dollars (e.g., $10 million should be entered as "10").)
Northwest Utility Company faces increasing needs for capital. Fortunately, it has an Aa3 credit rating. The corporate tax rate is 35 percent. Northwest’s treasurer is trying to determine the corporation’s current weighted average cost of capital in order to assess the profitability of capital budgeting projects.
Historically, the corporation’s earnings and dividends per share have increased about 4.6 percent annually and this should continue in the future. Northwest’s common stock is selling at $69 per share, and the company will pay a $6.20 per share dividend (D1).
The company’s $106 preferred stock has been yielding 6 percent in the current market. Flotation costs for the company have been estimated by its investment banker to be $4.00 for preferred stock.
The company’s optimum capital structure is 35 percent debt, 10 percent preferred stock, and 55 percent common equity in the form of retained earnings. Refer to the following table on bond issues for comparative yields on bonds of equal risk to Northwest.
The preferred stock is selling at $78 per share and pays a dividend of $7.40 per share. The corporate tax rate is 30 percent. The flotation cost is 2.5 percent of the selling price for preferred stock. The optimum capital structure for the firm is 30 percent debt, 10 percent preferred stock, and 60 percent common equity in the form of retained earnings.
The company currently has outstanding a bond with a 10.4 percent coupon rate and another bond with an 8.0 percent rate. The firm has been informed by its investment banker that bonds of equal risk and credit rating are now selling to yield 11.3 percent. The common stock has a price of $58 and an expected dividend (D1) of $1.78 per share. The historical growth pattern (g) for dividends is as follows:
The aftertax cost of debt is 7.00 percent; the cost of preferred stock is 11.00 percent; and the cost of common equity (in the form of retained earnings) is 14.00 percent.
a. D1 = $3.50, P0 = $90, g = 5%, F = $2.00. (Do not round intermediate calculations. Round your answers to 2 decimal places.)
b. D1 = $0.36, P0 = $50, g = 10%, F = $3.20. (Do not round intermediate calculations. Round your answers to 2 decimal places.)
c. E1 (earnings at the end of period one) = $4, payout ratio equals 35 percent, P0 = $27, g = 7.5%, F = $2.50. (Do not round intermediate calculations. Round your answers to 2 decimal places.)
d. D0 (dividend at the beginning of the first period) = $6, growth rate for dividends and earnings (g) = 6%, P0 = $53, F = $5. (Do not round intermediate calculations. Round your answers to 2 decimal places.)
The treasurer of Riley Coal Co. is asked to compute the cost of fixed income securities for her corporation. Even before making the calculations, she assumes the aftertax cost of debt is at least 1 percent less than that for preferred stock.
Debt can be issued at a yield of 8.6 percent, and the corporate tax rate is 30 percent. Preferred stock will be priced at $54 and pay a dividend of $3.80. The flotation cost on the preferred stock is $2.
Wallace Container Company issued $100 par value preferred stock 10 years ago. The stock provided a 9 percent yield at the time of issue. The preferred stock is now selling for $84.
Assume that because the new debt will be issued at par, the required yield to maturity will be 0.24 percent higher than the value determined in part a.
Terrier Company is in a 40 percent tax bracket and has a bond outstanding that yields 10 percent to maturity.
b. Assume that the yield on the bond goes down by 1 percentage point, and due to tax reform, the corporate tax rate falls to 25 percent. What is Terrier’s new aftertax cost of debt? (Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places.)
Airborne Airlines Inc. has a $1,000 par value bond outstanding with 10 years to maturity. The bond carries an annual interest payment of $90 and is currently selling for $960. Airborne is in a 20 percent tax bracket. The firm wishes to know what the aftertax cost of a new bond issue is likely to be. The yield to maturity on the new issue will be the same as the yield to maturity on the old issue because the risk and maturity date will be similar.
The Goodsmith Charitable Foundation, which is tax-exempt, issued debt last year at 7 percent to help finance a new playground facility in Los Angeles. This year the cost of debt is 20 percent higher; that is, firms that paid 9 percent for debt last year will be paying 10.80 percent this year.
a. If the Goodsmith Charitable Foundation borrowed money this year, what would the aftertax cost of debt be, based on their cost last year and the 20 percent increase? (Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places.)
A brilliant young scientist is killed in a plane crash. It is anticipated that he could have earned $320,000 a year for the next 40 years. The attorney for the plaintiff’s estate argues that the lost income should be discounted back to the present at 5 percent. The lawyer for the defendant’s insurance company argues for a discount rate of 11 percent.
What is the difference between the present value of the settlement at 5 percent and 11 percent? Compute each one separately. Use Appendix D for an approximate answer but calculate your final answer using the formula and financial calculator methods. (Do not round intermediate calculations. Round your answers to 2 decimal places.)
Speedy Delivery Systems can buy a piece of equipment that is anticipated to provide an 7 percent return and can be financed at 4 percent with debt. Later in the year, the firm turns down an opportunity to buy a new machine that would yield a 15 percent return but would cost 17 percent to finance through common equity. Assume debt and common equity each represent 50 percent of the firm’s capital structure.
Ecology Labs Inc. will pay a dividend of $4.45 per share in the next 12 months (D1). The required rate of return (Ke) is 16 percent and the constant growth rate is 8 percent. (Each question is independent of the others.)
b. Assume Ke, the required rate of return, goes up to 20 percent. What will be the new price? (Do not round intermediate calculations. Round your answer to 2 decimal places.)
c. Assume the growth rate (g) goes up to 11 percent. What will be the new price? Ke goes back to its original value of 16 percent. (Do not round intermediate calculations. Round your answer to 2 decimal places.)
d. Assume D1 is $5.00. What will be the new price? Assume Ke is at its original value of 16 percent and g goes back to its original value of 8 percent. (Do not round intermediate calculations. Round your answer to 2 decimal places.)
BioScience Inc. will pay a common stock dividend of $6.50 at the end of the year (D1). The required return on common stock (Ke) is 20 percent. The firm has a constant growth rate (g) of 9 percent.
You are called in as a financial analyst to appraise the bonds of Olsen’s Clothing Stores. The $1,000 par value bonds have a quoted annual interest rate of 12 percent, which is paid semiannually. The yield to maturity on the bonds is 12 percent annual interest. There are 25 years to maturity. Use Appendix B and Appendix D for an approximate answer but calculate your final answer using the formula and financial calculator methods.
b. With 20 years to maturity, if yield to maturity goes down substantially to 8 percent, what will be the new price of the bonds? (Do not round intermediate calculations. Round your final answer to 2 decimal places.)
Lance Whittingham IV specializes in buying deep discount bonds. These represent bonds that are trading at well below par value. He has his eye on a bond issued by the Leisure Time Corporation. The $1,000 par value bond pays 8 percent annual interest and has 17 years remaining to maturity. The current yield to maturity on similar bonds is 12 percent. Use Appendix B and Appendix D for an approximate answer but calculate your final answer using the formula and financial calculator methods.
Katie Pairy Fruits Inc. has a $2,000 21-year bond outstanding with a nominal yield of 17 percent (coupon equals 17% × $2,000 = $340 per year). Assume that the current market required interest rate on similar bonds is now only 12 percent. Use Appendix B and Appendix D for an approximate answer but calculate your final answer using the formula and financial calculator methods.
b. Find the present value of 5 percent × $2,000 (or $100) for 21 years at 12 percent. The $100 is assumed to be an annual payment. Add this value to $2,000. (Do not round intermediate calculations. Round your final answer to 2 decimal places. Assume interest payments are annual.)
Tom Cruise Lines Inc. issued bonds five years ago at $1,000 per bond. These bonds had a 25-year life when issued and the annual interest payment was then 14 percent. This return was in line with the required returns by bondholders at that point as described below:
Assume that five years later the inflation premium is only 3 percent and is appropriately reflected in the required return (or yield to maturity) of the bonds. The bonds have 20 years remaining until maturity.
Refer to Table 10-1, which is based on bonds paying 10 percent interest for 20 years. Assume interest rates in the market (yield to maturity) decline from 9 percent to 8 percent.
Question 1
Barry’s Steroids Company has $1,000 par value bonds outstanding at 14 percent interest. The bonds will mature in 50 years.
If the percent yield to maturity is 11 percent, what percent of the total bond value does the repayment of principal represent? Use Appendix B and Appendix D for an approximate answer but calculate your final answer using the formula and financial calculator methods. (Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places.)
Question 2
Refer to Table 10-1, which is based on bonds paying 10 percent interest for 20 years. Assume interest rates in the market (yield to maturity) decline from 12 percent to 6 percent.
a. What is the bond price at 12 percent?
b. What is the bond price at 6 percent?
c. What would be your percentage return on investment if you bought when rates were 12 percent and sold when rates were 6 percent? (Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places.)
Question 3
Tom Cruise Lines Inc. issued bonds five years ago at $1,000 per bond. These bonds had a 35-year life when issued and the annual interest payment was then 14 percent. This return was in line with the required returns by bondholders at that point as described below:
Assume that five years later the inflation premium is only 3 percent and is appropriately reflected in the required return (or yield to maturity) of the bonds. The bonds have 30 years remaining until maturity.
Compute the new price of the bond. Use Appendix B and Appendix D for an approximate answer but calculate your final answer using the formula and financial calculator methods. (Do not round intermediate calculations. Round your final answer to 2 decimal places. Assume interest payments are annual.)
Question 4
Katie Pairy Fruits Inc. has a $3,200, 24-year bond outstanding with a nominal yield of 17 percent (coupon equals 17% × $3,200 = $544 per year). Assume that the current market required interest rate on similar bonds is now only 12 percent. Use Appendix B and Appendix D for an approximate answer but calculate your final answer using the formula and financial calculator methods.
a. Compute the current price of the bond. (Do not round intermediate calculations. Round your final answer to 2 decimal places. Assume interest payments are annual.)
b. Find the present value of 5 percent × $3,200 (or $160) for 24 years at 12 percent. The $160 is assumed to be an annual payment. Add this value to $3,200. (Do not round intermediate calculations. Round your final answer to 2 decimal places. Assume interest payments are annual.)
Question 5
Lance Whittingham IV specializes in buying deep discount bonds. These represent bonds that are trading at well below par value. He has his eye on a bond issued by the Leisure Time Corporation. The $1,000 par value bond pays 4 percent annual interest and has 18 years remaining to maturity. The current yield to maturity on similar bonds is 12 percent.
a. What is the current price of the bonds? Use Appendix B and Appendix D for an approximate answer but calculate your final answer using the formula and financial calculator methods. (Do not round intermediate calculations. Round your final answer to 2 decimal places. Assume interest payments are annual.)
b. By what percent will the price of the bonds increase between now and maturity? (Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places.)
Question 6
You are called in as a financial analyst to appraise the bonds of Olsen’s Clothing Stores. The $1,000 par value bonds have a quoted annual interest rate of 10 percent, which is paid semiannually. The yield to maturity on the bonds is 10 percent annual interest. There are 15 years to maturity. Use Appendix B and Appendix D for an approximate answer but calculate your final answer using the formula and financial calculator methods.
a. Compute the price of the bonds based on semiannual analysis. (Do not round intermediate calculations. Round your final answer to 2 decimal places.)
b. With 10 years to maturity, if yield to maturity goes down substantially to 8 percent, what will be the new price of the bonds? (Do not round intermediate calculations. Round your final answer to 2 decimal places.)
Question 7
BioScience Inc. will pay a common stock dividend of $6.40 at the end of the year (D1). The required return on common stock (Ke) is 14 percent. The firm has a constant growth rate (g) of 5 percent.
Compute the current price of the stock (P0). (Do not round intermediate calculations. Round your answer to 2 decimal places.)
Question 8
Ecology Labs Inc. will pay a dividend of $5.30 per share in the next 12 months (D1). The required rate of return (Ke) is 19 percent and the constant growth rate is 8 percent. (Each question is independent of the others.)
a. Compute the price of Ecology Labs' common stock. (Do not round intermediate calculations. Round your answer to 2 decimal places.)
b. Assume Ke, the required rate of return, goes up to 23 percent. What will be the new price? (Do not round intermediate calculations. Round your answer to 2 decimal places.)
c. Assume the growth rate (g) goes up to 13 percent. What will be the new price? Ke goes back to its original value of 19 percent. (Do not round intermediate calculations. Round your answer to 2 decimal places.)
d. Assume D1 is $7.00. What will be the new price? Assume Ke is at its original value of 19 percent and g goes back to its original value of 8 percent. (Do not round intermediate calculations. Round your answer to 2 decimal places.)
Question 9
Justin Cement Company has had the following pattern of earnings per share over the last five years:
The earnings per share have grown at a constant rate (on a rounded basis) and will continue to do so in the future. Dividends represent 40 percent of earnings.
a. Project earnings and dividends for the next year (20X6). (Round the growth rate to the nearest whole percent. Do not round any other intermediate calculations. Round your answers to 2 decimal places.)
b. If the required rate of return (Ke) is 13 percent, what is the anticipated stock price (P0) at the beginning of 20X6? (Round the growth rate to the nearest whole percent. Do not round any other intermediate calculations. Round your answer to 2 decimal places.)
Question 10
Beasley Ball Bearings paid a $4 dividend last year. The dividend is expected to grow at a constant rate of 5 percent over the next four years. The required rate of return is 12 percent (this will also serve as the discount rate in this problem). Use Appendix B for an approximate answer but calculate your final answer using the formula and financial calculator methods.
a. Compute the anticipated value of the dividends for the next four years. (Do not round intermediate calculations. Round your final answers to 2 decimal places.)
b. Calculate the present value of each of the anticipated dividends at a discount rate of 12 percent. (Do not round intermediate calculations. Round your final answers to 2 decimal places.)
c. Compute the price of the stock at the end of the fourth year (P4). (Do not round intermediate calculations. Round your final answer to 2 decimal places.)
d. Calculate the present value of the year 4 stock price at a discount rate of 12 percent. (Do not round intermediate calculations. Round your final answer to 2 decimal places.)
e. Compute the current value of the stock. (Do not round intermediate calculations. Round your final answer to 2 decimal places.)
f. Use the formula given below to show that it will provide approximately the same answer as part e. (Do not round intermediate calculations. Round your final answer to 2 decimal places.)
g. If current EPS were equal to $5.51 and the P/E ratio is 1.2 times higher than the industry average of 10, what would the stock price be? (Do not round intermediate calculations. Round your final answer to 2 decimal places.)
h. By what dollar amount is the stock price in part g different from the stock price in part f? (Do not round intermediate calculations. Round your final answer to 2 decimal places.)
Question 11
Speedy Delivery Systems can buy a piece of equipment that is anticipated to provide an 10 percent return and can be financed at 7 percent with debt. Later in the year, the firm turns down an opportunity to buy a new machine that would yield a 17 percent return but would cost 19 percent to finance through common equity. Assume debt and common equity each represent 50 percent of the firm’s capital structure.
a. Compute the weighted average cost of capital. (Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places.)
b. Which project(s) should be accepted?
Question 12
A brilliant young scientist is killed in a plane crash. It is anticipated that he could have earned $210,000 a year for the next 20 years. The attorney for the plaintiff’s estate argues that the lost income should be discounted back to the present at 4 percent. The lawyer for the defendant’s insurance company argues for a discount rate of 15 percent.
What is the difference between the present value of the settlement at 4 percent and 15 percent? Compute each one separately. Use Appendix D for an approximate answer but calculate your final answer using the formula and financial calculator methods. (Do not round intermediate calculations. Round your answers to 2 decimal places.)
Question 13
The Goodsmith Charitable Foundation, which is tax-exempt, issued debt last year at 7 percent to help finance a new playground facility in Los Angeles. This year the cost of debt is 15 percent higher; that is, firms that paid 9 percent for debt last year will be paying 10.35 percent this year.
a. If the Goodsmith Charitable Foundation borrowed money this year, what would the aftertax cost of debt be, based on their cost last year and the 15 percent increase? (Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places.)
b. If the receipts of the foundation were found to be taxable by the IRS (at a rate of 25 percent because of involvement in political activities), what would the aftertax cost of debt be? (Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places.)
Question 14
Airborne Airlines Inc. has a $1,000 par value bond outstanding with 15 years to maturity. The bond carries an annual interest payment of $114 and is currently selling for $880. Airborne is in a 35 percent tax bracket. The firm wishes to know what the aftertax cost of a new bond issue is likely to be. The yield to maturity on the new issue will be the same as the yield to maturity on the old issue because the risk and maturity date will be similar.
a. Compute the yield to maturity on the old issue and use this as the yield for the new issue. (Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places.)
b. Make the appropriate tax adjustment to determine the aftertax cost of debt. (Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places.)
Question 15
Terrier Company is in a 35 percent tax bracket and has a bond outstanding that yields 9 percent to maturity.
a. What is Terrier’s aftertax cost of debt? (Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places.)
b. Assume that the yield on the bond goes down by 1 percentage point, and due to tax reform, the corporate tax rate falls to 20 percent. What is Terrier’s new aftertax cost of debt? (Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places.)
c. Has the aftertax cost of debt gone up or down from part a to part b?
Question 16
Keyspan corp. is planning to issue debt that will mature in 2,030. In many respects, the issue is similar to the currently outstanding debt of the corporation. Use Table 11-3.
a. Calculate the yield to maturity on similarly outstanding debt for the firm, in terms of maturity. (Input your answer as a percent rounded to 2 decimal places.)
Assume that because the new debt wil be issued at par, the required yield to maturity will be .16 percent higher than the value determined in part a.
b. What is the new yield to maturity? (Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places.)
c. If the firm is in a 40 percent tax bracket, what is the aftertax cost of debt for the yield determined in part b? (Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places.)
Question 17
Wallace Container Company issued $100 par value preferred stock 10 years ago. The stock provided a 7 percent yield at the time of issue. The preferred stock is now selling for $63.
What is the current yield or cost of the preferred stock? (Disregard flotation costs.) (Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places.)
Question 18
The treasurer of Riley Coal Co. is asked to compute the cost of fixed income securities for her corporation. Even before making the calculations, she assumes the aftertax cost of debt is at least 4 percent less than that for preferred stock.
Debt can be issued at a yield of 10.0 percent, and the corporate tax rate is 40 percent. Preferred stock will be priced at $58 and pay a dividend of $5.40. The flotation cost on the preferred stock is $5.
a. Compute the aftertax cost of debt. (Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places.)
b. Compute the aftertax cost of preferred stock. (Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places.)
c. Based on the facts given above, is the treasurer correct?
Question 19
Compute Ke and Kn under the following circumstances:
a. D1 = $7.80, P0 = $108, g = 3%, F = $6.00. (Do not round intermediate calculations. Round your answers to 2 decimal places.)
b. D1 = $.42, P0 = $37, g = 6%, F = $2.50. (Do not round intermediate calculations. Round your answers to 2 decimal places.)
c. E1 (earnings at the end of period one) = $13, payout ratio equals 20 percent, P0 = $45, g = 8.9%, F = $4.40. (Do not round intermediate calculations. Round your answers to 2 decimal places.)
d. D0 (dividend at the beginning of the first period) = $7, growth rate for dividends and earnings (g) = 5%, P0 = $71, F = $7. (Do not round intermediate calculations. Round your answers to 2 decimal places.)
Question 20
Global Technology’s capital structure is as follows:
The aftertax cost of debt is 7.50 percent; the cost of preferred stock is 11.50 percent; and the cost of common equity (in the form of retained earnings) is 14.50 percent.
Calculate the Global Technology’s weighted cost of each source of capital and the weighted average cost of capital. (Do not round intermediate calculations. Input your answers as a percent rounded to 2 decimal places.)
Question 21
Sauer Milk Inc. wants to determine the minimum cost of capital point for the firm. Assume it is considering the following financial plans:
a-1. Compute the weighted average cost for four plans. (Do not round intermediate calculations. Input your answers as a percent rounded to 2 decimal places.)
a-2. Which of the four plans has the lowest weighted average cost of capital?
b. What is the relationship between the various types of financing costs and the debt-to-equity ratio?
Question 22
A-Rod Manufacturing Company is trying to calculate its cost of capital for use in making a capital budgeting decision. Mr. Jeter, the vice-president of finance, has given you the following information and has asked you to compute the weighted average cost of capital.
The preferred stock is selling at $84 per share and pays a dividend of $8.00 per share. The corporate tax rate is 30 percent. The flotation cost is 3.0 percent of the selling price for preferred stock. The optimal capital structure for the firm is 25 percent debt, 20 percent preferred stock, and 55 percent common equity in the form of retained earnings.
The company currently has outstanding a bond with a 11.0 percent coupon rate and another bond with an 8.6 percent rate. The firm has been informed by its investment banker that bonds of equal risk and credit rating are now selling to yield 11.9 percent. The common stock has a price of $64 and an expected dividend (D1) of $1.84 per share. The historical growth pattern (g) for dividends is as follows:
The preferred stock is selling at $84 per share and pays a dividend of $8.00 per share. The corporate tax rate is 30 percent. The flotation cost is 3.0 percent of the selling price for preferred stock. The optimal capital structure for the firm is 25 percent debt, 20 percent preferred stock, and 55 percent common equity in the form of retained earnings.
a. Compute the historical growth rate. (Do not round intermediate calculations. Round your answer to the nearest whole percent and use this value as g. Input your answer as a whole percent.)
b. Compute the cost of capital for the individual components in the capital structure. (Use the rounded whole percent computed in part a for g. Do not round any other intermediate calculations. Input your answers as a percent rounded to 2 decimal places.)
c. Calculate the weighted cost of each source of capital and the weighted average cost of capital. (Do not round intermediate calculations. Input your answers as a percent rounded to 2 decimal places.)
Question 23
Northwest Utility Company faces increasing needs for capital. Fortunately, it has an Aa3 credit rating. The corporate tax rate is 30 percent. Northwest’s treasurer is trying to determine the corporation’s current weighted average cost of capital in order to assess the profitability of capital budgeting projects.
Historically, the corporation’s earnings and dividends per share have increased about 5.2 percent annually and this should continue in the future. Northwest’s common stock is selling at $61 per share, and the company will pay a $3.50 per share dividend (D1).
The company’s $90 preferred stock has been yielding 5 percent in the current market. Flotation costs for the company have been estimated by its investment banker to be $3.00 for preferred stock.
The company’s optimal capital structure is 40 percent debt, 15 percent preferred stock, and 45 percent common equity in the form of retained earnings. Refer to the following table on bond issues for comparative yields on bonds of equal risk to Northwest.
a. Compute the cost of debt, Kd (use the accompanying table—relate to the utility bond credit rating for yield.) (Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places.)
b. Compute the cost of preferred stock, Kp. (Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places.)
c. Compute the cost of common equity in the form of retained earnings, Ke. (Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places.)
d. Calculate the weighted cost of each source of capital and the weighted average cost of capital. (Do not round intermediate calculations. Input your answers as a percent rounded to 2 decimal places.)
Question 24
Delta Corporation has the following capital structure:
a. If the firm has $51 million in retained earnings, at what size capital structure will the firm run out of retained earnings? (Enter your answer in millions of dollars (e.g., $10 million should be entered as "10").)
b. The 10.6 percent cost of debt referred to earlier applies only to the first $18 million of debt. After that the cost of debt will go up. At what size capital structure will there be a change in the cost of debt? (Enter your answer in millions of dollars (e.g., $10 million should be entered as "10").)
Question 25
The Nolan Corporation finds it is necessary to determine its marginal cost of capital. Nolan’s current capital structure calls for 45 percent debt, 20 percent preferred stock, and 35 percent common equity. Initially, common equity will be in the form of retained earnings (Ke) and then new common stock (Kn). The costs of the various sources of financing are as follows: debt, 6.2 percent; preferred stock, 9 percent; retained earnings, 8 percent; and new common stock, 9.2 percent.
a. What is the initial weighted average cost of capital? (Include debt, preferred stock, and common equity in the form of retained earnings, Ke.) (Do not round intermediate calculations. Input your answers as a percent rounded to 2 decimal places.)
b. If the firm has $28 million in retained earnings, at what size capital structure will the firm run out of retained earnings? (Enter your answer in millions of dollars (e.g., $10 million should be entered as "10").)
c. What will the marginal cost of capital be immediately after that point? (Equity will remain at 35 percent of the capital structure, but will all be in the form of new common stock, Kn.) (Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places.)
d. The 6.2 percent cost of debt referred to earlier applies only to the first $9 million of debt. After that, the cost of debt will be 8.5 percent. At what size capital structure will there be a change in the cost of debt? (Enter your answer in millions of dollars (e.g., $10 million should be entered as "10").)
e. What will the marginal cost of capital be immediately after that point? (Consider the facts in both parts c and d.) (Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places.)
Question 26
Eaton Electronic Company’s treasurer uses both the capital asset pricing model and the dividend valuation model to compute the cost of common equity (also referred to as the required rate of return for common equity).
a. Compute Ki (required rate of return on common equity based on the capital asset pricing model). (Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places.)
b. Compute Ke (required rate of return on common equity based on the dividend valuation model). (Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places.)
