Exhibit 11.1 The Collins Group, a leading producer of custom automobile accessories, has hired you to estimate the firm's weighted average cost of capital. The balance sheet and some other information are provided below. $\begin{array}{c} \begin{array}{lll} \underline{ \text {Assets}}\\ \text {Current assets}\\ \text {Net plant, property, and equipment }\\ \text {Total assets}\\ \\ \underline{ \text {Liabilities and Equity}}\\ \text {Accounts payable}\\ \text {Accruals}\\ \text {Current liabilities}\\ \text {Long-term debt ( 40,000 bonds, \$ 1,000 par value) }\\ \text {Total liabilities}\\ \text {Common stock ( 10,000,000 shares)}\\ \text {Retained earnings}\\ \text {Total shareholders' equity}\\ \text {Total liabilities and shareholders' equity} \end{array} \begin{array}{r} \$ 38,000,000 \\ 101,000,000 \\ \underline{\$ 139,000,000} \\ \\ \$ 10,000,000 \\ 9,000,000 \\ \$ 19,000,000 \\ \underline{40,000,000} \\ \underline{ \$ 59,000,000} \\ 30,000,000 \\ 50,000,000 \\ \underline{80,000,000} \\ \underline{ \$ 139,000,000} \end{array} \end{array}$ The stock is currently selling for $15.25 per share, and its noncallable $1,000 par value, 20-year, 7.25% bonds with semiannual payments are selling for $875.00. The beta is 1.25, the yield on a 6-month Treasury bill is 3.50%, and the yield on a 20-year Treasury bond is 5.50%. The required return on the stock market is 11.50%, but the market has had an average annual return of 14.50% during the past 5 years. The firm's tax rate is 40%. -Refer to Exhibit 11.1.What is the best estimate of the after-tax cost of debt?

A) 4.64% B) 4.88% C) 5.14% D) 5.40% E) 5.67% A) 4.64% B) 4.88% C) 5.14% D) 5.40% E) 5.67%

Exam 11: Determining the Cost of Capital

Granby Foods' (GF)balance sheet shows a total of $25 million long-term debt with a coupon rate of 8.50%.The yield to maturity on this debt is 8.00%,and the debt has a total current market value of $27 million.The company has 10 million shares of stock,and the stock has a book value per share of $5.00.The current stock price is $20.00 per share,and stockholders' required rate of return,r_s,is 12.25%.The company recently decided that its target capital structure should have 35% debt,with the balance being common equity.The tax rate is 40%.Calculate WACCs based on book,market,and target capital structures.What is the sum of these three WACCs?

(Multiple Choice)

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Question 21

Exhibit 11.1 The Collins Group, a leading producer of custom automobile accessories, has hired you to estimate the firm's weighted average cost of capital. The balance sheet and some other information are provided below. Current assets Net plant, property, and equipment Total assets Accounts payable Accruals Current liabilities Long-term debt ( 40,000 bonds, \ 1,000 par value) Total liabilities Common stock ( 10,000,000 shares) Retained earnings Total shareholders' equity Total liabilities and shareholders' equity \ 38,000,000 101,000,000 \ 10,000,000 9,000,000 \ 19,000,000 30,000,000 50,000,000 The stock is currently selling for $15.25 per share, and its noncallable $1,000 par value, 20-year, 7.25% bonds with semiannual payments are selling for $875.00. The beta is 1.25, the yield on a 6-month Treasury bill is 3.50%, and the yield on a 20-year Treasury bond is 5.50%. The required return on the stock market is 11.50%, but the market has had an average annual return of 14.50% during the past 5 years. The firm's tax rate is 40%. -Refer to Exhibit 11.1.What is the best estimate of the after-tax cost of debt?

(Multiple Choice)

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Question 22

Taylor Inc.estimates that its average-risk projects have a WACC of 10%,its below-average risk projects have a WACC of 8%,and its above-average risk projects have a WACC of 12%.Which of the following projects (A,B,and C)should the company accept?

(Multiple Choice)

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Question 23

The president and CFO of Spellman Transportation are having a disagreement about whether to use market value or book value weights in calculating the WACC.Spellman's balance sheet shows a total of noncallable $45 million long-term debt with a coupon rate of 7.00% and a yield to maturity of 6.00%.This debt currently has a market value of $50 million.The company has 10 million shares of common stock,and the book value of the common equity (common stock plus retained earnings)is $65 million.The current stock price is $22.50 per share; stockholders' required return,r_s,is 14.00%; and the firm's tax rate is 40%.The CFO thinks the WACC should be based on market value weights,but the president thinks book weights are more appropriate.What is the difference between these two WACCs?

(Multiple Choice)

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Question 24

If a firm's marginal tax rate is increased,this would,other things held constant,lower the cost of debt used to calculate its WACC.

(True/False)

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Question 25

The Tierney Group has two divisions of equal size: an office furniture manufacturing division and a data processing division.Its CFO believes that stand-alone data processor companies typically have a WACC of 9%,while stand-alone furniture manufacturers typically have a 13% WACC.She also believes that the data processing and manufacturing divisions have the same risk as their typical peers.Consequently,she estimates that the composite,or corporate,WACC is 11%.A consultant has suggested using a 9% hurdle rate for the data processing division and a 13% hurdle rate for the manufacturing division.However,the CFO disagrees,and she has assigned an 11% WACC to all projects in both divisions.Which of the following statements is CORRECT?

(Multiple Choice)

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Question 26

A company's perpetual preferred stock currently sells for $92.50 per share,and it pays an $8.00 annual dividend.If the company were to sell a new preferred issue,it would incur a flotation cost of 5.00% of the issue price.What is the firm's cost of preferred stock?

(Multiple Choice)

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Question 27

Assume that you are an intern with the Brayton Company,and you have collected the following data: The yield on the company's outstanding bonds is 7.75%; its tax rate is 40%; the next expected dividend is $0.65 a share; the dividend is expected to grow at a constant rate of 6.00% a year; the price of the stock is $15.00 per share; the flotation cost for selling new shares is F = 10%; and the target capital structure is 45% debt and 55% common equity.What is the firm's WACC,assuming it must issue new stock to finance its capital budget?

(Multiple Choice)

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Question 28

The text identifies three methods for estimating the cost of common stock from reinvested earnings (not newly issued stock): the CAPM method,the DCF method,and the bond-yield-plus-risk-premium method.However,only the DCF method is widely used in practice.

(True/False)

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Question 29

Adams Inc.has the following data: r_RF = 5.00%; RP_M = 6.00%; and b = 1.05.What is the firm's cost of common from reinvested earnings based on the CAPM?

(Multiple Choice)

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Question 30

When working with the CAPM,which of the following factors can be determined with the most precision?

(Multiple Choice)

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Question 31

The cost of preferred stock to a firm must be adjusted to an after-tax figure because 70% of dividends received by a corporation may be excluded from the receiving corporation's taxable income.

(True/False)

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Question 32

Perpetual preferred stock from Franklin Inc.sells for $97.50 per share,and it pays an $8.50 annual dividend.If the company were to sell a new preferred issue,it would incur a flotation cost of 4.00% of the price paid by investors.What is the company's cost of preferred stock for use in calculating the WACC?

(Multiple Choice)

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Question 33

When estimating the cost of equity by use of the CAPM,three potential problems are (1)whether to use long-term or short-term rates for r_RF, (2)whether or not the historical beta is the beta that investors use when evaluating the stock,and (3)how to measure the market risk premium,RP_M.These problems leave us unsure of the true value of r_s.

(True/False)

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Question 34

The cost of external equity capital raised by issuing new common stock (r_e)is defined as follows,in words: "The cost of external equity equals the cost of equity capital from retaining earnings (r_s),divided by one minus the percentage flotation cost required to sell the new stock, (1 − F)."

(True/False)

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Question 35

Careco Company and Audaco Inc are identical in size and capital structure.However,the riskiness of their assets and cash flows are somewhat different,resulting in Careco having a WACC of 10% and Audaco a WACC of 12%.Careco is considering Project X,which has an IRR of 10.5% and is of the same risk as a typical Careco project.Audaco is considering Project Y,which has an IRR of 11.5% and is of the same risk as a typical Audaco project. Now assume that the two companies merge and form a new company,Careco/Audaco Inc.Moreover,the new company's market risk is an average of the pre-merger companies' market risks,and the merger has no impact on either the cash flows or the risks of Projects X and Y.Which of the following statements is CORRECT?

(Multiple Choice)

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Question 36

Which of the following statements is CORRECT? Assume a company's target capital structure is 50% debt and 50% common equity.

(Multiple Choice)

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Question 37

The cost of debt is equal to one minus the marginal tax rate multiplied by the average coupon rate on all outstanding debt.

(True/False)

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Question 38

Which of the following statements is CORRECT?

(Multiple Choice)

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Question 39

Which of the following statements is CORRECT?

(Multiple Choice)

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Question 40

Showing 21 - 40 of 92

Exam 11: Determining the Cost of Capital

Taylor Inc.estimates that its average-risk projects have a WACC of 10%,its below-average risk projects have a WACC of 8%,and its above-average risk projects have a WACC of 12%.Which of the following projects (A,B,and C)should the company accept?

If a firm's marginal tax rate is increased,this would,other things held constant,lower the cost of debt used to calculate its WACC.

A company's perpetual preferred stock currently sells for $92.50 per share,and it pays an $8.00 annual dividend.If the company were to sell a new preferred issue,it would incur a flotation cost of 5.00% of the issue price.What is the firm's cost of preferred stock?

The text identifies three methods for estimating the cost of common stock from reinvested earnings (not newly issued stock): the CAPM method,the DCF method,and the bond-yield-plus-risk-premium method.However,only the DCF method is widely used in practice.

Adams Inc.has the following data: rRF = 5.00%; RPM = 6.00%; and b = 1.05.What is the firm's cost of common from reinvested earnings based on the CAPM?

When working with the CAPM,which of the following factors can be determined with the most precision?

The cost of preferred stock to a firm must be adjusted to an after-tax figure because 70% of dividends received by a corporation may be excluded from the receiving corporation's taxable income.

The cost of external equity capital raised by issuing new common stock (re)is defined as follows,in words: "The cost of external equity equals the cost of equity capital from retaining earnings (rs),divided by one minus the percentage flotation cost required to sell the new stock, (1 − F)."

Which of the following statements is CORRECT? Assume a company's target capital structure is 50% debt and 50% common equity.

The cost of debt is equal to one minus the marginal tax rate multiplied by the average coupon rate on all outstanding debt.

Which of the following statements is CORRECT?

Which of the following statements is CORRECT?

An Overview of Financial Management and the Financial Environment

Risk and Return: Part I

Risk and Return: Part Ii

Bond Valuation

Financial Options

Accounting for Financial Management

Analysis of Financial Statements

Basic Stock Valuation

Corporate Valuation and Financial Planning

Corporate Governance

Capital Budgeting: Decision Rules

Cash Flow Estimation and Risk Analysis

Real Options

Distributions to Shareholders: Dividends and Repurchases

Capital Structure Decisions

Dynamic Capital Structures and Corporate Valuation

Initial Public Offerings, investment Banking, and Financial Restructuring

Lease Financing

Hybrid Financing: Preferred Stock, Warrants, and Convertibles

Supply Chains and Working Capital Management

Providing and Obtaining Credit

Advanced Issues in Cash Management and Inventory Control

Enterprise Risk Management

Bankruptcy, reorganization, and Liquidation

Mergers and Corporate Control

Multinational Financial Management

Time Value of Money

Basic Financial Tools: a Review

Pension Plan Management

Financial Management in Not-For-Profit Businesses

a Values of the Areas Under the Standard Normal

Filters

Adams Inc.has the following data: r_RF = 5.00%; RP_M = 6.00%; and b = 1.05.What is the firm's cost of common from reinvested earnings based on the CAPM?

The cost of external equity capital raised by issuing new common stock (r_e)is defined as follows,in words: "The cost of external equity equals the cost of equity capital from retaining earnings (r_s),divided by one minus the percentage flotation cost required to sell the new stock, (1 − F)."