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- Which of the following statements regarding long-term financing methods is most CORRECT? Group of answer choices: Preferred stock generally has a higher component cost of capital to the firm than common stock. None of these statements are correct. All unpaid cumulative preferred dividends must be paid before any dividends can be paid on the firm’s common stock. The after-tax cost of preferred stock is typically at the same level as that of debt. Convertibles bring in additional funds when they are converted.Which of the following statements is CORRECT? Group of answer choices When calculating the cost of preferred stock, companies must adjust for taxes, because dividends paid on preferred stock are deductible by the paying corporation. Because of tax effects, an increase in the risk-free rate will have a greater effect on the after-tax cost of debt than on the cost of common stock as measured by the CAPM. If a company's beta increases, this will increase the cost of equity used to calculate the WACC, but only if the company does not have enough reinvested earnings to take care of its equity financing and hence must issue new stock. Higher flotation costs reduce investors' expected returns, and that leads to a reduction in a company's WACC. When calculating the cost of debt, a company needs to adjust for taxes, because interest payments are deductible by the paying corporation.Schalheim Sisters Inc. has always paid out all of its earnings as dividends; hence, the firm has no retained earnings. This same situation is expected to persist in the future. The company uses the CAPM to calculate its cost of equity, and its target capital structure consists of common stock, preferred stock, and debt. Which of the following events would REDUCE its WACC? A. The flotation costs associated with issuing preferred stock increase. B. The company's beta increases. C. The flotation costs associated with issuing new common stock increase. D. The market risk premium declines. E. Expected inflation increases.
- Preferred stock may be good for a company because it a. is not as costly as common stock or bonds. b. expands the capital base of the firm without diluting the common stock ownership. c. has no future negative ramifications when dividend payments are missed. d. does not require interest payment in times of financial trouble, but are tax-deductible when dividends are paid.Ignoring possible tax effects and signaling costs, the total value of a firm’s equity remains the same irrespective of how the firm distributes its residual earnings—dividends or stock repurchases. Each distribution method has certain advantages and disadvantages. Based on your understanding of dividends and stock repurchases, select the best terms to go with the statements. Management is likely to repurchase stock if it believes that the stock is undervalued/overvalued ; this sends positive signals to investors. True or False: Based on the company’s earnings in a particular year, repurchases can be made on an ad hoc basis without sending any negative signals to investors. True False Repurchases are also used to make significant adjustments to a firm’s liquidity/debt to equity ratio. True or False: Repurchases are more dependable than dividends because the investor wealth does not decrease after a repurchase, whereas the stock price decreases…A firm’s preferred stock often sells at yields below its bonds because: Preferred stock generally carries a higher agency rating. Owners of preferred stock have a prior claim on the firm’s earnings. Owners of preferred stock have a prior claim on a firm’s assets in the event of liquidation. Corporations owning stock may exclude from income taxes most of the dividend income they receive. Which is the most risky transaction to undertake in the stock index option markets if the stock market is expected to increase substantially after the transaction is completed? Write a call option. Write a put option. Buy a call option. Buy a put option
- True or False: The following statement accurately describes how firms make decisions related to issuing new common stock. Taking flotation costs into account will reduce the cost of new common stock. True: Taking flotation costs into account will reduce the cost of new common stock, because you will multiply the cost of new common stock by 1 minus the flotation cost—similar to how the after-tax cost of debt is calculated. False: Flotation costs are additional costs associated with raising new common stock. Sunny Day Manufacturing Company is considering investing in a one-year project that requires an initial investment of $475,000. To do so, it will have to issue new common stock and will incur a flotation cost of 2.00%. At the end of the year, the project is expected to produce a cash inflow of $550,000. The rate of return that Sunny Day expects to earn on its project (net of its flotation costs) is (rounded to two decimal places). White Lion…The Rivoli Company has no debt outstanding, and its financial position is given by the following data: What is Rivoli’s intrinsic value of operations (i.e., its unlevered value)? What is its intrinsic stock price? Its earnings per share? Rivoli is considering selling bonds and simultaneously repurchasing some of its stock. If it moves to a capital structure with 30% debt based on market values, its cost of equity, rs, will increase to 12% to reflect the increased risk. Bonds can be sold at a cost, rd, of 7%. Based on the new capital structure, what is the new weighted average cost of capital? What is the levered value of the firm? What is the amount of debt? Based on the new capital structure, what is the new stock price? What is the remaining number of shares? What is the new earnings per share?Preferred stock is a hybrid security, because it has some characteristics typical of debt and others typical of equity. The following table lists various characteristics of preferred stock. Determine which of these characteristics is consistent with debt and which is consistent with equity. Characteristics Debt Equity Dividends are fixed. No tax adjustments are made when calculating the cost of preferred stock. Consider the case of Turnbull Enterprises: At the present time, Turnbull Enterprises does not have any preferred stock outstanding but is looking to include preferred stock in its capital structure in the future. Turnbull has found some institutional investors that are willing to purchase its preferred stock issue provided that it pays a perpetual dividend of $13 per share. If the investors pay $100.15 per share for their investment, then Turnbull’s cost of preferred stock (rounded to four decimal places) will be .
- 3. The cost of preferred stock Preferred stock is a hybrid security, because it has some characteristics typical of debt and others typical of equity. The following table lists various characteristics of preferred stock. Determine which of these characteristics is consistent with debt and which is consistent with equity. Characteristics Debt Equity Dividends are fixed. No tax adjustments are made when calculating the cost of preferred stock. Consider the case of Turnbull Enterprises: At the present time, Turnbull Enterprises does not have any preferred stock outstanding but is looking to include preferred stock in its capital structure in the future. Turnbull has found some institutional investors that are willing to purchase its preferred stock issue provided that it pays a perpetual dividend of $13 per share. If the investors pay $100.15 per share for their investment, then Turnbull’s cost of preferred stock (rounded to four…* Your answer is incorrect. A company may repurchase its own shares for all of the following reasons, except O to reduce the number of shares issued and thereby increase earnings per share and return on equity. to have additional shares available for use in the acquisition of other companies. O to attempt to influence the market price of the shares. O to reduce the number of shares issued in order to meet debt to equity bank covenant requirements.2. Which of the following is a characteristic of preferred stock?A. Give voting rights to its owner.B. It is like annuity.C. Investors cannot force the payment of the dividend.D. Dividends are tax-deductible for the firm as opposed to interest payment.
