Question

Question 1:

Jiminy’s Cricket Farm issued a zero coupon bond with 10 years left to maturity; the book value of this issue is $35 million, and the bonds sell for 51 percent of par.

Calculate the pre-tax cost of the debt (the yield to maturity) quoted as an EAR.  (Enter answer as a percent rounded to two decimals.)

Yield to Maturity

%

What is the pre-tax cost of the debt (yield to maturity) quoted as an APR with semi-annual compounding? (Don't round the EAR if you try converting the EAR into an APR. Enter the APR as a percent rounded to two decimals.)

Yield to Maturity

%

Question 2:

Holdup Bank issued preferred stock that pays a constant $6.05 dividend each year. That stock currently sells for $97 per share. What is the cost of preferred equity if the next dividend will be paid in one year? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

  

Cost of preferred stock

%

Question 3:  

Epley Industries stock has a beta of 1.20. The company just paid an annual dividend of $.50, and the dividends are expected to grow at 6 percent. The expected return on the market is 11 percent, and Treasury bills are yielding 4.9 percent. The most recent stock price for the company is $66.

a.	Calculate the cost of equity using the discounted cash flow method (Chapter 6). (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

DCF method

%

b.	Calculate the cost of equity using the Security Market Line (Chapter 13). (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

SML method

%

Answer 1

Question 1.

a.

EAR = YTM = 6.97%

Using financial calculator BA II Plus - Input details:	#
FV = Future Value / Face Value =	-$35.00
PV = Present Value = 51% x 35 =	$17.85
N = Number of years remaining x frequency =	10
PMT = Payment = Coupon / frequency =	$0.00
CPT > I/Y = Rate per period or YTM per period =	6.9653
Convert Yield in annual and percentage form = Yield*frequency / 100 =	6.97%

b.

APR = YTM = Pre-tax cost of debt = 6.85%

Using financial calculator BA II Plus - Input details:	#
FV = Future Value / Face Value =	-$35.00
PV = Present Value = 51% x 35 =	$17.85
N = Number of years remaining x frequency = 10 x 2 =	20
PMT = Payment = Coupon / frequency =	$0.00
CPT > I/Y = Rate per period or YTM per period =	3.4240
Convert Yield in annual and percentage form = Yield*2 / 100 =	6.85%

Question 2:

Cost of preferred Stock = Dividend / Market price = 6.05/97

Cost of preferred stock = 6.24%

Question 3:

a.

Cost of equity = 6.80%

Given details	#
Existing growth rate = g =	6.00%
Expected dividend = D1 = D0*(1+g) = 0.50 x (1+6%)	0.53
Expected rate = r = Cost of equity =	?
Current stock price = P0 =	66.00
Flotation cost = f =	0.00
Formula for calculating the Expected rate:
r = (D1/(P0-f))+g =	6.80%

b.

Cost of equity = Risk free rate + Beta x (Market return-Risk free rate)

Cost of equity = 4.9% + 1.20 x (11%-4.9%)

Cost of equity = 12.22%