Cost of Capital Problems

1
Cost of Capital Problems

• 3. Calculating Cost of Equity Stock in Eddy
  Industries has a beta of 0.9. The market risk
  premium is 9.5 percent, and T-bills are currently
  yielding 5 percent. Eddys most recent dividend
  was 3.75 per share, and dividends are expected
  to grow at a 3 percent annual rate indefinitely.
  If the stock sells for 32.50 per share, what is
  your best estimate of Eddys cost of equity?
• Answer 14.22

2
Cost of Capital Problems

• 8. Calculating Cost of Debt Gauss Corporation
  issued a 20-year,
• 9 percent semiannual bond 7 years ago. The bond
  currently sells
• for 108 percent of its face value. The companys
  tax rate is 38
• percent. The book value of this issue is 50
  million. In addition, the
• company has a second debt issue on the market, a
  zero-coupon
• bond with nine years left to maturity the book
  value of this issue
• is 30 million and the bonds sell for 48 percent
  of par. What is the
• companys total book value of debt? The total
  market value? What
• is your best estimate of the after-tax cost of
  debt?
• Answer Book Value80 million
• Market Value68.4 million
• Aftertax Cost5.11

3
Cost of Capital Problems

• 12. Book Value versus Market Value Merton
  Enterprises has 12.8
• million shares of common stock outstanding. The
  current share price is
• 29, and the book value per share is 18. Merton
  has also two bond issues
• outstanding. The first bond issue has a face
  value of 100 million, a 7
• percent coupon, and sells for 94 percent of par.
  The second issue has a
• face value of 75 million, a 5.5 percent coupon,
  and sells for 87 percent of
• par. The first issue matures in 13 years, the
  second in 8 years.
• a. What are Mertons capital structure weights on
  a book value basis?
• b. What are Mertons capital structure weights on
  a market value basis?
• c. Which are more relevant, the book or market
  value weights?
• Answer E/V0.568 D/V0.432
• E/V0.7 D/V0.3

4
Cost of Capital Problems

• 16. Finding the WACC Bluefield Corporation has 5
  million shares of
• common stock outstanding, 750,000 shares of 7
  percent preferred
• common stock outstanding, and 250,000 11 percent
  semiannual bonds
• outstanding, par value 1,000 each. The stock
  currently sells for 40 per
• share and has a beta of 1.2, the preferred stock
  currently sells for 75 per
• share, and the bonds have a 15 years to maturity
  and sell for 93.5 percent
• of par. The market risk premium is 6 percent,
  T-bills are yielding 4
• percent, and Bluefields tax rate is 34 percent.
• a. What is the firms market value capital
  structure?
• b. If Bluefield is evaluating a new investment
  project that has the same risk as the firms
  typical project, what rate should it use to
  discount the projects cash flows?
• Answer E/V0.4082 D/V0.4770 P/V0.1148
• WACC9.4