Assignment 1 – Jones Soda estimates that its cost of capital

Accounting Mathematical Assistant

Assignment 1

Jones Soda estimates that its cost of capital is 5.60 percent. You observe that the company’s required return on stock is 12.00 percent and the (after-tax) yield to maturity on its debt is 4.00 percent. What is the debt-to-equity ratio? Round your answer to two decimals.

Tribbles-R-Us has 200,000 shares outstanding and just paid a $0.25 per share dividend. The market risk-premium is 11.00 percent and the risk-free rate is 4.00 percent. What is the company’s cost of equity if Tribbles’ systematic risk is 60.00% larger than the market portfolio? Enter your answer as a percent rounded to two decimals, but don’t include % sign. 

The Down and Out Co. just issued an annual dividend of $2.61 per share on its common stock. The company is expected to maintain a constant 7 percent growth rate in its annual dividend indefinitely. If the stock sells for $40 a share, what is the company’s cost of equity? (Do not round your intermediate calculations.) Hint: The stock price is simply the present value of the expected future cash flows. Here the cash flows (dividends) happen to be a growing perpetuity.

rev: 09_20_2012

13.53%

7.16%

13.98%

14.68%

13.28%

References

Multiple Choice Learning Objective: 14-01 How to determine a firms cost of equity capital.

Difficulty: Basic Section: 14.2 The Cost of Equity

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Bond Coupon Rate Yield to Maturity Price Quote

(% of Face Value) Maturity Face Value

1 6.00%      4.21% 108% 5 years        $ 18,000,000   

2 7.30%         5.45% 113%      9 years        $ 43,000,000   

3 6.30%         5.95% 104%      19 years        $ 41,000,000   

4 6.80%         5.51% 119%      31 years        $ 57,000,000   

The Hold Up Bank has issued 45,000,000 shares of preferred stock. Each share pays a $3.00 quarterly dividend in perpetuity. If the next dividend is to be paid later today, and one preferred share currently costs $153.00, what is the cost of preferred equity? Calculate as an EAR, not an APR. Enter your answer as a percent rounded to two decimals. Hint: The stock price is simply the present value of the expected future cash flows. Here the cash flows (dividends) happen to be a constant perpetuity with the first payment taking place today.

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Ying Imports has several bond issues outstanding, each making semi-annual interest payments called coupons. These interest payments represent an annuity, and though paid semi-annually, they are quoted as an annual percent of face value. 

The face value represents the amount that must be repaid when the loan matures, and is usually equal to the original amount borrowed. Hence a 10% annual coupon typically means that the company has a 10% annual percentage interest rate (APR) on their loan, and pays off the interest every six months by paying 5% interest on the face value.  The current market price of a bond (i.e. what a bank would be willing to sell the loan for) is usually also quoted as a percent of face value. 

The yield to maturity represents the discount rate that sets the present value of the bond’s cash flows (the coupons and the repayment of face value at maturity) equal to the bond’s price. Since the coupons are paid semi-annually, this yield is quoted as an APR with semi-annual compounding just like the coupons.

Ying Imports’ bonds are listed in the following table. If the corporate tax rate is 33 percent, what is the after-tax cost of Ying Imports’ debt (leave your answer as an APR)? (Do not round your intermediate calculations.) 

v: 09_20_2012

3.47%

3.51%

3.66%

5.46%

3.84%

References

Multiple Choice Learning Objective: 14-02 How to determine a firms cost of debt.

Difficulty: Intermediate Section: 14.3 The Costs of Debt and Preferred Stock

Jiminy’s Cricket Farm issued a 30-year, 6 percent coupon bond 4 years ago. The bond makes semi-annual coupon payments and sells for 89 percent of its face value. The face value of the debt issue is $16 million and the yield to maturity is 6.914%. Note: YTM for coupon bonds is quoted as an APR with semi-annual compounding.

In addition, the company has a second debt issue on the market, a zero coupon bond with 4 years left to maturity; the face value of this issue is $83 million and the bonds sell for 79 percent of face value. Note:

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Zero-coupon bonds only make one payment: face value which is paid at maturity.

Required:

(a)What is the company’s total book value of debt? (Do not round your intermediate calculations.) (Click to select)

(b)What is the company’s total market value of debt? (Do not round your intermediate calculations.) (Click to select)

(c)What is the pre-tax cost of debt for the zero coupon bond? Report this as an APR with semi-annual compounding. (Enter your answer as a percent, rounding to three decimals.)

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(d)The company’s tax rate is 34 percent. What is the company’s after-tax cost of debt? Report this as an APR with semi-annual compounding. (Do not round your intermediate calculations.) (Click to select)

rev: 09_20_2012

References

Worksheet Learning Objective: 14-02 How to determine a firms cost of debt.

Difficulty: Basic Section: 14.3 The Costs of Debt and Preferred Stock

Jones Soda estimates that its required return on equity is 10.0 percent and the yield to maturity on its debt is 4.0 percent. The company’s equity-to-asset ratio is 0.5 and the marginal tax rate is 35%. What is the company’s weighted average cost of capital? Enter your answer as a percent and round to two decimals, but don’t include the % sign. 

Nacho Libre S.A. has 8,000,000 common shares outstanding that trade for $40.00 per share. The company has also issued one bond with a par value of $40,000,000 that currently trades at 110 percent of par. You observe that the company’s required return on stock is 17.00 percent and the (after-tax) yield to maturity on its debt is 4.00 percent. What is the weighted average cost of capital? Write your answer as a percent rounded to two decimals, but don’t include % sign. 

Dinklage Corp. has 7 million shares of common stock outstanding. The current share price is $86, and the book value per share is $5.

The company also has two bond issues outstanding. The first bond issue has a face value of $70 million, a yield to maturity of 9.42 percent, and sells for 96 percent of par. The second issue has a face value of $45

 

 

million, a yield to maturity of 9.12 percent, and sells for 104 percent of par. The first issue matures in 24 years, the second in 6 years.

Suppose the most recent annual dividend was $5.80 and the annual dividend growth rate is 7 percent. The tax rate is 34 percent. Calculate the company’s WACC.

Start by calculating the firm’s market value. (Enter your answer as a dollar amount, not millions of dollars, i.e. enter one million as 1,000,000) Firm’s Market Value (debt & equity) $

Now calculate the firm’s cost of equity and after-tax cost of debt. (Enter your answers as percent rounded to two decimals. Assume the YTMs are quoted as an EAR, not an APR.) Cost of Equity %

After-tax Cost of Debt %

Now calculate the WACC. (Don’t round your intermediate steps and enter your answer as a percent rounded to two decimals.) WACC %

References

Worksheet Learning Objective: 14-03 How to determine a firms overall cost of capital and how to use it to value a company.

Difficulty: Basic Section: 14.4 The Weighted Average Cost of Capital

Consider the following information for Evenflow Power Co.,

  Debt: 6,000 bonds that each year pay 6 percent of par value as an annual coupon, have a $1,000 par value, and a yield to maturity of 5.74 percent compounded annually. The bonds have 19 years to maturity and currently sell for 103 percent of par (face) value.

  Common stock:   126,000 shares outstanding, selling for $64 per share; the beta is 1.14.   Preferred stock: 19,500 preferred shares that pay a dividend of 5 percent annually on $100

par value, and currently sell for $105 per share.   Market:   7 percent market risk premium and 4.5 percent risk-free rate.

Assume the company’s tax rate is 33 percent. Note: Face value is sometimes used interchangeably with par value. Preferred shares almost always pay a constant dividend, but the dividend is usually quoted as a percent of par value ( just like coupons and bonds). So as an example, a 7% preferred dividend on a $100 par value means the annual dividend payment is $7. 

Required:

Find the WACC. (Do not round your intermediate calculations.)

rev: 09_20_2012

8.63%

8.95%

8.23%

8.13%

8.33%

References

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Multiple Choice Learning Objective: 14-03 How to determine a firms overall cost of capital and how to use it to value a company.

Difficulty: Basic Section: 14.4 The Weighted Average Cost of Capital

Sheaves Corp. has a debt−equity ratio of .85. The company is considering a new plant that will cost $114 million to build. When the company issues new equity, it incurs a flotation cost of 8.4 percent. The flotation cost on new debt is 3.9 percent.

What is the weighted average flotation cost if the company raises all equity externally? (Enter your answer as a percent and round to two decimals.)

Flotation Cost %

What is the initial cost of the plant if the company raises all equity externally? (Enter your answer in dollars, not millions of dollars, e.g., 1,234,567. Do not round intermediate calculations and round your answer to the nearest whole dollar amount, e.g., 32.)

Initial cash flow $

What is the initial cost of the plant if the company typically uses 65 percent retained earnings for equity financing? (Enter your answer in dollars, not millions of dollars, e.g., 1,234,567. Do not round intermediate calculations and round your answer to the nearest whole dollar amount, e.g., 32.)

Initial cash flow $

What is the initial cost of the plant if the company typically uses 100 percent retained earnings for equity financing? (Enter your answer in dollars, not millions of dollars, e.g., 1,234,567. Do not round intermediate calculations and round your answer to the nearest whole dollar amount, e.g., 32.)

Initial cash flow $

References

Worksheet Learning Objective: 14-04 How to correctly include flotation costs in capital budgeting projects.

Difficulty: Challenge Section: 14.6 Company Valuation with the WACC

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