The Cost of Capital

THE court OF CAPITALQ1. Place the creditors hierarchy in the oppose order. (PD)Ordinary Sh beholders 1Unsecured Creditors 2Creditors with floating(a) charges 3Preference Shargonholders 4Creditors with melio point charges 5(2 marks)Q2. Gecko Co. has just pay a dividend of $0.65/ distribute the authentic conduct worth in the grocery store in the stock commercialise is $3.6. report the appeal of truth? (FIB)3613156159500Ke %(2 marks)Q3. A persona has a received grocery prise of 86c, and the last dividend paid by the fellowship was 7.23c. The anticipate annual evolution evaluate of dividends is 7%. maneuver the speak to of legality pileus? (FIB)4013205270500Ke %(2 marks)Q4. Reeve Co. is about to pay a dividend of $1 per run-of-the-mill sh be. The Net assets of the connection argon $500,000. The hire for the company is $180,000.The Current sh ar price is $7 per sh be. Reeve Co. has in correspond degree centigrade,000 Ordinary shargons. What is the make up o f equity to the nearest whole percentage? (MCQ)27%30%33%35%(2 marks)Q5. Sago Co.s has 5 million shares in phone number & their dividend payments in the years were as follows demise of the year 20X7 20X8 20X9 20Y0 20X1Dividends ($000) 250 275 295 222 350The flow rate share price of Sago Co is $2/share. Calculate the salute of equity? (MCQ)11%12.6%13%15.1%(2 marks)Q6. Amok Co. is about to pay a dividend of 20c per share. The share price is 300c. The stray of draw is 16% & 25% of the earnings is a dividend. Calculate the address of equity? (FIB) 3917954508500Ke %(2 marks)Q7. Which of the succeeding(a) is/are the laying claims apply by Dividend evaluation illustration (DVM)? (MRQ) Income stream for the shareholders are the dividends paid by the companyDividends are constant or grow at a fixed castThe model assumes there is no need to incorpo consec roam any guessThe dividends paid by the company are till eternity (2 marks)Q8. Which of the pursuance statements is a dis wag es for Dividend valuation model (DVM)? (MCQ)The model stupefys metropolis gains of shareholders into accountIt assumes huge appeal is applicable to the get laid of new sharesNo all(prenominal)owance is made for the measureationThe growth in earnings is incorpo sum upd(2 marks)Q9. Shares in BLACK and snowy admit a important of 0.75. The equity run a risk insurance tribute is 5% and the unhazardous rate of authorise is 3%. What is the approach of equity groovy for BLACK and WHITE? (FIB)4921256223000Ke %(2 marks)Q10. The current average grocery place deliver organism paid on risky enthronements is 14%, com pared with 7% on Treasury bills. Halo Co cost of equity is 17.5%. What is the important factor? (FIB)4921256350000 important (2 marks)Q11. The Government securities fade is 7%. The overall stock market return is 11%. The pass judgment beta is 0.9. What would be the shares expect cling to if it is expected to earn an annual dividend of 5.3c, with no capital grow th? (FIB) 2006606096000Cents (2 marks)Q12. All companies given at a lower place operate in the same business industry. They all wipe out same characteristics except for the fact that their capital structures are different, which are as followsLoco Co. Choco Co. Rocco Co.Debt from the total market 27 35 49Equity from the total market 73 65 51The equity beta of Rocco Co. is 1.32 the equity beta of Loco Co. is 0.74.What range pass on Choco Co. beta fall? (MCQ)The beta of Choco Co is high than 1.32The beta of Choco Co. is above 0.74The beta of Choco Co. is between 0.74 1.32The beta of Choco Co is lower than 0.74(2 marks)Q13. enthronements mandatory return cornerstone be predicted using the corking asset set model. The risk-free rate of return is 5%. enthronization of import look on Return ValueAlpha 1.5 13% beta 0.7 15.3%Mega 1 12%Zeta 1.2 12.2%If Zeta is conciliately priced then select the suppress option for each putment? (PD) Alpha Underpriced of import mitigate Pri ceMega Overpriced(2 marks)Q14. Beak Frees Co. makes biscuits and cookies and there are some factors in the market that the investors are unable to distinguish all they are a magisterial or un- taxonomical risk to them. Help the investors in choosing the appropriate Risk? (HA) The warm increase in interest order imperious UNSYSTEMATICPrice increments in Flour utilise by the company SYSTEMATIC UNSYSTEMATICThe downfall of the prudence in which the company operates SYSTEMATIC UNSYSTEMATICIndustrial unrest in one of the factories SYSTEMATIC UNSYSTEMATIC (2 marks)Q15. Which of the following boldness is not related to Capital asset pricing model? (MCQ)Investors have a spread of investment in multiple companiesThere are no taxes applicableIt ignores earning a potential of the companyAll forecast made are for undivided period effect(2 marks)Q16. The systematic risk of a portfolio congress to the market portfolio is measured using the beta factor. Which of the following statements is/are true? (MRQ)If beta is greater than 1, the warranter is less sensitive to systematic risk than the marketIf Beta is lesser than 1, the shelter is less sensitive to systematic risk than the marketIf Beta equals 1, the securitys exposure to systematic risk matches the marketIf Beta equals 0 the security is risk-free(2 marks)Q17. Which of the following is an advantage of Capital asset pricing model? (MCQ)It leaves a initiation for establishing risk-adjusted discount rates for capital investment projects.Ignores revenue enhancement for the investorsIt is unable to distinguish between dividends & capital gainsIndividual companies have different systematic risk characteristics of their shares(2 marks)Q18. The cost of equity of a company is directly unaffected(p) by which of the following? (MCQ)The expected market returnThe companys expected betaThe expected return on the companys assetThe government securities return (2 marks)Q19. 10% irreformable pick shares having a share price-dividend of $7/share. The tax rate is 27%. Calculate the cost of preference shares if the par measure out is $0.6 correct to cardinal denary places? (FIB) 4521207747000Kp %(2 marks)Q20. Tangerine Co. wants to invest in an Investment appraisal project. The company decided to invest using a bank give. The company borrowed 7% $200,000 bring for the investment. What will be the cost of debt if the tax rate is 25%? (FIB)4521207175500Kd %(2 marks)Q21. 3G Co. has in recognise 12% ir fixable impart notes, currently trading at $105 cum-interest.If the tax rate changes from 27% to 20% for 3G co. then the cost of debt would likely (MCQ) Decreases to 8.4%Decreases to 9.42% Increases to 9.42%Increases to 10.3%(2 marks)Q22. A company issued their 10% unredeemable loan notes at 150. The current market price is $75. The company is paying crapper tax of 28%. What is the cost of loan notes? (FIB)4521206985000Kd %(2 marks)Q23. A company has in issue 8% redeemable debt with three years t o redemption at par. The current market treasure of the debt is $107.59. The corporation tax rate is 30%. What is the interest cost to the company? (MCQ)$8.6$32.3$8$5.6(2 marks)Q24. A company has in issue 5% redeemable loan notes having a current market value of $103/bond. These bonds will be redeemed in three year time at par value. Calculate the cost of debt if the tax rate is 29%? (MCQ)2%2.15%2.63%3% (2 marks)Q25. A 6% irredeemable preference shares are traded for $1.5 cumulative dividend. The tax rate is 30%. What is the cost of preference shares nearest to two decimal places? (FIB) 4521207810500Kp %(2 marks)Q26. A 3% 60,000 irredeemable preference shares are universe traded for $0.5 ex. Dividend. What is the cost of preference shares? (FIB)4521206985000Kp %(2 marks)Q27. A company has irredeemable loan notes currently trading at $36 ex-interest. The coupon rate is 11% and the rate of corporation tax is 30%.What is the return need by the debt pop the questionrs before tax is applicable? (MCQ)21.4%27.6%30.6%33%(2 marks)Q28. Sitcom Co. has a 5% redeemable loan notes which are redeemable at a 10% premium in 5 years time. The current market value is $ light speed per loan note. The tax rate is 25%. Calculate the cost of debt? (MCQ)2.7%3.53%4%5.62%(2 marks)Q29. A company has issued interchangeable loan notes which are callable to be redeemed at a 5% discount in five years time. The coupon rate is 7% and the current MV is $85. Alternatively, the investor can admit to convert each loan note into 10 shares in five years time. The company pays tax at 30% per annum. The companys shares are currently worth $9 and their value is expected to grow at a rate of 4% pa. Find the post-tax cost of the cashable debt to the company? (FIB)4521207683500Kd %(2 marks)Q30. Cobol Co. has in issue 6% convertible bonds having a market value of $ one hundred fifteen. These bonds can redeem at a premium of 2% in two years time or can be converted to 25 ordinary shares in two year s. The current share price $4 and its expected growth is 3% per annum. The corporation tax rate is 29%. Calculate the net present value if discount factor is 4%? (MCQ) $1.53$4.26$8.03$10(2 marks)Q31. Fichte Co. has in issue 12% convertible bonds having a market value of $97. These bonds can be converted into 40 ordinary shares in seven years time or can be redeemed at 12% premium in seven years time. The current share price is $3 with an annual growth rate of 4%.The tax rate per annum is 24%. Choose whether bonds should be converted or redeemed in seven years time? (MCQ)$108.64 repurchase $157.91 Conversion$108.64 Conversion$157.91 Redemption (2 marks)The following information is for Q32 & Q33Trico Co. has the capital structureCapital Structure $ m4 million $0.2 ordinary shares 0.810% irredeemable loan notes 13.58% Preference shares 10Reserves 15Total 39.3The loan notes are quoted and the ordinary shares are currently quoted at $50 and $4 respectively in the market. The cost of eq uity for Trico Co. is 11% and the current corporation tax is 30%. The preference shares are currently traded for $2.25 ex. Dividend.Q32. Calculate the weighted average cost of capital (WACC) for Trico Co. using the Book values? (MCQ) 8.45%10.37%11.13%11.27%(2 marks)Q33. Calculate market value weighted average cost of capital (WACC) for Trico Co.?9.24%9.97%10.79%12.38%(2 marks)Q34. Zeeman Co. has 5m $1 ordinary shares, the reserves are held at $10m and there are 15% irredeemable loan notes of $9m. The market value of ordinary shares is $5, and the loan notes are currently traded at $80. Zeeman Co. has just paid a dividend of $0.7 and its corporation tax is 26%. What is the cost of capital? (MCQ)13.98%14.23%16.76%17.89%(2 marks)THE COST OF CAPITAL (ANSWERS)Q1. Creditors (payables) hierarchyCreditors with fixed charges 1Creditors with floating charges 2Unsecured Creditors 3Preference Shareholders 4 Ordinary Shareholders 5Q2. 18.1%Ke = (0.65 3.6) coke = 18.1%Q3. 16%Ke = (7.23 1 + 0.0 7 86) + 0.07 = 0.1599 0.1599 speed of light = 16%Q4. DGrowth = b re b = (1 11.8) = 0.44 re = (1.85) = 0.36g = (0.44 0.36) carbon = 15.84%Ke = 1(1+15.84%) (7 1) = 0.1931 + 15.84% = 0.351Ke = 0.351 c = 35%Q5. Bg = (350 250) 1 (5-1) 1 100 = 8.8%D1 = (350 5000) (1 + 8.8%) = 0.076Ke = (0.076 2) + 8.8% 100 = 12.6%Q6. 12%g = (0.75 0.16) 100 = 12%D1 = 0.2 (1 + 12%) = 0.224Ke = 0.224 (3 0.2) = 0.08 + 12% = 0.2 100 = 12%Q7. All statements below are assumption of DVM Income stream for the shareholders are the dividends paid by the companyDividends are constant or grow at a fixed rateThe dividends paid by the company are till eternity The model assumes there is no need to incorporate any risk. This is weakness not an assumption for Dividend growth model.Q8. CThe model does not take capital gains of shareholders into accountIt assumes no cost is applicable to the issue of new sharesNo allowance is made for the taxation (Disadvantage)The growth in earnings are ignoredQ9. 6.75%Ke = 3 + (5 0.75)Ke =6.75%Q10. 1.517.5% = 7 + (14 7) (beta)Beta =1.5Q11. 50cKe = 7 + (11 7) (0.9) = 10.6%Share price = 5.3c 10.6% = 50cQ12. CThe higher the debt, the riskier the company. The higher the equity, the safer the company.Loco Co. is safer as Debt lower & Rocco Co is riskier as debt is higher which indicates that Choco Co falls between two betas as its debt is between both companies debt.Q13.Alpha OverpricedBeta UnderpricedMega Correct PriceIf Investment Zeta is correctly priced, the actual return via CAPM will be 12.2 = 5 + 1.2 (Rm 5)Rm = 12 Investment Alpha should leave alone a return of 5 + 1.5 (12 5) = 15.5Investment Beta should provide a return of 5 + 0.7 (12 5) = 9.9Investment Mega provides a return of 5 + 1 (12 5) = 12Investment Alpha does not provide a high return so is overpriced. Investment Beta provides too high return so is underpriced. Investment Mega provides the correct return so correct priced.Q14.The immediate increase in interest rates S YSTEMATIC Price increments in Flour used by the company UNSYSTEMATICThe downfall of the economy in which the company operates SYSTEMATIC Industrial unrest in one of the factories UNSYSTEMATICSystematic risk cannot be diversified by the investorUnsystematic risk can be diversified by the investorQ15. CInvestors have a spread of investment in multiple companies (Well-diversified portfolio)There are no taxes applicable (Indication of being in a perfect capital market)It ignores earning a potential of the company (Disadvantage of DVM)All forecast made are for the single period transaction (Considers single transaction rather than multiple transactions at once)Q16.If Beta is greater than 1, the security is less sensitive to systematic risk than the market (True)If Beta is lesser than 1, the security is less sensitive to systematic risk than the market (False, It is highly sensitive to systematic risk than the market)If Beta equals 1, the securitys exposure to systematic risk matches the market (True)If Beta equals 0 the security is risk-free (True)Q17. AIt provides a basis for establishing risk-adjusted discount rates for capital investment projects. (Advantage)Ignores taxation for the investors (Disadvantage)It is unable to distinguish between dividends capital gains (Disadvantage)Individual companies have different systematic risk characteristics of their shares (Disadvantage)Q18. CThe formula for required return is Ke = risk-free rate + beta (market rate risk-free rate)Q19. 0.86%D= 0.6 10% = 0.06Ex-Dividend = 7 0.06 = 6.94Kp = (0.06 6.94) 100 = 0.86%Q20. 5.25%Kd = 7% (1 25%) = 0.0525 100 = 5.25%Q21. DKd = (12% 100) (1 27%) (105 12) = 0.094 100 = 9.42%Kd = (12% 100) (1 20%) (105 12) = 0.103 100 = 10.3%Increases to 10.3%Q22. 9.6%Kd = (10% 100) ( 1 28%) 75 = 0.096 100 = 9.6%Q23. DInterest = (8% 100) (1 30%) = $5.6Q24. BYear Cash flow ($) DF (5%) open value ($) DF (10%) picture Value ($)MV/Bond 0 (103) 1 (103) 1 (103)Interest 1-3 3. 55 2.723 9.67 2.487 8.83Redemption 3 100 0.864 86.4 0.751 75.1NPV (6.93) (19.07)IRR = 5 + -6.93 (-6.93 (-19.07) (10 5) = 2.15%Q25. 4.17%D= 1 6% = 0.06Ex-Dividend = 1.5 0.06 = 1.44Kp = (0.06 1.44) 100 = 4.17%Q26. 6%D= 1 3% = 0.03Kp = (0.03 0.5) 100 = 6%Q27. CAs the question states before tax the calculation will beKd = (11% 100) 36 100 = 30.6%Q28. DYear Cash flow ($) DF (5%) Present value ($) DF (10%) Present Value ($)MV/Bond 0 (100) 1 (100) 1 (100)Interest 1-5 3.75 4.329 16.23 3.791 14.22Redemption 5 110 0.784 86.24 0.621 68.31NPV 2.47 (17.47)IRR = 5 + 2.47 (2.47 (-17.47) (10 5) = 5.62%Q29. 9.7%Year Cash flow ($) DF (5%) Present value ($) DF (10%) Present Value ($)MV/Bond 0 (85) 1 (85) 1 (85)Interest 1-5 4.9 4.329 21.21 3.791 15.58Convertible 5 109.5 0.784 85.85 0.621 68NPV 22.06 (1.42)Redemption= 85 95% = 80.75Convertible= 10 9 (104%)5 = 109.5IRR = 5 + 22.06 (22.06 (-1.42) (10 5) = 9.7%Q30. AYear Cash flow ($) DF (4%) Present value ($)MV/Bond 0 (115) 1 (11 5)Interest 1-2 4.26 1.886 8.03Redemption 2 117.3 0.925 108.5NPV 1.53Redemption= 115 102% = 117.3Convertible= 25 4 (103%)2 = 106.1Q31. BRedemption= $97 112% = $108.64Conversion= 40 3 (104%)7 = $157.91Q32. DKp= (8% 1) 2.25 100 = 3.56%Kd= (10% 100) (1 30%) 50 = 0.14 100 = 14% Book Value ($m) court ($m)Equity (15+0.8) 15.8 15.8 11% 1.738Preference shares 10 10 8% 0.8Debt (irredeemable) 13.5 13.5 14% 1.89Total 39.3 4.428WACC = (4.428 39.3) 100 = 11.27%Q33. CKp= (8% 1) 2.25 100 = 3.56%Kd= (10% 100) (1 30%) 50 = 0.14 100 = 14% Market Value ($m) Cost ($m)Equity 4m 4 =16 16 11% 1.76Preference shares 4m 2.25 = 9 9 8% 0.72Debt (irredeemable) (13.5 100) 50 = 6.75 6.75 14% 0.945Total 31.75 3.425WACC = (3.425 31.75) 100 = 10.79%Q34. AKe= ($0.7 $5) 100 = 14%Kd= (15% 100) (1 26%) 80 = 0.1387 100 = 13.87%Market Value ($m) Cost ($m)Equity 5m 5 =25 25 14% 3.5Debt (9 100) 80 = 7.2 7.2 13.87% 1Total 32.2 4.5WACC = (4.5 32.2) 100 = 13.98%