51) All else equal, an increase in beta results in
A) an increase in the cost of retained earnings.
B) an increase in the cost of newly issued common stock.
C) an increase in the after-tax cost of debt.
D) an increase in the cost of common equity, whether or not the funds come from retained earnings or
newly issued common stock.
Answer: D
Diff: 1 Page Ref: 304
Keywords: Beta, Cost of Common Equity
52) Haroldson Inc. common stock is selling for $22 per share. The last dividend was $1.20, and dividends
are expected to grow at a 6% annual rate. Flotation costs on new stock sales are 5% of the selling price.
What is the cost of Haroldson's retained earnings?
A) 5.73%
B) 11.45%
C) 11.78%
D) 12.09%
Answer: C
53) Haroldson Inc. common stock is selling for $22 per share. The last dividend was $1.20, and dividends
are expected to grow at a 6% annual rate. Flotation costs on new stock sales are 5% of the selling price.
What is the cost of Haroldson Inc.'s new common stock?
A) 5.73%
B) 11.45%
C) 11.78%
D) 12.09%
Answer: D
Diff: 2 Page Ref: 302
Keywords: Cost of New Common Stock
54) Which of the following should NOT be considered when calculating a firm's WACC?
A) cost of preferred stock
B) after-tax cost of bonds
C) cost of common stock
D) cost of carrying inventory
Answer: D
Diff: 1 Page Ref: 297
Keywords: Weighted Average Cost of Capital
55) Which of the following should NOT be considered when calculating a firm's WACC?
A) after-tax YTM on a firm's bonds
B) after-tax cost of accounts payable
C) cost of newly issued preferred stock
D) cost of newly issued common stock
Answer: B
Diff: 1 Page Ref: 297
Keywords: Weighted Average Cost of Capital
56) New Jet Airlines plans to issue 14-year bonds with a par value of $1,000 that will pay $60 every six
months. The bonds have a market price of $1,220. Flotation costs on new debt will be 4% of the selling
price. If the firm has a 35% marginal tax bracket, compute the following:
a. Yield to maturity of debt
b. After-tax cost of existing debt
c. After-tax cost of new debt
Answer:
a. YTM = 9.18% (Using Yield Function in Excel with rate =.12, Pr = 122, Redemption = 100,
Frequency = 2, and Basis = 0)
b. After-tax cost of debt = 9.18% × (1-.35) = 5.97%
c. After-tax cost of new debt = 9.73% × (1-.35) = 6.33% (The pre-tax cost is determined as in part a,
except the Pr is 117.12, based on a net price of $1,220 less flotation costs of $48.80.)
Diff: 2 Page Ref: 297
Keywords: Yield to Maturity, After-tax Cost of Existing Debt, After-tax Cost of New Debt, Flotation
Costs
57) Alarm Systems Corporation's preferred stock pays a dividend of $3.60 and sells for $28.00. Alarm
Systems Corporation has a marginal tax rate of 35%. What is the cost of preferred financing?
Answer: $3.60/$28 = .12857 =12.857%%
Diff: 1 Page Ref: 300
Keywords: Cost of Preferred Stock
58) NewLinePhone Corp. is very risky, with a beta equal to 2.8 and a standard deviation of returns of
32%. The risk-free rate of return is 3% and the market risk premium is 8%. NewLinePhone's marginal tax
rate is 35%. Use the capital asset pricing model to estimate NewLinePhone's cost of retained earnings.
Answer: 3% + (8%)(2.8) = 25.4%
Diff: 2 Page Ref: 302
Keywords: Cost of Retained Earnings, Capital Asset Pricing Model
59) Dickerson Corporation's common stock is currently selling for $38. Last year's dividend was $4.00
per share. Investors expect dividends to grow at an annual rate of 7 percent indefinitely. Flotation costs of
4% will be incurred when new stock is sold.
a. What is the cost of internal common equity?
b. What is the cost of new common equity?
Answer:
a. D1 = $4.00 × 1.07 = $4.28
Cost of internal common equity = $4.28/$38 + .07 = 18.26%
b. Cost of new common equity = $4.28/($38 × .96) + .07 = 18.73%
Diff: 2 Page Ref: 302
Keywords: Cost of Retained Earnings, Cost of New Common Stock, Flotation Costs
60) The common stock for El Viss Company currently sells for $20 per share. The firm just paid a
dividend of $1.50, and the dividend three years ago was $1.30. Dividends per share are anticipated to
grow at the same rate in the future as they have over the past three years. Flotation costs for new shares
will be 6% of the selling price. Calculate the following:
a. the cost of retained earnings
b. the cost of external equity capital
Answer:
a. g = 4.89% D1 = $1.50 × 1.049 = $1.57
Cost of retained earnings = $1.57/$20 + .049 = 12.75%
b. Cost of external equity = $1.57/($20 × .94) + .049 = 13.25%
Diff: 2 Page Ref: 302
Keywords: Cost of Retained Earnings, Cost of New Common Stock
