• Please show all work, calculation, or explanation to receive full credit and circle the correct answer.
(The following information applies to Problems 1-4)
The Collins Group, a leading producer of custom automobile accessories, has hired you to estimate the firm’s weighted average cost of capital. The balance sheet and some other information are provided below.
Current assets $ 38,000,000
Net plant, property, and equipment 101,000,000
Total assets $139,000,000
Liabilities and Equity
Accounts payable $ 10,000,000
Current liabilities $ 19,000,000
Long-term debt (40,000 bonds, $1,000 par value) 40,000,000
Total liabilities $ 59,000,000
Common stock (10,000,000 shares) 30,000,000
Retained earnings 50,000,000
Total shareholders’ equity 80,000,000
Total liabilities and shareholders’ equity $139,000,000
1. The Collins Group’s bond with $1,000 par value 20-year, 7.25% annual
coupon rate with semiannual coupon payment is selling or $875. What is the best estimate of the after-tax cost of debt if the firm’s tax rate is 40%?
2. The stock’s beta is 1.25, and the yield on a 20-year Treasury bond is 5.50%.
The required return on the stock market is 11.50%. Based on the CAPM,
what is the firm’s cost of common stock?
3. Which of the following is the best estimate for the weight of debt for use in calculating the firm’s WACC? The debt is selling for $875 per bond and the stock is selling or 15.25 per share
4. What is the best estimate of the firm’s WACC?
7. The management of California Fluoride Industries (CFI) is planning next year’s capital budget. The company’s earnings and dividends are growing at a constant rate of 4 percent. The last dividend, D0, was $0.80; and the current equilibrium stock price is $8.73. CFI can raise new debt at a 12 percent before tax cost. CFI is at its optimal capital structure, which is 35 percent debt and 65 percent equity, and the firm’s marginal tax rate is 40 percent. CFI has the following independent, indivisible, and equally risky investment opportunities:
Project Cost Rate of Return
A $ 18,000 9%
B 16,000 11%
C 13,000 15%
D 23,000 13%
What is CFI’s optimal capital budget?
a. $70,000 b. $36,000 c. $34,000 d. $47,000 e. $0
8. Radiator Products Company (RPC) is at its optimal capital structure of 75 percent common equity and 25 percent debt. RPC’s WACC is 12.50 percent. RPC has a marginal tax rate of 40 percent. Next year’s dividend is expected to be $2.50 per share, and RPC has a constant growth in earnings and dividends of 5 percent. The cost of common equity used in the WACC is based on retained earnings, while the before tax cost of debt is 10 percent. What is RPC’s current equilibrium stock price?
a. $12.73 b. $17.23 c. $25.83 d. $20.37 e. $23.70