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Exam 12: Cost of Capital

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Question 41

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

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) All of the above
G) B) and C)

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Question 42

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Which one of the following will decrease the aftertax cost of debt for a firm?

A) Decrease in the firm's beta
B) Increase in tax rates
C) Increase in the risk-free rate of return
D) Decrease in the market price of the debt
E) Increase in a bond's yield to maturity

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

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Question 43

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Black Stone Furnaces wants to build a new facility.The cost of capital for this investment is primarily dependent on which one of the following?

Tennessee Valley Antiques would like to issue new equity shares if its cost of equity declines to 12.5 percent.The company pays a constant annual dividend of $2.10 per share.What does the market price of the stock need to be for the firm to issue the new shares?

A firm wants to create a WACC of 11.2 percent.The firm's cost of equity is 16.8 percent and its pretax cost of debt is 8.7 percent.The tax rate is 35 percent.What does the debt-equity ratio need to be for the firm to achieve its target WACC?

The market rate of return is 11.8 percent and the risk-free rate is 3.45 percent.Galaxy Co.has 36 percent more systematic risk than the overall market and has a dividend growth rate of 3.5 percent.The firm's stock is currently selling for $42 a share and has a dividend yield of 2.8 percent.What is the firm's cost of equity?

City Rentals has 44,000 shares of common stock outstanding at a market price of $32 a share.The common stock just paid a $1.50 annual dividend and has a dividend growth rate of 2.5 percent.There are 7,500 shares of $9 preferred stock outstanding at a market price of $72 a share.The outstanding bonds mature in 11 years,have a total face value of $825,000,a face value per bond of $1,000,and a market price of $989 each,and a pretax yield to maturity of 8.3 percent.The tax rate is 35 percent.What is the firm's weighted average cost of capital?

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?

The common stock of Mill Stones has a beta that is 8 percent greater than the overall market beta.Currently,the market risk premium is 7.65 percent while the U.S.Treasury bill is yielding 4.3 percent.What is the cost of equity for this firm?

When evaluating a project,the dividend growth model:  

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?

The cost of capital for a project depends primarily on which one of the following?

A firm has a return on equity of 12.4 percent according to the dividend growth model and a return of 18.7 percent according to the capital asset pricing model.The market rate of return is 13.5 percent.What rate should the firm use as the cost of equity when computing the firm's weighted average cost of capital (WACC) ?

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?

Healthy Snacks has a target capital structure of 60 percent common stock,3 percent preferred stock,and 37 percent debt.Its cost of equity is 16.8 percent,the cost of preferred stock is 11.4 percent,and the pretax cost of debt is 8.3 percent.What is the company's WACC if the applicable tax rate is 34 percent?

Lester lent money to The Corner Store by purchasing bonds issued by the store.The rate of return that he and the other lenders require is referred to as the:

Cromwell's Interiors is considering a project that is equally as risky as the firm's current operations.The firm has a cost of equity of 15.4 percent and a pretax cost of debt of 8.9 percent.The debt-equity ratio is .46 and the tax rate is 34 percent.What is the cost of capital for this project?

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?

Kelly's uses the firm's WACC as the required return for some of its projects.For other projects,the firms uses a rate equal to WACC plus one percent,while another set of projects is assigned rates equal to WACC minus some amount.Which one of the following factors should be the key factor the firm uses to determine the amount of the adjustment it will make when assigning a discount rate to a specific project?

K's Bridal Shoppe has 4,000 shares of common stock outstanding at a price of $13 a share.It also has 500 shares of preferred stock outstanding at a price of $22 a share.There are 50 bonds outstanding that have a semiannual coupon payment of $25.The bonds mature in four years,have a face value of $1,000,and sell at 98 percent of par.What is the capital structure weight of the common stock?