1. Barry’s Steroids Company has $1000 par value bonds outstanding at 14% interest. The bonds will mature in 40 years. If the percent yield to maturity is 11%, what percent of the total bond value does the repayment of principal represent?
Principal as a percentage of bond price _____________%
2. Assume interest rates in the market (yield to maturity) decline from 12 percent to percent.
Bond price ______________________
What is the bond price at 6%?
What would be your percentage return on investment if you bought when rates were 12 percent and sold when rates were 6 percent?
3. Tom Cruise Lines Inc issued bonds five years ago at $1000 per bond. These bonds had a 25-year life when issued and the annual interest payment was then 15 percent. This return was in line with the required returns by bondholders at that point as described below.
Real rate of return 5%
Inflation premium 5
Risk premium 5
Total 15%
Assume that five years later the inflation premium is only 3% and is appropriately reflected in the required return (or yield to maturity) of the bonds have 20 years remaining until maturity.
Compute the new price of the bond. Assume interest payments are annual. Round to 2 decimal places.
4. Katie Pairy Fruits Inc. has a $3300, 12-year bond outstanding with a nominal yield of 18% (coupon equals 18% x 43300 = $594 per year). Assume that the current market required interest rate on similar bonds is now only 12 %.
Find the present value of 6% x $3300 (or $198) for 12 years at 12%. The $198 is assumed to be an annual payment. Add this value to $3300.
5. Lance Whittingham specializes in buying deep discount bonds. These represent bonds that are trading at well below par value. He has his eye on a bond issue by the leisure Time Corporation. The $1000 par value bond pays 8% annual interest and has 17 years remaining to maturity. The current yield to maturity on similar bonds is 10%.
What is the current price of the bonds? By what percent will the price of the bonds increase between now and maturity?
6. Appraise the bonds of Olsen Clothing Stores. The $1000 par value bonds have a quoted annual interest rate of 10%, which is paid semiannually. The yield to maturity on the bonds is 10% annual interest.
Price Semi-annual analysis __________________
With 5 years to maturity, if yield to maturity goes down substantially to 10%, what will be the new price of the bonds?
7. BioScience Inc. will pay a common stock dividend of $5.20 at the end of the year (D1) The required return on common stock (Ke) is 14 percent. The firm has a constant growth rate (g) of 7%. Compute the current price of the stock (p0)
8. Eco Labs will pay a dividend of $6.50 per share in the next 12 months (D1). The required rate of return (Ke) is 20% and the constant growth rate is 9%.
Compute the price of Ecology Labs’ common stock.
Assume Ke the required rate of return, goes up to 24%. What will be the new price?
Assume the growth rate (g) goes up to 13%. What will be the new price?
Assume D1 is $7.50. What will be the new price? Assume Ke is at its original value of 20% and g goes back to its original value of 9%.
9. Justin Company has had the following pattern of earnings per share over the last five years:
Earnings
Year Per Share
20X1 $8.00
20X2 8.40
20X3 8.82
20X4 9.26
20X XXXXXXXXXX
The earnings per share have grown at a constant rate (on a rounded basis) and will continue to do so in the future. Dividends represent 40% of earnings.
Project earnings and dividends for the next year (20X6).
If the required rate of return (Ke) is 13%, what is the anticipated stock price (Pe) at the beginning of 20X6?
10. Beasley Ball Bearings paid a $4 dividend last year. The dividend is expected to grow at a constant rate of 5% over the next four years. The required rate of return is 15% (this will also serve as the discount rate in this problem).
Compute the anticipated value of the dividends for the next 4 years.
| | Anticipated Value |
| D1 | |
| D2 | |
| D3 | |
| D4 | |
Calculate the present of each of the anticipated dividends at a discount rate of 15%
| | PV of Dividends |
| D1 | |
| D2 | |
| D3 | |
| D4 | |
| Total | |
Compute the price of the stock at the end of the fourth year (P4).
Calculate the present value of the year 4 stock price at a discount rate 15%.
| Present value of Year 4 stock price | |
a. Compute the current value of the stock
Use the formula given below to show that it will provide approximately the same answer as in (a)
P0 = _____D1_____
Ke - g
b. If current EPS were equal to $5.51 and the P/E ratio is 1.2 times higher than the industry average of 7, what would the stock price be?
By what dollar amount is the stock price in (b) different from the stock price in (a)
With regard to the stock prince in (a) indicate which direction it would move if:
| | | |
| (1) | D1 increases | |
| (2) | Ke increases | |
| (3) | G increases | |
11. Speedy Delivery Systems can buy a piece of equipment that is anticipated to provide an 12% return and can be financed at 9% with debt. Late in the year the firm turns down an opportunity to buy a new machine that would yield a 20% return but would cost 22% to finance through common equity. Assume debt and common equity. Assume debt and common equity each represent 50% of the firm’s capital structure.
Compute the weight average cost of capital.
| Weight average cost of capital | | % |
Which project(s) should be accepted?
New machine______
Piece of equipment_____
12. A brilliant young scientist is killed in a plane crash. It is anticipated that he could have earned $300,000 a year for the next 25 years. The attorney for the plaintiff’s estate argues that the lost income should be discounted back to the present at 5%. The lawyer for the defendant’s insurance company argues for a discount rate of 10%.
What is the difference between the present value of the settlement at 5% and 19 percent? Compute each one separately.
| | Present Value |
| PV at 5% rate | |
| PV at 10% rate | |
| Difference | |
13. The Goodsmith Charitable Foundation, which is tax-exempt, issued debt last year at 9% to help finance a new playground facility in Los Angeles. This year the cost of debt is 30% higher; that is, firms that paid 11% for debt last year will be paying 14.30% this year.
If Goodsmith borrowed money this year, what would the aftertax cost of debt be, based on their cost last year and the 30% increase?
If the receipts of the foundation were found to be taxable by the IRS (at a rate of 34% because of involvement in political activities), what would the aftertax cost of debt be?
14. Airborne Airlines Inc. has a $1,000 par value bond outstanding with 10-years to maturity. The board carries an annual interest payment of $112 and is currently selling $860. Airborne is in a 30% tax bracket. The firm wishes to know what the aftertax cost of a new bond issue is likely to be. The yield to maturity on the new issue will be the same as the yield to maturity on the old issue because the risk and maturity date will be similar.
Compute the yield to maturity on the old issue and use this as the yield for the new issue.
Make the appropriate tax adjustment to determine the aftertax cost of debt.
15. Terrier Company is in a 50% tax bracket and has a bond outstanding that yields 12% to maturity.
a. What is Terrier’s aftertax cost of debt?
b. Assume that the yield on the bond goes down by 1% point and due to tax reform, the corporate tax rate fall to 35%. What is Terrier’s new aftertax cost of debt?
Has the aftertax cost of debt gone up or down from part a to part b?
It has gone up ___________
It has gone down _________
16. Keyspan corp is planning to issue debt that will mature in 2030. In many respects, the issue is similar to the currently outstanding debt of the corporation
Calculate the yield to maturity on similarly outstanding debt for the firm, in terms of maturity.
Assume that because the new debt will be issued at par, the required yield to maturity will be .10% higher than the value determined above.
What is the new yield to maturity?
If the firm is in a 30% tax bracket, what is the aftertax cost of debt for the yield determined above.
17. Wallace Container Company issued $100 par value preferred stock 10-years ago. The stock provided a 11 percent yield at the time of issue. The preferred stock is now selling for $88.
What is the current yield or cost of the preferred stock?
18. The treasurer of Riley Coal Co. is asked to compute the cost of fixed income securities for her corporation. Even before making the calculations, she assumes the aftertax cost of debt is at least 2% less than that for preferred stock.
Debt can be issued at a yield of 10.4%, and the corporate tax rate is 25%. Preferred stock will be priced at $61 and pay a dividend of $5.20. The flotation cost on the preferred stock is $7.
Compute the aftertax cost of debt.
Compute the aftertax cost of preferred stock.
| Aftertax cost of preferred stock | | % |
Based on the facts given above is the treasurer correct? Yes_______ No _______
Compute Ke and Kn under the following circumstances:
D1 = $6.60 P0 = $76 g = 6% F = $4.00
D1 = $.35 P0 = $36 g = 10% F = $1.50
E1 (earnings at the end of period one) = 10, payout ratio equals 25%,
P0 = $40 g = 9.0% F = $2.50
D0 (dividend at the beginning of the first period) = $9, growth rate for dividends and earnings (g) = 2%
P0 = $66 F = $6
Global Technology’s capital structure is as follows:
Debt 50%
Preferred stock 35
Common equity 15
The aftertax cost of debt is 7.50 percent; the cost of preferred stock is 11.50 percent; and the cost of common equity (in the form f retained earnings) is 14.50 percent.
Calculate the Global Technology’s weighted cost of each source of capital and the weighted average cost of capital.
| | Weighted Cost | |
| Debt | | % |
| Preferred stock | | |
| Common equity | | |
| Weighted average cost of capital | | % |
21. Sauer Milk Inc. wants to determine the minimum cost of capital point for the firm. Assume it is considered the following financial plans:
Cost
(aftertax) Weights
Plan A
Debt 4.0% 10%
Preferred Stock 8.0 5
Common Equity XXXXXXXXXX
Plan B
Debt 4.5% 20%
Preferred Stock 8.5 5
Common Equity XXXXXXXXXX
Plan C
Debt 5.0% 30%
Preferred Stock 8.7 5
Common Equity 8.8 65
Plan D
Debt 7.0% 40%
Preferred Stock 9.2 5
Common Equity XXXXXXXXXX
Compute the weighted average cost for four plans
| | Weighted Cost | |
| Plan A | | % |
| Plan B | | % |
| Plan C | | % |
| Plan D | | % |
Which of the four plans has the lowest weighted average cost of capital?
Plan A
Plan B
Plan C
Plan D
What is the relationship between the various types of financing cost and the debt-tp-equity ratio?
All types of financing cost increase as the debt-to-equity ratio increases.
All types of financing cost decrease as the debt-to-equity ratio increases.
22. A-Rod Manufacturing Company is trying to calculate its cost of capital for use in making a capital budgeting decision. Mr. Jeter, the vice-president of finance, has given you the following information and has asked you to compute the weighted average cost of capital.
The company currently has outstanding a bond with a 11.4 % coupon rate and another bond with an 9.0 % rate. The firm has been informed by its investment banker that bonds of equal risk and credit rating are now selling to yield 12.3%. The common stock has a price of $68 and an expected dividend (D1) of $1.88 per share. The historical growth pattern (g) for dividends is as follows:
$1.43
$1.57
$1.72
$1.88
The preferred stock is selling at $88 per share and pays a dividend of $8.40 per share. The corporate tax rate is 30%. The flotation cost is 2.0% of the selling price for preferred stock. The optimal capital structure for the firm of 25% debt, 15% preferred stock, and 60 % common equity in the form of retained earnings.
Compute the historical growth rate.
Compute the cost of capital for the individual components in the capital structure.
| | Weighted Cost | |
| Debt | | % |
| Preferred Stock | | |
| Common equity | | |
Calculate the weighted cost of each source of capital and the weighed average cost of capital.
| | Weighted Cost | |
| Debt | | % |
| Preferred Stock | | |
| Common equity | | |
| Weighted average cost of capital | | % |
| | Weighted Cost | |
| Debt | | % |
| Preferred Stock | | |
| Common equity | | |
| Weighted average cost of capital | | % |
23. Delta Corporation has following capital structure:
Cost Weighted
(Aftertax) Weights Cost
Debt (Kd) 9.2% 35% 3.22%
Preferred stock (Kp XXXXXXXXXX
Common equity (Ke) (retained earnings XXXXXXXXXX
Weighted average cost of capital (Ka XXXXXXXXXX%
If the firm has $24 million in retained earnings, at what size capital structure will the firm run out of retained earnings?
| Capital structure size (X) | | million |
The 9.2% cost of debt referred to earlier applies only to the first $28 million of debt. After that the cost of debt will go up. At what size capital structure will there be a change in the cost of debt?
| Capital structure size (Z) | | million |
The Nolan Corporation finds it is necessary to determine its marginal cost of capital. Nolan’s current capital structure calls for 40% debt, 10% preferred stock and 50% common equity. Initially common equity will be in the form of retained earnings (Ke) and then new common stock (Kn). The costs of the various sources of financing are as follows: debt, 9.3 percent; preferred stock, 12% retained earnings, 13% and new common stock, 14.2%
What is the initial weighted average cost of capital?
| | Weighted Cost | |
| Debt | | % |
| Preferred Stock | | |
| Common equity | | |
| Weighted average cost of capital | | % |
If the firm has $25 million in retained earnings, at what size capital structure will the firm run out of retained earnings?
| Capital structure size (X) | | million |
What will the marginal cost of capital be immediately after that point.
| Marginal cost of capital | | million |
The 9.3% cost of debt referred to earlier applies only to the first $36 million of debt. After that the cost of debt will be 11.4%. At what size capital structure will there be a change in the cost of debt?
| Capital structure size (Z) | | million |
What will the marginal cost of capital be immediately after that point?
| Marginal cost capital | | million |
25. Eaton Electronic Company’s treasurer uses both the capital asset pricing model and the dividend valuation model to compute the cost of common equity.
Assume:
Rf = 8%
Km = 13%
B = 1.7
D1 = $.90
P0 = $20
g = 9%
Compute Ki (required rate of return on common equity based on the capital asset pricing model)
Compute Ke (required rate of return rate of return on common equity bases on the dividend valuation model).