Capital Structure – 8 Finance Questions
1) The corporate treasurer of Ajax Company expects the company to grow
at 4% in the future, and debt securities at 6% interest (tax rate = 30%) to be
a cheaper option to finance the growth. The current market price per share of
its common stock is $39, and the expected dividend in one year is $1.50 per
share. Calculate the cost of the company's retained earnings and check if the
treasurer's assumption is correct.
2) The risk-free rate on 10-year U.S. Treasury bills is 3% and the
expected rate of return on the overall stock market is 11%. The company has a
beta of 1.6. What is the cost of equity?
3) A company has a capital structure as follows:
Total Assets $600,000
Debt $300,000
Preferred Stock $100,000
Common Equity $200,000
What would be the minimum expected return from a
new capital investment project to satisfy the suppliers of the capital?
Assume the applicable tax rate is 40%, interest on
debt is 11%, flotation cost per share of preferred stock is $0.75, and flotation
cost per share of common stock is $4. The preferred and common stocks are
selling in the market for $26 and $143 a share respectively, and they are
expected to pay a dividend of $2 and $7, respectively, in one year. The
company's dividends are expected to grow at 13% per year. The firm would like
to maintain the existing capital structure to finance the new project.
4) Required rate of return is 10%.
Net Cash Flow
Year Project A Project B
0 -$2,000 -$2,500
1 $900 $1,500
2 $1,100 $1,300
3 $1,300 $800
a)Calculate the payback period for each project.
b) Calculate the net present value for each
project.
c)Which project do you think will be approved, if
only one project can be approved? Why?
d)What if the required rate of return was 20%?
5) A corporate bond has a face value of $1,000 and an annual coupon
interest rate of 7%. Interest is paid annually. 10 years of the life of the bond
remain. The current market price of the bond is $872. To the nearest whole
percent, what is the yield to maturity (YTM) of the bond today?
6)Ajax Manufacturing will pay a dividend of $8 per share of common stock
in one year. The dividend growth rate is 3% and the required return is 14%.
a)What is the current market price per share?
b)What is the annual rate of return if you purchase
the stock at $65?
7) A common stock sells for $82 per share, has a
growth rate of 7% and a dividend that was just paid of $3.82. What is the annual
percent yield per share?
8)A corporate bond has a face value of $1,000 and an annual coupon
interest rate of 6%. Interest is paid annually. 12
years of the life of the bond remain. The current market price of the bond is
$1,027, and it will mature at $1,100. To the nearest whole percent, what is the
yield to maturity (YTM) of the bond today?
TUTORIAL
PREVIEW
1) The
corporate treasurer of Ajax Company expects the company to grow at 4% in the
future
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Cost of retained earnings = (D1/ P0) +
g
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D1 =
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1.5
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P0 =
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39
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g =
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4%
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Cost of retained earnings =
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7.85%
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