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Fjord Luxury Liners has preferred shares outstanding that pay an annual dividend equal to \$10 per year. If the current price of Fjord preferred shares is \$147, what is the after-tax cost of preferred stock for Fjord? (Round intermediate calculations to 4 decimal places, e.g. 1.2514 and final answer to 2 decimal places, e.g. 15.25%.)

After-tax cost f preferred stock = ______________%

Describe the alternatives to using a firm’s WACC as a discount rate when evaluating a project.

What are direct out-of-pocket costs?

Explain why the cost of capital for a firm is equal to the expected rate of return to the investors in the firm.

1. Perpetual Ltd. has issued bonds that never require the principal amount to be repaid to investors. Correspondingly, Perpetual must make interest payments into the infinite future. The bondholders receive annual payments of \$84 and the current price of the bonds is \$814.

Pre-tax cost of debt = ____________%

2. The parts of this question must be completed in order.  This part will be available when you complete the part above.

The Imaginary Products Co. currently has debt with a market value of \$225 million outstanding. The debt consists of 9 percent coupon bonds (semiannual coupon payments) which have a maturity of 15 years and are currently priced at \$1,320.10 per bond. The firm also has an issue of 2 million preferred shares outstanding with a market price of \$20. The preferred shares pay an annual dividend of \$1.20. Imaginary also has 14 million shares of common stock outstanding with a price of \$20.00 per share. The firm is expected to pay a \$2.20 common dividend one year from today, and that dividend is expected to increase by 6 percent per year forever. If Imaginary is subject to a 40 percent marginal tax rate, then what is the firm’s weighted average cost of capital?

1. Calculate the Weights for debt, common equity, and preferred equity. (Round intermediate calculations to 4 decimal places, e.g. 1.2514 and final answer to 2 decimal places, e.g. 15.25%.)

Debt = ___________%

Preferred equity = ______________%

Common equity = ________________%

1. The parts of this question must be completed in order. This part will be available when you complete the part above
2. The parts of this question must be completed in order. This part will be available when you complete the part above
3. The parts of this question must be completed in order. This part will be available when you complete the part above
4. The parts of this question must be completed in order. This part will be available when you complete the part above

Hurricane Corporation is financed with debt, preferred equity, and common equity with market values of \$20 million, \$10 million, and \$30 million, respectively. The betas for the debt, preferred stock, and common stock are 0.2, 0.5, and 1.3, respectively. If the risk-free rate is 3.87 percent, the market risk premium is 6.02 percent, and Hurricane’s average and marginal tax rates are both 30 percent.

1. What is the company’s cost of capital? (Round intermediate calculation to 4 decimal places, e.g. 1.2512 and final answer to 2 decimal places e.g. 5.21%.)

Cost  of debt = ____________%

Cost of common equity = ____________%

Cost of preferred equity = ____________%

1. The parts of this question must be completed in order. This part will be available when you complete the part above.
2. For a typical firm, which of the following financial instruments has the lowest cost of capital?

Legitron Corporation has \$280 million of debt outstanding at an interest rate of 8 percent. What is the dollar value of the tax shield on that debt, just for this year, if Legitron is subject to a 36 percent Cmarginal tax rate?

Value of tax shield \$____________

Marx and Spender currently has a WACC of 18 percent. If the cost of debt capital for the firm is 9 percent and the firm is currently financed with 47 percent debt, then what is the current cost of equity capital for the firm? Assume that the assumptions in Modigliani and Miller’s Proposition 1 hold. (Round answer to 2 decimal places, e.g. 17.54%.)

Current cost of equity capital ___________%

The weighted average cost of capital for a firm (assuming all three Modigliani and Miller assumptions apply) is 17 percent. What is the current cost of equity capital for the firm if its cost of debt is 8 percent and the proportion of debt to total firm value for the firm is 0.5?

Current cost of capital __________%

Backwards Resources has a WACC of 11.9 percent, and it is subject to a 34 percent marginal tax rate. Backwards has \$379 million of debt outstanding at an interest rate of 10 percent and \$787 million of equity (market value) outstanding. What is the expected return on the equity with this capital structure? (Round answer to 2 decimal places, e.g. 17.54%.)

Expected return on equity _____________%

Santa’s Shoes is a retailer that has just begun having financial difficulty. Santa’s suppliers are aware of the increased possibility of bankruptcy. What might Santa’s suppliers do based on this information? (essay)

A few years ago, a friend of yours started a small business that develops gaming software. The company is doing well and is valued at \$1.5 million based on multiples for comparable public companies after adjustments for their lack of marketability. With 300,000 shares outstanding, each share is estimated to be worth \$5. Your friend, who has been serving as CEO and CTO (chief technology officer), has decided that he lacks sufficient managerial skills to continue to build the company. He wants to sell his 160,000 shares and invest the money in an MBA education. You believe you have the appropriate managerial skills to run the company. Would you pay \$5 each for these shares? What are some of the factors you should consider in making this decision? (essay)

A friend of yours is trying to value the equity of a company and, knowing that you have read this book, has asked for your help. So far she has tried to use the FCFE approach. She estimated the cash flows to equity to be as follows: (essay)

 Sales \$800.0 -CGS -450.0 -Depreciation -80.0 -Interest -24.0 Earnings before taxes (EBT) 246.0 -Taxes (0.35 x EBT) -86.1 = Cash Flow to Equity \$159.9

She also computed the cost of equity using CAPM as follows:

kE = kF + βE(Risk premium) = 0.06 + (1.25 x 0.084) = 0.165, or 16.5%

where the beta is estimated for a comparable publicly traded company. Using this cost of equity, she estimates the discount rate as

WACC = xDebtkDebtpretax(1 – t) + xcskcs

= [0.20 x 0.06 x (1-0.35)]+(0.80 x 0.165) = 0.14, or 14%

Based on this analysis, she concludes that the value of equity is \$159.9 million/0.14 = \$1,142 million.

Assuming that the numbers used in this analysis are all correct, what advice would you give your friend regarding her analysis?

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