Question 1

Which of the following makes this a true statement? Ideally, when searching for a beta for a new line of business

Accepted Answer

A)  one could find other firms engaged in the proposed new line of business and use their betas as proxies to estimate the project's risk. 
B)  one would like to find at least three or four pure-play proxies. 
C)  two (or even one) proxies might represent a suitable sample if their line of business resembles the proposed new project closely enough. 
D)  All of these choices are correct. 
A)  one could find other firms engaged in the proposed new line of business and use their betas as proxies to estimate the project's risk. 
B)  one would like to find at least three or four pure-play proxies. 
C)  two (or even one) proxies might represent a suitable sample if their line of business resembles the proposed new project closely enough. 
D)  All of these choices are correct.

Question 2

WC Inc. has a $10 million (face value), 10-year bond issue selling for 99 percent of par that pays an annual coupon of 9 percent. What would be WC's before-tax component cost of debt?

Accepted Answer

A)  9.00 percent 
B)  9.10 percent 
C)  9.16 percent 
D)  18.32 percent 
A)  9.00 percent 
B)  9.10 percent 
C)  9.16 percent 
D)  18.32 percent

Question 3

A firm uses only debt and equity in its capital structure. The firm's weight of equity is 70 percent. The firm's cost of equity is 13 percent and it has a tax rate of 21 percent. If the firm's WACC is 11 percent, what is the firm's before-tax cost of debt?

Accepted Answer

A)  7.19 percent 
B)  8.02 percent 
C)  6.38 percent 
D)  1.9 percent 
A)  7.19 percent 
B)  8.02 percent 
C)  6.38 percent 
D)  1.9 percent

Question 4

What is the theoretical minimum for the weighted average cost of capital?

Accepted Answer

A)  the after-tax cost of debt 
B)  the cost of preferred stock 
C)  CAPM 
D)  the cost of equity 
A)  the after-tax cost of debt 
B)  the cost of preferred stock 
C)  CAPM 
D)  the cost of equity

Question 5

Suppose that Tan Lines' common shares sell for $20 per share, are expected to set their next annual dividend at $1.00 per share, and that all future dividends are expected to grow by 5 percent per year, indefinitely. If Tan Lines faces a flotation cost of 10 percent on new equity issues, what will be the flotation-adjusted cost of equity?

Accepted Answer

A)  5.06 percent 
B)  5.50 percent 
C)  10.00 percent 
D)  10.56 percent 
A)  5.06 percent 
B)  5.50 percent 
C)  10.00 percent 
D)  10.56 percent

Question 6

FarCry Industries, a maker of telecommunications equipment, has 6 million shares of common stock outstanding, 1 million shares of preferred stock outstanding, and 10 thousand bonds. If the common shares are selling for $27 per share, the preferred shares are selling for $15 per share, and the bonds are selling for 119 percent of par ($1,000), what weight should you use for debt in the computation of FarCry's WACC?

Accepted Answer

A)  4.93 percent 
B)  5.07 percent 
C)  5.81 percent 
D)  6.30 percent 
A)  4.93 percent 
B)  5.07 percent 
C)  5.81 percent 
D)  6.30 percent

Question 7

Suppose that TW, Inc. has a capital structure of 25 percent equity, 15 percent preferred stock, and 60 percent debt. If the before-tax component costs of equity, preferred stock and debt are 13.5 percent, 9.5 percent and 4 percent, respectively, what is TW's WACC if the firm faces an average tax rate of 21 percent?

Accepted Answer

A)  7.19 percent 
B)  6.70 percent 
C)  2.90 percent 
D)  9.0 percent 
A)  7.19 percent 
B)  6.70 percent 
C)  2.90 percent 
D)  9.0 percent

Question 8

ADK has 30,000 15-year, 9 percent semi-annual coupon bonds outstanding. If the bonds currently sell for 90 percent of par and the firm pays an average tax rate of 21 percent, what will be the before-tax and after-tax component cost of debt?

Accepted Answer

A)  11.19 percent; 7.61 percent 
B)  10.32 percent; 8.15 percent 
C)  9.85 percent; 6.70 percent 
D)  10.12 percent; 6.88 percent 
A)  11.19 percent; 7.61 percent 
B)  10.32 percent; 8.15 percent 
C)  9.85 percent; 6.70 percent 
D)  10.12 percent; 6.88 percent

Question 9

Suppose a new project was going to be financed partially with retained earnings. What flotation costs should you use for retained earnings?

Accepted Answer

A)  use the same flotation cost that would be used to issue new common stock 
B)  use an average of the flotation costs for debt, preferred and common stock 
C)  use the industry average flotation cost for common stock 
D)  zero 
A)  use the same flotation cost that would be used to issue new common stock 
B)  use an average of the flotation costs for debt, preferred and common stock 
C)  use the industry average flotation cost for common stock 
D)  zero

Question 10

CJ Co. stock has a beta of 0.9, the current risk-free rate is 5.6, and the expected return on the market is 13 percent. What is CJ Co's cost of equity?

Accepted Answer

A)  12.26 percent 
B)  17.30 percent 
C)  19.50 percent 
D)  22.34 percent 
A)  12.26 percent 
B)  17.30 percent 
C)  19.50 percent 
D)  22.34 percent

Question 11

A firm uses only debt and equity in its capital structure. The firm's weight of equity is 75 percent. The firm's cost of equity is 16 percent and it has a tax rate of 21 percent. If the firm's WACC is 13%, what is the firm's before-tax cost of debt?

Accepted Answer

A)  6.89 percent 
B)  6.28 percent 
C)  5.71 percent 
D)  5.06 percent 
A)  6.89 percent 
B)  6.28 percent 
C)  5.71 percent 
D)  5.06 percent

Question 12

An all-equity firm is considering the projects shown as follows. The T-bill rate is 3 percent and the market risk premium is 6 percent. If the firm uses its current WACC of 12 percent to evaluate these projects, which project(s) will be incorrectly rejected?
$$\begin{array} { c c r } 
\text { Project } & \text { Expected Return } & \text { Beta } \
\text { A } & 10.0 \% & 0.9 \
\text { B } & 17.0 \% & 1.1 \
\text { C } & 12.5 \% & 1.4 \
\text { D } & 15.0 \% & 2.2
\end{array}$$

Accepted Answer

A)  Project A 
B)  Projects B and C 
C)  Project D 
D)  Project B 
A)  Project A 
B)  Projects B and C 
C)  Project D 
D)  Project B

Question 13

Suppose that Hanna Nails, Inc.'s capital structure features 45 percent equity, 55 percent debt, and that its before-tax cost of debt is 5 percent, while its cost of equity is 9 percent. If the appropriate weighted average tax rate is 21 percent, what will be Hanna Nails' WACC?

Accepted Answer

A)  5.18 percent 
B)  6.22 percent 
C)  6.72 percent 
D)  6.80 percent 
A)  5.18 percent 
B)  6.22 percent 
C)  6.72 percent 
D)  6.80 percent

Question 14

Paper Exchange has 80 million shares of common stock outstanding, 60 million shares of preferred stock outstanding, and 50 thousand bonds. If the common shares are selling for $20 per share, the preferred shares are selling for $10 per share, and the bonds are selling for 105 percent of par, what would be the weight used for preferred stock in the computation of Paper's WACC?

Accepted Answer

A)  26.64 percent 
B)  27.27 percent 
C)  33.33 percent 
D)  42.84 percent 
A)  26.64 percent 
B)  27.27 percent 
C)  33.33 percent 
D)  42.84 percent

Question 15

Amino Industries common shares sell for $100 per share. Amino expects to set their next annual dividend at $4.00 per share. If Amino expects future dividends to grow at 5 percent per year, indefinitely, the current risk-free rate is 2 percent, the expected rate on the market is 7 percent, and the stock has a beta of 1.5, what should be the best estimate of the firm's cost of equity, by taking an average of the 2 estimates?

Accepted Answer

A)  18.50 percent 
B)  13.25 percent 
C)  9.25 percent 
D)  7.27 percent 
A)  18.50 percent 
B)  13.25 percent 
C)  9.25 percent 
D)  7.27 percent

Question 16

Which of the following is a true statement regarding the appropriate tax rate to be used in the WACC?

Accepted Answer

A)  One would use the marginal tax rate that the firm paid the prior year. 
B)  One would use the average tax rate that the firm paid the prior year. 
C)  One would use the weighted average of the marginal tax rates that would have been paid on the taxable income shielded by the interest deduction. 
D)  One would use the marginal tax rates that would have been paid on the taxable income shielded by the interest deduction. 
A)  One would use the marginal tax rate that the firm paid the prior year. 
B)  One would use the average tax rate that the firm paid the prior year. 
C)  One would use the weighted average of the marginal tax rates that would have been paid on the taxable income shielded by the interest deduction. 
D)  One would use the marginal tax rates that would have been paid on the taxable income shielded by the interest deduction.

Question 17

A firm has 5,000,000 shares of common stock outstanding, each with a market price of $8.00 per share. It has 25,000 bonds outstanding, each selling for $1,100 with a $1,000 face value. The bonds mature in 12 years, have a coupon rate of 9 percent, and pay coupons semiannually. The firm's equity has a beta of 1.4, and the expected market return is 15 percent. The tax rate is 21 percent and the WACC is 14 percent. Calculate the risk-free rate.

Accepted Answer

A)  3.90 percent 
B)  15.27 percent 
C)  20.18 percent 
D)  1.19 percent 
A)  3.90 percent 
B)  15.27 percent 
C)  20.18 percent 
D)  1.19 percent

Question 18

TJ Co. stock has a beta of 1.45, the current risk-free rate is 5.75, and the expected return on the market is 14 percent. What is TJ Co's cost of equity?

Accepted Answer

A)  17.71 percent 
B)  21.20 percent 
C)  26.05 percent 
D)  28.64 percent 
A)  17.71 percent 
B)  21.20 percent 
C)  26.05 percent 
D)  28.64 percent

Question 19

Fern has preferred stock selling for 95 percent of par that pays an 8 percent annual coupon. What would be Fern's component cost of preferred stock?

Accepted Answer

A)  7.60 percent 
B)  8.00 percent 
C)  8.42 percent 
D)  9.00 percent 
A)  7.60 percent 
B)  8.00 percent 
C)  8.42 percent 
D)  9.00 percent

Question 20

An estimated WACC computed using some sort of proxy for the average equity risk of the projects in a particular business unit is known as the

Accepted Answer

A)  business unit WACC 
B)  pure-play beta 
C)  divisional WACC 
D)  component cost 
A)  business unit WACC 
B)  pure-play beta 
C)  divisional WACC 
D)  component cost

Which of the following makes this a true statement? Ideally, when searching for a beta for a new line of business

WC Inc. has a $10 million (face value), 10-year bond issue selling for 99 percent of par that pays an annual coupon of 9 percent. What would be WC's before-tax component cost of debt?

A firm uses only debt and equity in its capital structure. The firm's weight of equity is 70 percent. The firm's cost of equity is 13 percent and it has a tax rate of 21 percent. If the firm's WACC is 11 percent, what is the firm's before-tax cost of debt?

What is the theoretical minimum for the weighted average cost of capital?

ADK has 30,000 15-year, 9 percent semi-annual coupon bonds outstanding. If the bonds currently sell for 90 percent of par and the firm pays an average tax rate of 21 percent, what will be the before-tax and after-tax component cost of debt?

Suppose a new project was going to be financed partially with retained earnings. What flotation costs should you use for retained earnings?

CJ Co. stock has a beta of 0.9, the current risk-free rate is 5.6, and the expected return on the market is 13 percent. What is CJ Co's cost of equity?

A firm uses only debt and equity in its capital structure. The firm's weight of equity is 75 percent. The firm's cost of equity is 16 percent and it has a tax rate of 21 percent. If the firm's WACC is 13%, what is the firm's before-tax cost of debt?

Suppose that Hanna Nails, Inc.'s capital structure features 45 percent equity, 55 percent debt, and that its before-tax cost of debt is 5 percent, while its cost of equity is 9 percent. If the appropriate weighted average tax rate is 21 percent, what will be Hanna Nails' WACC?

Which of the following is a true statement regarding the appropriate tax rate to be used in the WACC?

TJ Co. stock has a beta of 1.45, the current risk-free rate is 5.75, and the expected return on the market is 14 percent. What is TJ Co's cost of equity?

Fern has preferred stock selling for 95 percent of par that pays an 8 percent annual coupon. What would be Fern's component cost of preferred stock?

An estimated WACC computed using some sort of proxy for the average equity risk of the projects in a particular business unit is known as the

Introduction to Financial Management

Reviewing Financial Statements

Analyzing Financial Statements

Time Value of Money 1: Analyzing Single Cash Flows

Time Value of Money 2: Analyzing Annuity Cash Flows

Understanding Financial Markets and Institutions

Valuing Bonds

Valuing Stocks

Characterizing Risk and Return

Estimating Risk and Return

Estimating Cash Flows on Capital Budgeting Projects

Weighing Net Present Value and Other Capital Budgeting Criteria

Working Capital Management and Policies

Financial Planning and Forecasting

Assessing Long-Term Debt, Equity, and Capital Structure

Sharing Firm Wealth: Dividends, Share Repurchases, and Other Payouts

Issuing Capital and the Investment Banking Process

International Corporate Finance

Mergers and Acquisitions and Financial Distress

Filters

Exam 11: Calculating the Cost of Capital

Which of the following makes this a true statement? Ideally, when searching for a beta for a new line of business

WC Inc. has a $10 million (face value), 10-year bond issue selling for 99 percent of par that pays an annual coupon of 9 percent. What would be WC's before-tax component cost of debt?

A firm uses only debt and equity in its capital structure. The firm's weight of equity is 70 percent. The firm's cost of equity is 13 percent and it has a tax rate of 21 percent. If the firm's WACC is 11 percent, what is the firm's before-tax cost of debt?

What is the theoretical minimum for the weighted average cost of capital?

ADK has 30,000 15-year, 9 percent semi-annual coupon bonds outstanding. If the bonds currently sell for 90 percent of par and the firm pays an average tax rate of 21 percent, what will be the before-tax and after-tax component cost of debt?

Suppose a new project was going to be financed partially with retained earnings. What flotation costs should you use for retained earnings?

CJ Co. stock has a beta of 0.9, the current risk-free rate is 5.6, and the expected return on the market is 13 percent. What is CJ Co's cost of equity?

A firm uses only debt and equity in its capital structure. The firm's weight of equity is 75 percent. The firm's cost of equity is 16 percent and it has a tax rate of 21 percent. If the firm's WACC is 13%, what is the firm's before-tax cost of debt?

Suppose that Hanna Nails, Inc.'s capital structure features 45 percent equity, 55 percent debt, and that its before-tax cost of debt is 5 percent, while its cost of equity is 9 percent. If the appropriate weighted average tax rate is 21 percent, what will be Hanna Nails' WACC?

Which of the following is a true statement regarding the appropriate tax rate to be used in the WACC?

TJ Co. stock has a beta of 1.45, the current risk-free rate is 5.75, and the expected return on the market is 14 percent. What is TJ Co's cost of equity?

Fern has preferred stock selling for 95 percent of par that pays an 8 percent annual coupon. What would be Fern's component cost of preferred stock?

An estimated WACC computed using some sort of proxy for the average equity risk of the projects in a particular business unit is known as the

Introduction to Financial Management

Reviewing Financial Statements

Analyzing Financial Statements

Time Value of Money 1: Analyzing Single Cash Flows

Time Value of Money 2: Analyzing Annuity Cash Flows

Understanding Financial Markets and Institutions

Valuing Bonds

Valuing Stocks

Characterizing Risk and Return

Estimating Risk and Return

Estimating Cash Flows on Capital Budgeting Projects

Weighing Net Present Value and Other Capital Budgeting Criteria

Working Capital Management and Policies

Financial Planning and Forecasting

Assessing Long-Term Debt, Equity, and Capital Structure

Sharing Firm Wealth: Dividends, Share Repurchases, and Other Payouts

Issuing Capital and the Investment Banking Process

International Corporate Finance

Mergers and Acquisitions and Financial Distress

Filters