davenport finc620 week 1 quiz

Several years ago the Jakob Company sold a $1,000
par value, noncallable bond that now has 20 years to maturity and a 7.00%
annual coupon that is paid semiannually. The bond currently sells for $925
and the company’s tax rate is 40%. What is the component cost of debt for use
in the WACC calculation?

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 $52.50 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?

To help finance a major expansion, Castro
Chemical Company sold a noncallable bond several years ago that now has 20
years to maturity. This bond has a 9.25% annual coupon, paid semiannually,
sells at a price of $1,075, and has a par value of $1,000. If the firm’s tax
rate is 40%, what is the component cost of debt for use in the WACC
calculation?

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?

A. Butcher Timber Company hired your consulting
firm to help them estimate the cost of common equity. The yield on the firm’s
bonds is 8.75%, and your firm’s economists believe that the cost of common
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 common from retained
earnings?

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.

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 after-tax cost of
debt?

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.

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?

Teall Development Company hired you as a
consultant to help them estimate its cost of capital. You have been provided
with the following data: D₁ = $1.45; P₀ =
$22.50; and g = 6.50% (constant). Based on the DCF approach, what is the cost
of common from retained earnings?

Which of the following statements is CORRECT?

Which of the following is NOT a
capital component when calculating the weighted average cost of capital
(WACC) for use in capital budgeting?

Assume that Kish Inc. hired you as a consultant
to help estimate its cost of common equity. You have obtained the following
data: D₀ =
$0.90; P₀ =
$27.50; and g = 7.00% (constant). Based on the DCF approach, what is the cost
of common from retained earnings?

Sapp Trucking’s balance sheet shows a total of
noncallable $45 million long-term debt with a coupon rate of 7.00% and a
yield to maturity of 6.00%. This debt currently has a market value of $50
million. The balance sheet also shows that the company has 10 million shares
of common stock, and the book value of the common equity (common stock plus
retained earnings) is $65 million. The current stock price is $22.50 per
share; stockholders’ required return, r_s, is 14.00%; and the firm’s tax rate is 40%. The CFO thinks the WACC
should be based on market value weights, but the president thinks book
weights are more appropriate. What is the difference between these two WACCs?

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.

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?

Cranberry Corp. has two divisions of equal size:
a computer manufacturing division and a data processing division. Its CFO
believes that stand-alone data processor companies typically have a WACC of
8%, while stand-alone computer manufacturers typically have a 12% WACC. He
also believes that the data processing and manufacturing divisions have the
same risk as their typical peers. Consequently, he estimates that the
composite, or corporate, WACC is 10%. A consultant has suggested using an 8%
hurdle rate for the data processing division and a 12% hurdle rate for the
manufacturing division. However, the CFO disagrees, and he has assigned a 10%
WACC to all projects in both divisions. Which of the following statements is
CORRECT?

Keys Printing plans to issue a $1,000 par value,
20-year noncallable bond with a 7.00% annual coupon, paid semiannually. The
company’s marginal tax rate is 40.00%, but Congress is considering a change
in the corporate tax rate to 30.00%. By how much would the component cost of
debt used to calculate the WACC change if the new tax rate was adopted?