Question

1. True or false: According to the Gordon Growth Model, firms that pay dividends will always have a higher cost of equity than firms that do not pay dividends.

2. True or false: Flotation costs reduce the cost of capital.

3. True or false: If investors expect returns on the market to be higher next year, then, according to the CAPM, an individual firm’s cost of equity will be lower.

4. Which one of the following typically reduces the weighted average cost of capital?

A)cost of external equity

B)cost of internal equity

C)cost of debt

D)cost of preferred stock

5. A firm is issuing new debt to finance a capital investment project. The firm will issue 15,550 new bonds with a $1,000 face value that will mature in 10 years. The bonds will pay a $35 semiannual coupon, and similar bonds are currently priced at 95% of par. The associated flotation costs are expected to be $15 per bond. Further, the company has a marginal tax rate of 34%. Given this information, what is the before-tax cost of debt?

A)6.85%

B)3.98%

C)9.54%

D)8.15%

E)7.96%

6. Job Cart Inc. has a preferred stock paying a 7% dividend on a $100 par value. The company issues new preferred stock, and the flotation cost will be 8% of the current price of $95.74. What is the cost of preferred stock?

A).95%

B)7.61%

C)7.31%

D)6.77%

7.A company just issued new stock that will pay a dividend of $2.50 per share each year and is expected to grow at a constant rate of 5% per year indefinitely. The price at which the shares were issued was $24.50. The underwriters have charged $3 per share in flotation costs. Given this information, what is the cost of equity for this company?

A)16.63%

B)15.20%

C)17.21%

D)14.55%

E)14.09%

8.A company has a beta of 0.8. The expected return on the market is 10%, and the risk-free rate is 3%. The flotation cost is 8%. Given this information, what is the company’s cost of external equity?

A)11.88%

B)8.60%

C)10.12%

D)9.29%

E)7.91%

9.Armadillo Mfg. Co. has a target capital structure of 50% debt and 50% equity. The firm is planning to invest in a project that will necessitate raising new capital. New debt will be issued at a before-tax yield of 12%, with a coupon rate of 10%. The equity will be provided by internally generated funds. No new outside equity will be issued. If the required rate of return on the firm’s stock is 15% and its marginal tax rate is 40%, what is the firm’s cost of capital?

A)12.5%

B)11.1%

C)13.5%

D)7.2%

10.Which one of the following is NOT an example in which a firm can use its weighted average cost of capital?

A)Chipotle opens new locations.

B)Apple produces cars for the first time.

C)Ford releases a new version of the F-150.

D)Microsoft launches a new version of Office.

Answer 1

(1) True.

According to Gordon Growth model, firms that pay dividends will always have a higher cost of equity than firms that do not pay dividends.

(2) False

Flotation costs increases the cost of capital as the capital is decreased due to incorporation expenses and cost of capital increases due to decrease in funds available.

(3) False

If investors expect returns on the market to be higher next year, then, according to the Capital Asset Pricing Model, an individual firm’s cost of equity shall be higher i.e. the amount to be paid by the firm to the investor.