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Fundamentals of Corporate Finance, 4/c/e

Fundamentals of Corporate Finance, 4/e

Stephen A. Ross, Massachusetts Institute of Technology
Randolph W. Westerfield, University of Southern California
Bradford D. Jordan, University of Kentucky
Gordon S. Roberts, York University

Cost of Capital

Quick Quiz 2

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1	Which of the following is true regarding the use of the dividend growth model for estimating the cost of equity capital?
		A)	The model cannot be used for firms that do not currently pay dividends.
		B)	One method of estimating future growth rates is the use of historical growth rates.
		C)	The results from this model are not sensitive to changes in the dividend growth rate.
		D)	The model works particularly well for companies that maintain a mostly unsteady dividend growth rate.
		E)	The model explicitly considers risk.


2	A firm that uses its WACC as a cutoff without considering project risk: I. Tends to become less risky over time. II. Tends to accept negative NPV projects over time. III. Tends to reject positive NPV projects over time.
		A)	II only
		B)	II and III only
		C)	I and III only
		D)	I and II only
		E)	I, II and III


3	We can estimate a firm's cost of debt by:
		A)	observing the firm's bank borrowing rate on short-term loans
		B)	observing the coupon rate on the firm's outstanding bonds
		C)	observing the yield to maturity on newly-issued debt of other firms without regard to risk
		D)	observing the risk-free rate and adding a risk premium to the coupon rate of existing debt
		E)	observing the yield to maturity on the firm's outstanding bonds


4	Suppose that Topstone Industries has a cost of equity of 14% and a cost of debt of 9%. If the target debt/equity ratio is 75%, and the tax rate is 34%, what is Topstone's weighted average cost of capital (WACC)?
		A)	10.6%
		B)	7.9%
		C)	8.4%
		D)	6.6%
		E)	10.9%


5	Rattle me Bones, Inc.'s common stock is currently selling for $66.25 per share. You expect the next dividend to be $5.30 per share. If the firm has a dividend growth rate of 4% that is expected to remain constant indefinitely, what is the firm's cost of equity?
		A)	14.1%
		B)	13.9%
		C)	13.5%
		D)	12.3%
		E)	12.0%


6	RMB, Inc. sold a 20-year bond at par 12 years ago. The bond pays an 8% annual coupon, has a $1,000 face value, and currently sells for $893.30. What is the firm's cost of debt?
		A)	8.0%
		B)	9.2%
		C)	9.5%
		D)	10.0%
		E)	10.5%


7	Anthony's Antiques, Inc. has preferred stock outstanding which pays a dividend of $4 per share a year. The current stock price is $32 per share. What is the cost of preferred stock?
		A)	12.5%
		B)	11.0%
		C)	10.0%
		D)	9.0%
		E)	8.0%


8	KCE Co. is operating at its target capital structure with market values of $110 million in equity and $175 million in debt outstanding. KCE plans to finance a new $32 million project using the same relative weights of debt and equity. Ignoring flotation costs, how much new debt must be issued to fund the project?
		A)	$12.4 million
		B)	$18.5 million
		C)	$19.6 million
		D)	$24.8 million
		E)	$32.0 million


9	Roberts Co.'s zero coupon bonds mature in 22 years and have a yield to maturity of 12.01%. Each zero has a face value of $1,000 and there are 2,000 of the bonds outstanding. If the market value of Roberts' equity is $1,000,000, what capital structure weight for debt would you use in computing the WACC, assuming Roberts' only debt consists of the zeros?
		A)	11.9%
		B)	18.9%
		C)	15.8%
		D)	14.2%
		E)	66.7%


10	The common stock of Tommy's Tools sells for $27.50. The firm's beta = 1.2, the risk-free rate is 4%, and the market risk premium is 8%. Next year's dividend is expected to be $1.50. Assuming that dividend growth is expected to remain constant for Tommy's over the foreseeable future, what is the firm's anticipated dividend growth rate?
		A)	7.6%
		B)	8.2%
		C)	7.8%
		D)	9.2%
		E)	10.1%

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