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    Chapter 27 Answer

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    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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    Chapter 27 Answer

    Uploaded by

    porchieeann
    835 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
    Download as doc, pdf, or txt
    835 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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    © All Rights Reserved
    Download as DOC, PDF, TXT or read online from Scribd
    Download as doc, pdf, or txt
    of 5

    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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