Practice Problems For Reading

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1. The cost of equity is equal to the:

A. expected market return.

B. rate of return required by stockholders.

C. cost of retained earnings plus dividends.

2. Which of the following statements is correct?

A. The appropriate tax rate to use in the adjustment of the before-tax cost of debt to determine the after-tax cost of debt is the average tax rate because interest is deductible against the company's entire taxable income.

B. For a given company, the after-tax cost of debt is generally less than both the cost of preferred equity and the cost of common equity.

C. For a given company, the investment opportunity schedule is upward sloping because as a company invests more in capital projects, the returns from investing increase.

3. Using the dividend discount model, what is the cost of equity capital for Zeller Mining if the company will pay a dividend of C$2.30 next year, has a payout ratio of 30 percent, a return on equity (ROE) of 15 percent, and a stock price of C$45?

B. 10.50 percent.

C. 15.61 percent.

4. Dot.Com has determined that it could issue $1,000 face value bonds with an 8 percent coupon paid semi-annually and a five-year maturity at $900 per bond. If Dot.Corn's marginal tax rate is 38 percent, its after-tax cost of debt is closest to:

5. The cost of debt can be determined using the yield-to-maturity and the bond rating approaches. If the bond rating approach is used, the:

A. coupon is the yield.

B. yield is based on the interest coverage ratio.

C. company is rated and the rating can be used to assess the credit default spread of the company's debt.

6. Morgan Insurance Ltd. issued a fixed-rate perpetual preferred stock three years ago and placed it privately with institutional investors. The stock was issued at $25 per share with a $1.75 dividend. If the company were to issue preferred stock today, the yield would be 6.5 percent. The stock's current value is:

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