ACF 103 – Fundamentals of Finance

Tutorial 9 - Questions
Chapter 15
1. The capital structure of Golden Gate Windsurfing, Inc. (given in terms of both
book value and market value) is as follows:

BOOK VALUE MARKET VALUE

Bonds $15,000,000 $13,000,000
Preferred stock 2,000,000 2,500,000
Common stock equity9,000,000 18,500,000
Retained earnings 4,000,000
TOTALS $30,000,000 $34,000,000

In addition: 1) its bonds currently provide a yield to maturity of 10%;

preferred stock is yielding 9%; common stock is yielding 13%; 2) its marginal
tax rate is 40%; and 3) its capital structure is considered optimal. The firm's
weighted average cost of capital is closest to ________.
A. 11.6%
B. 11.2%
C. 10.0%
D. 9.2%

2. The beta coefficient for ZZZ, Inc. is 1.0. If the risk-free rate is 8% and the
required return on stocks in general is 16%, the required return for ZZZ is
closest to ________.
A. 10%
B. 11%
C. 12%
D. 16%

3. The required rate of return on the bonds of the EAP Corporation is 12%. The
firm's beta coefficient is 1.2, the risk-free rate is 8%, and the required rate of
return on stocks in general is 14%. If the firm's marginal tax rate is 40%, and it
will be financing projects with a 50-50 debt to equity mix, find its weighted
average cost of capital.

4. Bay City Enterprises is considering the purchase of equipment costing

$800,000, which promises to generate after-tax cash flows of $150,000
annually for the next 10 years. The firm has a weighted average cost of capital
of 12%. For this project, the financial manager plans to provide $200,000 from
a new bond issue and $300,000 from a new stock issue. The balance of the
financing would come from retaining earnings. The after-tax flotation costs on
the debt issue will be 3% of the amount raised, while the common stock issue
will carry flotation costs of 10%. Should the firm purchase the new piece of
equipment?

5. Text book Ch 15, problem # 1 (p.412). This problem is asking you to develop
the general algebraic formula for calculating the weighted average cost of
capital.

ACF 103 HAUT 2015 Tutorial 9 1

6. Text book Ch 15, problem # 2 (p.412)

Homework problem
7. Text book Ch 15, problem # 3 (p.412)

8. Text book Ch 15, problem # 4 (p.412) (Hint: The answer lies between 12%
and 14%)

ACF 103 HAUT 2015 Tutorial 9 2