Practice Problems #12

APEC 3501

1. Topstone Industries is expected to pay a dividend of $2.10 per share in one year. This dividend,
along with firm earnings, etc., is expected to grow at a rate of 5% forever. If the current market
price for a share of Topstone is $38.62 what is the cost of equity? [10.44%]

2. Long-term debt of Topstone Industries is currently selling for 104.5% of its face value. The issue
matures in 10 years and pays an annual coupon of 8% of face. What is the cost of debt for
Topstone? [7.35%]

3. Topstone Industries' preferred stock pays an annual dividend of $4.00 per share. When issued, the
shares sold for their par value of $100 per share. What is the cost of preferred stock if the current
price is $125 per share? [3.2%]

4. Suppose that Topstone Industries has a cost of equity of 14% and a cost of debt of 9%. If the target
debt/equity ratio is 75%, and the tax rate is 34%, what is Topstone's weighted average cost of
capital (WACC)? [10.5%]

5. A firm needs to raise $165 million for a project. If external financing is used, the firm faces
flotation costs of 8% for equity and 2.5% for debt. If the project is to be financed 60% with equity
and the rest with debt, how much cash must the firm raise in order to finance the project?
[$175.2 million]

6. Suppose a firm has 10.4 million shares of common stock outstanding with a par value of $1.00 per
share. The current market price per share is $12.00. The firm has outstanding debt with a par
value of $56.0 million selling at 102% of par. What weight would you use for debt when
computing the WACC? [0.314]

7. Treasury bills currently have a return of 3.5% and the market risk premium is 8%. If a firm has a
beta of 1.6, what is its cost of equity? [16.3%]

8. Rattle me Bones, Inc. sold a 20-year bond issue 12 years ago. It pays an 8% annual coupon and
has a $1,000 face value. If the current price per bond is $893.30, what is the firm's cost of debt?
[10.0%]

9. KCE Corporation is currently operating at its target capital structure with market values of
$110,000,000 in equity and $175,000,000 in debt outstanding. KCE plans to finance a new $32
million project using the same relative weights of debt and equity. Ignoring flotation costs, how
much new debt must be issued to fund the project? [$19.6 million]

10. Given the following information, what is JEM Inc.'s weighted average cost of capital? Market
value of equity = $50 million; market value of debt = $30 million; cost of equity = 16%; cost of
debt = 8%; equity beta = 1.25; tax rate = 34%. [11.98%]
(over)
11. Anthony's Anchovies, Inc. sold a 20-year bond issue 2 years ago. The issue has a 5.35% annual
coupon and a $1,000 face value. If the current market price per bond is $751.64 and the tax rate is
34%, what is the after-tax cost of debt? [5.3%]

12. Ponderosa Co. bonds sell for $846.04. The coupon rate is 8 percent and the bonds mature in 25
years. Assume interest is paid semiannually and the firm's tax rate is 34 percent. What is
Ponderosa's after-tax cost of debt? [6.36%]

13. A firm has 2,000,000 shares of common stock outstanding with a market price of $2.00 each. It
has 2,000 bonds outstanding, each with a market value of $1,200 (120% of face). The bonds
mature in 15 years, have a coupon rate of 10%, and pay coupons annually. The firm’s beta is 1.2,
the risk free rate is 5%, and the market risk premium is 7%. The tax rate is 34%. Compute the
WACC. [10.28%]

14. Given this information, what is the firm's cost of equity? [13.0%]
Date Dividend
December 31, 1985 3.50
December 31, 1986 3.68
December 31, 1987 3.95
December 31, 1988 4.29
December 31, 1989 4.32
January 2, 1990 Price = $60

15. Given the following information, what is WBM Corporation's WACC? [13.30%]
Common Stock: 1 million shares outstanding
$40 per share, $1 par value
β = 1.3
Bonds: 10,000 bonds outstanding
$1,000 face value for each bond
8% annual coupon
22 years to maturity
Market price = $1,101.23
Market risk premium = 8.6%
Risk-free rate = 4.5% Marginal tax rate = 34%

16. JLP Industries has 6.5 million shares of common stock outstanding with a market price of $14.00
per share. The company also has outstanding preferred stock with a market value of $10 million
and 25,000 bonds, each with a face value of $1,000 and each selling at 90% of face. The cost of
equity is 14%, the cost of preferred is 10%, and the cost of debt is 7.25%. If the tax rate is 34%,
what is JLP's WACC? [12.0%]