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Chapter 13

# CH.13 WACC -Solutions to Help Session Problems-1.docx

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York University

Administrative Studies

ADMS 3530

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3530 Help Session Questions – Ch. 13 WACC - SOLUTIONS
1. A company just paid a $2.00 per share dividend on its common stock (Div0
= $2.00). The dividend is expected to grow at a constant rate of 7 percent per year. The stock
currently sells for $42 a share. What is the common equity’s cost of capital?
A) 5.10%
B) 11.76%
C) 11.98%
D) 12.10%
Solution D
Div0 = $2; Div1 = $2 x 1.07 = $2.14.
re = Div1/P0 + g = $2.14/$42 + 7% = 12.10%
2. Hamil Inc.’s 8 percent coupon rate, semi-annually payment, $1,000 par value bond, which
matures in 20 years, currently sells at a price of $686.86. The company’s tax rate is 40 percent.
What is the firm’s component cost of debt for purposes of calculating the WACC?
A) 6.11%
B) 7.33%
C) 7.56%
D) 12.22%
Solution B
Inputs: n = 40; PV = -686.86; PMT = 40; FV = 1000
Output: I = 6.11% periodic rate
YTM = 12.22%
rd after-tax = 12.22 x (1 - T) = 12.22 x (1 - 0.4) = 7.33%
3. Halley Industries' preferred stock pays an annual dividend of $3 per share. When issued, the
shares sold for their par value of $100 per share. What is the cost of preferred stock if the
current price is $85 per share?
A) 3.00%
B) 3.53%
C) 4.00%
D) 4.70%
Answer B
r = $3 / $85 = 3.53%.
preferred
4. What is Billabong’s WACC based on following information?
• Its capital structure consists of 40 percent debt and 60 percent common equity.
• The company has 20-year bonds outstanding with a 9 percent annual coupon
that are trading at par.
• The company’s tax rate is 40 percent.
• The risk-free rate is 5.5 percent.
• The market risk premium is 5 percent.
• The stock’s beta is 1.4 A) 8.31%
B) 9.66%
C) 11.10%
D) 11.18%
Solution B
rd = 9%
re = rf + beta x (rm - rf)
re = 5.5% + 1.4 x 5% = 12.5%.
WACC = wdrd(1 - T) + were
WACC = 0.4 x 9% x (1 - 0.4) + 0.6 x 12.5% = 9.66%
5. The WACC for a firm with only debt and equity in its capital structure, a debt-to-equity-ratio of
3/2, 8% before-tax cost of debt, 15% cost of equity, and a 35% tax rate is:
A) 7.02%
B) 9.12%
C) 10.80%
D) 13.80%
Solution B
It is straightforward to find that the weights of debt and equity in the firm’s capital structure are
60% and 40%, respectively. So we have:
WACC = 0.6 x 8% x (1 - 0.35) + 0.4 x 15% = 9.12%
6. A firm has a WACC of 12%. It is financed with 40% debt and 60% equity. The firm's before-
tax cost of debt is 10% and its tax rate is 40%. If the firm's dividend growth rate is 8% and its
current stock price is $40, what is the value of the dividend the firm is expected to pay at the
end of 1 year from now?
A) $2.60
B) $3.20
C) $4.25
D) Cannot be determined without additional information
Solution B
rd = 10%
WACC = 12% =0.4 x 10% x (1 - 0.4) + 0.6 x re
.60 x re = 12% - 2.40%
re = 9.60%/.60 = 16%
P0 = Div1/(re-g) 40 = DIV1/(16 - 8)
DIV1 = $40 x 8% = $3.20
7. Given the following information, what is WBM Corporation's WACC? Com

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