Subject: Business    / Finance
Question

1. ( T or F ) The most popular dividend policy in the U.S. is the constant payout ratio policy.

2. ( T or F ) The cost of debt is equal to the coupon rate on the bond issued by a firm.

3. ( T or F ) The optimal capital structure will vary over time as taxes and market conditions change.

4. ( T or F ) An investor is more likely to prefer a high dividend payout if a firm has few, if any, positive net present value projects.

5. ( T or F ) A stock repurchase program requires all shareholders to sell a fraction of their shares.

6. ( T or F ) Other things held constant, a decrease in the cost of capital for a firm will increase the probability that the firm accepts a project.

7. ( T or F ) The riskiness of a firm’s equity will rise if the firm increases its use of debt financing.

8. ( T or F ) The value of a firm is maximized when the cost of equity is maximized

9. ( T or F ) Investors prefer a low dividend policy since the tax on capital gains is deferred until the gain is

realized.

10. ( T or F ) If other things are the same, the cost of debt rises as the tax rate rises.

(The following information applies to the next three questions)

Jiminy’s Cricket Farm issued a bond with 15 years to maturity and a semiannual coupon rate of 6 percent

2 years ago. The bond currently sells for 95 percent of its par value. The company’s tax rate is 40 percent.

The book value of the debt issue is $60 million. In addition, the company has a second debt issue on the market,

a zero coupon bond with 15 years left to maturity; the book value of this issue is $35 million, and the bonds sell

for 51 percent of par. The par value of both bonds is $1,000.

11. What is the after-tax cost of the first bond?

12. What is the after-tax cost of the second (zero-coupon) bond?

13. What is the firm’s cost of debt?

14. Hootman Inc. expects $1.2 million of net income available to shareholders for next year. The company’s optimal capital structure is 50% debt and 50% equity. The capital needs for next year are $2.0 million. If the firm uses a residual dividend policy, what will be the firm’s dividend payout ratio for next year?

(The following information applies to the next four questions)

Ink Inc. has target capital structure of 10% preferred stock, 50% common equity, and 40% debt. Ink has outstanding 20 year annual, 6% coupon bonds selling for $894. The par value of the bonds is $1,000. Ink’s common stock sells for $50 per share and is expected to grow at 8% and expected to pay a $2 dividend next year. If Ink sells new common it must pay a $5 flotation fee. Ink’s preferred stock currently sells for $95, and its annual dividend is $5 per share. If Ink were to sell new preferred, it would pay $5 per share as flotation cost. Ink’s tax rate is 40%.

15. What is Ink’s after-tax cost of debt capital?

16. What is Ink’s cost of preferred stock capital?

17. What is Ink’s cost of common stock?

18. What is the firm’s WACC for the capital?

(The following information applies to the next two questions)

The market value balance sheet for Vena Sera Manufacturing is shown here. Vena Sera has declared a 28 percent stock dividend. The stock goes ex dividend tomorrow (the chronology for a stock dividend is

similar to that for a cash dividend). There are 14,000 shares of stock outstanding.

Market Value Balance Sheet

Cash

$156,000

Debt

$155,000

Fixed assets

386,000

Equity

387,000

Total

$542,000

Total

$542,000

19. What is the stock price today?

20. What will the ex-dividend price be?

(The following information applies to the next two questions)

The balance sheet for Ferguson Corp. is shown here in market

value terms. There are 5,000 shares of stock outstanding.

Market Value Balance Sheet

Cash

$

44,800

Equity

$

464,800

Fixed assets

420,000

Total

$

464,800

Total

$

464,800

The company has declared a dividend of $1.70 per share.

The stock goes ex dividend tomorrow.

21. Ignoring any tax effects, what is the stock selling for

today?

22. Ignoring any tax effects, what will it sell for tomorrow?

(The following information applies to the next two questions.)

ABC Inc. expects $1.75 million of net income available to shareholders for next year. The company’s optimal capital structure is 25% debt and 75% equity.

23. The capital needs for next year are $2 million. If the firm uses a residual dividend policy, what will be the firm’s dividends for next year?

24. In the above question, what if the capital needs are $3 million?

25. What is the impact of a stock repurchase on a company’s debt ratio? Explain carefully.

26. “Fast-growing companies tend to have lower target payout ratios.” Explain what is meant by this statement. Why do you think it is so?

27. When calculating the cost of capital, why is it that the company adjusts only the cost of debt for taxes?

28. In a world of taxes and no bankruptcy, why is a company’s optimal capital structure all debt? Explain

carefully.

29. Why would one-lender charge different rates to different borrowers for the same loan?

Why would two different lenders charge different rates to the same borrower for the same loan?

30. Does a stock split provide an increase in wealth for a shareholder? If yes, how? If no, why not?

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