[財管] HW5 Cost of Capital

Use the following information to answer the question(s) below.

Beta Volatility

"Eenie" 0.45 20%

"Meenie" 0.75 18%

"Miney" 1.05 35%

"Moe" 1.20 25%

Assume that the risk-free rate of interest is 3% and you estimate the market's expected return to be 9%.

1. Which firm has the highest cost of equity capital? (A) Eenie (B) Meenie (C) Miney (D) Moe

2. What is the cost of equity for Meenie? (A) 12%, (B) 7.5%, (C)9.75% (D) 9%

3. The market risk premium is (A)3% (B)9%, (C) 6%, (D) 4.5%

Market value Book value Cost of capital

Bond 100 100 8%

Stock 156 58 12%

4. When calculating WACC, the weight of bond is (A) 0.64 (B)1.72 (C) 0.39 (D) 0.63

5. WACC is equal to (A)9.4% (B) 5.1% (C) 10.4% (D) 9.5%

Luther Industries has 25 million shares outstanding trading at $18 per share. In addition, Luther has $150 million in outstanding debt. Suppose Luther's equity cost of capital is 13%, its debt cost of capital is 7%, and the corporate tax rate is 40%.

6. Luther's unlevered cost of capital is closest to: (A) 7.0% (B) 9.8% (C) 10.8% (D) 11.5%

7. Luther's after-tax debt cost of capital is closest to: (A) 4.2% (B) 5.4% (C) 7.0% (D) 9.8%

8. Luther's weighted average cost of capital is closest to: (A) 9.8% (B) 10.8% (C) 11.5% (D) 13.0%

9. Harrison Clothier’s stock currently sells for $20 a share. It just paid a dividend of $1.00 a share. The dividend is expected to grow at a constant rate of 6 percent a year. What stock return is expected ? (A)6%, (B)11.3%, (C)5.3%, (D)2.2%

10. Digital Media plans to change its capital structure from a debt-equity ratio of 38.90% to 69.91% equity and 30.09% debt. The marginal tax rate is 50%. The WACC for Digital Media is 16.45% and the new pre-tax cost of debt will be 7.42%. What will be the new cost of equity capital? A) 21.93, B) 19.90, C) 17.91, D) 15.92

sol:

1. D rE=rf+beta*(rM-rf)

2. B 3%+0.75*(9%-3%)=7.5%

3. C 9%-3%=6%

4. C 100/256=0.39

5. C 100/256*8+156/256*12=10.44

6. D 18*25/600*13+150/600*7=11.5

7. A 7*(1-0.4)=4.2

8. B 18*25/600*13+150/600*7*(1-0.4)=10.8

9. B 1.06/20+0.06=11.3%

10.A (16.45-0.3009*7.42*(1-0.5))/0.6991=21.93