PepsiCo uses 30-year Treasury bonds to measure the risk-free rate because: A. these bonds are essentially free of business risk. B. they capture the long-term inflation expectations of investors associated with investments in long-term assets. C. these bonds are essentially free of interest rate risk. D. none of the above.
38) The marginal cost of preferred stock is equal to: A. the preferred stock dividend divided by the net market price. B. the preferred stock dividend divided by its par value. C. (1 - tax rate) times the preferred stock dividend divided by net price. D. the preferred stock dividend divided by market price.
39) Cost of capital is: A. the average cost of the firm’s assets. B. a hurdle rate set by the board of directors. C. the rate of return that must be earned on additional investment if firm value is to remain unchanged. D. the coupon rate of debt.
40) Given the following information, determine the risk-free rate. Cost of equity = 12% Beta = 1.50 Market risk premium = 3% A. 6.5% B. 7.5% C. 7.0% D. 8.0%
41) The expected dividend is $2.50 for a share of stock priced at $25. What is the cost of retained earnings if the long-term growth in dividends is projected to be 8%? A. 18% B. 8% C. 25% D. 10%
42) Shawhan Supply plans to maintain its optimal capital structure of 30% debt, 20% preferred stock, and 50% common stock far into the future. The required return on each component is: debt–10%; preferred stock–11%; and common stock–18%. Assuming a 40% marginal tax rate, what after-tax rate of return must Shawhan Supply earn on its investments if the value of the firm is to remain unchanged? A. 14.2% B. 13.0% C. 10.0% D. 18.0%
43) Castle Corp. generated $2 million in operating income from sales of $20 million during the latest fiscal year. The firm’s interest expense was $500,000, and the corporate income tax rate was 40%. Investors require a rate of return of 18%. Using the dependence hypothesis approach to valuation, what is the market value of Castle? A. $5.1 million B. $7.2 million C. $8.3 million D. $9.6 million E. $6.5 million
44) Zybeck Corp. projects operating income of $4 million next year. The firm’s income tax rate is 40%. Zybeck presently has 750,000 shares of common stock which have a market value of $10 per share, no preferred stock, and no debt. The firm is considering two alternatives to finance a new product: (a) the issuance of $6 million of 10% bonds, or (b) the issuance of 60,000 new shares of common stock. If Zybeck issues common stock this year, what will projected EPS be next year? A. $1.67 B. $2.96 C. $2.33 D. $2.10
45) Lever Brothers has a debt ratio (debt to assets) of 20%. Management is wondering if its current capital structure is too conservative. Lever Brothers’s present EBIT is $3 million, and profits available to common shareholders are $1,680,000, with 457,143 shares of common stock outstanding. If the firm were to instead have a debt ratio of 40%, additional interest expense would cause profits available to stockholders to decline to $1,560,000, but only 342,857 common shares would be outstanding. What is the difference in EPS at a debt ratio of 40% versus 20%? A. $0.88 B. $1.95 C. $1.16 D. $2.12