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# Caital Structure, Price of Stock, Futures and Options

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Global Technology's capital structure is as follows:
Debt 35%
Preferred stock 15
Common equity 50
The after-tax cost of debt is 6.5 percent; the cost of preferred stock is 10 percent; and the cost of common equity (in the form of retained earnings) is 13.5 percent.
Calculate Global Technology's weighted average cost of capital in a manner similar to Table 11-1 on page 313.

Appendix 11A, Problems

11A-1
Assume that Rf = 5 percent and Km = 10.5 percent. Compute Kj for the following betas, using Formula 11A-2.
a. 0.6
b. 1.3
c. 1.9

Chapter 18: Problems

4
Springsteen Music Company earned \$820 million last year and paid out 20 percent of earnings in dividends.
a. By how much did the company's retained earnings increase?
b. With 100 million shares outstanding and a stock price of \$50, what was the dividend yield? (Hint: First compute dividends per share.)

10
The shares of the Dyer Drilling Co. sell for \$60. The firm has a P/E ratio of 15. Forty percent of earnings is paid out in dividends. What is the firm's dividend yield?

17
Eastern Telecom is trying to decide whether to increase its cash dividend immediately or use the funds to increase its future growth rate. It will use the dividend valuation model originally presented in Chapter 10 for purposes of analysis. The model was shown as Formula 10-9 and is reproduced below (with a slight addition in definition of terms).

D0 is currently \$3.00, Ke is 10 percent, and g is 5 percent.
Under Plan A, D0 would be immediately increased to \$3.40 and Ke and g will remain unchanged.
Under Plan B, D0 will remain at \$3.00 but g will go up to 6 percent and Ke will remain unchanged.
a. Compute P0 (price of the stock today) under Plan A. Note D1 will be equal to D0 × (1 + g) or \$3.40 (1.05). Ke will equal 10 percent and g will equal 5 percent.
b. Compute P0 (price of the stock today) under Plan B. Note D1 will be equal to D0 × (1 + g) or \$3.00 (1.06). Ke will be equal to 10 percent and g will be equal to 6 percent.
c. Which plan will produce the higher value?

Chapter 19: Questions

12
Suggest two areas where the use of futures contracts are most common. What percent of the value of the underlying security is typical as a down payment in a futures contract?

13
You buy a stock option with an exercise price of \$50. The cost of the option is \$4. If the stock ends up at \$56, indicate whether you have a profit or loss with a call option? With a put option?

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#### Solution Preview

Chapter 11, Problems

16
Global Technology's capital structure is as follows:
Debt 35%
Preferred stock 15
Common equity 50
The after-tax cost of debt is 6.5 percent; the cost of preferred stock is 10 percent; and the cost of common equity (in the form of retained earnings) is 13.5 percent.
Calculate Global Technology's weighted average cost of capital in a manner similar to Table 11-1 on page 313.

WACC=proportion of debt x after tax cost of debt + proportion of common stock x cost of common stock + proportion of preferred stock x cost of preferred stock

proportion After tax cost proportion x Cost
Debt: 35% 6.50% 2.275% =35.%*6.5%
Preferred stock: 15% 10.00% 1.500% =15.%*10.%
Common stock 50% 13.50% 6.750% =50.%*13.5%
Total: 100% 10.525%

Answer: Weighted average cost of capital=WACC= 10.525%

Appendix 11A, Problems

11A-1
Assume that Rf = 5 percent and Km = 10.5 percent. Compute Kj for the following betas, using Formula 11A-2.
a. 0.6
b. 1.3
c. 1.9

CAPM (Capital Asset Pricing Model equation is:
K j= r f + &#946;A (k m - r f)
risk free rate= r f = 5.0%
return on market portfolio= K m = 10.5%

Security Beta Expected return ...

#### Solution Summary

Answers to questions on Capital structure, WACC, CAPM, Retained Earnings, Price of Stocks, Futures, Options have been provided.

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