Investment Chapter 11 Answer

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CHAPTER 11 – CALCULATING THE COST OF CAPITAL

Questions

LG1 11-1 How would you handle calculating the cost of capital if a firm were planning two issue two different classes of common stock?

Solution: As the two different classes of common stock are likely to have different component costs, calculate the cost and weight for each separately.

LG2 11-2 Why don’t we multiply the cost of preferred stock by 1 minus the tax rate, as we do for debt?

Solution: Because dividends on preferred stock, unlike interest on debt, are paid out of after-tax income.

LG2 11-3 Expressing WACC in terms of iE, iP, and iD, what is the theoretical minimum for the WACC?

Solution: The theoretical minimum WACC would be that for an all-debt firm:
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What is JaiLai’s cost of equity?

Solution: Using equation 11-2:

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LG3 11-3 Oberon Inc. has a $20 million (face value) bond issue selling for 97 percent of par that pays an annual coupon of 8.25 percent. What would be Oberon’s before-tax component cost of debt?

Solution: Solving equation 11-5 for iD:

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Yields iD = .087115, or 8.7115%

LG3 11-4 KatyDid Clothes has a $150 million (face value) bond issue selling for 104 percent of par that carries a coupon rate of 11 percent, paid semiannually. What would be Katydid’s before-tax component cost of debt?

Solution: Solving equation 11-5 for iD:

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Yields iD = .052586, or 5.2586% on a semiannual basis. Since the cost of debt is normally quoted on a nominal annual basis, we should multiple this semiannual rate by two to get a quoted component cost of 5.2586% × 2 = 10.5172%

LG3 11-5 ILK has preferred stock selling for 97 percent of par that pays an 8 percent annual coupon. What would be ILK’s component cost of preferred stock?

Solution: Using equation 11-4:

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LG3 11-6 Marme Inc. has preferred stock selling for 137 percent of par that pays an 11 percent annual coupon. What would be Marme’s component cost of preferred stock?

Solution: Using equation 11-4:

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LG4 11-7 FarCry Industries, a maker of telecommunications equipment, has 2

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