WORKSHEET

1. MN Co. issues a $ 10,000, 8%, 20 year bond whose proceeds are $9,400. The tax rate is 40%.
What is the before tax and after tax cost of these bonds?
2. Ayenew Company’s financing plans for next year include the sale of long-term bonds with a 10% coupon.
The company believes it can sell the bonds at a price that will provide a YTM/before tax cost of debt is 12%
to investors. If it’s marginal tax rate is 35%.
What is Ayenew’s after-tax cost of debt?
3. Sefa Computer Systems Company has just issued preferred stock. The stock has 12% annual dividend and
Br. 100 par value and was sold at 102% of the par value. In addition, flotation costs of Br. 2.50 per share
must be paid.
Calculate the cost of the preferred stock.
4. An issue of common stock is sold to investors for Br. 20 per share. The issuing corporation incurs a selling
expense of Br. 1 per share. The current dividend is Br. 1.50 per share and it is expected to grow at 6%
annual rate.
Compute the specific cost of this common stock issue.
5. Zeila Auto Spare Parts Manufacturing Company expects to pay a common stock dividend of Br. 2.50 per
share during the next 12 months. The firm’s current common stock price is Br. 50 per share and the
expected dividend growth rate is 7%. A flotation cost of Br. 3 is involved to sale a share of common stock.
Required: Compute the cost of retained earnings
6. RAYA Textiles Share Company wishes to measure its cost of retained earnings. The firm’s stock is
currently selling for Br. 57.50. The firm expects to pay Br. 3.40 dividend at the end of the year. The
expected dividend growth rate is 8%.
Required: Determine the cost of retained earnings.
7. Muna Tools Manufacturing Company’s financial manager wants to compute the firm’s weighted average
cost of capital. The book and market values of the amounts as well as specific after-tax costs are shown in
the following table for each source of capital.

Source of capital Book value Market value Specific cost

Debt Br. 1,050,000 Br. 1,000,000 5.3%
Preferred stock 84,000 125,000 12.0
Common equity 966,000 1,375,000 16.0
Total Br. 2,100,000 Br. 2,500,000

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Required: Calculate the firm’s weighted average cost of capital using:

a. book value weights

b. market value weights

8. Suppose a corporation has book value of each type of capital in the capital structure as follows:

Source of capital Book value Specific cost

Bonds (100 par, 9.5% coupon) 15,000 4%

Preferred stock (200 shares at birr 25par) 5,000 8%

Common stock (1,000 shares at birr 20 par) 20,000 11.5%

Retained earnings 10,000 11%

Total 50,000

Required: Compute the WACC for the corporation if the corporation obtains new capital in book value
proportions.

9. Suppose ABC Corporation has a target capital structure calling for 35 percent debt, 15 percent preferred
stock, and 25 percent retained earnings and 25 percent common stock. It’s before-tax cost of debt, Kd, is 10
percent; its after-tax cost of debt = Kd (1-T) = 10% (1-0.3) = 7.0%; its cost of preferred stock, kp, is 8%
percent; its cost of new common stock, ke, is 12 percent; its cost of retained earnings, Kre, is 11 percent; its
tax rate is 30 percent.
Required: Calculate ABC’s weighted average cost of capital.
10. An investment has a net investment of Br 120,000 and annual cash flows of Br. 40, 000 for five years. If the
project has a maximum desired payback period of 4 years, compute the payback period and what would be
the decision rule?
11. Compute the payback period for the following cash flows, assuming a net investment of Br 200, 000

Year(t) 0 1 2 3 4 5
Yearly cash flows(Br) 0 80,000 60,000 40,000 12,000
20,000

What would be the decision rule if the specified PBP be four years?
12. Suppose the net earnings for the next four years are estimated to be Br 40, 000, Br 45, 000, Br 50, 000 and
Br 80, 000, respectively. If the initial investment is Br 200, 000, find the average rate of return.
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