Test bank chapter 1 Introduction

Solution: use Equation (19-2):
cost of common stock = 4/54 + .09 = 16.4%

22. Global Corp. has bonds outstanding. The bond's yield to maturity (before-tax cost of the bond) is 12.4 percent and the firm's tax rate is 40 percent. What is the after-tax cost of the bond?

A. 12.4%.
B. 10.9%.
* C. 7.4%.
D. 6.2%.
E. 4.1%.


Solution: use Equation (19-5):
cost of bond = .124(1 - .40) = 7.4%

23. Global Corp. has debt with a market value of $80,000 and common equity with a market value of $120,000. The component costs of the capital structure for Global Corp. are 7.4 percent for bond and 16.4 percent for common equity. What is the weighted average cost of capital for Global Corp.?

A. 7.4%.
* B. 12.8%.
C. 16.4%.
D. 19.6%.
E. 21.5%.


Solution: use Equation (19-1):
cost of capital = (120,000/200,000).164 + (80,000/200,000).074
= 12.8%

24. The riskless rate of interest is 6 percent, the expected rate of return on a market portfolio is 8 percent, and the beta coefficient of a common stock is 1.2. What is the cost of this common stock?

A. 5.0%
B. 6.3%
C. 7.3%
D. 7.9%
* E. 8.4%


Solution: Use Equation (19-3):
Cost of common stock = 0.06 + (0.08 - 0.06)1.2 = 8.4%.

25. A US company borrows Mexican pesos for one year at 30 percent. During the year, the peso depreciates 15 percent against the dollar. The US tax rate is 35 percent. What is the after-tax cost of this debt in US dollar terms?

A. 5.66%
B. 6.00%
C. 6.80%
* D. 6.83%
E. 7.00%


Solution: Use Equation (19-6):
The before-tax cost of debt = 0.30 x 0.85 - 0.15 = 0.105.
After-tax cost of debt = 0.105 (1 - 0.35) = 6.83%

26. The price-earnings ratio of a company is 25. What is the cost of the common stock for this company?

A. 25%
B. 20%
C. 10%
D. 5%
* E. 4%