Download Judy`s Boutique just paid an annual dividend of $1.65 on its

1. Judy's Boutique just paid an annual dividend of $1.65 on its common stock. The firm increases its
dividend by 2.5 percent annually. What is the rate of return on this stock if the current stock price is
$38.20 a share?
𝑃0 =
𝐷0 (1+𝑔)
𝑟−𝑔
38.20 =
1.65 (1 + .025)
𝑟 − .025
𝑟 = 0.06927 ≈ 0.0693
2. Jet Setters has a cost of equity of 17.8 percent. The market risk premium is 10.2 percent and the risk-free
rate is 4.4 percent. The company is acquiring a competitor, which will increase the company's beta to 1.6.
What effect, if any, will the acquisition have on the firm's cost of equity capital?
𝐾𝑒 = 𝑟𝑓 + 𝛽(𝑟𝑚 − 𝑟𝑓 )
. 044 + 1.6(. 102) = .2072
. 2072 − .178 = .0292
3. Musical Charts just paid an annual dividend of $2.45 per share. This dividend is expected to increase by
3.3 percent annually. Currently, the firm has a beta of 1.09 and a stock price of $36 a share. The risk-free
rate is 4.2 percent and the market rate of return is 12.6 percent. What is the cost of equity capital for this
firm using (i) discount growth model approach (ii) CAPM approach?
i. 𝑃0 =
𝐷0 (1+𝑔)
𝑟−𝑔
36 =
2.45 (1 + .033)
𝑟 − .033
𝑟 = 0.103301
ii. 𝐾𝑒 = 𝑟𝑓 + 𝛽(𝑟𝑚 − 𝑟𝑓 )
. 042 + 1.09(. 126 − .042) = .13356
4. Winter Wear, Inc. has 6 percent bonds outstanding that mature in 13 years. The bonds pay interest
semiannually and have a face value of $1,000. Currently, the bonds are selling for $993 each. What is the
firm's pre-tax cost of debt?
**find the yield to maturity for the bond
𝑎𝑝𝑝𝑟𝑜𝑥 𝑌𝑡𝑚 =
𝐹−𝑃
)
𝑛
𝐹+𝑃
(
)
2
𝐶+ (
C = coupon payment
F= face value
P = present value
N= years to maturity
𝑎𝑝𝑝𝑟𝑜𝑥 𝑌𝑡𝑚 =
1000 − 993
)
13
= 0.060751 ≈ .0608
1000 − 993
(
)
2
60 + (
5. Sunshine Cruises issues only common stock and coupon bonds. The firm has a debt-equity ratio of 0.55.
The cost of equity is 16.3 percent and the pre-tax cost of debt is 9.9 percent. What is the capital structure
weight of the firm's equity if the firm's tax rate is 34 percent?
. 55 =
𝐷 = 55
𝐷
55
=
𝐸
100
𝐸 = 100
𝑀𝑉 = 𝐷 + 𝐸 = 55 + 100 = 155
%𝐸 =
𝐸
100
=
= .64516 ≈ .6452
𝑀𝑉
155
6. Catnip Stores has a $20 million bond issue outstanding that currently has a market value of $18.6 million.
The bonds mature in 6.5 years and pay semiannual interest payments of $30 each. What is the firm's pretax cost of debt?
18.6
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑝𝑟𝑖𝑐𝑒 𝑜𝑓 𝑏𝑜𝑛𝑑 = (
) ∗ 1000 = 930
20
𝑃𝑀𝑇 = 30
𝑁 = 6.5 ∗ 2 = 13
𝑃𝑉 = −930
𝐹𝑉 = 1000
𝐼 =?
𝐼 = .036875
𝐼 = .036875 ∗ 2 = .0737
7. Hi Tech Products has 35,000 bonds outstanding that are currently quoted at 102.3. The bonds mature in
11 years and carry a 9 percent annual coupon. What is the firm's after-tax cost of debt if the applicable tax
rate is 35 percent?
𝑃𝑀𝑇 = 9
𝑁 = 11
𝑃𝑉 = −102.3
𝐹𝑉 = 100
𝐼 =?
𝐼 = .08667
𝐾𝑑 = 𝑖 ∗ (1 − 𝑡) = .08667 ∗ (1 − .35) = .0563
8. The General Store has a cost of equity of 15.8 percent, a pre-tax cost of debt of 7.7 percent, and a tax rate
of 32 percent. What is the firm's weighted average cost of capital if the debt-equity ratio is 0.40?
.4 =
𝐷 = 40
𝐷
40
=
𝐸
100
𝐸 = 100
𝑀𝑉 = 𝐷 + 𝐸 = 40 + 100 = 140
%𝐸 =
𝐸
100
=
= .7143
𝑀𝑉
140
%𝐷 =
𝐸
40
=
= .2857
𝑀𝑉
140
𝑊𝐴𝐶𝐶 = 𝐷 ∗ 𝐾𝑑 ∗ (1 − 𝑡) + 𝐸 ∗ 𝐾𝑒 = .2857 ∗ .077 ∗ .32 + .7143 ∗ .158 = .1278
9. A firm wants to create a weighted average cost of capital (WACC) of 10.4 percent. The firm's cost of
equity is 14.5 percent and its pre-tax cost of debt is 8.5 percent. The tax rate is 34 percent. What does the
debt-equity ratio need to be for the firm to achieve its target WACC?
𝑀𝑉 = 𝐷 + 𝐸 .
𝑀𝑉
𝐸
𝐷
= 1+( )
𝐸
. 104 =
𝐸
𝐷
𝐸
𝐷
∗ .145 +
∗ .085 ∗ .66 =
∗ .145 +
∗ .0561
𝑀𝑉
𝑀𝑉
𝑀𝑉
𝑀𝑉
(. 104)
𝑀𝑉
𝐸
𝐷
𝑀𝑉
= (. 145 (
) + .0561 (
))
𝐸
𝑀𝑉
𝑀𝑉
𝐸
𝐷
𝐷
. 104 (1 + ( )) = .145 + .0561 ( )
𝐸
𝐸
𝐷
𝐷
. 104 + .104 ( ) = .145 + .0561 ( )
𝐸
𝐸
𝐷
𝐷
. 104 ( ) = .041 + .0561 ( )
𝐸
𝐸
𝐷
. 0479 ( ) = .041
𝐸
𝐷
. 041
=
= .855 ≈ .86
𝐸
. 0479
10. Southwest Tours currently has a weighted average cost of capital of 11.3 percent based on a combination
of debt and equity financing. The firm has no preferred stock. The current debt-equity ratio is 0.58 and the
after-tax cost of debt is 6.4 percent. The company just hired a new president who is considering
eliminating all debt financing. All else constant, what will the firm's cost of capital be if the firm switches
to an all-equity firm?
. 58 =
𝐷 = 58
𝐷
58
=
𝐸
100
𝐸 = 100
𝑀𝑉 = 𝐷 + 𝐸 = 58 + 100 = 158
%𝐸 =
𝐸
100
=
= .6329
𝑀𝑉
158
%𝐷 =
𝐸
58
=
= .3671
𝑀𝑉
158
. 113 = .3671 ∗ .064 + .6329 ∗ 𝐾𝑒 = .0234944 + .6329 ∗ 𝐾𝑒
. 113 = .0234944 + .6329 ∗ 𝐾𝑒
. 0895056 = .6329 ∗ 𝐾𝑒
𝐾𝑒 = .1414