Question
1.
You are called in as a financial analyst to appraise the bonds of Olsen’s Clothing Stores. The $1,000 par
value bonds have a quoted annual interest rate of 10 percent, which is paid semiannually. The yield to
maturity on the bonds is 12 percent annual interest. There are 25 years to maturity. Use Appendix
B andAppendix D for an approximate answer but calculate your final answer using the formula and
financial calculator methods.
a. Compute the price of the bonds based on semiannual analysis. (Do not round intermediate
calculations. Round your final answer to 2 decimal places.)
$
Bond price
b. With 20 years to maturity, if yield to maturity goes down substantially to 8 percent, what will be the
new price of the bonds? (Do not round intermediate calculations. Round your final answer to 2
decimal places.)
$
New bond price
2.
Wallace Container Company issued $100 par value preferred stock 10 years ago. The stock provided a 6
percent yield at the time of issue. The preferred stock is now selling for $78.
What is the current yield or cost of the preferred stock? (Disregard flotation costs.) (Do not round
intermediate calculations. Input your answer as a percent rounded to 2 decimal places.)
Current yield
%
3.
Airborne Airlines Inc. has a $1,000 par value bond outstanding with 30 years to maturity. The bond
carries an annual interest payment of $108 and is currently selling for $850. Airborne is in a 20 percent
tax bracket. The firm wishes to know what the aftertax cost of a new bond issue is likely to be. The yield
to maturity on the new issue will be the same as the yield to maturity on the old issue because the risk
and maturity date will be similar.
a. Compute the yield to maturity on the old issue and use this as the yield for the new issue. (Do not
round intermediate calculations. Input your answer as a percent rounded to 2 decimal places.)
%
Yield on new issue
b. Make the appropriate tax adjustment to determine the aftertax cost of debt. (Do not round
intermediate calculations. Input your answer as a percent rounded to 2 decimal places.)
Aftertax cost of debt
%
4.
Terrier Company is in a 40 percent tax bracket and has a bond outstanding that yields 10 percent to
maturity.
a. What is Terrier’s aftertax cost of debt? (Do not round intermediate calculations. Input your
answer as a percent rounded to 2 decimal places.)
Aftertax cost of debt
%
b. Assume that the yield on the bond goes down by 1 percentage point, and due to tax reform, the
corporate tax rate falls to 25 percent. What is Terrier’s new aftertax cost of debt? (Do not round
intermediate calculations. Input your answer as a percent rounded to 2 decimal places.)
Aftertax cost of debt
%
c. Has the aftertax cost of debt gone up or down from part a to part b?
It has gone up
It has gone down
5.
Global Technology’s capital structure is as follows:
Debt
Preferred stock
Common equity
15%
50
35
The aftertax cost of debt is 6.50 percent; the cost of preferred stock is 10.50 percent; and the cost of
common equity (in the form of retained earnings) is 13.50 percent.
Calculate the Global Technology’s weighted cost of each source of capital and the weighted average cost
of capital. (Do not round intermediate calculations. Input your answers as a percent rounded to 2
decimal places.)
Debt (Kd)
Weighted Cost
%
Preferred stock (Kp)
Common equity (Ke)
Weighted average cost of capital (Ka)
%
6.
Speedy Delivery Systems can buy a piece of equipment that is anticipated to provide a return of 12
percent and can be financed at 9 percent with debt. Later in the year, the firm turns down an opportunity
to buy a new machine that would yield a return of 16 percent but would cost 18 percent to finance
through common equity. Assume debt and common equity each represent 50 percent of the firm’s capital
structure.
a. Compute the weighted average cost of capital. (Do not round intermediate calculations. Input
your answer as a percent rounded to 2 decimal places.)
Weighted average cost of capital
%
b. Which project(s) should be accepted?
New machine
Piece of equipment
Appx B http://lectures.mhhe.com/connect/0077861612/Appendix_B.jpg
Appx D http://lectures.mhhe.com/connect/0077861612/Appendix_D.jpg
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