a. 12.22%
b. 17.22%
c. 10.33%
d.
9.66%
e. 16.00%
WACC
Answer: d
Diff: E
71
.
What is the firm’s weighted average cost of capital if the firm has
sufficient retained earnings to fund the equity portion of its capital
budget?
a. 11.95%
b. 12.22%
c. 12.88%
d. 13.36%
e. 14.21%
(The following information applies to the next two problems.)
Byron Corporation’s present capital structure, which is also its target capital
structure, is 40 percent debt and 60 percent common equity.
Assume that the
firm has no retained earnings.
The company’s earnings and dividends are growing
at a constant rate of 5 percent; the last dividend (D
0
) was $2.00; and the
current equilibrium stock price is $21.88.
Byron can raise all the debt
financing it needs at 14 percent.
If Byron issues new common stock, a 20
percent flotation cost will be incurred.
The firm’s marginal tax rate is 40
percent.
Cost of external equity
Answer: a
Diff: E
72
.
What is the component cost of the equity raised by selling new common
stock?
a. 17.0%
b. 16.4%
c. 15.0%
d. 14.6%
e. 12.0%
WACC
Answer: b
Diff: E
73
.
What is the firm’s weighted average cost of capital?
a. 10.8%
b. 13.6%
c. 14.2%
d. 16.4%
e. 18.0%
Chapter 9 - Page
26

(The following information applies to the next six problems.)
Rollins Corporation has a target capital structure consisting of 20 percent
debt, 20 percent preferred stock, and 60 percent common equity.
Assume the firm
has insufficient retained earnings to fund the equity portion of its capital
budget. Its bonds have a 12 percent coupon, paid semiannually, a current
maturity of 20 years, and sell for $1,000.
The firm could sell, at par, $100
preferred stock that pays a 12 percent annual dividend, but flotation costs of 5
percent would be incurred.
Rollins’ beta is 1.2, the risk-free rate is 10
percent, and the market risk premium is 5 percent. Rollins is a constant growth
firm that just paid a dividend of $2.00, sells for $27.00 per share, and has a
growth rate of 8 percent.
The firm’s policy is to use a risk premium of 4
percentage points when using the bond-yield-plus-risk-premium method to find k
s
.
Flotation costs on new common stock total 10 percent, and the firm’s marginal
tax rate is 40 percent.
Cost of debt
Answer: e
Diff: E
74
.
What is Rollins’ component cost of debt?
a. 10.0%
b.
9.1%
c.
8.6%
d.
8.0%
e.
7.2%
Cost of preferred stock
Answer: d
Diff: E
75
.
What is Rollins’ cost of preferred stock?
a. 10.0%
b. 11.0%
c. 12.0%
d. 12.6%
e. 13.2%
Cost of equity: CAPM
Answer: c
Diff: E
76
.
What is Rollins’ cost of retained earnings using the CAPM approach?
a. 13.6%
b. 14.1%
c. 16.0%
d. 16.6%
e. 16.9%
Cost of equity: DCF
Answer: c
Diff: E
77
.
What is the firm’s cost of retained earnings using the DCF approach?
a. 13.6%
b. 14.1%
c. 16.0%
d. 16.6%
e. 16.9%
Chapter 9 - Page
27

Chapter 9 - Page
28

Cost of equity: risk premium
Answer: c
Diff: E
78
.
What is Rollins’ cost of retained earnings using the bond-yield-plus-risk-
premium approach?
a. 13.6%
b. 14.1%
c. 16.0%
d. 16.6%
e. 16.9%
WACC
Answer: b
Diff: E
79
.
What is Rollins’ WACC, if the firm has insufficient retained earnings to
fund the equity portion of its capital budget?

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