4. Chapter 10 - The Cost of Capital Question MC #71

(Points: 10)

A. Butcher Timber Company hired your consulting firm to help them estimate the cost of equity. The yield on the firm's bonds is 10.50%, and your firm's economists believe that the cost of equity can be estimated using a risk premium of 3.85% over a firm's own cost of debt. What is an estimate of the firm's cost of equity from retained earnings?

1. 16.50%

2. 14.35%

3. 11.62%

4. 15.64%

5. 14.92%

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5. Chapter 10 - The Cost of Capital Question MC #80

(Points: 10)

Sorensen Systems Inc. is expected to pay a $2.50 dividend at year end (D1 = $2.50), the dividend is expected to grow at a constant rate of 5.50% a year, and the common stock currently sells for $67.50 a share. The before-tax cost of debt is 7.50%, and the tax rate is 40%. The target capital structure consists of 45% debt and 55% common equity. What is the company’s WACC if all the equity used is from retained earnings?

1. 6.02%

2. 5.95%

3. 5.88%

4. 6.24%

5. 7.09%

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6. Chapter 10 - The Cost of Capital Question MC #85

(Points: 10)

The CFO of Lenox Industries hired you as a consultant to help estimate its cost of capital. You have obtained the following data: (1) rd = yield on the firm’s bonds = 7.00% and the risk premium over its own debt cost = 4.00%. (2) rRF = 5.00%, RPM = 6.00%, and b = 1.45. (3) D1 = $1.20, P0 = $35.00, and g = 8.00% (constant). You were asked to estimate the cost of equity based on the three most commonly used methods and then to indicate the difference between the highest and lowest of these estimates. What is that difference?

1. 2.13%

2. 2.70%

3. 3.11%

4. 2.59%

5. 2.92%

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