# Bonds and Stocks by shitingting

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```									1. At the current time Warren Industries can issue 15-year, \$1,000 par-value bonds paying
annual interest at a 12% coupon rate. As a result of current interest rates, the bonds can be
sold for \$1,010 each. Flotation costs of \$30 per bond will be incurred in the process (which
implies that f = 2.97%, or 0.0297 in decimal form) and the firm is in a 40% tax bracket.
(a) Find the net proceeds from the sale of each bond for Warren Industries.
(b) Calculate the before-tax and the after-tax cost of debt for Warren Industries.

2. Drywall Systems, Inc., is presently in discussions with its investment bankers regarding the
issuance of new bonds. The investment banker has informed the company that different
maturities will carry different coupon rates and sell at different prices. Drywall Systems
must choose among several alternatives. In each case, the bonds will have a \$1,000 par
value and flotation costs will be \$30 per bond. This implies that the firm will net \$970 per
bond, before the adjustment for the premium (+) or discount (-). The company is taxed at a
rate of 40%. Calculate the after-tax costs of financing with each of the following
alternatives.

Alternative            Coupon Rate             Time to Maturity           Premium (+) or
Discount (-)
A                     9%                     16 years                  + \$250
B                     7%                     5 years                    + \$50
C                     6%                     7 years                     Par
D                     5%                     10 years                   - \$75

3. Gem Systems has recently issued preferred stock. The stock has a 12% annual dividend based
on a par value of \$100 per share. The stock is currently selling for \$97.50 per share in the
secondary market (so that Po = \$97.50). Finally, flotation costs of \$2.50 must be paid for each
new share Gem Systems issues.
(a) Calculate the cost of preferred stock based on the outstanding issue, given the current
market price.
(b) If Gem Systems sells a new issue of preferred stock carrying a par value of \$100 but with an
annual dividend of 10% of par, what is the cost of this newly issued preferred stock if the
firm nets \$90.00 per share after flotation costs?

4. Calculate the cost of preferred stock (rPS) for each of the following:

Preferred          Par Value        Current Price (Po)     Flotation Cost         Annual
Stock                                                                          Dividend
(% of Par)
A               \$100                 \$101                \$9.00                 11%
B                \$40                  \$38                \$3.50                  8%
C                \$35                  \$37                \$4.00                \$5.00
D                \$30                  \$26               5% of par             \$3.00
E                \$20                  \$20                \$2.50                  9%
5. JPM Corporation common stock has a beta of 1.2. The risk-free rate is 6%, and the market
return is 11%.
(a) Derive the risk premium on JPM common stock.
(b) Determine JPM’s cost of common equity using the CAPM.

6. Reynolds Textiles wants to measure its cost of common equity. The firm’s stock is currently
selling for \$57.50 per share. The firm expects to pay a \$3.40 dividend at the end of 2011 (so
assume that
D1 = \$3.40 for purposes of calculation). The dividends for the last 5 years are as follows:

Year                            Dividend

2010                            \$3.10
2009                            \$2.92
2008                            \$2.60
2007                            \$2.30
2006                            \$2.12

After incurring flotation costs, Reynolds Textiles expects to net \$52 per share on a new issue.
(a) Determine the growth rate of dividends (g).
(b) By applying the constant-growth valuation model, determine the cost of retained earnings
common equity (rs).
(c) By applying the constant-growth valuation model, determine the cost of newly-issued
common equity (re).

7. Brite Lighting Corporation wants to investigate the effect on its cost of capital based on the
rate at which the company is taxed. The firm wishes to maintain a capital structure of 30%
debt, 10% preferred stock, and 60% common stock. The cost of financing with retained
earnings is 14% (i.e., rs = 14%), the cost of preferred stock financing is 9% (rps = 9%), and the
before-tax cost of debt is 11% (rd = 11%). Calculate the weighted average cost of capital
(WACC) given the tax rate assumptions in parts (a) to (c) below.
(a) Tax rate = 40%.
(b) Tax rate = 35%.
(c) Tax rate = 25%.

8. Westerly Manufacturing has compiled the information shown in the following table:

Source of Capital           Book Value            Market Value             After-tax Cost
Long-Term Debt              \$4,000,000             \$3,840,000                   6.0%
Preferred Stock             \$40,000                \$60,000                    13.0%
Common Stock Equity           \$1,060,000             \$3,000,000                  17.0%
Totals                \$5,100,000             \$6,900,000
(a) Calculate the firm’s weighted average cost of capital (WACC) using book value weights.
(b) Calculate the firm’s weighted average cost of capital (WACC) using market value weights.
(c) Compare your answers found in parts (a) and (b) and briefly explain the differences. Other
things equal, would you recommend that Westerly Manufacturing rely on its book value
weights or market value weights in determining its WACC?

9. To help finance a major expansion, Delano Development Company sold a noncallable bond
several years ago that now has 15 years to maturity. This bond has a 10.25% annual
coupon, paid semiannually, it sells at a price of \$1,025, and it has a par value of \$1,000. If
Delano’s tax rate is 40%, what component cost of debt should be used in the WACC
calculation?

10. Roxie Epoxy’s balance sheet shows a total of \$50 million long-term debt with a coupon rate
of 8.00% and a yield to maturity of 7.00%. This debt currently has a market value of \$55
million. The balance sheet also shows that that the company has 20 million shares of
common stock, and the book value of the common equity (common stock plus retained
earnings) is \$65 million. The current stock price is \$8.25 per share; stockholders' required
return, rs, is 10.00%; and the firm's tax rate is 40%. Based on market value weights, and
assuming the firm is currently at its target capital structure, what WACC should Roxie use to
evaluate capital budgeting projects?

11. Bruner Breakfast Foods’ (BBF) balance sheet shows a total of \$20 million long-term debt
with a coupon rate of 8.00% (assume each bond to have a maturity value, M, of \$1,000).
The yield to maturity on this debt is 10.00%, and the debt has a total current market value
of \$18 million. The balance sheet also shows that that the company has 10 million shares of
stock, and total of common equity (common stock plus retained earnings) is \$30 million.
The current stock price is \$4.50 per share, and stockholders' required rate of return, r s, is
12.25%. The company recently decided that its target capital structure should have 50%
debt, with the balance being common equity. The tax rate is 40%. Calculate WACCs based
on target, book, and market value capital structures (Note: I am asking for three (3)
separate WACC values here).

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