Question 1

Given the following information for Electric Transport, find the WACC.Assume the company's tax rate is 35 percent.
Debt:8,100, 6.9 percent coupon bonds outstanding.$1,000 par value, 17 years to maturity, selling for 101 percent of par, the bonds make semiannual payments.
Common stock: 175,000 shares outstanding, selling for $77 per share, beta is 1.32.
Preferred stock:9,000 shares of $7.50 preferred stock outstanding, currently selling for $73 per share.
Market: 7.9 percent market risk premium and 3.6 percent risk-free rate.

Accepted Answer

A)  10.4 percent
B)  12.0 percent
C)  12.4 percent
D)  11.1 percent
E)  9.8 percentF) C) and D)
G) B) and C)

Question 2

Bob's is a retail chain of specialty hardware stores.The firm has 18,000 shares of stock outstanding that are currently valued at $82 a share and provide a rate of return of 13.2 percent.The firm also has 600 bonds outstanding that have a face value of $1,000, a market price of $1,032, and a coupon rate of 7 percent.These bonds mature in 7 years and pay interest semiannually.The tax rate is 35percent.The firm is considering expanding by building a new superstore.The superstore will require an initial investment of $9.3 million and is expected to produce cash inflows of $1.07 million annually over its 10-year life.The risks associated with the superstore are comparable to the risks of the firm's current operations.The initial investment will be depreciated on a straight line basis to a zero book value over the life of the project.At the end of the 10 years, the firm expects to sell the superstore for an aftertax value of $4.7 million.Should the firm accept or reject the superstore project and why?

Accepted Answer

A)  Accept; The project's NPV is $1.27 million.
B)  Accept; The NPV is $4.89 million.
C)  Reject; The NPV is $1.06 million.
D)  Reject; The NPV -$1.15 million.
E)  Reject; The NPV is -$5.71 million.F) A) and E)
G) C) and D)

Question 3

Gulf Coast Tours currently has a weighted average cost of capital of 12.4 percent based on a combination of debt and equity financing.The firm has no preferred stock.The current debt-equity ratio is .47 and the aftertax cost of debt is 6.1 percent.The company just hired a new president who is considering eliminating all debt financing.All else constant, what will the firm's cost of capital be if the firm switches to an all-equity firm?

Accepted Answer

A)  15.45 percent
B)  12.92 percent
C)  12.89 percent
D)  13.37 percent
E)  15.36 percentF) B) and C)
G) B) and E)

Question 4

To value a non-dividend-paying firm, the terminal value used in the valuation calculation will most likely be based on a(n) :

Accepted Answer

A)  subjective value determined by the firm's senior managers.
B)  salvage value of zero.
C)  target ratio.
D)  pure play rate of return.
E)  expected book value of equity.F) A) and D)
G) None of the above

Question 5

Which statement is correct, all else held constant?

Accepted Answer

A)  Beta is used to compute the return on equity and the standard deviation is used to compute the return on preferred.
B)  A decrease in a firm's WACC will increase the attractiveness of the firm's investment options.
C)  The aftertax cost of debt increases when the market price of a bond increases.
D)  If you have both the dividend growth and the security market line's costs of equity, you should use the higher of the two estimates when computing WACC.
E)  WACC is applicable only to firms that issue both common and preferred stock.F) C) and D)
G) A) and C)

Question 6

The 8.4 percent preferred stock of Dynachili Distributing is selling for $48 per share.What is the firm's cost of preferred stock if the tax rate is 21 percent and the par value per share is $100?

Accepted Answer

A)  19.52 percent
B)  17.94 percent
C)  18.19 percent
D)  18.54 percent
E)  17.50 percentF) C) and D)
G) A) and D)

Question 7

Lester's is a globally diverse company with multiple divisions and a cost of capital of 15.8 percent.Med, Inc., is a specialty firm in the medical equipment field with a cost of capital of 13.7 percent.With the aging of America, both firms recognize the opportunities that exist in the medical field and are considering expansion in this area.At present, there is an opportunity for multiple firms to be involved in a new medical devices project.Each project will require an initial investment of $8.4 million with annual returns of $2.2 million per year for seven years.Which company(ies) , if either, should become involved in the new projects?

Accepted Answer

A)  Lester's only
B)  Med, Inc., only
C)  Both Lester's and Med, Inc.
D)  Neither Lester's nor Med, Inc.
E)  The answer cannot be determined based on the information provided.F) B) and E)
G) A) and C)

Question 8

An increase in a levered firm's tax rate will:

Accepted Answer

A)  decrease the cost of preferred stock.
B)  increase both the cost of preferred stock and debt.
C)  decrease the firm's cost of capital.
D)  decrease the cost of equity capital.
E)  increase the firm's WACC.F) B) and D)
G) A) and E)

Question 9

Orchard Farms has a pretax cost of debt of 7.29 percent and a cost of equity of 16.3 percent.The firm uses the subjective approach to determine project discount rates.Currently, the firm is considering a project to which it has assigned an adjustment factor of 1.25 percent.The firm's tax rate is 35 percent and its debt-equity ratio is .48.The project has an initial cost of $3.9 million and produces cash inflows of $1.26 million a year for 5 years.What is the net present value of the project?

Accepted Answer

A)  $421,619
B)  $446,556
C)  $514,370
D)  $561,027
E)  $478,721F) A) and B)
G) B) and C)

Question 10

Kurt, who is a divisional manager, continually brags that his division's required return for its projects is one percent lower than the return required for any other division of the firm.Which one of the following most likely contributes the most to the lower rate requirement for Kurt's division?

Accepted Answer

A)  Kurt tends to overestimate the projected cash inflows on his projects.
B)  Kurt tends to underestimate the variable costs of his projects.
C)  Kurt has the most efficiently managed division.
D)  Kurt's division is less risky than the other divisions.
E)  Kurt's projects are generally financed with debt while the other divisions' projects are financed with equity.F) A) and B)
G) A) and E)

Question 11

Country Markets has an EBIT of $42,650, an increase in net working capital of $2,615, interest expense of $4,300, net capital spending of $3,620, and a tax rate of 34 percent.The firm's WACC is 11.2 percent and its growth rate is 3.1 percent.What is the adjusted value of the firm?

Accepted Answer

A)  $287,097.17
B)  $311,208.16
C)  $270,543.21
D)  $238,009.72
E)  $308,315.22F) B) and C)
G) C) and E)

Question 12

You are given the following information concerning Around Town Tours:
Debt:7,500, 6.8 percent coupon bonds outstanding, with 11 years to maturity and a quoted price of 97.9.These bonds pay interest semiannually.
Common stock: 284,000 shares of common stock selling for $68 per share.The stock has a beta of 1.04 and will pay a dividend of $2.62 next year.The dividend is expected to grow by 2.5 percent per year indefinitely.
Preferred stock:9,000 shares of $8 preferred stock selling at $88 per share.
Market: 14.6 percent expected return, 4.1 percent risk-free rate
Company:34 percent tax rate.
Calculate the WACC for this firm.

Accepted Answer

A)  9.0 percent
B)  8.7 percent
C)  9.4 percent
D)  9.6 percent
E)  10.0 percentF) A) and D)
G) None of the above

Question 13

The common stock of Serenity Homescapes has a beta of 1.21 and a standard deviation of 17.8 percent.The market rate of return is 13.5 percent and the risk-free rate is 3.2 percent.What is the cost of equity for this firm?

Accepted Answer

A)  15.66 percent
B)  13.61 percent
C)  13.93 percent
D)  16.25 percent
E)  14.90 percentF) A) and D)
G) C) and E)

Question 14

Regulation Insurance has a beta of 0.90, a dividend growth rate of 2.5 percent for the foreseeable future, a stock price of $47 per share, and an expected annual dividend of $0.60 per share next year.The market rate of return is 13.9 percent and the risk-free rate is 3.4 percent.What is the firm's average cost of equity?

Accepted Answer

A)  6.69 percent
B)  8.31 percent
C)  8.25 percent
D)  8.67 percent
E)  6.41 percentF) A) and E)
G) A) and D)

Question 15

Country Cook's cost of equity is 16.2 percent and its aftertax cost of debt is 5.8 percent.What is the firm's weighted average cost of capital if its debt-equity ratio is .42 and the tax rate is 34 percent?

Accepted Answer

A)  12.54 percent
B)  11.47 percent
C)  13.12 percent
D)  12.28 percent
E)  13.01 percentF) A) and E)
G) A) and B)

Question 16

Western Electric has 21,000 shares of common stock outstanding at a price per share of $61 and a rate of return of 15.6 percent.The firm has 11,000 shares of $8 preferred stock outstanding at a price of $48 a share.The outstanding debt has a total face value of $275,000 and currently sells for 104 percent of face.The yield to maturity on the debt is 8.81 percent.What is the firm's weighted average cost of capital if the tax rate is 35 percent?

Accepted Answer

A)  14.52 percent
B)  13.44 percent
C)  14.19 percent
D)  14.37 percent
E)  13.92 percentF) D) and E)
G) A) and E)

Question 17

Great Lakes Packing has two bond issues outstanding.The first issue has a coupon rate of8 percent, matures in 6 years, has a total face value of $5 million, and is quoted at 101.2 percent of face value.The second issue has a 7.5 percent coupon, matures in 13 years, has a total face value of $18 million, and is quoted at 99 percent of face value.Both bonds pay interest semiannually.What is the firm's weighted average aftertax cost of debt if the tax rate is 34 percent?

Accepted Answer

A)  5.05 percent
B)  5.12 percent
C)  5.63 percent
D)  5.95 percent
E)  6.08 percentF) B) and D)
G) A) and E)

Question 18

Assume a firm has a beta of 1.2.All else held constant, the cost of equity for this firm will increase if the:

Accepted Answer

A)  market risk premium decreases.
B)  risk-free rate decreases.
C)  market rate of return decreases.
D)  beta decreases.
E)  either the risk-free rate or the market rate of return decreases.F) C) and D)
G) All of the above

Question 19

Bermuda Cruises issues only common stock and coupon bonds.The firm has a debt-equity ratio of .45.The cost of equity is 17.6 percent and the pretax cost of debt is 8.9 percent.What is the capital structure weight of the firm's equity if the firm's tax rate is 35 percent?

Accepted Answer

A)  66.75 percent
B)  49.97 percent
C)  52.93 percent
D)  59.08 percent
E)  68.97 percentF) None of the above
G) C) and E)

Question 20

Swizer Industries has two separate divisions.Division X has less risk so its projects are assigned a discount rate equal to the firm's WACC minus .75 percent.Division Y has more risk and its projects are assigned a rate equal to the firm's WACC plus 1 percent.The company has a debt-equity ratio of .48 and a tax rate of 34 percent.The cost of equity is 15.4 percent and the aftertax cost of debt is 5.4 percent.Presently, each division is considering a new project.Division Y's project provides a return of 12.9percent while Division X's project is expected to earn 11.5 percent.Which project(s) , if any, should the company accept?

Accepted Answer

A)  Accept both X and Y
B)  Accept X and reject Y
C)  Reject X and accept Y
D)  Reject both X and Y
E)  The answer cannot be determined based on the information provided.F) C) and E)
G) A) and D)

Exam 12: Cost of Capital

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Which statement is correct, all else held constant?

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Kurt, who is a divisional manager, continually brags that his division's required return for its projects is one percent lower than the return required for any other division of the firm.Which one of the following most likely contributes the most to the lower rate requirement for Kurt's division?

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Bermuda Cruises issues only common stock and coupon bonds.The firm has a debt-equity ratio of .45.The cost of equity is 17.6 percent and the pretax cost of debt is 8.9 percent.What is the capital structure weight of the firm's equity if the firm's tax rate is 35 percent?

Correct Answer
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Country Markets has an EBIT of $42,650, an increase in net working capital of $2,615, interest expense of $4,300, net capital spending of $3,620, and a tax rate of 34 percent.The firm's WACC is 11.2 percent and its growth rate is 3.1 percent.What is the adjusted value of the firm?

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Assume a firm has a beta of 1.2.All else held constant, the cost of equity for this firm will increase if the:

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To value a non-dividend-paying firm, the terminal value used in the valuation calculation will most likely be based on a(n) :

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The 8.4 percent preferred stock of Dynachili Distributing is selling for $48 per share.What is the firm's cost of preferred stock if the tax rate is 21 percent and the par value per share is $100?

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The common stock of Serenity Homescapes has a beta of 1.21 and a standard deviation of 17.8 percent.The market rate of return is 13.5 percent and the risk-free rate is 3.2 percent.What is the cost of equity for this firm?

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Country Cook's cost of equity is 16.2 percent and its aftertax cost of debt is 5.8 percent.What is the firm's weighted average cost of capital if its debt-equity ratio is .42 and the tax rate is 34 percent?

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An increase in a levered firm's tax rate will:

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Exam 12: Cost of Capital

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Which statement is correct, all else held constant?

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Kurt, who is a divisional manager, continually brags that his division's required return for its projects is one percent lower than the return required for any other division of the firm.Which one of the following most likely contributes the most to the lower rate requirement for Kurt's division?

Correct AnswerverifiedShow Answer

Bermuda Cruises issues only common stock and coupon bonds.The firm has a debt-equity ratio of .45.The cost of equity is 17.6 percent and the pretax cost of debt is 8.9 percent.What is the capital structure weight of the firm's equity if the firm's tax rate is 35 percent?

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Country Markets has an EBIT of $42,650, an increase in net working capital of $2,615, interest expense of $4,300, net capital spending of $3,620, and a tax rate of 34 percent.The firm's WACC is 11.2 percent and its growth rate is 3.1 percent.What is the adjusted value of the firm?

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Correct AnswerverifiedShow Answer

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Assume a firm has a beta of 1.2.All else held constant, the cost of equity for this firm will increase if the:

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To value a non-dividend-paying firm, the terminal value used in the valuation calculation will most likely be based on a(n) :

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

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The 8.4 percent preferred stock of Dynachili Distributing is selling for $48 per share.What is the firm's cost of preferred stock if the tax rate is 21 percent and the par value per share is $100?

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The common stock of Serenity Homescapes has a beta of 1.21 and a standard deviation of 17.8 percent.The market rate of return is 13.5 percent and the risk-free rate is 3.2 percent.What is the cost of equity for this firm?

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Correct AnswerverifiedShow Answer

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Country Cook's cost of equity is 16.2 percent and its aftertax cost of debt is 5.8 percent.What is the firm's weighted average cost of capital if its debt-equity ratio is .42 and the tax rate is 34 percent?

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Correct AnswerverifiedShow Answer

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An increase in a levered firm's tax rate will:

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