PRACTICE PROBLEMS

Equity & Debt- WACC

Practice Problem 1

Your company currently has 650,000 shares of common stock outstanding. The
capital budget for the upcoming year is $1.8 million. Assuming that new stock may
be issued for $16 a share, what is the number of shares that must be issued to provide
the necessary funds to meet the capital budget?

Practice Problem 2

Your company wants to raise $3 million in its first public issue of common stock.
After its issuance, the total market value of stock is expected to be $7 million.
Currently, there are 140,000 outstanding shares that are closely held.
Compute the number of new shares that must be issued to raise the $3 million.

Practice Problem 3

Your company expected the dividend for the year to be $10 a share. The cost of
capital is 13%. The growth rate in dividends is expected to be constant at 8%.
What is the price per share?

Practice Problem 4

Your company's earnings per share are $7. It is expected that the company's stock
should sell at eight times its earnings.
What is the market price per share?

Practice Problem 5

Assuming an indefinite stream of future dividends of $300,000 and a required return

Your company is considering a public issue of its securities. The average price/
earnings multiple in the industry is 15. The company's earnings are $400,000. There
will be 100,000 shares outstanding after the issuance of the stock.
What is the expected price per share?

Practice problem 7

Your company is considering issuing either debt or preferred stock to finance the
purchase of a plant costing $1.3 million. The interest rate on the debt is 15%. The
dividend rate on the preferred stock is 10%. The tax rate is 34%.

Select the best possible source of financing

Practice problem 8

Your company has sales of $30 million a year. It needs $6 million in financing for
capital expansion. The debt-to-equity ratio is 68%. Your company is in a risky
industry, and net income is not stable. The common stock is selling at a high P/E
ratio compared to the competition. Under consideration is the issuance of either
common stock or a convertible bond.

Select the best possible source of financing

Practice problem 9

Your company is a mature one in its industry. There is limited ownership. The
company has vacillating sales and earnings. Your firm’s debt-to-equity ratio is 70%
relative to the industry standard of 55%. The after-tax rate of return is 16%.
Since your company is a seasonal business, there are certain times during the year
when its liquidity position is inadequate. Your company is unsure about the best way
to finance.

Select the best possible source of financing

Practice problem 10

Your company wants to construct a plant that will take about 1 year to construct. The
plant will be used to produce a new product line, for which your company expects a
high demand. The new plant will materially increase corporate size. The following
costs are expected:
 Cost to build the plant $800,000
Funds needed for contingencies $100,000
Annual operating costs $175,000

The asset, debt, and equity positions of your company are similar to industry
standards. The market price of the company's stock is less than it should be, taking
into account the future earning power of the new product line.

What would be the appropriate means to finance the construction?

Practice problem 11
Your company wants to acquire another business but has not determined the optimal
means to refinance the acquisition. The current debt to equity position is within the
industry guideline. In prior years, financing has been achieved through the issuance
of short-term debt.

Profit has shown vacillation and, as a result, the market price of the stock has
fluctuated. Currently, however, the market price of stock is strong. Your company's
tax bracket is low.

Select the best possible source of financing

Practice problem 12

Assume that the capital structure at the latest statement date is indicative of the
proportions of financing that the company intends to use over time:
Cost
Bonds ($1,000 par) $20,000,000 4.80%
Preferred stock ($100 par) $5,000,000 12.00%
Common stock ($40 par) $20,000,000 16.00%
Retained earnings $5,000,000 16.00%

Practice problem 13

The company has a target capital structure of 40% debt and 60% equity. Bonds with
face value of $ 1,000 pay a 10% coupon (semiannual), mature in 20 years, and sell
for $849.54 with a yield to maturity of 12%. The company stock beta is 1.2.
Risk-free rate is 10%, and market risk premium is 5%.

The company is a constant-growth firm that just paid a dividend of $2, sells for $27
per share, and has a growth rate of 8%. The company's marginal tax rate is 40%.

The company has a target capital structure of 40% debt and 60% equity. Bonds with
face value of $ 1,000 pay a 10% coupon (semiannual), mature in 20 years, and sell
for $849.54 with a yield to maturity of 12%. The company stock beta is 1.2.
Risk-free rate is 10%, and market risk premium is 5%.

The company is a constant-growth firm that just paid a dividend of $2, sells for $27
per share, and has a growth rate of 8%. The company's marginal tax rate is 40%.

Calculate the company's after-tax cost of debt; the company's cost of equity using the
capital asset pricing model (CAPM) approach; The company's cost of equity using
the dividend discount model; The company's weighted average cost of capital (using
the cost of equity from CAPM)