Problem Assignments and Solutions - Capital Structure
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 ssumption 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, repectively, 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.
Project A Project B
b) Calculate the net present value for each project.
Project A Project B
c) Which project do you think will be approved, if only one project can be approved? Why?
Project A Project B
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 is expected to pay a dividend of $8 per share next year. The dividend growth rate is expected to continue to be 3%.
Required rate of return is 14%.
a) What should be 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?
D0 = $3.82 and therefore D1 = $3.82 x 1.07 = $4.09
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?