FINC620 – Quiz – Week 1

1.      Bosio Inc.’s perpetual preferred stock sells for $97.50 per share, and it pays an $8.50 annual dividend. If the company were to sell a new preferred issue, it would incur a flotation cost of 4.00% of the price paid by investors. What is the company’s cost of preferred stock for use in calculating the WACC?

2.      Assume that you are on the financial staff of Vanderheiden Inc., and you have collected the following data: The yield on the company’s outstanding bonds is 7.75%; its tax rate is 40%; the next expected dividend is $0.65 a share; the dividend is expected to grow at a constant rate of 6.00% a year; the price of the stock is $15.00 per share; the flotation cost for selling new shares is F = 10%; and the target capital structure is 45% debt and 55% common equity. What is the firm’s WACC, assuming it must issue new stock to finance its capital budget?

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3. For a typical firm, which of the following sequences is CORRECT? All rates are after taxes, and assume that the firm operates at its target capital structure.

 

4.      Multi-Part 9-1:
Assume that you have been hired as a consultant by CGT, a major producer of chemicals and plastics, including plastic grocery bags, styrofoam cups, and fertilizers, to estimate the firm’s weighted average cost of capital. The balance sheet and some other information are provided below.

Assets
Current assets	$  38,000,000
Net plant, property, and equipment	101,000,000
Total assets	$139,000,000
Liabilities and Equity
Accounts payable	$  10,000,000
Accruals	9,000,000
Current liabilities	$  19,000,000
Long-term debt (40,000 bonds, $1,000 par value)	40,000,000
Total liabilities	$  59,000,000
Common stock (10,000,000 shares)	30,000,000
Retained earnings	50,000,000
Total shareholders’ equity	80,000,000
Total liabilities and shareholders’ equity	$139,000,000

FINC620 – Quiz – Week 1
The stock is currently selling for $15.25 per share, and its noncallable $1,000 par value, 20-year, 7.25% bonds with semiannual payments are selling for $875.00. The beta is 1.25, the yield on a 6-month Treasury bill is 3.50%, and the yield on a 20-year Treasury bond is 5.50%. The required return on the stock market is 11.50%, but the market has had an average annual return of 14.50% during the past 5 years. The firm’s tax rate is 40%.

Refer to Multi-Part 9-1. What is the best estimate of the firm’s WACC?

 

5.      Which of the following statements is CORRECT?

 

6.      S. Bouchard and Company hired you as a consultant to help estimate its cost of common equity. You have obtained the following data: D₀ = $0.85; P₀ = $22.00; and g = 6.00% (constant). The CEO thinks, however, that the stock price is temporarily depressed, and that it will soon rise to $40.00. Based on the DCF approach, by how much would the cost of common from retained earnings change if the stock price changes as the CEO expects?

 

7.      Safeco Company and Risco Inc are identical in size and capital structure. However, the riskiness of their assets and cash flows are somewhat different, resulting in Safeco having a WACC of 10% and Risco a WACC of 12%. Safeco is considering Project X, which has an IRR of 10.5% and is of the same risk as a typical Safeco project. Risco is considering Project Y, which has an IRR of 11.5% and is of the same risk as a typical Risco project.

 

Now assume that the two companies merge and form a new company, Safeco/Risco Inc. Moreover, the new company’s market risk is an average of the pre-merger companies’ market risks, and the merger has no impact on either the cash flows or the risks of Projects X and Y. Which of the following statements is CORRECT?

 

8.      Which of the following statements is CORRECT?

 

9.      Which of the following is NOT a capital component when calculating the weighted average cost of capital (WACC) for use in capital budgeting?   10.  Which of the following statements is CORRECT? Assume that the firm is a publicly-owned corporation and is seeking to maximize shareholder wealth.

 

2         out of 2 points

	11.  Which of the following statements is CORRECT?

 

12.  Multi-Part 9-1:
Assume that you have been hired as a consultant by CGT, a major producer of chemicals and plastics, including plastic grocery bags, styrofoam cups, and fertilizers, to estimate the firm’s weighted average cost of capital. The balance sheet and some other information are provided below.

Assets
Current assets	$  38,000,000
Net plant, property, and equipment	101,000,000
Total assets	$139,000,000
Liabilities and Equity
Accounts payable	$  10,000,000
Accruals	9,000,000
Current liabilities	$  19,000,000
Long-term debt (40,000 bonds, $1,000 par value)	40,000,000
Total liabilities	$  59,000,000
Common stock (10,000,000 shares)	30,000,000
Retained earnings	50,000,000
Total shareholders’ equity	80,000,000
Total liabilities and shareholders’ equity	$139,000,000

The stock is currently selling for $15.25 per share, and its noncallable $1,000 par value, 20-year, 7.25% bonds with semiannual payments are selling for $875.00. The beta is 1.25, the yield on a 6-month Treasury bill is 3.50%, and the yield on a 20-year Treasury bond is 5.50%. The required return on the stock market is 11.50%, but the market has had an average annual return of 14.50% during the past 5 years. The firm’s tax rate is 40%.

Refer to Multi-Part 9-1. Which of the following is the best estimate for the weight of debt for use in calculating the firm’s WACC?

FINC620 – Quiz – Week 1

13.Which of the following statements is CORRECT?

 

14. Weaver Chocolate Co. expects to earn $3.50 per share during the current year, its expected dividend payout ratio is 65%, its expected constant dividend growth rate is 6.0%, and its common stock currently sells for $32.50 per share. New stock can be sold to the public at the current price, but a flotation cost of 5% would be incurred. What would be the cost of equity from new common stock?

 

 

FINC620 – Quiz – Week 1