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Chapter 27 Answer

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This document provides solutions to review questions and problems from a chapter on calculating the cost of capital. For multiple choice questions, it lists the correct answer for each. For problems, it shows calculations to determine the cost of debt, preferred shares, retained earnings, and the weighted average cost of capital using both book and market value weights. It also calculates the break-even point for a new investment project based on the firm's cost of capital.

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Chapter 27 Answer

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porchieeann
932 views5 pages
This document provides solutions to review questions and problems from a chapter on calculating the cost of capital. For multiple choice questions, it lists the correct answer for each. For problems, it shows calculations to determine the cost of debt, preferred shares, retained earnings, and the weighted average cost of capital using both book and market value weights. It also calculates the break-even point for a new investment project based on the firm's cost of capital.

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This document provides solutions to review questions and problems from a chapter on calculating the cost of capital. For multiple choice questions, it lists the correct answer for each. For problems, it shows calculations to determine the cost of debt, preferred shares, retained earnings, and the weighted average cost of capital using both book and market value weights. It also calculates the break-even point for a new investment project based on the firm's cost of capital.

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© All Rights Reserved
Download as DOC, PDF, TXT or read online from Scribd
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932 views5 pages

Chapter 27 Answer

Uploaded by

porchieeann
This document provides solutions to review questions and problems from a chapter on calculating the cost of capital. For multiple choice questions, it lists the correct answer for each. For problems, it shows calculations to determine the cost of debt, preferred shares, retained earnings, and the weighted average cost of capital using both book and market value weights. It also calculates the break-even point for a new investment project based on the firm's cost of capital.

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Solutions Manual

CHAPTER 27
CALCULATING THE COST OF CAPITAL
SUGGESTED ANSWERS TO THE REVIEW QUESTIONS AND PROBLEMS
I. Multiple Choice Questions
1.
2.
3.

D
A
C

4.
5.
6.

C
D
A

7.
8.
9.

C
D
C

II. Problems
Problem 1
The approximate before-tax cost of new debt is:
kd =

P120 + (P1,000 P970) / 15


(P1,000 + P970) / 2
P122
P985

=
=

0.1239 or 12.39%

The approximate after-tax cost of new debt is:


kdt =
=

(12.39) (1 0.34)
8.18%

Problem 2
The cost of new preferred share is:
kp =
=

P4.50
P47.50

0.0947 or 9.47%

27-1

10.

Chapter 27

Calculating the Cost of Capital

Problem 3
(a) The compound annual growth rate (FVIF i,n) at which dividends grew from
P1.98 to P2.50 over 4 years is as follows:
FVIF i,4=

=
=

Ending dividend
Beginning dividend
P2.50
P1.98
1.263

As shown in the table for Future Value of P1 for 4 periods of 1.263.


(b) The expected dividends to be received during 20x5, D 1, equal P2.65 (1.06 x
P2.50). The cost of retained earnings is:
kr=

P2.65
P40.00

0.0663 + 0.06

0.1263 or 12.63%

0.06

(c) The cost of new ordinary equity share is:


ks=

P2.65
P40.00 P3.00 +

0.0716 + 0.06

0.1316 or 13.16%

0.06

Problem 4
The estimated cost of retained earnings is:
kr=

0.05 + 0.95 (0.13 0.05)

0.050 + 0.076

0.1260 or 12.60%
27-2

Calculating the Cost of Capital

Chapter 27

Problem 5
The cost of retained earnings using the generalized risk premium method is:
kr=

0.100 + 0.025

0.1250 or 12.50%

Problem 6
The cost of retained earnings using the earnings-price ratio is:
P6.00
P40.00

kr=
=

0.1500 or 15.00%

Problem 7
The market value of each source of capital is found as follows:
Number of
Securities
(1)

Source of
Capital
Bonds
Preferred share
Ordinary equity share
Total

Market
Price
(2)

3,000 *
25,000
200,000

Market
Value
(1) (2)

P965
18
40

P 2,895,000
450,000
8,000,000
P11,345,000

*3,000,000 book value / P1,000 per bond = 3,000 bonds

Problem 8
(a) The book value weights are:
Long-term debt=
=

P2,000,000
P4,000,000

Preferred share=
=

0.500

Ordinary equity share=


=

27-3

P1,500,000
P4,000,000
0.375

P500,000
P4,000,000
0.125

Chapter 27

Calculating the Cost of Capital

The firms weighted average cost of capital is:


WACC =

(0.500) (0.0700) + (0.125) (0.1200) + (0.375) (0.1600)

0.0350 + 0.0150 + 0.0600

0.1100 or 11.00%

(b) The market value weights are:


P1,800,000
P6,000,000

Long-term debt=
=

Preferred share=
=

0.30

Ordinary equity share=


=

P600,000
P6,000,000
0.10

P3,600,000
P6,000,000
0.60

The firms weighted average cost of capital is:


WACC =

(0.30) (0.0700) + (0.10) (0.1200) + (0.60) (0.1600)

0.0210 + 0.0120 + 0.0960

0.1290 or 12.90%

Problem 9
The break-even point of total new investment (financing) is:
BPi=
=

P26,000,000
0.65
P40,000,000

27-4

Calculating the Cost of Capital

27-5

Chapter 27

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