Name: ______________________________________________ Section:___________________ Score: /65 (FINMAN QUIZ 2)

Multiple choice. (2 pts each)

____1. A group of individuals got together and purchased all of the outstanding shares of common stock of DL Smith, Inc. What is the
return that these individuals require on this investment called?
A. dividend yield C. capital gains yield
B. cost of equity D. cost of capital

____2. The average of a firm's cost of equity and after tax cost of debt that is weighted based on the firm's capital structure is called the:
A. reward to risk ratio. C. structured cost of capital.
B. weighted capital gains rate. D. weighted average cost of capital.

____3. The weighted average cost of capital for a wholesaler:

A. is equivalent to the after tax cost of the firm's liabilities.
B. should be used as the required return when analyzing a potential acquisition of a retail outlet.
C. is the minimum return investors require on the total assets of the firm.
D. remains constant when the debt-equity ratio changes.

____4. A firm's overall cost of equity is:

A. is generally less that the firm's WACC given a leveraged firm.
B. unaffected by changes in the market risk premium.
C. highly dependent upon the growth rate and risk level of the firm.
D. generally less than the firm's after tax cost of debt.

____5. The pre-tax cost of debt:

A. is based on the current yield to maturity of the firm's outstanding bonds.
B. is equal to the coupon rate on the latest bonds issued by a firm.
C. is equivalent to the average current yield on all of a firm's outstanding bonds.
D. is based on the original yield to maturity on the latest bonds issued by a firm.

____6. Morris Industries has a capital structure of 55 percent common stock, 10 percent preferred stock, and 45 percent debt. The firm
has a 60 percent dividend payout ratio, a beta of 0.89, and a tax rate of 38 percent. Given this, which one of the following statements is
correct?
A. The aftertax cost of debt will be greater than the current yield-to-maturity on the firm's bonds.
B. The firm's cost of preferred is most likely less than the firm's actual cost of debt.
C. The firm's cost of equity is unaffected by a change in the firm's tax rate.
D. The cost of equity can only be estimated using the SML approach.

____7. The after tax cost of debt:

A. varies inversely to changes in market interest rates.
B. will generally exceed the cost of equity if the relevant tax rate is zero.
C. will generally equal the cost of preferred if the tax rate is zero.
D. has a greater effect on a firm's cost of capital when the debt-equity ratio increases.

____8. Chelsea Fashions is expected to pay an annual dividend of $0.80 a share next year. The market price of the stock is $22.40 and
the growth rate is 5 percent. What is the firm's cost of equity?
A. 7.58 percent C. 8.24 percent
B. 7.91 percent D. 8.57 percent

____9. Nelson's Landscaping has 1,200 bonds outstanding that are selling for P990 each. The company also has 2,500 shares of preferred
stock at a market price of P28 a share. The common stock is priced at P37 a share and there are 28,000 shares outstanding. What is the
weight of the common stock as it relates to the firm's weighted average cost of capital?
A. 43.08 percent
B. 45.16 percent
C. 47.11 percent
D. 54.00 percent

____10. Jungle, Inc. has a target debt-equity ratio of 0.72. Its WACC is 11.5 percent and the tax rate is 34 percent. What is the cost of
equity if the aftertax cost of debt is 5.5 percent?
A. 13.75 percent
B. 13.84 percent
C. 14.41 percent
D. 15.82 percent.
Problems. (3 points per answer)
1. Tulfo Brothers Inc. is planning to use retained earnings to finance anticipated capital expenditures. The beta coefficient for its stock
is 1.5, the risk free rate of the interest is 8.5% and the market return is estimated at 12.4%. If a new issue of common stock were
used in this model the flotation costs would be 7%. By using the Capital Asset Pricing Model:

a. find the cost of the Retained Earnings?____________________

b. if the return on the market portfolio is 10% and the risk free rate is 5%, what is the effect on the company’s
required rate of return on its stock if the beta will increase from 1.2 to 1.5? _________________

2. Mimiyuh Inc. has a weighted average cost of capital of 11.5%. Its target capital structure is 55% equity and the rest is debt. The
company has sufficient retained earnings to fund the equity portion of its capital budget. The before tax cost of debt s 9% and
company’s tax rate is 30%. If the expected dividend next period is P5 and the current stock price is P45, what is the company’s
growth rate? _______________________

3. Alyas Linda Co. has determined that its optimal capital structure consists of 40% debt and the remaining for equity. Assume the firm
will NOT have enough retained earnings to fund the equity portion of its capital budget. Given the following information below:
Yield to Maturity = 10%
Plowback Ratio = 40%
Tax Rate = 25%
Sales = P100,000
Price per share = P30
Outstanding shares = 20,000
Total Cost = P40,000
Flotation Cost per share = 5.00

a. Find the KdAT = ________________

b. Find the KRE, zero growth rate= _________________
c. Find the WACC = _______________
d. From the preceding numbers, calculate the growth of the capital assuming that the Debt to Asset Ratio is 0.5 with Total
Assets amounting to P800,000. ___________________
e. Find the WACC based from the given in (d) ________________

4. Killer Bride Co. has a capital structure with a Debt to Equity Ratio of 0.70. In order to calculate the WACC, an analyst has
accumulated the following information:
- The company currently has a 5 yr bonds outstanding with annual coupon rate of 9%. Bonds have a face value of
P1000 and selling for P900. The company’s net of tax portion is 75%.
- The risk-free rate is 5%
- The market rate of return is 10 percent on top of the risk free rate.
- The beta on this stock is 1.1
- The company’s retained earnings is sufficient so that they won’t be issuing new shares to raise capital.

__________a. What is the company’s Cost of Debt After Tax?

__________b. What is the company’s Cost of Retained earnings?
__________c. What is the WACC?

5. Gold Squad Company is estimating its WACC using the following information below:
- Its capital structure consists of 60% equity equally divided for preferred and common shares, and the remaining
portion is for the debt.
- The company has a 20-year outstanding bonds with 9% coupon rate trading at par.
- The market premium is at 5% and the market rate of return is 10.5%. Stocks beta is 1.4
- The company’s tax rate is 40%
- The preferred stocks are currently selling at P40 each with constant growth rate of 5%. Last dividend paid 2 years
ago was P2.00 and the cost of issuance is 20% of the price.

__________a. What is the company’s Cost of Debt After Tax?

__________b. What is the company’s Cost of Retained earnings?
__________c. What is the company’s Cost of Preferred Stock?
__________d. What is the WACC?