bus 320 connect homework 5
.
value:
1.00 points
Problem 102 Bond value [LO3]
Applied Software has $1,000 par value bonds outstanding at 16 percent interest. The bonds will mature in 20 years. Use Appendix B and Appendix D. 
Compute the current price of the bonds if the present yield to maturity is (Round "PV Factor" to 3 decimal places, intermediate and final answers to 2 decimal places. Omit the "$" sign in your response): 

Price of the 
(a) 8 percent 
$ 
(b) 14 percent 
$ 
(c) 11 percent 
$ 

2.
value:
1.00 points
Problem 104 Bond value [LO3]
Barry’s Steroids Company has $1,000 par value bonds outstanding at 14 percent interest. The bonds will mature in 40 years. 
If the percent yield to maturity is 12 percent, what percent of the total bond value does the repayment of principal represent? Use Appendix B and Appendix D. (Round intermediate calculations to 2 decimal places, "PV Factor" and final answer to 3 decimal places. Omit the "%" sign in your response.) 
Principal repayment 
% 
3.
value:
1.00 points
Problem 105 Bond value [LO3]
Essex Biochemical Co. has a $1,000 par value bond outstanding that pays 14 percent annual interest. The current yield to maturity on such bonds in the market is 9 percent. Use Appendix B and Appendix D. 
Compute the price of the bonds for these maturity dates (Round "PV Factor" to 3 decimal places, intermediate and final answers to 2 decimal places. Omit the "$" sign in your response): 

Price of the 
(a) 40 years 
$ 
(b) 17 years 
$ 
(c) 5 years 
$ 

4.
value:
2.00 points
Problem 108 Interest rate effect [LO3]
Refer to Table 101, which is based on bonds paying 10 percent interest for 20 years. Assume interest rates in the market (yield to maturity) go from 10 percent to 9 percent. 
(a) 
What was the bond price at 10 percent? (Round "PV Factor" to 3 decimal places, intermediate calculations and final answers to 2 decimal places. Omit the "$" sign in your response.) 
Bond price 
$ 
(b) 
What is the bond price at 9 percent? (Round "PV Factor" to 3 decimal places, intermediate calculations and final answers to 2 decimal places. Omit the "$" sign in your response.) 
Bond price 
$ 
(c) 
What would be your percentage return on the investment if you bought when rates were 10 percent and sold when rates were 9 percent? (Round "PV Factor" to 3 decimal places, intermediate calculations and final answers to 2 decimal places. Enter the value as positive value. Omit the "%" sign in your response.) 

% 
5.
value:
1.00 points
Problem 1011 Effect of maturity on bond price [LO3]
Refer to Table 102 
(a) 
Assume the interest rate in the market (yield to maturity) goes down to 8 percent for the 10 percent bonds. Using column 2, indicate what the bond price will be with a 5year, a 25year, and a 30year time period. (Round "PV Factor" to 3 decimal places, intermediate calculations and final answers to 2 decimal places. Omit the "$" sign in your response.) 
Maturity 
Bond price 
5 Years 
$ 
25 years 

30 years 


(b) 
Assume the interest rate in the market (yield to maturity) goes up to 12 percent for the 10 percent bonds. Using column 3, indicate what the bond price will be with a 5year, a 25year, and a 30year period. (Round "PV Factor" to 3 decimal places, intermediate calculations and final answers to 2 decimal places. Omit the "$" sign in your response.) 
Maturity 
Bond price 
5 Years 
$ 
25 years 

30 years 


(c) 
Assume the interest rate in the market (yield to maturity) goes down to 8 percent for the 10 percent bonds. If interest rates in the market are going down, which bond would you choose to own? 






(d) 
Assume the interest rate in the market (yield to maturity) goes up to 12 percent for the 10 percent bonds. If interest rates in the market are going up, which bond would you choose to own? 






6.
value:
1.00 points
Problem 1013 Effect of yield to maturity on bond price [LO3]
Tom Cruise Lines, Inc., issued bonds five years ago at $1,000 per bond. These bonds had a 30year life when issued and the annual interest payment was then 15 percent. This return was in line with the required returns by bondholders at that point as described below: 



Real rate of return 
5 
% 
Inflation premium 
6 

Risk premium 
4 




Total return 
15 
% 




Assume that five years later the inflation premium is only 2 percent and is appropriately reflected in the required return (or yield to maturity) of the bonds. The bonds have 25 years remaining until maturity. 
Compute the new price of the bond. Use Appendix B and Appendix D. (Round "PV Factor" to 3 decimal places, intermediate and final answer to 2 decimal places. Omit the "$" sign in your response.) 
New price 
$ 
7.
value:
2.00 points
Problem 1014 Analyzing bond price changes [LO3]
(a) 
Find the present value of 3 percent × $1,000 (or $30) for 25 years at 12 percent. The $30 is assumed to be an annual payment. Use Appendix D. (Round "PV Factor" to 3 decimal places, intermediate and final answer to 2 decimal places. Omit the "$" sign in your response.) 
Present value 
$ 
(b) 
Add the answer obtained in part a to 1,000. (Round "PV Factor" to 3 decimal places, intermediate and final answer to 2 decimal places. Omit the "$" sign in your response.) 
Present value 
$ 
8.
value:
2.00 points
Problem 1017 Deep discount bonds [LO3]
Lance Whittingham IV specializes in buying deep discount bonds. These represent bonds that are trading at well below par value. He has his eye on a bond issued by the Leisure Time Corporation. The $1,000 par value bond pays 7 percent annual interest and has 16 years remaining to maturity. The current yield to maturity on similar bonds is 12 percent. 
(a) 
What is the current price of the bonds? Use Appendix B and Appendix D. (Round "PV Factor" to 3 decimal places, intermediate and final answers to 2 decimal places. Omit the "$" sign in your response.) 
Current price 
$ 
(b) 
By what percent will the price of the bonds increase between now and maturity? (Round "PV Factor" to 3 decimal places, intermediate and final answers to 2 decimal places. Omit the "%" sign in your response.) 
Price increases by 
% 
9.
value:
1.00 points
Problem 1019 Approximate yield to maturity [LO3]
Bonds issued by the Tyler Food Corporation have a par value of $1,000, are selling for $1,570, and have 20 years remaining to maturity. The annual interest payment is 14.5 percent ($145). 
Compute the approximate yield to maturity. (Do not round intermediate calculations. Round your answer to 2 decimal places. Omit the "%" sign in your response.) 
Approximate yield to maturity 
% 
10.
value:
2.00 points
Problem 1022 Bond valuesemiannual analysis [LO3]
You are called in as a financial analyst to appraise the bonds of Olsen’s Clothing Stores. The $1,000 par value bonds have a quoted annual interest rate of 8 percent, which is paid semiannually. The yield to maturity on the bonds is 10 percent annual interest. There are 15 years to maturity. Use Appendix B andAppendix D. 
(a) 
Compute the price of the bonds based on semiannual interest payments. (Round "PV Factor" to 3 decimal places, intermediate and final answer to 2 decimal places. Omit the "$" sign in your response.) 
Price of the bonds 
$ 
(b) 
With 10 years to maturity, if yield to maturity goes down substantially to 8 percent, what will be the new price of the bonds? (Round "PV Factor" to 3 decimal places, intermediate and final answer to 2 decimal places. Omit the "$" sign in your response.) 
New price 
$ 
11.
value:
1.00 points
Problem 1024 Preferred stock value [LO4]
Bedford Mattress Company issued preferred stock many years ago. It carries a fixed dividend of $11 per share. With the passage of time, yields have gone down from the original 10 percent to 9 percent (yield is the same as required rate of return). 
(a) 
What was the original issue price? (Round your answer to 2 decimal places. Omit the "$" sign in your response.) 
Original price 
$ 
(b) 
What is the current value of this preferred stock?(Round your answer to 2 decimal places. Omit the "$" sign in your response.) 
Current value 
$ 
12.
value:
1.00 points
Problem 1026 Preferred stock rate of return [LO4]
Grant Hillside Homes, Inc., has preferred stock outstanding that pays an annual dividend of $14.20. Its price is $139. 
What is the required rate of return (yield) on the preferred stock? (Round your answer to 2 decimal places. Omit the "%" sign in your response.) 
Rate of return 
% 
13.
value:
1.00 points
Problem 1028 Common stock value [LO5]
Laser Optics will pay a common stock dividend of $3.20 at the end of the year (D_{1}). The required rate of return on common stock (K_{e}) is 20 percent. The firm has a constant growth rate (g) of 10 percent. 
Compute the current price of the stock (P_{0}). (Round your answer to 2 decimal places. Omit the "$" sign in your response.) 
Current price 
$ 
14.
value:
2.00 points
Problem 1029 Common stock value under different market conditions [LO5]
Ecology Labs, Inc., will pay a dividend of $3.75 per share in the next 12 months (D_{1}). The required rate of return (K_{e}) is 16 percent and the constant growth rate is 6 percent. (Each question is independent of the others.) 
(a) 
Compute the price of Ecology Labs' common stock. (Round your intermediate and final answer to 2 decimal places. Omit the "$" sign in your response.) 
Price 
$ 
(b) 
Assume K_{e}, the required rate of return, goes up to 19 percent; what will be the new price? (Round your intermediate and final answer to 2 decimal places. Omit the "$" sign in your response.) 
New price 
$ 
(c) 
Assume the growth rate (g) goes up to 10 percent; what will be the new price? K_{e }goes back to its original value of 16 percent. (Round your intermediate and final answer to 2 decimal places. Omit the "$" sign in your response.) 
New price 
$ 
(d) 
Assume D_{1} is $5.00; what will be the new price? Assume K_{e }is at its original value of 16 percent and g goes back to its original value of 6 percent. (Round your intermediate and final answer to 2 decimal places. Omit the "$" sign in your response.) 
New price 
$ 
15.
value:
2.00 points
Problem 1031 Common stock value based on determining growth rate [LO5]
Justin Cement Company had the following pattern of earnings per share over the last five years: 
Year 
Earnings 

2006 
$ 
9.00 

2007 
9.54 

2008 
10.11 

2009 
10.72 

2010 
11.36 


The earnings per share have grown at a constant rate (on a rounded basis) and is expected to do so in the future. Dividends represent 40 percent of earnings. 
(a) 
Project earnings and dividends for the next year (2011). (Round your intermediate and final answers to 2 decimal places. Omit the "$" sign in your response.) 
2011 

Earnings 
$ 

Dividend 
$ 


(b) 
If the required rate of return (K_{e}) is 13 percent, what is the anticipated stock price (P_{0}) at the beginning of 2011? (Round your intermediate and final answers to 2 decimal places. Omit the "$" sign in your response.) 
Anticipated stock price 
$ 
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16.
value:
1.00 points
Problem 1032 Common stock required rate of return [LO5]
A firm pays a $12.80 dividend at the end of year one (D_{1}), has a stock price of $88, and a constant growth rate (g) of 5 percent. 
Compute the required rate of return (K_{e}). (Round your intermediate and final answer to 2 decimal places. Omit the "%" sign in your response.) 
Rate of return 
% 
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17.
value:
4.00 points
Problem 1035 Common stock value based on PV calculations [LO5]
Beasley Ball Bearings paid a $4 dividend last year. The dividend is expected to grow at a constant rate of 6 percent over the next four years. The required rate of return is 19 percent (this will also serve as the discount rate in this problem). Use Appendix B. 
(a) 
Compute the anticipated value of the dividends for the next four years. (Round your intermediate calculations and final answers to 3 decimal places. Omit the "$" sign in your response.) 

Anticipated 
D_{1} 
$ 
D_{2} 
$ 
D_{3} 
$ 
D_{4} 
$ 

(b) 
Calculate the present value of each of the anticipated dividends at a discount rate of 19 percent.(Round "PV Factor", intermediate calculations and final answers to 3 decimal places. Omit the "$" sign in your response.) 

PV of 

D_{1} 
$ 

D_{2} 


D_{3} 


D_{4} 





Total 
$ 





(c) 
Compute the price of the stock at the end of the fourth year (P_{4}). (Round "PV Factor", intermediate calculations and final answer to 3 decimal places. Omit the "$" sign in your response.) 
Price of the stock 
$ 
(d) 
Calculate the present value of the year 4 stock price at a discount rate of 19 percent. (Round "PV Factor", intermediate calculations and final answer to 3 decimal places. Omit the "$" sign in your response.) 
Price of the stock (discounted) 
$ 
(e) 
Compute the current value of the stock. (Round "PV Factor", intermediate calculations and final answer to 3 decimal places. Omit the "$" sign in your response.) 
Current value 
$ 
(f) 
Use formula given below to show that it will provide approximately the same answer as part e. (Omit the "$" sign in your response.) 
P_{0} 
= 
D_{1} 
K_{e} − g 
Current value 
$ 
(g) 
If current EPS is equal to $5.700 and the P/E ratio is 1.2 times higher than the industry average of 5, what would the stock price be? (Round your intermediate calculations and final answers to 2 decimal places. Omit the "$" sign in your response.) 
Stock price 
$ 
(h) 
By what dollar amount is the stock price in part g different from the stock price in part f? (Input the amount as a positive value. Round intermediate calculations and final answer to 2 decimal places. Omit the "$" sign in your response.) 
Amount 
$ 
(i) 
In regard to the stock price in part f, indicate which direction it would move if 



(1) 
D_{1} increases 

(2) 
K_{e} increases 

(3) 
g increases 


rev: 10_18_2012
18.
value:
1.00 points
Problem 112 Cost of capital [LO2]
Speedy Delivery Systems can buy a piece of equipment that should provide an 8 percent return and can be financed at 5 percent with debt. The CEO likes earning more than the cost of debt, and he thinks this would be a good deal. The firm can also buy a machine that would yield a 16 percent return but would cost 18 percent to finance through common equity. Earning less than the cost of equity sounds bad to the CEO. Assume debt and common equity each represent 50 percent of the firm’s capital structure. 
(a) 
Compute the weighted average cost of capital. (Round your intermediate and final answers to 1 decimal place. Omit the "%" sign in your response.) 
Weighted average cost of capital 
% 
(b) 
Which project(s) should be accepted? 






19.
value:
1.00 points
Problem 113 Effect of discount rate [LO2]
A brilliant young scientist is killed in a plane crash. It was anticipated that he could have earned $210,000 a year for the next 20 years. The attorney for the plaintiff’s estate argues that the lost income should be discounted back to the present at 4 percent. The lawyer for the defendant’s insurance company argues for a discount rate of 15 percent. 
What is the difference between the present value of the settlement at 4 percent and 15 percent? Compute each one separately. Use Appendix D. (Round "PV Factor" to 3 decimal places. Round your answers to the nearest dollar amount. Omit the "$" sign in your response) 

Present value 

PV at 4% rate 
$ 

PV at 15% rate 





Difference 
$ 





20.
value:
1.00 points
Problem 115 Aftertax cost of debt [LO3]
Calculate the aftertax cost of debt under each of the following conditions. (Round your answers to 2 decimal places. Omit the "%" sign in your response.) 
Yield 
Corporate 
Cost of debt 

a. 
7.0 
% 
31 
% 
% 

b. 
14.0 



25 






c. 
15.5 



25 







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21.
value:
1.00 points
Problem 117 Aftertax cost of debt [LO3]
The Goodsmith Charitable Foundation, which is taxexempt, issued debt last year at 9 percent to help finance a new playground facility in Los Angeles. This year the cost of debt is 25 percent higher; that is, firms that paid 11 percent for debt last year will be paying 13.75 percent this year. 
(a) 
If the Goodsmith Charitable Foundation borrowed money this year, what would the aftertax cost of debt be, based on its cost last year and the 25 percent increase? (Round your answer to 2 decimal places. Omit the "%" sign in your response.) 
Cost of debt 
% 
(b) 
If the receipts of the foundation were found to be taxable by the IRS (at a rate of 35 percent because of involvement in political activities), what would the aftertax cost of the debt be? (Round your answer to 2 decimal places. Omit the "%" sign in your response.) 
Cost of debt

22.
value:
1.00 points
Problem 119 Approximate yield to maturity and cost of debt [LO3]
Airbone Airlines, Inc., has a $1,000 par value bond outstanding with 30 years to maturity. The bond carries an annual interest payment of $100 and is currently selling for $880. Airbone is in the 25 percent tax bracket. The firm wishes to know what the aftertax cost of a new bond issue is likely to be. The yield to maturity on the new issue will be the same as the yield to maturity on the old issue because the risk and maturity date will be similar. 
(a) 
Compute the approximate yield to maturity on the old issue and use this as the yield for the new issue.(Do not round intermediate calculations. Round your answer to 2 decimal places. Omit the "%" sign in your response.) 
Yield on new issue 
% 
(b) 
Make the appropriate tax adjustment to determine the aftertax cost of debt. (Do not round intermediate calculations. Round your answer to 2 decimal places. Omit the "%" sign in your response.) 
Cost of debt 
% 
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23.
value:
1.00 points
Problem 1111 Changing rates and cost of debt [LO3]
Russell Container Corporation has a $1,800 par value bond outstanding with 20 years to maturity. The bond carries an annual interest payment of $111 and is currently selling for $1,200 per bond. Russell Corp. is in a 20 percent tax bracket. The firm wishes to know what the aftertax cost of a new bond issue is likely to be. The yield to maturity on the new issue will be the same as the yield to maturity on the old issue because the risk and maturity date will be similar. Assume that the yield on the bonds goes up by 1 percentage point and that the tax rate is now 39 percent. 
(a) 
What is the new aftertax cost of debt? (Hint: Use the approximate yield to maturity to compute aftertax cost of debt) (Round your answer to 2 decimal places. Omit the "%" sign in your response.) 
Cost of debt 
% 
(b) 
Has the aftertax cost of debt gone up or down? 






24.
value:
2.00 points
Problem 1112 Realworld example and cost of debt [LO3]
KFW is planning to issue debt that will mature in the year 2012. In many respects the issue is similar to currently outstanding debt of the corporation. Using Table 112, identify: 
(a) 
The yield to maturity on similarly outstanding debt for the firm, in terms of maturity. (Round your answer to 2 decimal places. Omit the "%" sign in your response.) 
Yield 
% 
(b) 
Calculate yield to maturity with an increase of 0.25 percent than the value determined in part a. (Round your answer to 2 decimal places. Omit the "%" sign in your response.) 
Yield 
% 
(c) 
If the firm is in a 40 percent tax bracket, what is the aftertax cost of debt for yield determined in part b?(Round your answer to 2 decimal places. Omit the "%" sign in your response.) 
Cost of debt 
% 
rev: 07212011
25.
value:
1.00 points
Problem 1114 Cost of preferred stock [LO3]
The Meredith Corporation issued $100 par value preferred stock 10 years ago. The stock provided an 10 percent yield at the time of issue. The preferred stock is now selling for $70. (Disregard flotation costs.) 
What is the current yield or cost of preferred stock? (Round your answer to 2 decimal places. Omit the "%" sign in your response.) 
Yield 
% 
26.
value:
2.00 points
Problem 1115 Comparison of the costs of debt and preferred stock [LO3]
The treasurer of Riley Coal Co. is asked to compute the cost of fixed income securities for her corporation. Even before making the calculations, she assumes the aftertax cost of debt is at least 1 percent less than that for preferred stock. 
Debt can be issued at a yield of 8.6 percent, and the corporate tax rate is 30 percent. Preferred stock will be priced at $54 and pay a dividend of $3.80. The flotation cost on the preferred stock is $2. 
(a) 
Compute the aftertax cost of debt. (Round your answer to 2 decimal places. Omit the "%" sign in your response.) 
Aftertax cost of debt 
% 
(b) 
Compute the aftertax cost of preferred stock. (Round your answer to 2 decimal places. Omit the "%" sign in your response.) 
Aftertax cost of preferred stock 
% 
(c) 
Based on the facts given above, is the treasurer correct? 






27.
value:
2.00 points
Problem 1117 Costs of retained earnings and new common stock [LO3]
Compute K_{e} and K_{n} under the following circumstances: 
(a) 
D_{1} = $8.00, P_{0} = $82, g = 7%, F = $6.00. (Round your intermediate and final answers to 2 decimal places. Omit the "%" sign in your response.) 


K_{e} 
% 
K_{n} 
% 

(b) 
D_{1} = $0.50, P_{0} = $46, g = 3%, F = $4.50. (Round your intermediate and final answers to 2 decimal places. Omit the "%" sign in your response.) 


K_{e} 
% 
K_{n} 
% 

(c) 
E_{1} (earnings at the end of period one) = $13, payout ratio equals 40 percent, P_{0} = $46, g = 3.5%, F = $2.10. (Round your intermediate and final answers to 2 decimal places. Omit the "%" sign in your response.) 


K_{e} 
% 
K_{n} 
% 

(d) 
D_{0} (dividend at the beginning of the first period) = $6, growth rate for dividends and earnings (g) = 4%, P_{0}= $72, F = $3. (Round your intermediate and final answers to 2 decimal places. Omit the "%" sign in your response.) 


K_{e} 
% 
K_{n} 
% 

28.
value:
1.00 points
Problem 1119 Weighted average cost of capital [LO1]
United Business Forms’ capital structure is as follows: 



Debt 
40 
% 
Preferred stock 
15 

Common equity 
45 


The aftertax cost of debt is 11 percent, the cost of preferred stock is 14 percent, and the cost of common equity (in the form of retained earnings) is 17 percent. 
Calculate United Business Forms’ weighted cost of each source of capital and the weighted average cost of capital. (Round your answers to 2 decimal places. Omit the "%" sign in your response.) 

Weighted cost 

Debt (K_{d}) 

% 
Preferred stock (K_{p}) 


Common equity (K_{e}) 





Weighted average cost of capital (K_{a}) 

% 




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29.
value:
2.00 points
Problem 1121 Weighted average cost of capital [LO1]
Sauer Milk, Inc., wants to determine the minimum cost of capital point for the firm. Assume it is considering the following financial plans: 

Cost 
Weights 

Plan A 






Debt 

5.0 
% 

20 
% 
Preferred stock 

10.0 


10 

Common equity 

14.0 


70 

Plan B 






Debt 

5.2 
% 

30 
% 
Preferred stock 

10.2 


10 

Common equity 

15.0 


60 

Plan C 






Debt 

6.0 
% 

40 
% 
Preferred stock 

15.7 


10 

Common equity 

11.6 


50 

Plan D 






Debt 

12.0 
% 

50 
% 
Preferred stock 

16.6 


10 

Common equity 

13.6 


40 


(a1) 
Compute the weighted average cost for four plans. (Round your intermediate and final answers to 2 decimal places. Omit the "%" sign in your response.) 

Weighted cost 
Plan A 
% 
Plan B 

Plan C 

Plan D 


(a2) 
Which of the four plans has the lowest weighted average cost of capital? 






(b) 
Among Plan C and Plan D, which has higher weighted average cost of capital. 



30.
value:
2.00 points
Problem 1125 Changes in cost and weighted average cost of capital [LO1]
ARod Manufacturing Company is trying to calculate its cost of capital for use in making a capital budgeting decision. Mr. Jeter, the vicepresident of finance, has given you the following information and has asked you to compute the weighted average cost of capital. 

The company currently has outstanding a bond with a 9.6 percent coupon rate and another bond with an 7.2 percent rate. The firm has been informed by its investment banker that bonds of equal risk and credit rating are now selling to yield 10.5 percent. The common stock has a price of $50 and an expected dividend (D_{1}) of $1.70 per share. The historical growth pattern (g) for dividends is as follows: 



1.39 

1.54 

1.70 
The preferred stock is selling at $70 per share and pays a dividend of $6.60 per share. The corporate tax rate is 30 percent. The flotation cost is 2.0 percent of the selling price for preferred stock. The optimum capital structure for the firm is 25 percent debt, 10 percent preferred stock, and 65 percent common equity in the form of retained earnings. 
(a) 
Compute the historical growth rate. (Round your intermediate calculations and your final answer to 2 decimal Places. Omit the "%" sign in your response.) 
Growth rate 
% 
(b) 
Compute the cost of capital for the individual components in the capital structure. (Round growth rate to nearest whole percent. Round your answers to 2 decimal places. Omit the "%" sign in your response.) 

Cost of capital 
Debt (K_{d}) 
% 
Preferred stock (K_{p}) 

Common equity (K_{e}) 


(c) 
Calculate the weighted cost of each source of capital and the weighted average cost of capital. (Round your intermediate calculations and final answers to 2 decimal places. Omit the "%" sign in your response.) 

Weighted cost 
Debt (K_{d}) 
% 
Preferred stock (K_{p}) 

Common equity (K_{e}) 



Weighted average cost of capital (K_{a}) 
% 



31.
value:
2.00 points
Problem 1126 Impact of credit ratings on cost of capital [LO3]
Northwest Utility Company faces increasing needs for capital. Fortunately, it has an Aa3 credit rating. The corporate tax rate is 35 percent. Northwest’s treasurer is trying to determine the corporation’s current weighted average cost of capital in order to assess the profitability of capital budgeting projects. 

Historically, the corporation’s earnings and dividends per share have increased about 4.6 percent annually and this should continue in the future. Northwest’s common stock is selling at $69 per share, and the company will pay a $6.20 per share dividend (D_{1}). 

The company’s $106 preferred stock has been yielding 6 percent in the current market. Flotation costs for the company have been estimated by its investment banker to be $4.00 for preferred stock. 

The company’s optimum capital structure is 35 percent debt, 10 percent preferred stock, and 55 percent common equity in the form of retained earnings. Refer to the table below on bond issues for comparative yields on bonds of equal risk to Northwest. 
Data on Bond Issues 

Issue 
Moody’s 

Price 
Yield to maturity 

Utilities: 






Southwest electric power––7^{1}/_{4} 2023 
Aa2 
$ 
920.18 

8.66 
% 
Pacific bell––7^{3}/_{8} 2025 
Aa3 

896.25 

8.44 

Pennsylvania power & light––8^{1}/_{2} 2022 
A2 

995.66 

8.45 

Industrials: 






Johnson & Johnson––6^{3}/_{4} 2023 
Aaa 

850.24 

8.35 
% 
Dillard’s Department Stores––7^{1}/_{8} 2023 
A2 

910.92 

8.88 

Marriott Corp.––10 2015 
B2 
1,060.10 

9.55 


(a) 
Compute the cost of debt, K_{d} (use the accompanying table—relate to the utility bond credit rating for yield.) (Round your answer to 2 decimal places. Omit the "%" sign in your response.) 
Cost of debt 
% 
(b) 
Compute the cost of preferred stock, K_{p}. (Round your answer to 2 decimal places. Omit the "%" sign in your response.) 
Cost of preferred stock 
% 
(c) 
Compute the cost of common equity in the form of retained earnings, K_{e}. (Round your answer to 2 decimal places. Omit the "%" sign in your response.) 
Cost of common equity 
% 
(d) 
Compute the weighted average cost of capital. (Round your intermediate and final answers to 2 decimal places. Omit the "%" sign in your response.) 

Weighted cost 
Debt (K_{d}) 
% 
Preferred stock (K_{p}) 

Common equity (K_{e}) 



Weighted average cost of capital (K_{a}) 
% 



32.
value:
2.00 points
Problem 1127 Marginal cost of capital [LO5]
Delta Corporation has the following capital structure: 

Cost 
Weights 
Weighted 

Debt (K_{d}) 

6.6 
% 

20 
% 

1.32 
% 
Preferred stock (K_{p}) 

11.2 


10 


1.12 

Common equity (K_{e}) (retained earnings) 

11.2 


70 


7.84 











Weighted average cost of capital (K_{a}) 







10.28 
% 











(a) 
If the firm has $49 million in retained earnings, at what size capital structure will the firm run out of retained earnings? (Enter your answer in millions. Omit the "$" sign in your response.) 
Capital structure size (X) 
$ million 
(b) 
The 6.6 percent cost of debt referred to above applies only to the first $23 million of debt. After that the cost of debt will go up. At what size capital structure will there be a change in the cost of debt? (Enter your answer in millions. Omit the "$" sign in your response.) 
Capital structure size (Z) 
$ million 
rev: 04_27_2012
33.
value:
2.00 points
Problem 1128 Marginal cost of capital [LO5]
The Nolan Corporation finds that it is necessary to determine its marginal cost of capital. Nolan’s current capital structure calls for 45 percent debt, 15 percent preferred stock, and 40 percent common equity. Initially common equity will be in the form of retained earnings (K_{e}) and then new common stock (K_{n}). The costs of the various sources of financing are as follows: debt, 4.2 percent; preferred stock, 6 percent; retained earning, 14 percent; and new common stock, 15.2 percent. 
(a) 
What is the initial weighted average cost of capital? (Round your intermediate calculations and final answer to 2 decimal places. Omit the "%" sign in your response.) 
Weighted average cost of capital 
% 
(b) 
If the firm has $26 million in retained earnings, at what size capital structure will the firm run out of retained earnings? (Enter your answer in millions. Omit the "$" sign in your response.) 
Capital structure size (X) 
$ million 
(c) 
What will the marginal cost of capital be immediately after that point? (Equity will remain at 40 percent of the capital structure, but will all be in the form of new common stock, K_{n}.)(Round your intermediate calculations and final answer to 2 decimal places. Omit the "%" sign in your response.) 
Marginal cost of capital 
% 
(d) 
The 4.2 percent cost of debt referred to above applies only to the first $45 million of debt. After that the cost of debt will be 6.5 percent. At what size capital structure will there be a change in the cost of debt?(Enter your answer in millions. Omit the "$" sign in your response.) 
Capital structure size (Z) 
$ million 
(e) 
What will the marginal cost of capital be immediately after that point? (Consider the facts in both parts cand d.) (Round your intermediate calculations and final answer to 2 decimal places. Omit the "%" sign in your response.) 
Marginal cost of capital 
% 
34.
value:
2.00 points
Problem 1130 Capital asset pricing model and dividend valuation model [LO3]
Eaton Electronic Company’s treasurer uses both the capital asset pricing model and the dividend valuation model to compute the cost of common equity (also referred to as the required rate of return for common equity). 
Assume: 

R_{f} 
= 

5 
% 
K_{m} 
= 

11 
% 
β 
= 

1.3 

D_{1} 
= 
$ 
.75 

P_{0} 
= 
$ 
15 

g 
= 

9 
% 
(a) 
Compute K_{i} (required rate of return on common equity based on the capital asset pricing model).(Round your final answers to 2 decimal places. Omit the "%" sign in your response.) 
K_{i} 
% 
(b) 
Compute K_{e} (required rate of return on common equity based on the dividend valuation model). (Round your intermediate and final answers to 2 decimal places. Omit the "%" sign in your response.) 
K_{e} 
% 
rev: 06202011
bus 320 connect homework 5
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