FIN331 Financial Management and Capital Structure: Problem Set

Name: FIN331 Financial Management and Capital Structure: Problem Set
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Financial Management and Capital Structure: Problem Set
FIN331
1. Which one (s) is (are) an external financing and has the flotation cost?
a. Retained earnings
b. Bonds
c. Preferred stock
d. a & b
e. b & c -answer
Retained earnings are internal source of fund. Issuing bonds, preferred stocks, and common
stocks are external source of fund, which have the floation cost.
2. The costs of financing from different sources are as follows:
IEF = 5%, EEF=6%, cost of debt before tax = 5%, tax rate=20%, the size of retained
earnings=$30m. The capital structure is: We=40% and Wd=60%. Determine the WAMCC before
and after the break point.
a. 4.4% 4.8%
b. 4.4% 5.2%
c. 4.6% 4.8%
d. 4.6% 5.2%
e. 4.8% 5.2%
5%*(1 – 0.2)*0.6 + 5%*0.4 = 4.4%,
5%*(1 – 0.2)*0.6 + 6%*0.4 =4.8%
3. Given D1 = $1.00 and K=10%, what is the value of the stock at 8% growth rate? If the current
price of the stock is $50, would you buy it?
a. $55, Buy
b. $54, Buy
c. $55, Don’t
d. $54, Don’t
e. $50, Indifferent
PV=D1/(k-g)=1.00/(0.10 - 0.08) = $50. Since the price=PV, you are indifferent.
4. For a preferred stock with the dividend amount of $2.00 each quarter, what is the PV of it with an
annual discount rate of 8%? If the price of the preferred stock is $80, what is the yield (ROI, APR)
of this security?
a. $60, 8%
b. $80, 8%
c. $60, 10%
d. $80, 10%
e. $100, 10%
V0 = D/k = 8/0.08 = $100. ROI = (80+8)/80 = 10%

5. I checked the Microsoft stock price at 9:12am this morning. It was $24.88. The last 12 month
trailing (ttm) net earnings is $14.58 billion with 9 billion shares. What is the 12 month trailing
EPS and P/E ratio?
a. $1.62, 15.36
b. $2.26, 13.31
c. $1.26, 17.88
d. $2.32, 12.21
e. $1.18, 20.33
EPS = NE/Shares Outstanding = $14.58/9 = $1.62
P/E = Price per share/Earnings per share = $24.88/$1.62 = 15.36
6. For a common stock with the current dividend amount of = $.70 (Do = .70), what is the (P)V of it
with an annual discount rate of 12% and the dividend is expected to grow at the rate of 10% per
annum forever?
a. $33.5
b. $35.0
c. $38.5
d. $45.0
e. $37.5
V0 = D1 / (k-g) = (0.70* 1.1)/(0.12-0.10) = 38.5
7. The preemptive right is important to shareholders because it
a. allows managers to buy additional shares below the current market price.
b. will result in higher dividends per share.
c. is included in every corporate charter.
d. protects the current shareholders against a dilution of their ownership interests.
e. protects bondholders, and thus enables the firm to issue debt with a relatively low interest rate.
8. Which of the following statements is CORRECT?
a. The constant growth model takes into consideration the capital gains investors expect to
earn on a stock.
b. Two firms with the same expected dividend and growth rate must also have the same stock
price.
c. It is appropriate to use the constant growth model to estimate a stock's value even if its
growth rate is never expected to become constant.
d. If a stock has a required rate of return rs = 12%, and if its dividend is expected to grow at a
constant rate of 5%, this implies that the stock’s dividend yield is also 5%.
e. The price of a stock is the present value of all expected future dividends, discounted at the
dividend growth rate.
Statement a is true, because the expected growth rate is also the expected capital gains yield. All
the other statements are false.
9. The Francis Company is expected to pay a dividend of D1 = $1.25 per share at the end of the year,
and that dividend is expected to grow at a constant rate of 6.00% per year in the future. The

company's beta is 1.15, the market risk premium is 5.50%, and the risk-free rate is 4.00%. What
is the company's current stock price?
a. $28.90
b. $29.62
c. $30.36
d. $31.12
e. $31.90
D1 $1.25
b 1.15
rRF 4.00%
RPM 5.50%
g 6.00%
rs = rRF + b(RPM) = 10.33%
P0 = D1/(rs − g) $28.90
10. Goode Inc.'s stock has a required rate of return of 11.50%, and it sells for $25.00 per share.
Goode's dividend is expected to grow at a constant rate of 7.00%. What was the last dividend, D0?
a. $0.95
b. $1.05
c. $1.16
d. $1.27
e. $1.40
Stock price $25.00
Required return 11.50%
Growth rate 7.00%
P0 = D1/(rs − g), so D1 = P0(rs − g) = $1.1250
Last dividend = D0 = D1/(1 + g) $1.05
11. You must estimate the intrinsic value of Noe Technologies’ stock. The end-of-year free cash
flow (FCF1) is expected to be $27.50 million, and it is expected to grow at a constant rate of 7.0%
a year thereafter. The company’s WACC is 10.0%, it has $125.0 million of long-term debt plus
preferred stock outstanding, and there are 15.0 million shares of common stock outstanding.
What is the firm's estimated intrinsic value per share of common stock?
a. $48.64
b. $50.67
c. $52.78
d. $54.89
e. $57.08
FCF1 $27.50
Constant growth rate 7.0%
WACC 10.0%
Debt & preferred stock $125
Shares outstanding 15
Total firm value = FCF1/(WACC − g) = $916.67
Less: Value of debt & preferred -$125.00
Value of equity $791.67

Number of shares 15
Value per share = Equity value/Shares = $52.78
12. Carter's preferred stock pays a dividend of $1.00 per quarter. If the price of the stock is $45.00,
what is its nominal (not effective) annual rate of return?
a. 8.03%
b. 8.24%
c. 8.45%
d. 8.67%
e. 8.89%
Pref. quarterly dividend $1.00
Annual dividend = Qtrly dividend × 4 = $4.00
Preferred stock price $45.00
Nom. required return = Annual dividend/Price = 8.89%
13. Capital structure refers to
a. The types of projects a firm invests in.
b. The mixture of short-term and long-term debt.
c. The amount of debt and equity a firm has
d. Short-term assets and short-term liabilities.
e. The size, timing, and risk
14. Which of the following statements is CORRECT?
a. When calculating the cost of debt, a company needs to adjust for taxes, because interest
payments are deductible by the paying corporation.
b. When calculating the cost of preferred stock, companies must adjust for taxes, because
dividends paid on preferred stock are deductible by the paying corporation.
c. Because of tax effects, an increase in the risk-free rate will have a greater effect on the after-
tax cost of debt than on the cost of common stock as measured by the CAPM.
d. If a company’s beta increases, this will increase the cost of equity used to calculate the
WACC, but only if the company does not have enough retained earnings to take care of its
equity financing and hence must issue new stock.
e. Higher flotation costs reduce investors' expected returns, and that leads to a reduction in a
company’s WACC.
Statement “a” is true, because interest payments on debt are tax deductible. The other statements
are false.
15. What is the % of total financing by equity if the total $12m funding include $7.5m from debt?
a. 35%
b. 37.5%
c. 46.5%
d. 50%
e. 62.5%
Component of capital: (LT)debt, PFD stocks, and Common Equity. Therefore (12-7.5)/12 = 37.5%

16. The amount of retained earnings limit the size of internal equity financing. If the amount of
retained earnings is $25m, where do you have a switch from the internal to external equity
financing in terms of the size of the total funding when the equity financing accounts for 25% of
the total funding and the remaining is from debt?
a. $150m
b. $100m
c. $180m
d. $130m
e. $150m
25m/0.25=$100m
17. Long-term debt of Topstone Industries is currently selling for $1,045. Its face value is $1,000.
The issue matures in 10 years and pays an annual coupon of 8% of face. What is the before-tax
cost of debt for Topstone if the company is in 30% tax bracket?
a. 6.75%
b. 7.35%
c. 6.85%
d. 7.45%
e. 8.35%
Find YTM. N=10, PV=-1045, PMT=80, FV=1000 => I/Y= 7.35%
18. Several years ago the Jakob Company sold a $1,000 par value, noncallable bond that now has 20
years to maturity and a 7.00% annual coupon that is paid semiannually. The bond currently sells
for $925, and the company’s tax rate is 40%. What is the component cost of debt for use in the
WACC calculation?
a. 4.28%
b. 4.46%
c. 4.65%
d. 4.83%
e. 5.03%
Coupon rate 7.00%
Periods/year 2
Maturity (yr) 20
Bond price $925.00
Par value $1,000
Tax rate 40%
Calculator inputs:
N = 2 × 20 40
PV = Bond's price -$925.00
PMT = Coupon rate × Par/2 $35
FV = Par = Maturity value $1,000
I/YR 3.87%
Times periods/yr = before-tax cost of debt 7.74%
= After-tax cost of debt (A-T rd) for use in WACC 4.65%
19. Weaver Chocolate Co. expects to earn $3.50 per share during the current year, its expected
dividend payout ratio is 65%, its expected constant dividend growth rate is 6.0%, and its common

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Finance

FIN331 Financial Management and Capital Structure: Problem Set

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