Unformatted text preview: BADM 115 – Section 11 Prof. Isabelle Bajeux‐Besnainou Fall 2008 Form A QUIZ #6 1. (3 points) The Patrick Company’s cost of common equity is 19 percent, its before‐tax cost of debt is 14 percent, and its marginal tax rate is 45 percent. The stock sells at book value. Using the following balance sheet, calculate Patrick’s WACC. Assets Liabilities and Equity $ 200 Cash 390 Accounts receivable Inventories 680 Long‐term debt $ 1,225 Plant and equipment, net 2,230 2,275 Common equity Total assets $ 3,500 Total liabilities and equity $ 3,500 ANSWER: Capital Sources Long‐term debt Common Equity Amount $1,225 2,275 $3,500 Capital Structure Weight 35.0% 65.0 100.0% WACC = wdrd(1 – T) + wcrs = 0.35(0.14)(0.55) + 0.65(0.19) = 0.0270 + 0.1235 = 15.05%. 2. (4 points) Javits & Sons’ common stock currently trades at $90 a share. It is expected to pay an annual dividend of $5.00 a share at the end of the year (D1 = $5.00), and the constant growth rate is 6.5 percent a year. a. What is the company’s cost of common equity if all of its equity comes from retained earnings? b. If the company were to issue new stock, it would incur a 15 percent flotation cost. What would the cost of equity from new stock be? ANSWER: a. P0 = $90; D1 = $5.00; g = 6.5%; rs = D1/P0 + g = 12.06%. b. F = 15%; re = D1/[(1‐F)*P0] + g = 13.04%. 3. (3 points) What will be the nominal rate of return on a perpetual preferred stock with a $100 par value, a stated dividend of 11 percent of par, and a current market price of a. $45 b. $75 c. $125 ANSWER: Vp = Dp/rp; therefore, rp = Dp/Vp. a. rp = $11/$45 = 24.44%. b. rp = $11/$75 = 14.67%. c. rp = $11/$125 = 8.80%. A ‐ 1 ...
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 Fall '08
 Bajeux
 Management, Debt, common equity, The Patrick Company, debt Common Equity, Common equity Total

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