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Exam 14: Cost of Capital

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Question 31

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Which one of the following statements related to WACC is correct for a company that uses debt in its capital structure?

A) The WACC would most likely decrease if the firm replaced its preferred stock with debt.
B) The weight assigned to preferred stock decreases as the market value of the preferred stock increases.
C) The WACC will decrease as the corporate tax rate decreases.
D) The weight of equity is based on the number of shares outstanding and the book value per share.
E) The WACC will remain constant unless a company retires some of its debt.

F) C) and D)
G) B) and D)

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Question 32

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The Market Outlet is an all-equity financed firm with a beta of 1.08 and a cost of equity of 12.58 percent. The risk-free rate of return is 3.6 percent. What discount rate should the firm assign to a new project that has a beta of 1.22?

A) 13.33 percent
B) 13.58 percent
C) 13.74 percent
D) 14.14 percent
E) 14.36 percent

F) C) and D)
G) A) and C)

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Question 33

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The cost of preferred stock:

Decline Inc. is trying to determine its cost of debt. The firm has a debt issue outstanding with 13 years to maturity that is quoted at 105.2 percent of face value. The issue makes semiannual payments and has an embedded cost of 6 percent annually. What is the aftertax cost of debt if the tax rate is 21 percent?

AZ Products has 140,000 shares of common stock outstanding at a market price of $27 a share. Next year's annual dividend is expected to be $1.43 a share and the dividend growth rate is 2 percent. The company also has 2,500 bonds outstanding with a face value of $1,000 per bond. The bonds have a pretax yield of 7.35 percent and sell at 98.2 percent of face value. The company's tax rate is 21 percent. What is the weighted average cost of capital?

Jenner's is a multi-division firm that uses its overall WACC as the discount rate for all proposed projects. Each division is in a separate line of business and each presents risks unique to those lines. Given this, a division within the firm will tend to:

Which one of the following is the primary determinant of a firm's cost of capital?

A company's overall cost of equity is:

The Well Derrick has 6.3 percent preferred stock outstanding that sells for $57 a share. This stock was originally issued at $45 per share and has a stated value of $100 per share. What is the cost of preferred stock if the relevant combined tax rate is 23 percent?

Theresa's Flower Garden has 650 bonds outstanding that are selling for $1,007 each, 2,100 shares of preferred stock with a market price of $68 a share, and 42,000 shares of common stock valued at $44 a share. What weight should be assigned to the preferred stock when computing the weighted average cost of capital?

Travis & Sons has a capital structure that is based on 45 percent debt, 5 percent preferred stock, and 50 percent common stock. The pretax cost of debt is 8.3 percent, the cost of preferred is 9.2 percent, and the cost of common stock is 15.4 percent. The tax rate is 21 percent. A project is being considered that is equally as risky as the overall company. This project has initial costs of $287,000 and annual cash inflows of $91,000, $248,000, and $145,000 over the next three years, respectively. What is the projected net present value of this project?

Mullineaux Corporation has a target capital structure of 46 percent common stock, 5 percent preferred stock, and the balance in debt. Its cost of equity is 15.8 percent, the cost of preferred stock is 8.3 percent, and the aftertax cost of debt is 6.8 percent. What is the WACC given a tax rate of 23 percent?

Jiminy's Cricket Farm issued a 20-year, 7 percent, semiannual bond four years ago. The bond currently sells for 108 percent of its face value. What is the aftertax cost of debt if the company's combined tax rate is 23 percent?

Delta Lighting has 24,500 shares of common stock outstanding at a market price of $19 a share. This stock was originally issued at $21 per share. The firm also has a bond issue outstanding with a total face value of $250,000 which is selling for 94 percent of par. The cost of equity is 12.6 percent while the aftertax cost of debt is 5.8 percent. The firm has a beta of 1.33 and a tax rate of 23 percent. What is the weighted average cost of capital?

Holdup Bank has an issue of preferred stock with a stated dividend of $7 that just sold for $87 per share. What is the bank's cost of preferred?

Dee's Toys has a target debt-equity ratio of .62. Its WACC is 11.3 percent and the tax rate is 21 percent. What is the cost of equity if the aftertax cost of debt is 6.3 percent?

All else constant, which one of the following will increase a company's cost of equity if the company computes that cost using the security market line approach? Assume the firm currently pays an annual dividend of $1 a share and has a beta of 1.2.

Southern Bakeries just paid its annual dividend of $.48 a share. The stock has a market price of $17.23 and a beta of .93. The return on the U.S. Treasury bill is 3.1 percent and the market risk premium is 7.6 percent. What is the cost of equity?

The subjective approach to project analysis:

The discount rate assigned to an individual project should be based on: