# Finance problem sheets

Problem 1

A company issues 15-year, $1,000 par-value bonds, with a coupon rate of 5%. The bonds are sold for $619.70. The tax rate is 30%. Compute the cost of debt before taxes and after taxes.

Problem 2

Suppose a company issues common stock to the public for $25 a share. The expected dividend is $2.50 per share and the growth in dividends is 8%. If the flotation cost is 10% of the issue proceeds, compute the cost of external equity, re.

Problem 3

Calculate the cost of preferred stock (rPS) with the given information:

Par Value = $200

Current Price = $208

Flotation Cost = $16

Annual Dividend = 12% of Par

Problem 4

A company is investigating the effect on its cost of capital with respect to the tax rate. Suppose there is a capital structure of 20% debt, 10% preferred stock, and 70% common stock. The cost of financing with retained earnings is re = 12%, the cost of preferred stock financing is rPS = 7%, and the before-tax cost of debt is rd = 9%. Calculate the weighted average cost of capital (WACC) given a tax rate of 35%.

Problem 5

Suppose you are informed that a company expects to pay a $2.50 dividend at year end (D1 = $2.50), the dividend is expected to grow at a constant rate of 5.50% a year, and the common stock currently sells for $52.50 a share. The before-tax cost of debt is 7.50%, and the tax rate is 40%. The target capital structure consists of 45% debt and 55% common equity. What is the company's WACC if all the equity used is from retained earnings?

Problem 6

Alpha Products maintains a capital structure of 40 percent debt and 60 percent common equity. To finance its capital budget for next year, the firm will sell $50 million of 11 percent debentures at par and finance the balance of its $125 million capital budget with retained earnings. Next year Alpha expects net income to grow 7 percent to $140 million, and dividends also are expected to increase 7 percent to $1.40 per share and to continue growing at that rate for the foreseeable future. The current market value of Alpha's stock is $30. If the firm has a marginal tax rate of 40 percent, what is its weighted cost of capital for the coming year?

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#### Solution Summary

The expert computes the cost of debts before taxes and after taxes.

Problem 18-16 Dynastatics Corporation: Build financial model

Problem 18-16

Build financial models

The following tables contain financial statements for Dynastatics Corporation. Although the company has not been growing, it now plans to expand and will increase net fixed assets (that is assets net of depreciation) by $200 per year for the next 5 years and forecasts that the ratio of revenues to total assets will remain at 1.5. Annual depreciation is 10 percent of net fixed assets at the start of the year. Fixed costs are expected to remain at $56 and variable costs at 80 percent of revenue. The company's policy is to pay out two-thirds of net income as dividends and to maintain a book debt ratio of 25 percent of total capital.

a. Produce a set of financial statements for 2001. Assume that net working capital will equal 50% of fixed assets.

b. Now assume that the balancing item is debt and that no equity is to be issued. Prepare a completed proforma balance sheet for 2001. What is the projected debt ratio for 2001?

INCOME STATEMENT, 2000

(figures in thousands of dollars)

Revenue $1,800

Fixed costs 56

Variable costs (80% of revenue) 1,440

Depreciation 80

Interest (8% of beginning-of-year debt) 24

Taxable income 200

Taxes (at 40%) 80

Net Income $120

Dividends $80

Retained earnings $40

BALANCE SHEET, YEAR-END

(figures in thousands of dollars)

1999 2000

Assets

Net working capital $400 $400

Fixed assets 800 800

Total assets $1,200 $1,200

Liabilities and shareholders' equity

Debt $300 $300

Equity 900 900

Total liabilities and shareholders' equity $1,200 $1,200