Multiple choice

1. J & B, Inc. has $5 million of debt outstanding with a coupon rate of 12%. Currently, the yield to maturity on these bonds is 14%. If the firm's tax rate is 40%, what is the cost of debt to J & B?
a. 12.0%
b. 14.0%
c. 8.4%
d. 5.6%
2. Shawhan Supply plans to maintain its optimal capital structure of 30% debt, 20% preferred stock, and 50% common stock far into the future. The required return on each component is: debt-10%; preferred stock-11%; and common stock-18%. Assuming a 40% marginal tax rate, what after-tax rate of return must Shawhan Supply earn on its investments if the value of the firm is to remain unchanged?
a. 18.0%
b. 13.0%
c. 10.0%i
d. 14.2%

3. Bender and Co. is issuing a $1,000 par value bond that pays 9% interest annually. Investors are expected to pay $918 for the 10-year bond. Bender will have to pay $33 per bond in flotation costs. What is the cost of debt if the firm is in the 34% tax bracket?
a. 7.23%
b. 9.01%
c. 9.23%
d. 11.95%

4. Armadillo Mfg. Co. has a target capital structure of 50% debt and 50% equity. They are planning to invest in a project which will necessitate raising new capital. New debt will be issued at a before-tax yield of 12%, with a coupon rate of 10%. The equity will be provided by internally generated funds. No new outside equity will be issued. If the required rate of return on the firm's stock is 15% and its marginal tax rate is 40%, compute the firm's cost of capital.
a. 13.5%
b. 12.5%
c. 7.2%
d. 11.1%

5. Given the following information, determine the risk-free rate.
Cost of equity = 12%
Beta = 1.50
Market risk premium = 3%
a. 8.0%
b. 7.5%
c. 7.0%
d. 6.5%

6. What is the present value of $12,500 to be received 10 years from today? Assume a discount rate of 8% compounded annually and round to the nearest $10.
a. $5,790
b. $11,574
c. $9,210
d. $17,010

Solution Summary

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