2 Over the past four years the returns on the market and on J Mart were as

2 over the past four years the returns on the market

This preview shows page 9 - 12 out of 12 pages.

(2)Over the past four years, the returns on the market and on J-Mart were as follows:YearMarketJ-Mart200112.0%14.5%200217.2 22.22003-3.8 -7.5200420.0 24.0(3)The current risk-free rate is 6.35 percent, and the expected return on the market is 11.35 percent. The company's tax rate is 35 percent.The company anticipates that its proposed investment projects will be financed with 70 percent debt and 30 percent equity. What is the company's estimated weighted average cost of capital (WACC)?a.8.04%b.9.00%c. 10.25%d. 12.33%e. 13.14%
CHAPTER 9ANSWERS AND SOLUTIONSChapter 9 - Page 10
1.Cost of common stockAnswer: d Diff: EThe cost of common stock is:rs= \$1(1.06)/\$20 + 0.06 = 0.053 + 0.06 = 0.113 = 11.3%.2.Cost of common stockAnswer: b Diff: Ers= + 5% = 9.2%.3.Cost of common stockAnswer: e Diff: Ers= + 0.05 = 0.1600 = 16.00%.4.WACC with Flotation CostsAnswer: a Diff: EWACC = wdrd(1 - T) + wcere. rdis given = 9%. Find re:re= D1/[P0(1 - F)] + g= \$0.8/[\$25(1 - 0.1)] + 0.09= 0.125556.Now you can calculate WACC:WACC = (0.3)(0.09)(0.6) + (0.7)(0.125556) = 10.41%.5.WACCAnswer: d Diff: MWeights should be based on the target capital structure: wd= 40% and we= 60%. The cost of debt should be based on the yield of 11.11%.WACC = 0.60 (12%) + 0.4 (1-.4) (11.11%) = 9.87%.6.Cost of common stockAnswer: d Diff: MThe cost of common equity as calculated from the CAPM is rs= rRF+ (rM- rRF)b= 5% + (6%)1.2= 12.2%.7.Cost of common stockAnswer: b Diff: Mrs= + 0.06% = 10.24% 10.2%.8.WACCAnswer: b Diff: MFind the cost of common stock:rs= D1/P0+ g = \$2(1.0)/\$25 + 0%; rs= 0.08 = 8%.Finally, calculate WACC, using rs= 0.08, and rd= 0.06, soWACC= (D/A)(1 - Tax rate)rd+ (E/A)rs= 0.4(1 - 0.4)(0.06) + 0.6(0.08) = 0.0624 6.2%.9.WACCAnswer: c Diff: MThe cost of common stock is: rs= D1/P0+ g = \$2.12/\$30 + 0.06 = 13.07%.The cost to the company of the bonds is the YTM multiplied by 1 mi
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