# Stocks X and Y sell at - Expert Answers

3. Stocks X and Y sell at the same price. Stock X has a required return of 12% while Y's required return is 10%. Stock X’s dividend is expected to grow at a constant rate of 6% a year, while Stock Y’s dividend is expected to grow at a constant rate of 4%. If the market is in equilibrium so that expected returns equal required returns, which of the following statements is CORRECT?

One year from now, Stock X’s price is expected to be higher than Stock Y’s price.

Stock X has a higher dividend yield than Stock Y.

Stock X has the higher expected year-end dividend.

Stock Y has a higher capital gains yield.

Stock Y has a higher dividend yield than Stock X.

4. Stock A has a beta of 1.1 and Stock B's beta is 0.9. The market risk premium is 6%, and the risk-free rate is 6.3%. Both stocks have a constant dividend growth rate of 7%. If the market is in equilibrium, which of the following statements is CORRECT?

Stock B must have the higher required return.

Stock B’s dividend yield equals its expected dividend growth rate.

Stock A must have a higher stock price than Stock B.

Stock A must have a higher dividend yield than Stock B.

Stock B could have the higher expected return

10. ABC inc, an investor-owned healthcare enterprise, is considering a leasing arrangement to finance some proton equipment that it needs to provide proton therapy for the next 3 years. Given expected technological advances, the equipment will be obsolete and worthless after 3 years. The firm will depreciate the cost of the proton equipment on a straight-line basis over their 3-year life. It can borrow $4,800,000, the purchase price, at 10% and buy the equipment, or it can make 3 equal end-of-year lease payments of $2,100,000 each and lease them. The loan obtained from the bank is a 3-year simple interest loan, with interest paid at the end of the year. ABC's tax rate is 40%. Annual maintenance costs associated with ownership are estimated at $240,000, but this cost would be borne by the lessor if it leases. What is the net advantage to leasing (NAL)?

$44,388

None of the above

$117,320

$106,191

-$44,388

18. To help finance a major expansion, Smith Holdings sold a non-callable bond with 15 years to maturity. This bond has a 10.25% annual coupon, it sells at a price of $1,025, and it has a par value of $1,000. If LNCR’s tax rate is 40%, what after-tax component cost of debt should be used in the CCC calculation?

a. 5.11%

b. 5.95%

c. 5.37%

d. 6.25%

5.66%

19. Jones corp. recently paid a $3.29 dividend, the dividend is expected to grow at a constant rate of 6.50% a year, and the common stock currently sells for $62.50 a share. The before-tax cost of debt is 7.50%, and the tax rate is 40%. The target capital structure consists of 40% debt and 60% common equity. What is the company’s CCC if all equity is from retained earnings?

a. 9.80%

b. 9.06%

c. 8.70%

d. 8.35%

e. 9.42%

20 ABC Corp’s balance sheet shows a total of $50 million long-term debt with a coupon rate of 8.00% and a yield to maturity of 7.00%. This debt currently has a market value of $55 million. The balance sheet also shows that that the company has 20 million shares of common stock, and the book value of the common equity (common stock plus retained earnings) is $65 million. The current stock price is $8.25 per share; stockholders' required return is 10.00%; and the firm's tax rate is 40%. Based on market value weights, and assuming the firm is currently at its target capital structure, what CCC should ABC Corp use to evaluate capital budgeting projects?

a. 8.55%

b. 7.56%

c. 7.26%

d. 8.21%

e. 7.88%

21. Odyssey Healthcare (ODSY) hired you as a consultant to help estimate its cost of capital. You have been provided with the following data. (1): yield on the firm’s bonds = 7.00% and the risk premium over its own debt cost = 4.00%. (2) rRF = 5.00%, RPM = 6.00%, and b = 1.25. (3) D1 = $1.20; P0 = $35.00 and g = 8.00% (constant). You were asked to estimate the cost of equity based on the three most commonly used methods and then to indicate the difference between the highest and lowest of these estimates. What is that difference?

1.13%

2.34%

1.88%

2.58%

1.50%

One year from now, Stock X’s price is expected to be higher than Stock Y’s price.

Stock X has a higher dividend yield than Stock Y.

Stock X has the higher expected year-end dividend.

Stock Y has a higher capital gains yield.

Stock Y has a higher dividend yield than Stock X.

4. Stock A has a beta of 1.1 and Stock B's beta is 0.9. The market risk premium is 6%, and the risk-free rate is 6.3%. Both stocks have a constant dividend growth rate of 7%. If the market is in equilibrium, which of the following statements is CORRECT?

Stock B must have the higher required return.

Stock B’s dividend yield equals its expected dividend growth rate.

Stock A must have a higher stock price than Stock B.

Stock A must have a higher dividend yield than Stock B.

Stock B could have the higher expected return

10. ABC inc, an investor-owned healthcare enterprise, is considering a leasing arrangement to finance some proton equipment that it needs to provide proton therapy for the next 3 years. Given expected technological advances, the equipment will be obsolete and worthless after 3 years. The firm will depreciate the cost of the proton equipment on a straight-line basis over their 3-year life. It can borrow $4,800,000, the purchase price, at 10% and buy the equipment, or it can make 3 equal end-of-year lease payments of $2,100,000 each and lease them. The loan obtained from the bank is a 3-year simple interest loan, with interest paid at the end of the year. ABC's tax rate is 40%. Annual maintenance costs associated with ownership are estimated at $240,000, but this cost would be borne by the lessor if it leases. What is the net advantage to leasing (NAL)?

$44,388

None of the above

$117,320

$106,191

-$44,388

18. To help finance a major expansion, Smith Holdings sold a non-callable bond with 15 years to maturity. This bond has a 10.25% annual coupon, it sells at a price of $1,025, and it has a par value of $1,000. If LNCR’s tax rate is 40%, what after-tax component cost of debt should be used in the CCC calculation?

a. 5.11%

b. 5.95%

c. 5.37%

d. 6.25%

5.66%

19. Jones corp. recently paid a $3.29 dividend, the dividend is expected to grow at a constant rate of 6.50% a year, and the common stock currently sells for $62.50 a share. The before-tax cost of debt is 7.50%, and the tax rate is 40%. The target capital structure consists of 40% debt and 60% common equity. What is the company’s CCC if all equity is from retained earnings?

a. 9.80%

b. 9.06%

c. 8.70%

d. 8.35%

e. 9.42%

20 ABC Corp’s balance sheet shows a total of $50 million long-term debt with a coupon rate of 8.00% and a yield to maturity of 7.00%. This debt currently has a market value of $55 million. The balance sheet also shows that that the company has 20 million shares of common stock, and the book value of the common equity (common stock plus retained earnings) is $65 million. The current stock price is $8.25 per share; stockholders' required return is 10.00%; and the firm's tax rate is 40%. Based on market value weights, and assuming the firm is currently at its target capital structure, what CCC should ABC Corp use to evaluate capital budgeting projects?

a. 8.55%

b. 7.56%

c. 7.26%

d. 8.21%

e. 7.88%

21. Odyssey Healthcare (ODSY) hired you as a consultant to help estimate its cost of capital. You have been provided with the following data. (1): yield on the firm’s bonds = 7.00% and the risk premium over its own debt cost = 4.00%. (2) rRF = 5.00%, RPM = 6.00%, and b = 1.25. (3) D1 = $1.20; P0 = $35.00 and g = 8.00% (constant). You were asked to estimate the cost of equity based on the three most commonly used methods and then to indicate the difference between the highest and lowest of these estimates. What is that difference?

1.13%

2.34%

1.88%

2.58%

1.50%

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