61) A company is going to issue a $1,000 par value bond that pays a 7% annual coupon.

The company
expects investors to pay $942 for the 20-year bond. The expected flotation cost per bond is $42, and the
firm is in the 34% tax bracket. Compute the following:
a. the yield to maturity on the firm's bonds
b. the firm's after-tax cost of existing debt
c. the firm's after-tax cost of new debt
Answer:
a. YTM = 7.57%
b. After-tax cost of existing debt = 7.57% × (1 - .34) = 5%
c. After-tax cost of new debt = 8.02% × (1 - .34) = 5.29%
Diff: 2 Page Ref: 297
Keywords: After-tax Cost of Debt, Yield to Maturity, Flotation Costs

62) Toto and Associates' preferred stock is selling for $27.50 a share. The firm nets $25.60 after issuance
costs. The stock pays an annual dividend of $3.00 per share. What is the cost of existing, and new,
preferred stock respectively?
Answer: Cost of existing preferred stock = $3.00/$27.50 = 10.91%
Cost of new preferred stock = $3.00/$25.60 = 11.72%
Diff: 2 Page Ref: 300
Keywords: Cost of Existing Preferred Stock, Cost of New Preferred Stock
63) Sutter Corporation's common stock is selling for $16.80 a share. Last year Sutter paid a dividend of
$.80. Investors are expecting Sutter's dividends to grow at an annual rate of 5% per year. What is the cost
of internal equity?
Answer: D1 = $.80 × 1.05 = $.84
Cost of internal equity = $.84/$16.80 + .05 = 10%
Diff: 2 Page Ref: 302
Keywords: Cost of Retained Earnings

64) Gibson Industries is issuing a $1,000 par value bond with an 8% annual interest coupon rate that
matures in 11 years. Investors are willing to pay $972, and flotation costs will be 9%. Gibson is in the
34% tax bracket. What will be the after-tax cost of new debt for the bond?
Answer: 9.76% × (1 - .34) = 6.44%
Diff: 2 Page Ref: 297
Keywords: After-tax Cost of Debt, Flotation Costs

65) The preferred stock of Wells Co. sells for $17 and pays a $1.75 dividend. The net price of the stock
after issuance costs is $15.30. What is the cost of capital for new preferred stock?
Answer: $1.75/$15.30 = 11.44%
Diff: 1 Page Ref: 300
Keywords: Cost of Preferred Stock

66) Glenna Gayle common stock sells for $55, and dividends paid last year were $1.35. Flotation costs on
issuing stock will be 8% of the market price. The dividends are predicted to have a 10% growth rate.
What is the cost of internal equity, and new equity, respectively for Glenna Gayle?
Answer: D1 = $1.35 × 1.1 = $1.49
Cost of internal equity = $1.49/$55 + .1 = 12.71%
Cost of new equity = $1.49/($55 × .92) + .1 = 12.94%
Diff: 2 Page Ref: 302
Keywords: Cost of Retained Earnings, Cost of New Common Stock, Flotation Costs

67) Toombes, Inc. is issuing new common stock at a market price of $55. Dividends last year were $3.30
per share and are expected to grow at a rate of 6%. Flotation costs will be 5% of the market price. What is
Toombes' cost of retained earnings, and new equity, respectively?
Answer: D1 = $3.30 × 1.06 = $3.50
Cost of retained earnings = $3.50/$55 + .06 = 12.36%
Cost of new equity = $3.50/($55 × .95) + .06 = 12.70%
Diff: 2 Page Ref: 302
Keywords: Cost of Retained Earnings, Cost of New Common Stock, Flotation Costs
Learning Objective 9.3

14) A firm's weighted average cost of capital is determined using all of the following inputs EXCEPT
A) the firm's capital structure.
B) the amount of capital necessary to make the investment.
C) the firm's after-tax cost of debt.
D) the probability distribution of expected returns.
Answer: D
Diff: 1 Page Ref: 307
Keywords: Weighted Average Cost of Capital

15) Cost of capital is commonly used interchangeably with all of the following terms EXCEPT
A) the firm's required rate of return.
B) the hurdle rate for new investments.
C) the internal rate of return for new investments.
D) the firm's opportunity cost of funds.
Answer: C
Diff: 1 Page Ref: 307
Keywords: Cost of Capital, Required Rate of Return, Hurdle Rate, Opportunity Cost of Funds

16) Baxter Inc. has a target capital structure of 30% debt, 15% preferred stock, and 55% common equity.
The company's after-tax cost of debt is 7%, its cost of preferred stock is 11%, its cost of retained earnings
is 15%, and its cost of new common stock is 16%. The company stock has a beta of 1.5 and the
company's marginal tax rate is 35%. What is the company's weighted average cost of capital if retained
earnings are used to fund the common equity portion?
A) 11.20%
B) 12.00%
C) 13.80%
D) 14.45%
Answer: B
Diff: 2 Page Ref: 310
Keywords: Weighted Average Cost of Capital

17) GHJ Inc. is investing in a major capital budgeting project that will require the expenditure of $16
million. The money will be raised by issuing $2 million of bonds, $4 million of preferred stock, and $10
million of new common stock. The company estimates is after-tax cost of debt to be 7%, its cost of
preferred stock to be 9%, the cost of retained earnings to be 14%, and the cost of new common stock to be
17%. What is the weighted average cost of capital for this project?
A) 12.20%
B) 13.12%
C) 13.75%
D) 14.23%
Answer: C
Diff: 2 Page Ref: 310
18) Coyote Inc. operates three divisions. One division involves significant research and development, and
thus has a high-risk cost of capital of 15%. The second division operates in business segments related to
Coyote's core business, and this division has a cost of capital of 10% based upon its risk. Coyote's core
business is the least risky segment, with a cost of capital of 8%. The firm's overall weighted average cost
of capital of 11% has been used to evaluate capital budgeting projects for all three divisions. This
approach will
A) favor projects in the core business division because that division is the least risky.
B) favor projects in the related businesses division because the cost of capital for this division is the
closest to the firm's weighted average cost of capital.
C) favor projects in the research and development division because the higher risk projects look more
favorable if a lower cost of capital is used to evaluate them.
D) not favor any division over the other because they all use the same company-wide weighted average
cost of capital.
Answer: C
Diff: 1 Page Ref: 308
Keywords: Weighted Average Cost of Capital, Risk-Return Tradeoff