Test 2

Question 1

XYZ Corp can issue new bonds to yield 7%. They have a corporate tax rate of 35%. Issue costs for the bond are $20 or 2% of the proceeds. What is the Flotation Costs?

Answer 1

Kd = [Y (1 - T)] / (1 - F)
= [0.07 (1 - 0.35)] / (1 - 0.02)
= 4.64%

Question 2

XT Corp issues $25 preferred shares that pay a $1.25 dividend. Flotations costs are 4% or $1/share. What is the Cost of Preferred Shares?

Answer 2

Kp = (Dp / Pp) / (1 - F)
= (1.25 / 25) / (1 - 0.04)
= 5.21%

Question 3

The company provides the additional information of:

• Interest on the bank loan is 10%
• The current yield on bonds of the same time to maturity and risk is 9%
• The floatation cost of a new bond is 1%
• Government of Canada securities are currently providing a return of 2.5% Beta for Corp XYZ is 1.3 and return on market is expected to be 12%
• Corporate Tax rate is 25%
• The company has sufficient Retained Earnings to finance new investment projects.

With this Information find the required rate of return for Bank Debt, Bonds Payable and Common Stock
* hint 3 different required return formulas are used *

Answer 3

Bank Debt:
= Kd (1 - T)
= 0.10 (1 - 0.25)
= 7.5%

Bonds Payable:
= [Kd (1 - T)] / (1 - F)
= [0.09 (1 - 0.25)] / (1 - 0.01)
= 6.82

Common Stock:
= Rf + B (Rm- Rf)
= 0.025 + 1.3 (0.12 - 0.025)
= 14.85%

Question 4

Beta is 1.2, risk free rate is 4% and return on the market portfolio is 12%. What is the expected rate of return?

Answer 4

Ke = Rf + B (Rm - Rf)
= 0.04 + 1.2 (0.12 - 0.04)
= 13.6%

Question 5

Beta of 1.05, market portfolio return for the upcoming year is 16% anticipated market risk premium is 7%, Calculate the expected yield on this stock based on the CAPM?

Answer 5

Rf = Rm - Rp 
= 0.16 - 0.07
= 0.09
Ke = Rf + B (Rm - Rf)
= 0.09 + 1.05 (0.16 - 0.09)
= 16.35%

Question 6

A Canadian Pacific Railway (CP) share had a value of $61.40 at the beginning of 2013. By the end of the year, the price went up to $64.22. In addition, during the year, CP paid a $0.90 dividend per share. What is the total percentage return, the dividend yield and the capital gain yield?

Answer 6

Percentage Return = (Capital Gain + Dividends) / Initial Share Price
= [(64.22 - 61.40) + 0.90] / 61.40
= 6.06%
OR
Percentage Return = Capital Gain Yield + Dividend Yield
= 4.59 + 1.47
= 6.06%
Capital Gain Yield = Capital Gain / Initial Share Price
= (64.22 - 61.40) / 61.40
= 4.59
Dividend Yield = Dividend per share / Initial Share Price
= 0.90 / 61.40
= 1.47%