Chapter 9 Practice Exam Q&A

Chapter 9 Practice Exam Q&A - Chapter 9 Practice...

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Chapter 9 Practice Exam
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Question 1 Shawhan Supply plans to maintain its optimal capital structure of 30% debt, 20% preferred stock, and 50% common stock far into the future. The required return on each component is: debt-10%; preferred stock- 11%; and common stock-18%. Assuming a 40% marginal tax rate, what after-tax rate of return must Shawhan Supply earn on its investments if the value of the firm is to remain unchanged?
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Answer - Question 1 WACC Calculation = 30% (D/V) * 10% (kd) * (1-40%) (1-t) + 20% (P/V) * 11% (kps) + 50% (C/V) * 18% (kcs) 1.8% + 2.2% + 9.0% = 13.0% Answer: B
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Question 2 The most expensive source of capital is: a. preferred stock. b. new common stock. c. debt. d. retained earnings.
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Answer – Question 2 Costs of capital (i.e., returns) are dependent on the type and risk involved with each source. New common stock issues are the riskiest of the potential financing sources listed and therefore will be the most expensive (have highest cost/yield/rate of return). Answer: B
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Question 3 Bender and Co. is issuing a $1,000 par value bond that pays 9% interest annually. Investors are expected to pay $918 for the 10-year bond. Bender will have to pay $33 per bond in flotation costs. What is the cost of debt if the firm is in the 34% tax bracket? a. 7.23% b. 9.10% c. 9.23%
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Answer – Question 3 Cost of debt = kd = YTM on a bond YTM = I/YR on financial calculator. This is a 4 find 5 problem: FV = $1000; PMT = $90 (1000*9%); PV = 918-33 (floatation costs) = $885 (input as negative number in financial calculator); N = 10 Solve for I/YR = 10.95% After-tax cost of debt = 10.95% * (1-34%) =
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Question 4 Given the following information, determine the risk-free rate: Cost of equity = 12% Beta = 1.50 Market risk premium = 3% a. 8.0% b. 7.5% c. 7.0% d. 6.5%
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Answer – Question 4 Use CAPM equation: Ke = Rf + Beta*(Rm – Rf) 12% = Rf + 1.5*(3%); remember, Rm – Rf = market risk premium Rf = 12% - 1.5*3% = 7.5% Answer: B
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Chapter 9 Practice Exam Q&A - Chapter 9 Practice...

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