Question 1

Florida Groves has a $380,000 bond issue outstanding that is selling at 97.4 percent of face value. The firm also has 2,600 shares of preferred stock valued at $61 a share and 37,500 shares of common stock valued at $19 a share. What weight should be assigned to the common stock when computing the weighted average cost of capital?

Accepted Answer

A)   55.75 percent
B)   62.20 percent
C)   58.75 percent
D)   61.03 percent
E)   57.40 percentF) A) and D)
G) A) and E)

Question 2

Franktown Motors is expected to have an EBIT of $687,400 next year. Depreciation, the increase in net working capital, and capital spending are expected to be $48,000, $7,000, and $42,000, respectively. All cash flow items are expected to grow at 6 percent per year for four years. After Year 5, the CFA* is expected to grow at 2.1 percent indefinitely. The company currently has $3.2 million in debt and 250,000 shares outstanding. The company's WACC is 9.9 percent and the tax rate is 21 percent. What is the price per share of the company's stock?

Accepted Answer

A)   $17.82
B)   $18.74
C)   $12.07
D)   $20.12
E)   $16.47F) A) and B)
G) All of the above

Question 3

The Oil Derrick has an overall cost of equity of 12.7 percent and a beta of 1.13. The firm is financed solely with common stock. The risk-free rate of return is 4.8 percent. What is an appropriate cost of capital for a division within the firm that has an estimated beta of 1.16?

Accepted Answer

A)   12.37 percent
B)   12.41 percent
C)   12.54 percent
D)   12.67 percent
E)   12.91 percentF) A) and B)
G) C) and E) E

Question 4

You are evaluating a project that requires $324,000 in external financing. The flotation cost of equity is 8.4 percent and the flotation cost of debt is 5.1 percent. What is the initial cost of the project including the flotation costs if you maintain a debt-equity ratio of .35?

Accepted Answer

A)   $352,842
B)   $349,021
C)   $350,439
D)   $355,551
E)   $346,646F) B) and C)
G) C) and D) C

Question 5

The capital structure weights used in computing a company's weighted average cost of capital:

Accepted Answer

A)   are based on the book values of debt and equity.
B)   are based on the market values of the outstanding securities.
C)   depend upon the financing obtained to fund each specific project.
D)   remain constant over time unless new securities are issued or outstanding securities are redeemed.
E)   are restricted to debt and common stock.F) B) and E)
G) A) and B)

Question 6

Cookie Dough Manufacturing has a target debt-equity ratio of .76. Its cost of equity is 15.3 percent, and its pretax cost of debt is 9 percent. What is the WACC given a tax rate of 21 percent?

Accepted Answer

A)   11.76 percent
B)   12.78 percent
C)   13.11 percent
D)   11.48 percent
E)   12.53 percentF) B) and D)
G) B) and C)

Question 7

Assume Russo's has a debt-equity ratio of .4 and uses the capital asset pricing model to determine its cost of equity. As a result, the company's cost of equity:

Accepted Answer

A)   is affected by the firm's rate of growth projections.
B)   implies that the firm pays out all of its earnings to its shareholders.
C)   is dependent upon a reliable estimate of the market risk premium.
D)   would be unaffected if the dividend discount model were applied instead.
E)   will be unaffected by changes in overall market risks.F) B) and E)
G) A) and E)

Question 8

The average of a company's cost of equity, cost of preferred, and aftertax cost of debt that is weighted based on the company's capital structure is called the:

Accepted Answer

A)   reward-to-risk ratio.
B)   weighted capital gains rate.
C)   structured cost of capital.
D)   subjective cost of capital.
E)   weighted average cost of capital.F) A) and C)
G) C) and D)

Question 9

Which one of the following statements is correct?

Accepted Answer

A)   Firms should accept low-risk projects prior to funding high-risk projects.
B)   Making subjective adjustments to a company's WACC when determining project discount rates unfairly punishes low-risk divisions within the company.
C)   A project that is unacceptable today might be acceptable tomorrow given a change in market returns.
D)   The pure play method is most frequently used for projects involving the expansion of a company's current operations.
E)   Companies that elect to use the pure play method for determining a discount rate for a project cannot subjectively adjust the pure play rate.F) None of the above
G) B) and D)

Question 10

Phillips Equipment has 6,500 bonds outstanding that are selling at 96.5 percent of par. Bonds with similar characteristics are yielding 6.7 percent, pretax. The company also has 48,000 shares of 5.5 percent preferred stock and 75,000 shares of common stock outstanding. The preferred stock sells for $64 a share. The common stock has a beta of 1.32 and sells for $41 a share. The preferred stock has a stated value of $100. The U.S. Treasury bill is yielding 2.2 percent and the return on the market is 10.6 percent. The corporate tax rate is 21 percent. What is the weighted average cost of capital?

Accepted Answer

A)   8.09 percent
B)   8.64 percent
C)   10.18 percent
D)   9.30 percent
E)   10.56 percentF) B) and D)
G) B) and E) A

Question 11

Rosa's has a weighted average cost of capital of 11.73 percent. The cost of equity is 15.8 percent and the pretax cost of debt is 7.6 percent. The tax rate is 21 percent. What is the target debt-equity ratio?

Accepted Answer

A)   .89
B)   1.87
C)   1.41
D)   .53
E)   .71F) B) and D)
G) A) and E)

Question 12

A company's pretax cost of debt:

Accepted Answer

A)   is based on the current yield to maturity of the company's outstanding bonds.
B)   is equal to the coupon rate on the latest bonds issued by the company.
C)   is equivalent to the average current yield on all of a company's outstanding bonds.
D)   is based on the original yield to maturity on the latest bonds issued by a company.
E)   has to be estimated as it cannot be directly observed in the market.F) B) and E)
G) A) and B)

Question 13

When a firm has flotation costs equal to 8.3 percent of the funding need, project analysts should:

Accepted Answer

A)   increase the project's discount rate to offset these expenses by multiplying the company's WACC by 1.083.
B)   increase the project's discount rate to offset these expenses by dividing the company's WACC by (1 − .083) .
C)   add 8.3 percent to the company's firm's WACC to determine the discount rate for the project.
D)   increase the initial project cost by multiplying that cost by 1.083.
E)   increase the initial project cost by dividing that cost by (1 − .083) .F) D) and E)
G) A) and E)

Question 14

Carson Electronics uses 58 percent common stock and 42 percent debt to finance its operations. The aftertax cost of debt is 5.4 percent and the cost of equity is 15.3 percent. Management is considering a project that will produce a cash inflow of $49,600 in the first year. The cash inflows will then grow at 2.5 percent per year forever. What is the maximum amount the firm can initially invest in this project to avoid a negative net present value for the project?

Accepted Answer

A)   $599,032
B)   $573,941
C)   $411,406
D)   $482,979
E)   $541,414F) B) and D)
G) B) and C)

Question 15

Fashion Wear has bonds outstanding that mature in 11 years, pay interest annually, and have a coupon rate of 6.45 percent. These bonds have a face value of $1,000 and a current market price of $994. What is the company's aftertax cost of debt if its tax rate is 21 percent?

Accepted Answer

A)   4.86 percent
B)   4.28 percent
C)   5.16 percent
D)   5.21 percent
E)   4.53 percentF) None of the above
G) B) and E)

Question 16

Granite Works maintains a debt-equity ratio of .58 and has a tax rate of 21 percent. The pretax cost of debt is 8.9 percent. There are 18,000 shares of stock outstanding with a beta of 1.42 and a market price of $23 a share. The current market risk premium is 7.8 percent and the current risk-free rate is 3.1 percent. This year, the firm paid an annual dividend of $1.68 a share and expects to increase that amount by 2 percent each year. Using an average expected cost of equity, what is the weighted average cost of capital?

Accepted Answer

A)   8.44 percent
B)   9.78 percent
C)   8.96 percent
D)   9.13 percent
E)   10.06 percentF) A) and E)
G) A) and B)

Question 17

Handy Man, Inc., has zero coupon bonds outstanding that mature in 4 years. The bonds have a face value of $1,000 and a current market price of $798. What is the pretax cost of debt? (Use semiannual compounding.)

Accepted Answer

A)   6.55 percent
B)   5.91 percent
C)   5.72 percent
D)   6.31 percent
E)   6.48 percentF) C) and D)
G) A) and B)

Question 18

National Home Rentals has a beta of 1.06, a stock price of $17, and recently paid an annual dividend of $.92 a share. The dividend growth rate is 2.2 percent. The market has a rate of return of 11.2 percent and a risk premium of 7.3 percent. What is the estimated cost of equity using the average return of the CAPM and the dividend discount model?

Accepted Answer

A)   10.05 percent
B)   8.67 percent
C)   9.13 percent
D)   10.30 percent
E)   9.68 percentF) A) and E)
G) A) and C)

Question 19

Chelsea Fashions is expected to pay an annual dividend of $1.26 a share next year. The market price of the stock is $24.09 and the growth rate is 2.6 percent. What is the cost of equity?

Accepted Answer

A)   9.77 percent
B)   7.91 percent
C)   9.24 percent
D)   7.83 percent
E)   7.54 percentF) C) and D)
G) C) and E)

Question 20

Silo Mills is an all-equity financed firm that has a beta of 1.18 and a cost of equity of 12.2 percent. The risk-free rate of return is 2.9 percent. The firm is currently considering a project that has a beta of 1.03 and a project life of six years. What discount rate should be assigned to this project?

Accepted Answer

A)   11.33 percent
B)   11.02 percent
C)   10.62 percent
D)   11.84 percent
E)   12.09 percentF) A) and E)
G) All of the above

Exam 14: Cost of Capital

Correct Answer
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Correct Answer
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The Oil Derrick has an overall cost of equity of 12.7 percent and a beta of 1.13. The firm is financed solely with common stock. The risk-free rate of return is 4.8 percent. What is an appropriate cost of capital for a division within the firm that has an estimated beta of 1.16?

Correct Answer
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E

You are evaluating a project that requires $324,000 in external financing. The flotation cost of equity is 8.4 percent and the flotation cost of debt is 5.1 percent. What is the initial cost of the project including the flotation costs if you maintain a debt-equity ratio of .35?

Correct Answer
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C

The capital structure weights used in computing a company's weighted average cost of capital:

Correct Answer
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Cookie Dough Manufacturing has a target debt-equity ratio of .76. Its cost of equity is 15.3 percent, and its pretax cost of debt is 9 percent. What is the WACC given a tax rate of 21 percent?

Correct Answer
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Assume Russo's has a debt-equity ratio of .4 and uses the capital asset pricing model to determine its cost of equity. As a result, the company's cost of equity:

Correct Answer
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The average of a company's cost of equity, cost of preferred, and aftertax cost of debt that is weighted based on the company's capital structure is called the:

Correct Answer
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Which one of the following statements is correct?

Correct Answer
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Correct Answer
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A

Rosa's has a weighted average cost of capital of 11.73 percent. The cost of equity is 15.8 percent and the pretax cost of debt is 7.6 percent. The tax rate is 21 percent. What is the target debt-equity ratio?

Correct Answer
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A company's pretax cost of debt:

Correct Answer
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When a firm has flotation costs equal to 8.3 percent of the funding need, project analysts should:

Correct Answer
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Correct Answer
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Fashion Wear has bonds outstanding that mature in 11 years, pay interest annually, and have a coupon rate of 6.45 percent. These bonds have a face value of $1,000 and a current market price of $994. What is the company's aftertax cost of debt if its tax rate is 21 percent?

Correct Answer
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Correct Answer
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Handy Man, Inc., has zero coupon bonds outstanding that mature in 4 years. The bonds have a face value of $1,000 and a current market price of $798. What is the pretax cost of debt? (Use semiannual compounding.)

Correct Answer
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Correct Answer
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Chelsea Fashions is expected to pay an annual dividend of $1.26 a share next year. The market price of the stock is $24.09 and the growth rate is 2.6 percent. What is the cost of equity?

Correct Answer
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Correct Answer
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Exam 14: Cost of Capital

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

The Oil Derrick has an overall cost of equity of 12.7 percent and a beta of 1.13. The firm is financed solely with common stock. The risk-free rate of return is 4.8 percent. What is an appropriate cost of capital for a division within the firm that has an estimated beta of 1.16?

Correct AnswerverifiedE

You are evaluating a project that requires $324,000 in external financing. The flotation cost of equity is 8.4 percent and the flotation cost of debt is 5.1 percent. What is the initial cost of the project including the flotation costs if you maintain a debt-equity ratio of .35?

Correct AnswerverifiedC

The capital structure weights used in computing a company's weighted average cost of capital:

Correct AnswerverifiedShow Answer

Cookie Dough Manufacturing has a target debt-equity ratio of .76. Its cost of equity is 15.3 percent, and its pretax cost of debt is 9 percent. What is the WACC given a tax rate of 21 percent?

Correct AnswerverifiedShow Answer

Assume Russo's has a debt-equity ratio of .4 and uses the capital asset pricing model to determine its cost of equity. As a result, the company's cost of equity:

Correct AnswerverifiedShow Answer

The average of a company's cost of equity, cost of preferred, and aftertax cost of debt that is weighted based on the company's capital structure is called the:

Correct AnswerverifiedShow Answer

Which one of the following statements is correct?

Correct AnswerverifiedShow Answer

Correct AnswerverifiedA

Rosa's has a weighted average cost of capital of 11.73 percent. The cost of equity is 15.8 percent and the pretax cost of debt is 7.6 percent. The tax rate is 21 percent. What is the target debt-equity ratio?

Correct AnswerverifiedShow Answer

A company's pretax cost of debt:

Correct AnswerverifiedShow Answer

When a firm has flotation costs equal to 8.3 percent of the funding need, project analysts should:

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Fashion Wear has bonds outstanding that mature in 11 years, pay interest annually, and have a coupon rate of 6.45 percent. These bonds have a face value of $1,000 and a current market price of $994. What is the company's aftertax cost of debt if its tax rate is 21 percent?

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Handy Man, Inc., has zero coupon bonds outstanding that mature in 4 years. The bonds have a face value of $1,000 and a current market price of $798. What is the pretax cost of debt? (Use semiannual compounding.)

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Chelsea Fashions is expected to pay an annual dividend of $1.26 a share next year. The market price of the stock is $24.09 and the growth rate is 2.6 percent. What is the cost of equity?

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

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E

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C

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A

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