Exam 11: Calculating the Cost of Capital

Suppose your firm has decided to use a divisional WACC approach to analyze projects.The firm currently has 2 divisions,A and B,with betas for each division of 0.5 and 1.5,respectively.If all current and future projects will be financed with half debt and half equity,and if the current cost of equity (based on an average firm beta of 1.0 and a current risk-free rate of 5 percent)is 14 percent and the after-tax yield on the company's bonds is 6 percent,what are the WACCs for divisions A and B?

When firms use multiple sources of capital,they need to calculate the appropriate discount rate for valuing their firm's cash flows as:

JAK Industries has 5 million shares of stock outstanding selling at $25 per share and an issue of $40 million in 8 percent,annual coupon bonds with a maturity of 15 years,selling at 108 percent of par ($1000).If JAK's weighted average tax rate is 34 percent and its cost of equity is 15 percent,what is JAK's WACC?

Which of the following is a situation in which you would want to use the constant growth model approach for estimating the component cost of equity?

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?

An all-equity firm is considering the projects shown as follows.The T-bill rate is 4 percent and the market risk premium is 9 percent.If the firm uses its current WACC of 14 percent to evaluate these projects,which project(s)will be incorrectly rejected?

Which of the following makes this a true statement? If the new project does significantly increase the firm's overall risk:

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

A firm has 4,000,000 shares of common stock outstanding,each with a market price of $12.00 per share.It has 25,000 bonds outstanding,each selling for $980.The bonds mature in 20 years,have a coupon rate of 9 percent,and pay coupons semi-annually.The firm's equity has a beta of 1.5,and the expected market return is 15 percent.The tax rate is 30 percent and the WACC is 15 percent.What is the risk-free rate?

FlavR Co.stock has a beta of 2.0,the current risk-free rate is 2,and the expected return on the market is 9 percent.What is FlavR Co's cost of equity?

XYZ Industries has 10 million shares of stock outstanding selling at $10 per share and an issue of $30 million in 8.5 percent,annual coupon bonds with a maturity of 25 years,selling at 102 percent of par ($1,000).If XYZ's weighted average tax rate is 40 percent and its cost of equity is 15 percent,what is XYZ's WACC?

Which of the following will increase the cost of equity?

A firm uses only debt and equity in its capital structure.The firm's weight of debt is 45 percent.The firm could issue new bonds at a yield to maturity of 10 percent and the firm has a tax rate of 30 percent.If the firm's WACC is 12 percent,what is the firm's cost of equity?

Which of the following will impact the cost of equity component in the weighted average cost of capital?

Suppose that Wave Runners' common shares sell for $35 per share,are expected to set their next annual dividend at $2.00 per share,and that all future dividends are expected to grow by 10 percent per year,indefinitely.If Wave faces a flotation cost of 15 percent on new equity issues,what will be the flotation-adjusted cost of equity?

Which of the following is most correct?

Rings N Things Industries has 40 million shares of common stock outstanding,20 million shares of preferred stock outstanding,and 50 thousand bonds.If the common shares are selling for $25 per share,the preferred shares are selling for $15 per share,and the bonds are selling for 100 percent of par ($1,000),what would be the weights used in the calculation of Rings' WACC for common stock,preferred stock,and bonds,respectively?

FDR Industries has 50 million shares of stock outstanding selling at $30 per share and an issue of $200 million in 9.5 percent,annual coupon bonds with a maturity of 10 years,selling at 105 percent of par ($1,000).If FDR's weighted average tax rate is 28 percent and its cost of equity is 16 percent,what is FDR's WACC?

A firm has 5,000,000 shares of common stock outstanding,each with a market price of $10.00 per share.It has 55,000 bonds outstanding,each selling for $990 with a $1,000 face value.The bonds mature in 15 years,have a coupon rate of 8 percent,and pay coupons semi-annually.The firm's equity has a beta of 2.0,and the expected market return is 15 percent.The tax rate is 35 percent and the WACC is 16 percent.Calculate the risk-free rate.

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 32 percent,what will be the before-tax and after-tax component cost of debt?