AFTER-TAX COST OF DEBT The Heuser Company’s currently outstanding bonds have a 10% coupon

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Dated: 10th Sep'17 02:17 PM
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CHAPTER 10

Questions

10.1/ How would each of the following scenarios affect a firm’s cost of debt, rd(1 – T); its cost of equity, rs; and its WACC? Indicate with a plus (+), a minus (-), or a zero (0) if the factor would raise, would lower, or would have an indeterminate effect on the item in question. Assume for each answer that other things are held constant even though in some instances this would probably not be true. Be prepared to justify your answer but recognize that several of the parts have no single correct answer. These questions are designed to stimulate thought and discussion. rd(1 – T)


Problems

10.1/ AFTER-TAX COST OF DEBT The Heuser Company’s currently outstanding bonds have a 10% coupon and a 12% yield to maturity. Heuser believes it could issue new bonds at par that would provide a similar yield to maturity. If its marginal tax is 35%, what is Heuser’s after-tax cost of debt?


10.2/ COST OF PREFERRED STOCK Tunney Industries can issue perpetual preferred stock at a price of $47.50 a share. The stock would pay a constant annual dividend of $3.80 a share. What is the company’s cost of preferred stock, rp?


10.3/ COST OF COMMON EQUITY Percy Motors has a target capital structure of 40% debt and 60% common equity, with no preferred stock. The yield to maturity on the company’s outstanding bonds is 9%, and its tax rate is 40%. Percy CFO estimates that the company’s WACC is 9.96%. What is Percy’s cost of common equity?


10.8/ COST OF COMMON EQUITY AND WACC Patton Paints Corporation has a target capital structure of 40% debt and 60% common equity, with no preferred stock. Its before-tax cost of debt is 12%, and its marginal tax is 40%. The current stock price is P0=$22.50. The last dividend was D0=$2.00, and it is expect to grows at a 7% constant rate. What is its cost of common equity and its WACC?


10.9/ WACC The Patrick Company’s cost of common equity is 16% its before-tax cost of debt is 13%, and its marginal tax rate is 40%. The stock sells at book value. Using the following balance sheet, calculate Patrick’s WACC.


10.18/ WACC AND OPTIMAL CAPITAL BUDGET Adams Corporation is considering four average risk projects with the following costs and rates of return:

Project

Cost

Expected Rate of Return

1

$2,000

16.00%

2

3,000

15.00

3

5,000

13.75

4

2,000

12.50

The company estimates that it can issue debt at a rate of rd=10%, and its tax rate is 30%. It can issue preferred stock that pays a constant dividend of $5.00 per year at $49.00 per share. Also, its common stock currently sells for $36.00 per share; the next expected dividend, D1, is $3.50; and the dividend is expected to grow at a constant rate of 6% per year. The target capital structure consists of 75% common stock, 15% debt, and 10% preferred stock.

a. What is the cost of each of the capital components?

b. What is Adam’ WACC?

c. Only projects with expected returns that exceed WACC will be accepted. Which project should Adams accept?


AFTER-TAX COST OF DEBT The Heuser Company’s currently outstanding bonds have a 10% coupon
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