# Cost of Capital, Capital Structure, and Dividend Policy

1. A relatively young firm has capital components valued at book and market and market component costs as follows. No new securities have been issued since the firm was originally capitalized. Values Component Debt Preferred Stock Market \$42,830 \$10,650 Book \$40,000 \$10,000 Market Cost 8.5% 10.6%

Common Equity \$65,740 \$32,000 25.3% Calculate the firm's capital structures and WACCs based on both book and market values, and compare the two. What appears to have happened to interest rates since the company was started? Does the firm seem to be successful? a. Interest rates have gone up; the firm is not successful. b. Interest rates have gone down; the firm is successful.

2. The Pepperpot Company's stock is selling for \$52. Its last dividend was \$4.50, and the firm is expected to grow at 7% indefinitely. Flotation costs associated with the sale of common stock are 10% of the proceeds raised. Estimate Pepperpot's cost of retained earnings. a. 12.5% b. 14.3% c. 16.3% d. 17.5%

3. The Pepperpot Company's stock is selling for \$52. Its last dividend was \$4.50, and the firm is expected to grow at 7% indefinitely. Flotation costs associated with the sale of common stock are 10% of the proceeds raised. Estimate Pepperpot's cost of equity from the sale of new stock. a. 16.3% b. 17.3% c. 14.2% d. 12.1%

4. Randal Flapjack is a retired short-order cook living on a fixed income in the state of Utopia where all financial markets are perfectly efficient. Randal has 20,000 shares of the Sugarcooky Corp., which pays an annualized dividend of \$1.00 per share. Sugarcooky sells at a P/E of 10, has maintained a payout ratio of 50% for many years, and has not grown in some time. Management has recently announced that it will reduce Sugarcooky's payout ratio to 25% but expects earnings to grow at 5% from now on. What is Sugarcooky's current price? a. \$10 b. \$50 c. \$20 d. \$1.50

5. Randal Flapjack is a retired short-order cook living on a fixed income in the state of Utopia where all financial markets are perfectly efficient. Randal has 20,000 shares of the Sugarcooky Corp., which pays an annualized dividend of \$1.00 per share. Sugarcooky sells at a P/E of 10, has maintained a payout ratio of 50% for many years, and has not grown in some time. Management has recently announced that it will reduce Sugarcooky's payout ratio to 25% but expects earnings to grow at 5% from now on. How much current income is Randal losing as a result of management's action? a. \$20,000 b. \$10,000 c. \$5,000 d. \$1,000

6. Randal Flapjack is a retired short-order cook living on a fixed income in the state of Utopia where all financial markets are perfectly efficient. Randal has 20,000 shares of the Sugarcooky Corp., which pays an annualized dividend of \$1.00 per share. Sugarcooky sells at a P/E of 10, has maintained a payout ratio of 50% for many years, and has not grown in some time. Management has recently announced that it will reduce Sugarcooky's payout ratio to 25% but expects earnings to grow at 5% from now on. If Randal keeps his money in Sugarcooky but needs to maintain his current income, how many shares will he have to sell in the first year? a. 10 b. 50 c. 200 d. 500

7. Randal Flapjack is a retired short-order cook living on a fixed income in the state of Utopia where all financial markets are perfectly efficient. Randal has 20,000 shares of the Sugarcooky Corp., which pays an annualized dividend of \$1.00 per share. Sugarcooky sells at a P/E of 10, has maintained a payout ratio of 50% for many years, and has not grown in some time. Management has recently announced that it will reduce Sugarcooky's payout ratio to 25% but expects earnings to grow at 5% from now on. What will be the value of his remaining shares (assuming that he sells off shares to maintain his current income) at the end of a year if the P/E remains the same? Is his investment growing? a. \$20,000 b. \$11,500 c. \$9,500 d. \$5,000

000 now. 12.75 9.00 What was the average price at which the company originally sold its stock? Reconstruct the equity statement above to reflect a four-for-one stock split. Compute the after-tax cost of debt for these bonds if Husky's marginal tax rate is 40 percent. Issuance costs are estimated to be \$2 a share. If the decline is 45%. \$600. The company has a marginal tax rate of 40%.75 b.000. 3.74% d. \$600.15% . \$500.000. how much will the split make you? a. Calculate the after-tax cost of preferred stock for Bozeman-Western Airlines. \$1.8.000 gain c.50 each. Husky received \$604. The Alligator Lock Company is planning a two-for-one stock split.000 after. 11. \$2.000 shares of Alligator's common stock that is currently selling for \$120 a share.000 gain b. \$600. \$60. \$10. \$60.000 now. \$2. and what will it be after the split? Alligator's CFO says that the value of the shares will decline less than proportionately with the split because the stock is now out of its trading range.000. 7.2% b.000 gain 10. 13.6% c.000 after. 12% 11.000 after.000 maturity value and pay \$50 interest at the end of each year. \$750. \$500. The bonds have a \$1..000 gain d.000 after.50 cumulative preferred stock to the public at a price of \$50 a share.000 now. The stock is currently selling for \$3 per share. What is the value of your Alligator stock now.000 \$32. Common Stock (8 million shares outstanding. After flotation costs. a. Husky Enterprises recently sold an issue of 10-year maturity bonds. a.000 now. \$2.54% c. \$60. You own 5. . \$2 par) \$16. 15% b.00 c.000 \$4.000.2% d. \$600.50 d.000 Paid in Excess Retained Earnings Total Common Equity Book Value per share 4. The bonds were sold at a deep discount price of \$615 each. The Addington Book Company has the following equity position. a.000 12. which is planning to sell \$10 million of \$6. Inc. \$600.

7% 4.5 13. Globe should diversify. 14.10 1. Proportion of Debt Cost of Debt. Globe Steel has decided to diversify into the home improvement field.1 12. D0 . b.0 17.0 Determine the firm's optimal capital structure. are \$3. 13.50 0.60. The expected market return is 16% and the risk-free rate is 10%. EPS = \$1. 55% equity d. what are the dividends per share? a. Determine how much higher its weighted average cost of capital is than at the optimal capital structure.60 . Hartley is financed 100 percent with equity and intends to maintain this capital structure after the expansion. DPS = \$0.5 6. and the expected future long-term growth rate in the firm's dividends drops from 8 to 7%. If the expansion is expected to produce an internal rate of return of 17%. 65% equity 15.10.0 13. 75% equity c. Optimal: 25% debt. The firm has 1. DPS = \$0.9 15. Hartley should not make the investment.40 0. and the current dividends per share. a.00 0.12.3 to 0.9. Optimal: 35% debt. EPS = \$1.0% 12.5 12.60 4. Jersey Computer Company has estimated the costs of debt and equity capital (with bankruptcy and agency costs) for various proportions of debt in its capital structure: Cost of Equity. 60% equity b.50 c. Globe's beta value drops from 1. kd (I-T) kc 0.9. Optimal: 45% debt.40. EPS = \$1. Should Globe undertake the planned diversification? a. the risk-free rate is 7%. As a result of this expansion. Compute the earnings per share of Jacobs.1 7. Optimal: 40% debt.20 0.30 0. Suppose that the firm's current capital structure consists of 30% debt (and 70% equity). Globe should not diversify. The expected market return is 14%. The Hartley Hotel Corporation is planning a major expansion. b. Hartley should make the investment. DPS = \$0.1 5. DPS = \$0.50 d.6 million shares of common stock outstanding. EPS = \$1. Hartley's beta is 0.40 b. If Jacobs' dividend policy calls for a 40% payout ratio. Jacobs Corporation earned \$2 million after taxes. should Hartley make the investment? a.9 5.25.

What is the current price? If the yield-to-maturity remains constant.000 c. and that debt and equity will be the only sources of funds to finance capital projects over the year. \$883 d.275. Wolverine anticipates earnings of \$6.000 shares next year.000 d. Clynne has 10 million shares of common stock outstanding.000 18. \$893 .000. \$440.25 per share over the year. \$452.000 b. \$304. how much external equity must it raise? Assume Wolverine's capital structure includes only common equity and debt. \$2. Sealtight. \$1.140 d. and plans to pay a dividend of \$0.300. Incorporated has just negotiated a 5-year term loan of \$8. \$2. what capital outlays are planned for the coming year? a.70 for the year.000. \$2.000. \$893 c.000 c. During the year Clynne expects to borrow \$10 million in addition to its already outstanding loan balances. \$452.000. The loan is fully amortized at an annual rate of interest of 12%.400. \$402. If all capital outlays are funded from retained earnings and new borrowings and if Clynne follows a residual dividend policy. \$23. Clynne Resources expects earnings this year to be \$2 per share. a.16. \$3.425. \$1. \$89 b.600. \$13. \$2.000. \$414.115. what will be the bond's price 7 years before maturity? One year before maturity? a. A zero coupon bond with a \$1.000.263 19.000 c. \$404.000 b. If the company has a capital budget requiring an investment of \$4 million over the year and it desires to maintain its present debt to total assets (debt ratio) of 0. \$975.000 b. \$1. \$27.000 par value and a maturity of 8 years has a yield-to-maturity of 12%. What are the required annual payments? a.000 17.219.40.000 d. \$452. Wolverine Corporation plans to pay a \$3 dividend per share on each of its 300.

\$592. principal.96.000 25.000.300.200.000 c. \$13.000 par value. and a 6% coupon rate even though the yield-to-maturity is expected to be 14%.420 21. principal.961. As an alternative to zero coupon bonds. Ohio Plastics has the following net worth on its balance sheet Common Stock (\$1.700. 1.75 . \$686.50 per value) Contributed Capital In Excess-of-Par Net Worth \$3.05 b. \$582. What is the expected price of each bond? In order to raise the needed \$400. It has decided to set the subscription price at FF100 per share.25 c.05 d.153.000 shares of common stock currently outstanding that sell for FF120 per share. \$13. 2. Bond price. Interest is paid annually. \$258.200.420 d.000 d.000 through a subscription of common stock.000.000 b.000.000 \$28. \$682.000. 200.96. \$582.000.200. \$686.000.400. How many shares must be issued to raise the desired amount of funds? a.20. 225. 20. 2.420 b. Bond price. principal. principal. \$582.250. It has 2. \$13.961. Diebold Pulp and Paper has decided to raise FF20. 2. Pacific Oil is considering the issuance of "deep discount" bonds.96.420 c. \$1.000 How many shares outstanding does the firm have? What is the average price per share? a. Bond price. how large must the principal of the bond issue be? a.961. The bonds would have a 10-year maturity.000. Bond price.96.000. 250.000 22. \$13.

\$20. The market price of the common stock is \$47. \$42. \$20. \$9 24. Sales are \$180.00 par value) Capital Surplus Retained Earnings 2.000.000 10. what was the price per share at the time of issue? a. \$8. \$18. BEP . Find the conversion price for a convertible \$1.00 per share.000.000. 33. find the EBIT.000. \$705 c.000. Missouri Valley Industries. 25%. NI. \$800 c.000. \$20.8%. \$4.880.000.000.000 shares of common stock outstanding and interest on debt is 12%. \$470 b.000. 34. \$180 26.000.000 6. \$1.880.000. 34.35 d.000.000 Calculate the book value per share of its common stock. 35%.500.23. and EPS. \$900 d. A firm has a capital structure that is half debt and half common equity and totals \$120. \$9.00 per share.000 with variable costs equal to 60% of sales and fixed operating costs of \$30.000. 35%. \$72. \$8. \$42.8%.000 bond.000. 34.8%.500. \$34.00 per share.000 bond with a conversion ratio of 15.000 shares of common stock were sold at the same time.000 Total Equity \$20. \$10.50 c. \$740 d. Assuming that all 2.000.000.000.000 shares of common stock outstanding and total equity as given below: Preferred Stock (\$100 par \$2. \$9 b.000. \$42. \$4 d. \$9.35 c. Find the conversion price of a convertible \$1. If the corporate tax rate is 40%.880.000.000 value) Common Stock (\$1.000.000. has 2.800 b.000. ROE. It has 2. 35%. Inc. \$8.000.35 . \$750 25. \$12. a.8%. convertible into common stock at \$20. a. a.880. The market price of the common stock is \$18.35 b.

000 c. 18. 5% d. The firm currently has assets of \$10. \$75. £800. Standex expects to continue a policy of borrowing 30% of its needed capital with the remainder provided by common equity. find Winston's EBIT.000. a.000. \$37.000 d. Its common stock is selling for DM36. ROE.5% c. ROE. EPS.500.000 shares of common stock selling at \$50 per share. Ametek Shipping's last annual dividend was DM2.000 28.000. \$3. 15% b. a. Its EPS and ROE are unaffected by changes in financial leverage. The management of ACM Corporation is evaluating a change in the capital structure of the firm to benefit from the effects of financial leverage.000 financed entirely with 200. 7.00 per share. 12% 30.000 next year before interest and taxes. 13% d. Given that its cost of debt is 8%.000. EPS. 14% c. EPS. 7. The firm's tax rate is 50%.50 per share. ROE.000 b. Management expects the firm to earn \$1. £7.7% . 11% c.75. Calculate its weighted average cost of capital. ROE. 7.000.87% d.50. EPS. \$7. £600. £6. 16% b. Standex Products has estimated that its after-tax cost of debt is 6% and its cost of common equity is 16%. 15% 29. 1. The firm would alter its capital structure by borrowing funds at an interest rate of 12% and repurchasing shares at \$50 per share. What is the expected earnings per share (EPS) and return on equity (ROE) at next year's expected level of EBIT if the firm remains 100% equity financed? a.7% b.27. If analysts are projecting 11% growth in earnings and dividends for the foreseeable future. what is Ametek Shipping's cost of common equity? a. Winston Products' total assets equal £75.50.

After dividend. ¥3.000 shares of common stock outstanding. ¥250. Barnes Corporation is expected to continue paying out 100% of its earnings as a dividend. ¥3. Rikon KK has 3.000 d. the current market price for Barnes' stock. \$60 b.000. \$60 d.held by an investor who owned 100 shares prior to the dividend. all shares after. ¥3.000 per year indefinitely.000 c. all shares before. If all other factors affecting the stock's pric e remain unchanged.000. all shares before. The required rate of return on equity is 10%. all shares before. \$4. and the market price of the stock one year from now.000 b. \$60 c. \$6.000. ¥450.000 .000 shares of stock outstanding selling for 4500 per share. ¥4. all shares after. \$5. \$60. The next dividend is one year from now. EBIT is expected to be \$1. After dividend. and the total value of all shares of stock .000. it has 100. a. all shares before. After dividend. The board has just declared a 20% stock dividend. all shares after.000. ¥450. calculate the market price per share after the stock dividend. \$6.before and after the dividend .31. \$50. \$50. a. \$60. After dividend.750. There is no debt in Barnes capital structure. \$60 32. and the corporate tax rate is 40%. ¥375.000.750. ¥135. Because it has no plans for reinvestme nt. Calculate the dividend per share each year. ¥375. all shares after.600. ¥375. ¥450.500.

Flotation costs associated with the sale of common stock are 10% of the proceeds raised. c.9% 15.29 9.5% 14. This could be due to an increase in stock price or a rapid accumulation of retained earnings or a combination of both. Interest rates have gone up.5% .650 \$65.5% 10. Interest rates appear to have fallen.6% 25.122 . The firm seems to be successful because of the substantial increase in the value of equity.SOLUTIONS Part 5. a. 2. ANSWER: b SOLUTION: Factors Market Debt Preferred Stock Common Equity \$42. the firm is successful.3% 16.94 15.000 \$82.000 \$32.6% 25.5% 10.551 1.3% 17.740 \$119.15 1.830 \$10.3% Calculate the firm's capital structures and WACCs based on both book and market values. and the firm is expected to grow at 7% indefinitely.3% Comparison: The overall cost of capital has risen due to the net impact of a large increase in the value of the firm's equity. d. 12.390 1.830 \$10. and compare the two.05 .95 13.000 Weights .000 Market Cost 8.000 Book \$40. A relatively young firm has capital components valued at book and market and market component costs as follows. b. Its last dividend was \$4.090 .488 . The Pepperpot Company's stock is selling for \$52. Interest rates have gone down.3% Market Book 3. the firm is not successful.220 Weights .50.87 17.000 \$32.Long Term Financing Section 1 .31 Use WACCs = 17.000 \$10. b.94 4.Basic 1. since the market values of debt and preferred exceed their original values.359 .000 \$10. Values Component Debt Preferred Stock Common Equity Market \$42.THE PROBLEM BANK . This throws more of equity's high cost into the WACC.650 \$65.740 Book \$40.000 Costs 8. What appears to have happened to interest rates since the company was started? Does the firm seem to be successful? a. No new securities have been issued since the firm was originally capitalized. Estimate Pepperpot's cost of retained earnings.

which pays an annualized dividend of \$1.1% ANSWER: b SOLUTION: Cost of equity from new stock: 4. and has not grown in some time.2% 12. Sugarcooky sells at a P/E of 10. b.07 [ '] [)] [ ] 52 [+] .3% 14. and the firm is expected to grow at 7% indefinitely.07 [)] [ ] 52 [+] . d. The Pepperpot Company's stock is selling for \$52. d. Randal has 20. \$10 \$50 \$20 \$1.00 per share. c.16 3. Its last dividend was \$4.000 shares of the Sugarcooky Corp. 16.5 [x] [(] 1 [+] . Management has recently announced that it will reduce Sugarcooky's payout ratio to 25% but expects earnings to grow at 5% from now on.07 [=] Solution: .. b. a. Estimate Pepperpot's cost of equity from the sale of new stock. Flotation costs associated with the sale of common stock are 10% of the proceeds raised. has maintained a payout ratio of 50% for many years. What is Sugarcooky's current price? a.16 TI 4.50 ANSWER: c SOLUTION: . Randal Flapjack is a retired short-order cook living on a fixed income in the state of Utopia where all financial markets are perfectly efficient. c.3% 17.5 [x] [ '] [(] 1 [+] .50.ANSWER: c SOLUTION: Cost from retained earnings: KEYSTROKES: HP 4.07 [=] Solution: .

000 shares of the Sugarcooky Corp..00 per share. What will be the value of his remaining shares (assuming that he sells off shares to maintain his current income) at the end of a year if the P/E remains the same? Is his investment growing? .Payout ratio = 50%. has maintained a payout ratio of 50% for many years. Management has recently announced that it will reduce Sugarcooky's payout ratio to 25% but expects earnings to grow at 5% from now on. b. Sugarcooky sells at a P/E of 10. a reduction of \$0.00 EPS = \$1/0. Sugarcooky sells at a P/E of 10. \$0. Randal Flapjack is a retired short-order cook living on a fixed income in the state of Utopia where all financial markets are perfectly efficient.. Randal has 20.50 = \$2 P = EPS x P/E = \$20 5. Sugarcooky sells at a P/E of 10.000 ANSWER: b SOLUTION: D = \$2. which pays an annualized dividend of \$1.. and has not grown in some time. 10 50 200 500 ANSWER: d SOLUTION: \$10. which pays an annualized dividend of \$1. Randal Flapjack is a retired short-order cook living on a fixed income in the state of Utopia where all financial markets are perfectly efficient. d. how many shares will he have to sell in the first year? a.25 = \$0. \$20.00 per share.000 shares of the Sugarcooky Corp.000/\$20 = 500 shares. Randal has 20. has maintained a payout ratio of 50% for many years. b. Randal Flapjack is a retired short-order cook living on a fixed income in the state of Utopia where all financial markets are perfectly efficient. d.50 per share. c.000 6. Management has recently announced that it will reduce Sugarcooky's payout ratio to 25% but expects earnings to grow at 5% from now on. and has not grown in some time.000 \$1.00 x 0.000 \$10.000 \$5. Management has recently announced that it will reduce Sugarcooky's payout ratio to 25% but expects earnings to grow at 5% from now on. Randal has 20. has maintained a payout ratio of 50% for many years.00 per share.50. and has not grown in some time. which pays an annualized dividend of \$1. Dividend = \$1.000 shares of the Sugarcooky Corp. If Randal keeps his money in Sugarcooky but needs to maintain his current income. c.000 = \$10. How much current income is Randal losing as a result of management's action? a.50 x 20. 7.

The Addington Book Company has the following equity position. The stock is currently selling for \$3 per share.000 Growth in investment = \$ 9. b. \$1.500 The stock's value is increasing at 5%.500 x \$21 = \$409.000 4.50 \$2.10 x 10 = \$21 New value = 19.05 = \$2.00 \$2. c. c.000 .000 4.667 par) Paid in Excess Retained Earnings Total Common Equity \$16.a.000.000 \$11.75 ANSWER: c SOLUTION: Amount paid for 8M shares: Par Excess \$16M 4M \$20M Original price = \$20M/8M shares = \$2. b. Four-for-one Stock Split: Common Stock (24 million shares outstanding.000. Therefore.500 Old value = 20.000 \$32.000.000. a.500 \$9.000.000 ANSWER: c SOLUTION: New EPS = \$2 x 1.000.000.5% of his shares.50 per share.000 \$4.75 \$2.000 x \$20 = \$400.500 \$5.10 P = EPS x P/E = \$2. \$20. \$. 8. his net investment is growing.000 12.000 12. Common Stock (8 million shares outstanding. d. \$2 par) Paid in Excess Retained Earnings Total Common Equity Book Value per share \$16. but Randal sold off only 2.00 What was the average price at which the company originally sold its stock? Reconstruct the equity statement above to reflect a four-for-one stock split. d.000 \$32.000.

\$60.45) = \$66 Value = 10.000 x \$66 = \$660. What is the value of your Alligator stock now. \$500.000 now. Husky Enterprises recently sold an issue of 10-year maturity bonds.000 shares of Alligator's common stock that is currently selling for \$120 a share.2% 12% ANSWER: c SOLUTION: . You own 5. \$60.000 gain \$600.000 gain \$500. The bonds have a \$1. Husky received \$604. \$600. b.000 10. \$10. a.000 45% decline implies new P = \$120 (1 .000 now.33 9.000 after. \$600.000 after.000 x \$60 = \$600. If the decline is 45%. how much will the split make you? a.000 gain = \$60.000 gain \$600.000 after. d. The bonds were sold at a deep discount price of \$615 each.000 after. c.6% 7. d.000 now. The Alligator Lock Company is planning a two-for-one stock split.000 maturity value and pay \$50 interest at the end of each year. Compute the after-tax cost of debt for these bonds if Husky's marginal tax rate is 40 percent. \$600.000 now.Book Value per share \$1. After flotation costs. and what will it be after the split? Alligator's CFO says that the value of the shares will decline less than proportionately with the split because the stock is now out of its trading range..000 gain ANSWER: a SOLUTION: Now 5. 3. \$60. c.000 After 10. b. \$750.2% .50 each.000 x \$120 = \$600.

10%) = 15. If the expansion is expected to produce an internal rate of return of 17%.] [PV] 1. b.322) \$604.00 [x] [(] 1 [.4% Because the expected return (17%) exceeds the cost of equity capital (15.50 = \$50 (PVIFAi.50 = \$604.] [PV] 1. The company has a marginal tax rate of 40%.5 [ +/.50 = \$50 (5. 15% 13.000 (PVIF i.4 [)] [=] Solution: 7.4 [ '] [)] [=] Solution: 7.1354 or 13.15% ANSWER: b SOLUTION: kp = Dp/Pnet = \$6.50/(\$50 . Hartley's beta is 0.0.2% KEYSTROKES: HP 605.74% 11.10) + \$1.650) + \$1.4) ki = 7.5 [ +/. which is planning to sell \$10 million of \$6.] . Hartley should . Issuance costs are estimated to be \$2 a share.10) Try i = 12% \$604. ANSWER: a SOLUTION: ks = 10% + 0. a.] .\$2) = 0. Inc. The expected market return is 16% and the risk-free rate is 10%.9.4%). The Hartley Hotel Corporation is planning a major expansion.5 ki = 12% (1 . Hartley should not make the invest ment.(Using the table) \$604.54% 12.00 [x] [ '] [(] 1 [.000 [FV] 50 [PMT] 10 [N] [I/YR] Partial solution: 12. should Hartley make the investment? a. Hartley should make the investment.50 cumulative preferred stock to the public at a price of \$50 a share. d. Hartley is financed 100 percent with equity and intends to maintain this capital structure after the expansion.2 11.2 TI 605.000 (0.9 (16% .000 [FV] 50 [PMT] 10 [N] [CPT] [I/Y] Partial solution: 12. c. b.54% 12. Calculate the after-tax cost of preferred stock for Bozeman-Western Airlines..

invest.1 7.5 12. are \$3.07) 0.1 12.60 4. Globe should not diversify.3 = 0.07) = \$50.0.133 or 13.3 to 0.5 13. The expected market return is 14%. 55% equity Optimal: 35% debt.133 . Jersey Computer Company has estimated the costs of debt and equity capital (with bankruptcy and agency costs) for various proportions of debt in its capital structure: Cost of Equity.0. the risk-free rate is 7%. b.9 5. Proportion of Debt Cost of Debt. 60% equity Optimal: 25% debt.9.95 Since diversification is expected to increase the price of Globe's stock.08)/(0. and the current dividends per share. Globe Steel has decided to diversify into the home improvement field. kd (I-T) kc 0.0.14 .7% 4. Should Globe undertake the planned diversification? a.0 13. Determine how much higher its weighted average cost of capital is than at the optimal capital structure. 13. and the expected future long-term growth rate in the firm's dividends drops from 8 to 7%.14 . 65% equity ANSWER: a SOLUTION: . d.5 6.1 5.0 Determine the firm's optimal capital structure.161 . 14.08) = \$40 Value of a share assuming diversification: ks = 0.0% 12.20 0. a.9 15.07) 1. b.30 0.50 0.0 17. D0 .0.9 = 0. Globe's beta value drops from 1.07 + (0.07)/(.40 0. Optimal: 40% debt. 75% equity Optimal: 45% debt.3% 0 = \$3(1. As a result of this expansion.1% 0 = \$3 (1.07 + (.161 or 16. Globe should diversify. Globe should diversify.00 0.10 1. Suppose that the firm's current capital structure consists of 30% debt (and 70% equity). ANSWER: a SOLUTION: Value of a share assuming no diversification: ks = 0. c.

60 ANSWER: c SOLUTION: EPS = 2.000 = \$1.6 million shares of common stock outstanding.\$3. how much external equity must it raise? Assume Wolverine's capital structure includes only common equity and debt. c.25/share 300. EPS = \$1. Wolverine Corporation plans to pay a \$3 dividend per share on each of its 300.000 total retained equity for year Equity portion of capital budget requirements: .400.600.50 EPS = \$1. DPS = \$0.000 ANSWER: d SOLUTION: Retention for coming year: \$6.15.000 \$2.25 DPS = \$1. DPS = \$0.10.50 16.25 .000/1.25(0. Jacobs Corporation earned \$2 million after taxes. Wolverine anticipates earnings of \$6.60. d.000 \$1. b. a. d.25. DPS = \$0. \$975.40.40 EPS = \$1.50 EPS = \$1.000 \$1.25/share = \$975.000 shares next year. and that debt and equity will be the only sources of funds to finance capital projects over the year. The firm has 1.000.000 shares x \$3. Compute the earnings per share of Jacobs.00 = \$3. If Jacobs' dividend policy calls for a 40% payout ratio. what are the dividends per share? a.40. c.425. DPS = \$0.275. b.25 per share over the year.4) = \$0. If the company has a capital budget requiring an investment of \$4 million over the year and it desires to maintain its present debt to total assets (debt ratio) of 0.

219.000 \$13.00 [PV] 0 [FV] 5 [N] 12 [I/Y] [CPT] [PMT] Solution: -2. Clynne Resources expects earnings this year to be \$2 per share.000 \$27.000.277.00 [PV] 0 [FV] 5 [N] 12 [I/YR] [PMT] Solution: -2.400.277.000 \$1.60 (\$4.425.300. If all capital outlays are funded from retained earnings and new borrowings and if Clynne follows a residual dividend policy. What are the required annual payments? a. b. Incorporated has just negotiated a 5-year term loan of \$8. d. \$3.000) = \$2.000.000 ANSWER: c SOLUTION: Capital outlays = debt funds raised plus equity retained = \$10 million + \$1.000 17.000 External equity needed: \$2.000. c.86 (cost) . \$1.219. c.000 \$2.000.000. Clynne has 10 million shares of common stock outstanding.70 for the year.000.000.263 ANSWER: d SOLUTION: KEYSTROKES: HP 8.400.0. The loan is fully amortized at an annual rate of interest of 12%. b.000.219.86 (cost) TI 8. and plans to pay a dividend of \$0.115. d. During the year Clynne expects to borrow \$10 million in addition to its already outstanding loan balances.000 \$23.600.000.000. what capital outlays are planned for the coming year? a. Sealtight.000.3(10 million shares) = \$23 million 18.000 \$2.000 -975.140 \$2.

c. b. Diebold Pulp and Paper has decided to raise FF20. \$452.000 .96.000 through a subscription of common stock.961.153.000 shares of common stock currently outstanding that sell for FF120 per share. The bonds would have a 10-year maturity. It has 2. What is the current price? If the yield-to-maturity remains constant.96 21.000) (0. \$582.420 Bond price. how large must the principal of the bond issue be? a.N) + (PAR) (PVIF i. b. \$592. \$893 ANSWER: a SOLUTION: VB = (0) (PVIFAi.N) VB = (\$1. and a 6% coupon rate even though the yield-to-maturity is expected to be 14%.000 200.420 Bond price.404) = \$404 V B = (\$1.8) = (\$1. b. \$404.000 20. principal.7) = (\$1. \$682.000. c. \$686. Bond price.96.420 Bond price.10) + (\$1. \$258. c. \$686.000.000. \$89 \$440.000) (0. It has decided to set the subscription price at FF100 per share.893) = \$893 20. principal.000) (0.961.000 par value and a maturity of 8 years has a yield-to-maturity of 12%.000) (DF 0. d.000) (PVIF 12%. d. \$893 \$304. \$582.000 par value. \$402. principal.19. \$582.420 ANSWER: c SOLUTION: VB = (Int) (PVIFAi.000.1) = (\$1.000 250.961.N) VB = (\$60) (PVIFA14%.452) = \$452 VB = (\$1.000) (0. \$883 \$414. How many shares must be issued to raise the desired amount of funds? a. \$1. Interest is paid annually.270) = \$582.96.000) (PVIF 12%. 225.96.216) + (\$1.N) + (PAR) (PVIF i. d. A zero coupon bond with a \$1. As an alternative to zero coupon bonds. what will be the bond's price 7 years before maturity? One year before maturity? a.10) VB = (\$60) (5. \$452. principal. What is the expected price of each bond? In order to raise the needed \$400.000) (PVIF 14%.12. \$452. Pacific Oil is considering the issuance of "deep discount" bonds.

000 How many shares outstanding does the firm have? What is the average price per share? a.ANSWER: c SOLUTION: KEYSTROKES: HP 20.000. Ohio Plastics has the following net worth on its balance sheet Common Stock (\$1.200.300.00 22.05 2.000. Inc.700.000 shares of common stock outstanding and total equity as given below: Preferred Stock (\$100 par \$2.000 value) .000.200.000 25.05 23.000.400. has 2.200. \$13.75 ANSWER: c SOLUTION: Number of Shares Outstanding = Common Stock/Par Value = \$3.000 \$28.25 2. d. \$13.000 = \$13. b.000.000.000.000.700.000 Average Price per Share = Net Worth/Number of Shares = \$28.250. c. \$13.300.50 per value) Contributed Capital In Excess-of-Par Net Worth \$3.000 [ 100 [=] ] TI 20.05 2. Missouri Valley Industries.200.200.00 Solution: 200. 1.000/\$1.000.50 = 2.000/2.000. \$13.000 [ 100 [=] ] Solution: 200.

000 Book Value = \$18.50 \$9. \$4.000.000.000.000. a.00 per share 24.000 -2. d. \$1.000.000 shares = \$9.000 Selling Price = \$8. \$470 \$705 \$740 \$750 ANSWER: b SOLUTION: Pc = Conversion Ratio x Current Market Price per Share Pc = 15 x \$47. b. c. convertible into common stock at \$20.00 par value) Capital Surplus Retained Earnings 2.000. The market price of the common stock is \$47.000 \$18.000/2.000. \$9 ANSWER: c SOLUTION: Total Equity Preferred Stock Common Equity \$20. Find the conversion price of a convertible \$1.000 6.000. c. b.000 Calculate the book value per share of its common stock. The market price of the common stock is \$18. Assuming that all 2.00 per share.000.000.000 10.000.000 bond with a conversion ratio of 15.00 per share.000.000.000 shares = \$4.000. \$4 \$12.000 6.800 \$800 \$900 \$180 .000/2.Common Stock (\$1. c. \$18.00 per share. d. d.00 = \$705 25.000 bond.000 Common Stock \$8.00 per share Common stock at par Capital surplus \$2. Find the conversion price for a convertible \$1.000 Total Equity \$20. b. what was the price per share at the time of issue? a.000. \$9 \$9.000 shares of common stock were sold at the same time. a.

000.000 (60.920.000 \$34.000.000.000 -13.880.35 27.000.000.000 x 0.000.000.8%.000 . find the EBIT. and EPS.000 \$72.8% EPS = \$20.000. 35%.880. 34.12) \$180.500.000.000/\$120.ANSWER: c SOLUTION: Pc = 50 x \$18.8%. 33. 35%. ROE.000.8%.000 shares = \$8.000. \$8.880.000 = 35% ROE = \$20. d.000 -108.500. \$20.000 BEP = \$42.000 with variable costs equal to 60% of sales and fixed operating costs of \$30.000. \$10.000.000 shares of common stock outstanding and interest on debt is 12%.000.000.000/2. Given that its cost of debt is 8%.880. c.800.000 -7. Its EPS and ROE are unaffected by changes in financial leverage. 34.000. \$34. a. \$20.000 -30. It has 2.000/\$60.200.35 \$42. \$42.000.000. BEP .35 \$42.000 \$42.000. 35%. 34.000 \$20.000.880. b. 25%.000.000 = 34.35 ANSWER: a SOLUTION: EBIT: Sales -Variable Costs -Fixed Costs EBIT NI: EBIT Interest EBT -Taxes NI \$42. find Winston's EBIT. Winston Products' total assets equal £75.8%.000.000. A firm has a capital structure that is half debt and half common equity and totals \$120. a.000. Sales are \$180.00 = \$900 26.880. NI. \$8. £800.880.000. \$20.000. \$8. If the corporate tax rate is 40%.000.35 \$72.000.500.

000 next year before interest and taxes. Management expects the firm to earn \$1. ROE. Standex Products has estimated that its after-tax cost of debt is 6% and its cost of common equity is 16%.000)/(0.000 shares of common stock selling at \$50 per share. 15% ANSWER: c SOLUTION: 100% Equity Financed: Assets \$10.08) = £6. 7.000 EBIT = (£75.000.000. What is the expected earnings per share (EPS) and return on equity (ROE) at next year's expected level of EBIT if the firm remains 100% equity financed? a. \$3.000 Debt Equity Shares EBIT Interest EBT -Taxes NI ----------10. c.000. EPS.500.000 29. ROE.000 financed entirely with 200.000. The firm's tax rate is 50%.50.000 £7. \$37.000 \$1. 16% 14% .b. c. \$7.000 28.000 ANSWER: c SOLUTION: EPS and ROE will be unaffected by changes in financial leverage only when kd = BEP: BEP = EBIT/ Total Assets 0.000 ----------\$1. d.75. \$75.000.000 £6. Calculate its weighted average cost of capital. The firm would alter its capital structure by borrowing funds at an interest rate of 12% and repurchasing shares at \$50 per share.50. b.5% EPS. 15% EPS. b. ROE.000 \$750.000.08 = EBIT/£75. Standex expects to continue a policy of borrowing 30% of its needed capital with the remainder provided by common equity. £600.000. a.000 200. ROE. The management of ACM Corporation is evaluating a change in the capital structure of the firm to benefit from the effects of financial leverage. The firm currently has assets of \$10. d.5% EPS.000 -750. 7.500.000.500.

11 [ '] [ ) ] [ 36 [+] . b.130 = 13% 30. d.06)(0. EBIT is expected to be \$1.000 shares of common stock outstanding. \$50. c.c.7% 11% 1. Ametek Shipping's last annual dividend was DM2. and the market price of the stock one year from now. \$50. Its common stock is selling for DM36.16)(0. 13% 12% ANSWER: c SOLUTION: WACC= (Wd) (kd)(I-T) + (Ws) (Ks) = (0. d.7 31. 7.5 [x] [ ( ] 1 [+] .112 = 0. Because it has no plans for reinvestment.87% 18. c.5 [x] [ '] [ ( ] 1 [+] . \$60 \$5.11 [=] Solution: 18.70) = 0. \$60 \$6. If analysts are projecting 11% growth in earnings and dividends for the foreseeable future. \$60. \$6. \$60 \$4.11 [ ) ] [ 36 [+] . Calculate the dividend per share each year.00 per share. a.018 + 0.11 [=] ] Solution: 18. the current market price for Barnes' stock. \$60 .000. it has 100. There is no debt in Barnes capital structure.7 ] TI 2. and the corporate tax rate is 40%.30) + (0. what is Ametek Shipping's cost of common equity? a. The next dividend is one year from now. b. \$60.50 per share. The required rate of return on equity is 10%.7% ANSWER: d SOLUTION: KEYSTROKES: HP 2. Barnes Corporation is expected to continue paying out 100% of its earnings as a dividend.000 per year indefinitely. d.

000. ¥135. ¥450. all shares before. The board has just declared a 20% stock dividend. b.000 After dividend. d. all shares after.750. all shares after.000 \$600. all shares after.000.000 \$6. Rikon KK has 3. all shares before.held by an investor who owned 100 shares prior to the dividend.ANSWER: a SOLUTION: Year 1 EBIT Taxes NI Shares EPS Payout Ratio ks \$1.00)(1.00 1 = DPS/k = \$6.000 After dividend.00/0. ¥250. After dividend.000.000.000. and the total value of all shares of stock .00 100% 10% Dividend per Share = EPS x Payout Ratio DPS 1. so is the market price of the stock. If all other factors affecting the stock's price remain unchanged.000 After dividend. all shares before.00) = \$6. ¥3.600. ¥3. so the valuation formula used is identical to the perpetuity formula.000 ANSWER: d SOLUTION: .00 Since the EPS and DPS are constant over time. a. calculate the market price per share after the stock dividend.000 shares of stock outstanding selling for 4500 per share.10 = \$60. ¥450.= (\$6. ¥450. c. ¥375. This is a nogrowth stock.750. 32.00 0 = DPS/k = \$6. all shares after.10 = \$60.before and after the dividend . ¥375.000 400. ¥3.500. all shares before.000 100.00/0.000. ¥4. ¥375.