Objective type questions on Cost of Capital & Stock

1. Your firm has debt worth $200,000, with a yield of 9 percent, and equity worth $300,000. It is growing at a 5 percent rate, and faces a 40 percent tax rate. A similar firm with no debt has a cost of equity of 12 percent. Under the MM extension with growth, what is its cost of equity?

a)    9.36%

b)   12.0%

c)    12.8%

d)   13.2%

e)    14.0%

2. Refer to Trumbull, Inc. What is the value of Trumbull\'s equity if it is viewed as an option?

Trumbull, Inc.

Trumbull, Inc., has total value (debt plus equity) of $5 million and $2 million face value of 1-year zero coupon debt. The volatility (?) of Trumbull\'s total value is 0.60, and the risk free rate is 5 percent. Assume that N(d1) = 0.9720 and N(d2) = 0.9050.

a)    $3.000 million

b)   $3.050 million

c)    $3.138 million

d)   $4.860 million

e)    $5.000 million

3. Refer to Gomez Computer Systems. According to the MM extension with growth, what is the value of Gomez\'s tax shield?

Gomez Computer Systems

Gomez Computer Systems has EBIT of $200,000, a growth rate of 6 percent, and faces a tax rate of 40 percent. In order to support growth, Gomez must reinvest 20 percent of its EBIT in net operating assets. Gomez has $300,000 in 8 percent debt outstanding, and a similar company with no debt has a cost of equity of 11 percent.

a)    $87,273

b)   $192,000

c)    $120,000

d)   $288,000

e)    $300,000

4. You just purchased a zero coupon bond with a yield to maturity of 9 percent. The bond matures in 12 years, and has a face value of $1,000. Your tax rate is 25 percent. What is the dollar amount of tax that you will pay on the bond at the end of the first year of holding the bond?

a)    $5.00

b)   $6.00

c)    $7.00

d)   $8.00

e)    $9.00

5. Vogril Company issued 20-year, zero coupon bonds with an expected yield to maturity of 9 percent. The bonds have a par value of $1,000 and were sold for $178.43 each. What is the expected interest expense on these bonds in Year 8?

a)    $29.35

b)   $32.00

c)    $90.00

d)   $26.12

e)    $25.79

6. Which of the following statements about listing on a stock exchange is most correct?

a)    Listing is a decision of more significance to a firm than going public.

b)   Any firm can be listed on the NYSE as long as it pays the listing fee.

c)    Listing provides a company with some \"free\" advertising, and status as a listed company may enhance the firm\'s prestige.

d)   Listing reduces the reporting requirements for firms, because listed firms file reports with the exchange rather than with the SEC.

e)    Statements b and c are both correct.

7. Which of the following factors will increase the likelihood that a company will choose to call its outstanding bonds?

a)    An increase in the yield to maturity on the company\'s outstanding bonds.

b)   An increase in the call price of the outstanding bonds.

c)    A reduction in the flotation costs associated with issuing new bonds.

d)   Answers a and c are correct.

e)    None of the answers above is correct.

8. Basic Buildings Inc. has decided to go public with a $5,000,000 new equity issue. Its investment bankers agreed to take a smaller fee now (6 percent of par value versus 10 percent) in exchange for a 1-year option to purchase an additional 200,000 shares of the company at $5.00 per share. The investment banking firm expects to exercise its option and purchase the 200,000 shares in exactly one year\'s time when the stock price is expected to be $6.50 per share. However, if the stock price is actually $12.00 per share one year from now, what is the present value of the entire underwriting agreement to the investment banker? Assume that the investment banker\'s required return on such arrangements is 15 percent and ignore any tax considerations.

a)    $300,000

b)   $642,782

c)    $1,400,000

d)   $1,700,000

e)    $1,517,391

9. Machina Corporation is financing an ongoing construction project. The firm needs $8 million of new capital during each of the next three years. The firm has a choice of issuing new debt and equity each year as the funds are needed, or issuing the debt now and the equity later. The firm\'s capital structure is 40 percent debt and 60 percent equity. Flotation costs for a single debt issue would be 1.6 percent of the gross debt proceeds. Yearly flotation costs for three separate issues of debt would be 3.0 percent of the gross amount. Ignoring time value effects due to timing of the cash flows, what is the absolute difference in dollars saved by raising the needed debt all at once in a single issue rather than in three separate issues?

a)    $0

b)   $171,387

c)    $140,809

d)   $156,098

e)    $134,400