True/False
a. Secured debt holders have a preferred position over other creditors, but not over preferred stock holders.
b. Kimberly-Clark recently repurchased 12.4 million shares of common stock at a price of $97 per share. One plausible reason for this is that the company feels that its stock is overvalued at the current market price.
c. In 2013, Macy's paid $359 million of cash dividends. These dividends reduce assets and reduced retained earnings.
True/False
a. Secured debt holders have a preferred position over other creditors, but not over preferred stock holders.
b. Kimberly-Clark recently repurchased 12.4 million shares of common stock at a price of $97 per share. One plausible reason for this is that the company feels that its stock is overvalued at the current market price.
c. In 2013, Macy's paid $359 million of cash dividends. These dividends reduce assets and reduced retained earnings.
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Related questions
Instructions: Use the formula below to compute the problems: âPlease Read the question carefully.â
Kd = Yield (1 â T)
1. Telecom Systems can issue debt yielding 8 percent. The company is in a 35 percent bracket. What is its after-tax cost of debt?
2. After-tax cost of debt: Royal Jewelers Inc., has an aftertax cost of debt of 6 percent. With a tax rate of 40 percent, what can you assume the yield on the debt is?
3.
Cash flow: Assume a corporation has earnings before depreciation and taxes of $100,000, depreciation of $50,000, and that it has a 30 percent tax bracket. Compute its cash flow using the format below.
Earnings before depreciation and taxes _____
Depreciation _____
Earnings before taxes _____
Taxes @ 30% _____
Earnings after taxes _____
Depreciation _____
4.
Cost of preferred stock: Medco Corporation can sell preferred stock for $80 with an estimated flotation cost of $3. It is anticipated the preferred stock will pay $6 per share in dividends.
a. Compute the cost of preferred stock for Medco Corp.
b. Do we need to make a tax adjustment for the issuing firm?
5. Cost of preferred stock: The Meredith Corporation issued $100 par value preferred stock 10 years ago. The stock provided an 8 percent yield at the time of issue. The preferred stock is now selling for $75. What is the current yield or cost of the preferred stock? (Disregard flotation costs.)
6. Costs of retained earnings and new common stock: Barton Electronics wants you to calculate its cost of common stock. During the next 12 months, the company expects to pay dividends (D1) of $1.20 per share, and the current price of its common stock is $30 per share. The expected growth rate is 9 percent.
a. Compute the cost of retained earnings (Ke). Use Formula 11-6.
b. If a $2 flotation cost is involved, compute the cost of new common stock (Kn). Use Formula 11-7.
7. A firm's cost of preferred stock is equal to the preferred dividend divided by market price plus the dividend growth rate (Kp= D/Po+ g).
8. The coefficient of variation, calculated as the standard deviation of expected returns divided by the expected return, is a standardized measure of the risk per unit of expected return.
a. True
b. False
9. The standard deviation is a better measure of risk than the coefficient of variation if the expected returns of the securities being compared differ significantly.
a. True
b. False
10. The CAPM is built on historic conditions, although in most cases we use expected future data in applying it. Because betas used in the CAPM are calculated using expected future data, they are not subject to changes in future volatility. This is one of the strengths of the CAPM.
a. True
b. False
11. You have the following data on three stocks:
Stock | Standard Deviation | Beta |
A | 20% | 0.59 |
B | 10% | 0.61 |
C | 12% | 1.29 |
If you are a strict risk minimizer, you would choose Stock if it is to be held in isolation and Stock if it is to be held as part of a well-diversified portfolio.
a. A; A.
b. A; B.
c. B; A.
d. C; A.
e. C; B.
12. A portfolioâs risk is measured by the weighted average of the standard deviations of the securities in the portfolio. It is this aspect of portfolios that allows investors to combine stocks and thus reduce the riskiness of their portfolios.
a. True
b. False
13. You are considering two bonds. Bond A has a 9% annual coupon while Bond B has a 6% annual coupon. Both bonds have a 7% yield to maturity, and the YTM is expected to remain constant. Which of the following statements is CORRECT?
a. The price of Bond B will decrease over time, but the price of Bond A will increase over time.
b. The prices of both bonds will remain unchanged.
c. The price of Bond A will decrease over time, but the price of Bond B will increase over time.
d. The prices of both bonds will increase by 7% per year.
e. The prices of both bonds will increase over time, but the price of Bond A will increase at a faster rate.
14. A 12-year bond has an annual coupon of 9%. The coupon rate will remain fixed until the bond matures. The bond has a yield to maturity of 7%. Which of the following statements is CORRECT?
a. If market interest rates decline, the price of the bond will also decline.
b. The bond is currently selling at a price below its par value.
c. If market interest rates remain unchanged, the bondâs price one year from now will be lower than it is today.
d. The bond should currently be selling at its par value.
e. If market interest rates remain unchanged, the bondâs price one year from now will be higher than it is today.
15. Suppose the real risk-free rate is 3.50% and the future rate of inflation is expected to be constant at 2.20%. What rate of return would you expect on a 1-year Treasury security, assuming the pure expectations theory is valid? Disregard cross-product terms, i.e., if averaging is required, use the arithmetic average.
a. 5.14%
b. 5.42%
c. 5.70%
d. 5.99%
e. 6.28%
16. Suppose 1-year T-bills currently yield 7.00% and the future inflation rate is expected to be constant at 3.20% per year. What is the real risk-free rate of return, r*? Disregard any cross-product terms, i.e., if averaging is required, use the arithmetic average.
a. 3.80%
b. 3.99%
c. 4.19%
d. 4.40%
e. 4.62%
17. Assume that interest rates on 20-year Treasury and corporate bonds are as follows:
T-bond = 7.72% AAA = 8.72% A = 9.64% BBB = 10.18%
The differences in these rates were probably caused primarily by:
a. Tax effects.
b. Default and liquidity risk differences.
c. Maturity risk differences.
d. Inflation differences.
e. Real risk-free rate differences.
18. You plan to analyze the value of a potential investment by calculating the sum of the present values of its expected cash flows. Which of the following would lower the calculated value of the investment?
a. The cash flows are in the form of a deferred annuity, and they total to $100,000. You learn that the annuity lasts for only 5 rather than 10 years, hence that each payment is for $20,000 rather than for $10,000.
b. The discount rate increases.
c. The riskiness of the investmentâs cash flows decreases.
d. The total amount of cash flows remains the same, but more of the cash flows are received in the earlier years and less are received in the later years.
e. The discount rate decreases.
19. Assume that inflation is expected to decline steadily in the future, but that the real risk-free rate, r*, will remain constant. Which of the following statements is CORRECT, other things held constant?
a. If the pure expectations theory holds, the Treasury yield curve must be downward sloping.
b. If the pure expectations theory holds, the corporate yield curve must be downward sloping.
c. If there is a positive maturity risk premium, the Treasury yield curve must be upward sloping.
d. If inflation is expected to decline, there can be no maturity risk premium.
e. The expectations theory cannot hold if inflation is decreasing.
20. Disregarding risk, if money has time value, it is impossible for the present value of a given sum to exceed its future value.
a. True
b. False
Additional funds needed
Morrissey Technologies Inc.'s 2012 financial statements are shown here.
Morrissey Technologies Inc.: Balance Sheet as of December 31, 2012 | ||||
Cash | $180,000 | Accounts payable | $360,000 | |
Receivables | 360,000 | Notes payable | 56,000 | |
Inventories | 720,000 | Accrued liabilities | 180,000 | |
Total current assets | $1,260,000 | Total current liabilities | $596,000 | |
Long-term debt | 100,000 | |||
Fixed assets | 1,440,000 | Common stock | 1,800,000 | |
Retained earnings | 204,000 | |||
Total assets | $2,700,000 | Total liabilities and equity | $2,700,000 |
Morrissey Technologies Inc.: Income Statement for December 31, 2012 | |||
Sales | $3,600,000 | ||
Operating costs including depreciation | 3,279,720 | ||
EBIT | $320,280 | ||
Interest | 20,280 | ||
EBT | $300,000 | ||
Taxes (40%) | 120,000 | ||
Net Income | $180,000 | ||
Per Share Data: | |||
Common stock price | $45.00 | ||
Earnings per share (EPS) | $1.80 | ||
Dividends per share (DPS) | $1.08 |
Suppose that in 2013, sales increase by 15% over 2012 sales. The firm currently has 100,000 shares outstanding. It expects to maintain its 2012 dividend payout ratio and believes that its assets should grow at the same rate as sales. The firm has no excess capacity. However, the firm would like to reduce its Operating costs/Sales ratio to 89.5% and increase its total debt-to-assets ratio to 30%. (It believes that its current debt ratio is too low relative to the industry average.) The firm will raise 30% of 2013 forecasted total debt as notes payable, and it will issue long-term bonds for the remainder. The firm forecasts that its before-tax cost of debt (which includes both short-term and long-term debt) is 12%. Assume that any common stock issuances or repurchases can be made at the firm's current stock price of $45.
- Construct the forecasted financial statements assuming that these changes are made. What are the firm's forecasted notes payable and long-term debt balances? What is the forecasted addition to retained earnings? Round your answers to the nearest cent.
Morrissey Technologies Inc. Pro Forma Income Statement December 31, 2013 2012 2013 Pro Forma Sales $3,600,000 $ Operating costs (includes depreciation) 3,279,720 $ EBIT $320,280 $ Interest expense 20,280 $ EBT $300,000 $ Taxes (40%) 120,000 $ Net Income $180,000 $ Dividends $ $ Addition to RE $ $ Morrissey Technologies Inc. Pro Forma Balance Statement December 31, 2013 2012 2013 Pro Forma Cash $180,000 $ Accounts receivable 360,000 $ Inventories 720,000 $ Fixed assets 1,440,000 $ Total assets $2,700,000 $ Payables + accruals $540,000 $ Short-term bank loans 56,000 $ Total current liabilities $596,000 $ Long-term bonds 100,000 $ Total debt $696,000 $ Common stock 1,800,000 $ Retained earnings 204,000 $ Total common equity $2,004,000 $ Total liab. and equity $2,700,000 $ - If the profit margin remains at 5% and the dividend payout ratio remains at 60%, at what growth rate in sales will the additional financing requirements be exactly zero? In otherwords, what is the firm's sustainable growth rate? (Hint: Set AFN equal to zero and solve for g.) Round your answer to two decimal places.
%
The Stone Meat Corporation is a mediumâsized agricultural products company headquartered in Ogden, Utah. Its primary products are beef, pork and poultry and include packaged deli meats to half animals sold directly to in-store butcher markets in the retail grocery stores. They also supply their own butcher packs to various retail outlets including grocery stores, big box stores, and restaurants. In addition, they have their own factory store. The firm's products are well recognized within the markets in terms of quality and food safety. During the 2000's and the early 2010's sales and earnings had grown rapidly. Sales in 2002 were approximately $60 million, but had reached $180 million by 2012. Per share earnings and dividends more than kept pace. The relevant figures are contained in Exhibit 1. In order to support the firm's expansion, substantial expenditures on plant and equipment were required during the period indicated. The majority of funds came from retained earnings and the private placement of debentures with insurance companies. In 2004, however, the company was forced to sell additional common stock because it felt that the debt level, which would ensue from trying to borrow the money to keep up its expansion program, would be excessive. In particular, possible adverse effects in its stock price were feared since, at the time, the firm's ratio of debt to total capitalization was already somewhat above the industry average of 30 percent. The firm's balance sheet as of December 31, 2012 is shown in Exhibit 1. Originally, the company's Board of Directors had established a policy of paying out half its annual earnings as dividends. The actual percentage varied from year to year because an attempt was made to stabilize the dividends despite fluctuating profit. By the late 2000's, this policy had been revised to set oneâthird of earnings as the target payâout ratio due to the continuing need for capital. At their last annual meeting, the Directors announced that the 2012 dividend would be 60 cents per share, payable quarterly in 15 cent installments. The company's stock is listed on the AMEX and trades actively. The range of yearly stock prices is included in Exhibit 1. The closing price on June 30, 2012 was $24. Market data indicated that Stone was somewhat less risky than the market as a whole with a beta of .80. Returns on the market were averaging approximately 12% and risk free borrowing was still low following the financial meltdown of 2008. These rates averaged 3.5%. Preferred stock, which had been issued many years ago as a part of a financial deal, was selling at $90 per share. Tax rates had averaged 30% over the last few years. Early in 2012, the treasurer of Stone was reviewing its investment and financing strategies with an eye toward improving both. The question as to an appropriate cutâoff ratio of return on new investments was of special concern. The treasurer was of the opinion that many capital expenditures had been made in the past without proper analysis. He wanted a figure he could justify to the firm's managers as a cost of capital in order to achieve a more accurate capital budgeting procedure throughout the organization. He felt this was an especially timely move in view of an article he had just read in the WSJ and which is reproduced in Exhibit Ill. Stone's own longârange planning group had earlier forecast a trend not unlike that indicated in the Journal. The treasurer was well aware that financing did not come free and that the costs of issuance of preferred stock would cost 8%, bonds would cost 4% and equity 12%. He thought it important to determine how such costs would inflate the costs of any proposed projects the company might pursue in the futures. Thus he wanted to determine what the total cost of a $1,000,000 investment would be after considering any financing costs
Exhibit 1
Year Sales eps dps Stock Price
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Exhibit II
Balance Sheet As of 12/31/2012 (figures in Millions)
Cash 20 Accounts Receivable 10 Inventories 30 Plant and Equipment, net 60 Total Assets 120 Accounts Payable 20 Misc Accruals 10 Preferred Stock (5%) 10 Long term Debt 24 Common Stock (2.5 million shares) 12 Capital Surplus 4 Retained Earnings 40 Total Liabilities and Equity 120 The firm's bonds carried a 6% coupon, a 12/31/2022 maturity and were selling for $960 as of 6/30/2012.
What is the cost of preferred stock?