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FINS 1613 Tutorial Week 10 QAs _Ch 12 and 15_

FINS 1613 Tutorial Week 10 QAs _Ch 12 and 15_ - FINS...

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FINS 1613 (also Quiz 3 held during tutorial) Tutorial Week 10 (based on week 9 lecture and assigned readings – Text chapters 12 and 15) Chapter 12: Cost of Capital Concepts Review and Critical Thinking Questions: 2, 3, and 4. Answers to Concepts Review and Critical Thinking Questions 2. Book values for debt are likely to be much closer to their market values than are book values for equity. 3. No. The cost of capital depends on the risk of the project, not the source of the money. 4. In a classical tax system interest expense is tax-deductible and there is no difference between pretax and after tax equity costs. In an imputation system tax is tax deductible reducing its cost however for the shareholder the dividend does generate a franking credit if the company has paid tax in Australia or New Zealand and the shareholder is a resident. This has the effect of reducing the cost of equity for the firm for these shareholders. Questions and Problems: 1, 2, 7, 9, 26, and 30(a)(b). Solutions to Questions and Problems Basic 1. With the information given, we can find the cost of equity, using the dividend growth model. Using this model, the cost of equity is: R E = [\$1.90(1.06)/\$38] + 0.06 R E = 0.1130 or 11.30% 2. Here we have information to calculate the cost of equity, using the CAPM. The cost of equity is: R E = 0.05 + 1.27(0.13 – 0.05) R E = 0.1516 or 15.16% 7. a. The pretax cost of debt is the YTM of the company’s bonds, so: P 0 = \$960 = \$30(PVIFA R%,44 ) + \$1,000(PVIF R%,44 ) R = 3.1698% YTM = 2 × 3.1698% YTM = 6.34% b. The aftertax cost of debt is: R D = 0.0634(1 – 0.30) R D = 0.04438 or 4.44% c. The after-tax rate is more relevant because that is the actual cost to the company. 9. a. Using the equation to calculate the WACC, we find: WACC classical tax = 0.65(.15) + 0.10(.06) + 0.25(.075)(1 – 0.30) WACC classical tax = 0.1166 or 11.66%

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Assuming that the preference and ordinary shares carry 100% franking credits at the 30% tax rate
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FINS 1613 Tutorial Week 10 QAs _Ch 12 and 15_ - FINS...

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