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Homework #7 Due July 24 9:00 AM Assignments must be submitted electronically via Blackboard, either typed or handwritten and scanned. Working in groups is encouraged, but each group member must submit his or her own separate write-up. 1. Why do we use an aftertax figure for cost of debt but not for cost of equity? 2. If you can borrow all the money you need for a project at 6%, doesn't it follow that 6% is your cost of capital for the project? 3. JC Corp. issued a 30-year, 8% semi-annual bond 3 years ago. The bond currently sells for 93% of its face value. The company's tax rate is 35%. a. What is the pretax cost of debt? b. What is the aftertax cost of debt? c. Which is more relevant, the pretax or the aftertax cost of debt? Why? 4. Paget Inc. has a target debt-equity ratio of 1.25. Its WACC is 9.2% and the tax rate is 35%. a. If the company's cost of equity is 14%, what is its pretax cost of debt? b. If instead you know that the aftertax cost of debt is 6.8%, what is the cost of equity? 5. An all-equity firm is considering the following projects: Project Beta IRR W .60 8.8% X .85 9.5 Y 1.15 11.9 Z 1.45 15.0 The T-bill rate is 4%, and the expected return on the market is 11%. a. Which projects have a higher expected return than the firm's 11% cost of capital? b. Which projects should be accepted? c. (optional see Session 18 slide 16) Which projects would be incorrectly accepted or rejected if the firm's overall cost of capital were used as a hurdle rate? 6. Berta Industries stock has a beta of 1.25. The company just paid a dividend of $0.40 and the dividends are expected to grow at 5%. The expected return on the market is 12%, and Treasury bills are yielding 5.5%. The most recent stock price for Berta is $72. a. Calculate the cost of equity using the DGM method. b. Calculate the cost of equity using the SML-CAPM method. c. Why do you think your estimates in (a) and (b) are so different