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FinMan Unit 7 Tutorial Cost of Capital Revised Sep2021

The document contains 13 multiple choice questions regarding financial management concepts such as cost of capital, weighted average cost of capital (WACC), cost of debt, cost of preferred stock, cost of common equity, and capital budgeting. Specifically, students are asked to calculate costs of different capital sources, WACC, and make project recommendations based on costs of capital. Formulas for costs of capital, WACC, and capital budgeting are required to solve the various questions.

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Ajani McPherson
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183 views3 pages

FinMan Unit 7 Tutorial Cost of Capital Revised Sep2021

The document contains 13 multiple choice questions regarding financial management concepts such as cost of capital, weighted average cost of capital (WACC), cost of debt, cost of preferred stock, cost of common equity, and capital budgeting. Specifically, students are asked to calculate costs of different capital sources, WACC, and make project recommendations based on costs of capital. Formulas for costs of capital, WACC, and capital budgeting are required to solve the various questions.

Uploaded by

Ajani McPherson
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
You are on page 1/ 3

University of Technology, Jamaica

FINANCIAL MANAGEMENT: FIN3001


UNIT 7: Cost of Capital

TUTORIAL QUESTIONS

1. Rainy Industries can issue perpetual preferred stock at a price of $38.75 a share. The
issue is expected to pay a constant annual dividend of $4.25 a share. What is the
company’s cost of preferred stock, kp?

2. Sunny Industries can issue perpetual preferred stock at a price of $48.50 a share. The
issue is expected to pay a constant annual dividend of $4.15 a share. They will be
required to pay a 5% of the share price to cover the flotation cost. What is the
company’s cost of preferred stock, kp?

3. Damara Corporation’s currently outstanding bonds have a 8% coupon and a YTM of


10% to maturity. Damara believes it could issue at par new bonds that would provide
a similar YTM. If its marginal tax rate is 30%, what is Damara’s after-tax cost of
debt?

4. ACT Limited has a target capital structure of 40% debt and 60% equity. The yield to
maturity on the company’s outstanding bonds is 7% and the company’s tax rate is
25%. ACT’s CFO has calculated the company’s WACC as 12%. What is the
company’s cost of common equity?

5. Uni Bank Ltd has four (4) investment projects with the following costs and expected
rates of return. All projects are independent of each other.

COST RATE OF RETURN

Project ZA $12,000 14.10%


Project ZB $13,000 9.97%
Project ZC $15,000 10.5%
Project ZD $12,000 15.3%

The firm estimates that it can issue debt with a yield to maturity of 10%, and its tax rate is
40%.
It can also issue preferred stock at $40 per share, which pays a constant dividend of $3.50
per year.
Uni Bank’s common stock currently sells for $35/share and is expected to pay a dividend
of $3.01 next year. Dividends are expected to grow at a constant rate of 4.5%.
The company’s capital structure consists of 60% common stock, 24% debt, and 16%
preferred stock.

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(i) What is the cost of each of the capital components?

(ii) What is the WACC?

(iii) If all the projects are of average risk, which should the firm select?

6. a) Why do we adjust for taxes when calculating cost debt? b) Why is there a cost for
using retained earnings to finance a capital project?

7. Samba’s common stock is currently trading at $24 a share. The stock recently paid a
dividend of $2.00 per share and the dividend is expected to grow at a constant rate of
6% per annum. If the company were to issue equity, it would incur a 10% flotation
cost. What are the costs of internal and external equity?

8. Memorex Limited plans to issue some $100 par preferred stock with a 13% dividend.
The stock is selling on the market for $90 but Memorex must pay flotation costs of
6% of the price, so the net price the firm will receive is $91.20 per share. What is
Memorex’s cost of preferred stock with flotation considered?

9. The Nadar Company’s most recent dividend is $2.60; its growth rate is 5% and the
stock now sells for $40. New stock can be sold to net the firm $37.20 per share.

a) What is Nadar’s cost of retained earnings, ks?


b) What is Nadar’s percentage flotation cost, F?
c) What is Nadar’s cost of new common stock, ke?

10. The Bibby Company’s cost of common equity is 18% and they are able to borrow at a
rate of 12%. Its marginal tax rate is 25% and the stock sells at book value.
Using the following information from the company’s balance sheet, calculate Bibby’s
weighted average cost of capital:

Balance Sheet information In Millions


Long-term Debt $2,160
Equity $2,640

11. Hook Industries has a capital structure that consists solely of debt and common
equity. The company can issue debt at 14% and the stock currently trades at $25.
They are expected to pay a dividend of $3.15 per share next year and dividends are
expected to grow at a constant rate 5% per year. The tax rate is 25% and the WACC
is estimated to be 14.76%. What percentage of the company’s capital structure
consists of debt financing?

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12. MTech uses only debt and equity. It can borrow unlimited amounts at an interest rate
of 10% if it finances at its target capital structure, which calls for 35% debt and 65%
common equity. It is expected to pay a dividend was $2.50 next year, and dividends
are expected to grow at a constant rate of 4.8%. MTech’s tax rate is 40% and its stock
sells at a price of $25.
Two projects are available: Project A has a rate of return of 13.5%, while Project B
has a rate of return of 12.7%. All the company’s potential projects are equally risky
and as risky as the firm’s other assets.
a) What is MTech’s cost of common equity?

b) What is MTech’s WACC? What does the WACC represent?

c) Which projects should MTech select?

13. The future earnings, dividends, and common stock price of Caretta Technologies Inc.
are expected to grow 8% per year. Caretta’s common stock currently sells for $24.50
per share, its last dividend was $2.50. A flotation cost of 10% will be paid for raising
new common equity.

a. Using the information provided, calculate the cost of retained earnings (ks).

b. Using the information provided, calculate the cost of external equity (ke).

c. If the firm’s beta is 1.85, the risk-free is 4.8%, and the market risk premium is
7.6%, what will be the firm’s cost of common equity using the CAPM approach?

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