Question 1

Wentworth Industries is 100 percent equity financed. Its current beta is 0.9. The expected market rate of return is 14 percent and the risk-free rate is 8 percent.

a) Calculate Wentworth's cost of equity.

b) If Wentworth changes its capital structure to 30 percent debt, it estimates that its beta will increase to 1.1. The after-tax cost of debt will be 7 percent. Should Wentworth make the capital structure change?

Question 2

3. Shaken Corp. issued a 30-year, 7 percent semiannual bond 7 years ago. The bond currently sells for 108 percent of its face value. The company tax rate is 35 percent

a) What is the pre-tax cost of debt?

b) What is the after-tax cost of debt?

c) Which one is more relevant, the pretax or the after-tax cost of debt? Why?

Question 3

Alonso Corp. wants to issue bonds with a 9 percent coupon rate, a face value of RM1,000, and 12 years to maturity. Alonso estimates that the bonds will sell for RM1,090 and that flotation costs will equal RM15 per bond. Alonso Corp. common stock currently sells for RM30 per share and sells additional shares by incurring flotation costs of RM3 per share. Alonso paid a dividend yesterday of RM4.00 per share and expects the dividend to grow at a constant rate of 5 percent per year. Company also expects to have RM12 million of retained earnings available for use in capital budgeting projects during the coming year. Alonso's capital structure is 40 percent debt and 60 percent equity with marginal tax rate is 35 percent. Calculate the marginal average cost of capital assuming total capital budget is RM30 million.