Chapter 14



Chapter 14

Practice Quiz 2- Answer Key

1. Cyclone Software Co. is trying to estimate its optimal capital structure. Cyclone’s current capital structure consists of 25 percent debt and 75 percent equity; however, management believes the firm should use more debt. The risk-free rate is 5 percent, the market risk premium, is 6 percent, and the firm’s tax rate is 40 percent. Currently, Cyclone’s cost of equity is 14 percent, which is determined on the basis of the CAPM. What would be Cyclone’s estimated cost of equity if it were to change its capital structure from its present capital structure to 50 percent debt and 50 percent equity?

A. 13%

B. 15%

C. 17%-ANSWER

D. 19%

2. Currently, Bloom Flowers Inc. has a capital structure consisting of 20 percent debt and 80 percent equity. Bloom’s debt currently has an 8 percent yield to maturity. The risk-free rate is 5 percent, and the market risk premium is 6 percent. Using the CAPM, Bloom estimates that its cost of equity is currently 12.5 percent. The company has a 40 percent tax rate. What is Bloom’s current WACC?

A. 10.88%

B. 10.96%-ANSWER

C. 11.05%

D. 11.13%

3. Using the information from Problem 2, what is the current beta on Bloom’s common stock?

A. 1.21

B. 1.23

C. 1.25-ANSWER

D. 1.27

4. Using the information from Problem 2, what would Bloom’s beta be if the company had no debt in its capital structure?

A. 1.02

B. 1.05

C. 1.06

D. 1.09-ANSWER

5. Continuing on from Problem 2, Bloom’s financial staff is considering changing its capital structure to 40 percent debt and 60 percent equity. If the company went ahead with the proposed change, the yield to maturity on the company’s bonds would rise to 9.5 percent. The proposed change will have no effect on the company’s tax rate. What would be the company’s new cost of equity if it adopted the proposed change in capital structure?

A. 14.13%-ANSWER

B. 14.17%

C. 14.23%

D. 14.27%

................
................

In order to avoid copyright disputes, this page is only a partial summary.

Google Online Preview   Download