If Sun State wants to reduce its required rate of return to 16 percent, what is the maximum beta coefficient the new division could have?a. 2.2b. 1.0c. 1.8d. 1.6e. 2.0Tough:WACCAnswer: b Diff: T67.Heavy Metal Corp. is a steel manufacturer that finances its operations with 40 percent debt, 10 percent preferred stock, and 50 percent equity. The interest rate on the company’s debt is 11 percent. The preferred stock pays an annual dividend of $2 and sells for $20 a share. The company’s common stock trades at $30 a share, and its current dividend (D0) of $2 a share is expected to grow at a constant rate of 8 percent per year. The flotation cost of external equity is 15 percent of the dollar amount issued, while the flotation cost on preferred stock is 10 percent. The company estimates that its WACC is 12.30 percent. Assume that the firm will not have enough retained earnings to fund the equity portion of its capital budget. What is the company’s tax rate?a. 30.33%b. 32.86%c. 35.75%d. 38.12%e. 40.98%Chapter 9 - Page 24
Chapter 9 - Page 25
WACC and cost of preferred stockAnswer: b Diff: T68.Anderson Company has four investment opportunities with the following costs (paid at t = 0) and expected returns:ExpectedProjectCost ReturnA $2,000 16.0%B 3,000 14.5C 5,000 11.5D 3,000 9.5The 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 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 earningsAnswer: e Diff: E69.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%Chapter 9 - Page 26
Cost of external equityAnswer: b Diff: E70.What is the cost of common equity raised by selling new stock?
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