2.1. Suppose stock in Sun Corporation has a beta of 0.60.

The market risk premium is 8 percent,

and the risk-free rate is 5 percent. Sun’s last dividend was $1.00 per share, and the dividend is
expected to grow at 6 percent indefinitely. The stock currently sells for $30 per share. What is
Sun’s cost of equity capital?

2.2. In addition to the information given in the previous problem, suppose Sun has a target debt-
equity ratio of 1/3. Its cost of debt is 8 percent before taxes. If the tax rate is 30 percent, what is the
WACC?

2.3. The Tribiani Co. just issued a dividend of $2.90 per share on its common stock. The company
is expected to maintain a constant 4.5 percent growth rate in its dividends indefinitely. If the stock
sells for $56 a share, what is the company’s cost of equity?

2.4. The Swanson Corporation’s common stock has a beta of 1.07. If the risk-free rate is 3.4 percent
and the expected return on the market is 11 percent, what is the company’s cost of equity capital?

2.5. Stock in Jansen Industries has a beta of 1.05. The market risk premium is 7 percent, and T-
bills are currently yielding 3.5 percent. The company’s most recent dividend was $2.45 per share,
and dividends are expected to grow at an annual rate of 4.1 percent indefinitely. If the stock sells
for $44 per share, what is your best estimate of the company’s cost of equity?

2.6. Suppose Wacken, Ltd., just issued a dividend of $2.73 per share on its common stock. The
company paid dividends of $2.31, $2.39, $2.48, and $2.58 per share in the last four years. If the
stock currently sells for $43, what is your best estimate of the company’s cost of equity capital
using the arithmetic average growth rate in dividends?

2.7. Holdup Bank has an issue of preferred stock with a $6 stated dividend that just sold for $96
per share. What is the bank’s cost of preferred stock?

2.8. Ninecent Corporation has a target capital structure of 70 percent common stock, 5 percent
preferred stock, and 25 percent debt. Its cost of equity is 13 percent, the cost of preferred stock is
6 percent, and the cost of debt is 8 percent. The relevant tax rate is 30 percent.

a. What is the company’s WACC?

b. The company president has approached you about the company’s capital structure. He wants to
know why the company doesn’t use more preferred stock financing because it costs less than debt.
What would you tell the president?

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2.9. Brannan Manufacturing has a target debt-equity ratio of 0.6. Its cost of equity is 14 percent,
and its cost of debt is 8.5 percent. If the tax rate is 30 percent, what is the company’s WACC?

2.10. Fama’s Llamas has a weighted average cost of capital of 10.5 percent. The company’s cost
of equity is 14 percent, and its pretax cost of debt is 8 percent. The tax rate is 30 percent. What is
the company’s target equity-to-debt ratio?

2.11. Jungle, Inc., has a target debt-equity ratio of 1.05. Its WACC is 9.4 percent, and the tax rate
is 35 percent.

a. If Jungle’s cost of equity is 14 percent, what is its pretax cost of debt?

b. If instead you know that the after-tax cost of debt is 6.8 percent, what is the cost of equity?

2.12. Fujita, Inc., has no debt outstanding and a total market value of $222,000. Earnings before
interest and taxes, EBIT, are projected to be $18,000 if economic conditions are normal. If there is
strong expansion in the economy, then EBIT will be 25 percent higher. If there is a recession, then
EBIT will be 30 percent lower. The company is considering a $60,000 debt issue with an interest
rate of 7 percent. The proceeds will be used to repurchase shares of stock. There are currently 7,400
shares outstanding. Ignore taxes for this problem.

a. Calculate earnings per share (EPS) under each of the three economic scenarios before any debt
is issued. Also calculate the percentage changes in EPS when the economy expands or enters a
recession.

b. Repeat part (a) assuming that the company goes through with recapitalization. What do you
observe?

2.13. Repeat parts (a) and (b) in Problem 2.12 assuming the company has a tax rate of 21 percent,
a market-to-book ratio of 1.0, and the stock price remains constant.

2.14. Foundation, Inc., is comparing two different capital structures: an all-equity plan (Plan I) and
a levered plan (Plan II). Under Plan I, the company would have 160,000 shares of stock
outstanding. Under Plan II, there would be 80,000 shares of stock outstanding and $2.8 million in
debt outstanding. The interest rate on the debt is 8 percent, and there are no taxes.

a. If EBIT is $350,000, which plan will result in the higher EPS?

b. If EBIT is $500,000, which plan will result in the higher EPS?

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c. What is the break-even EBIT?

2.15. A company’s fixed operating costs are $600,000, its variable costs are $2.00 per unit, and the
product’s sales price is $5.00. What is the company’s breakeven point; that is, at what unit sales
volume will its income equal its costs?

2.16. The Watch Company sells watches for $300; the fixed costs are $2,000,000 and variable costs
are $200 per watch.

a. What is the firm’s gain or loss at sales of 15,000 watches? At 26,000 watches?

b. What is the breakeven point?

c. What would happen to the breakeven point if the selling price was raised to $350? What is the
significance of this analysis?

d. What would happen to the breakeven point if the selling price was raised to $350 but the variable
costs rose to $230 a unit?

2.17. Night Shades, Inc., manufactures biotech sunglasses. The variable materials cost is $12.14
per unit, and the variable labor cost is $6.89 per unit.

a. What is the variable cost per unit?

b. Suppose the company incurs fixed costs of $845,000 during a year in which total production is
210,000 units. What are the total costs for the year?

c. If the selling price is $49.99 per unit and depreciation is $450,000 per year, what is the break-
even point?