Deck 14: Cost of Capital

Question 1

A company's current cost of capital is based on:

A) only the return required by the company's current shareholders.
B) the current market rate of return on equity shares.
C) the weighted costs of all future funding sources.
D) both the returns currently required by its debtholders and stockholders.
E) the company's original debt-equity ratio.

Answer 1

both the returns currently required by its debtholders and stockholders.

Question 2

Assume Russo's has a debt-equity ratio of .4 and uses the capital asset pricing model to determine its cost of equity. As a result, the company's cost of equity:

A) is affected by the firm's rate of growth projections.
B) implies that the firm pays out all of its earnings to its shareholders.
C) is dependent upon a reliable estimate of the market risk premium.
D) would be unaffected if the dividend discount model were applied instead.
E) will be unaffected by changes in overall market risks.

Answer 2

is dependent upon a reliable estimate of the market risk premium.

Question 3

A company's overall cost of equity is:

A) generally less than its WACC given a debt-equity ratio of .5.
B) unaffected by changes in the market risk premium.
C) directly related to the risk level of the firm.
D) generally less than the firm's aftertax cost of debt.
E) inversely related to changes in the level of inflation.

Answer 3

directly related to the risk level of the firm.

Question 4

A company's weighted average cost of capital:

A) is equivalent to the aftertax cost of the outstanding liabilities.
B) should be used as the required return when analyzing any new project.
C) is the return investors require on the total assets of the firm.
D) remains constant when the debt-equity ratio changes.
E) is unaffected by changes in corporate tax rates.

Question 5

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.

A) A reduction in the dividend amount
B) An increase in the dividend amount
C) A reduction in the market rate of return
D) A reduction in the firm's beta
E) A reduction in the risk-free rate

Question 6

The capital asset pricing model approach to equity valuation:

A) is dependent upon the unsystematic risk of a security.
B) assumes the reward-to-risk ratio increases as beta increases.
C) can only be applied to dividend-paying firms.
D) assumes a firm's future risks will be higher than its current risks.
E) assumes the reward-to-risk ratio is constant.

Question 7

The cost of preferred stock:

A) is equal to the dividend yield.
B) is equal to the yield to maturity.
C) is highly dependent on the dividend growth rate.
D) is independent of the stock's price.
E) decreases when tax rates increase.

Question 8

The cost of preferred stock is computed the same as the:

A) pretax cost of debt.
B) rate of return on an annuity.
C) aftertax cost of debt.
D) rate of return on a perpetuity.
E) cost of an irregular growth common stock.

Question 9

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

A) Debt-equity ratio of any new funds raised
B) Marginal tax rate
C) Pretax cost of equity
D) Aftertax cost of equity
E) Use of the funds raised

Question 10

Black River Tours has a capital structure of 60 percent common stock, 5 percent preferred stock, and 35 percent debt. The dividend payout ratio is 30 percent, the company's beta is 1.21, and the tax rate is 21 percent. Given this, which one of the following statements is correct?

A) The aftertax cost of debt will be greater than the current yield-to-maturity on the company's outstanding bonds.
B) The company's cost of preferred is most likely less than the company's actual cost of debt.
C) The cost of equity is unaffected by a change in the company's tax rate.
D) The cost of equity can only be estimated using the capital asset pricing model.
E) The weighted average cost of capital will remain constant as long as the company's capital structure remains constant.

Question 11

A group of individuals got together and purchased all of the outstanding shares of common stock of DL Smith Inc. What is the return that these individuals require on this investment called?

A) Dividend yield
B) Cost of equity
C) Capital gains yield
D) Cost of capital
E) Income return

Question 12

Textile Mills borrows money at a rate of 8.7 percent. This interest rate is referred to as the:

A) compound rate.
B) current yield.
C) cost of debt.
D) capital gains yield.
E) cost of capital.

Question 13

A company's pretax cost of debt:

A) is based on the current yield to maturity of the company's outstanding bonds.
B) is equal to the coupon rate on the latest bonds issued by the company.
C) is equivalent to the average current yield on all of a company's outstanding bonds.
D) is based on the original yield to maturity on the latest bonds issued by a company.
E) has to be estimated as it cannot be directly observed in the market.

Question 14

The primary advantage of using the dividend growth model to estimate a company's cost of equity is:

A) the ability to apply either current or future tax rates.
B) the model's applicability to all corporations.
C) is the model's consideration of risk.
D) the stability of the computed cost of equity over time.
E) the simplicity of the model.

Question 15

The capital structure weights used in computing a company's weighted average cost of capital:

A) are based on the book values of debt and equity.
B) are based on the market values of the outstanding securities.
C) depend upon the financing obtained to fund each specific project.
D) remain constant over time unless new securities are issued or outstanding securities are redeemed.
E) are restricted to debt and common stock.

Question 16

The cost of equity for a company with a debt-equity ratio of .41:

A) tends to remain static even as the company's level of risk increases.
B) increases as the unsystematic risk of the company's stock increases.
C) is affected by either a change in the company's beta or its projected rate of growth.
D) equals the risk-free rate plus the market risk premium.
E) equals the company's pretax weighted average cost of capital.

Question 17

Which one of these will increase a company's aftertax cost of debt?

A) A decrease in the company's debt-equity ratio
B) A decrease in the company's tax rate
C) An increase in the credit rating of the company's bonds
D) An increase in the company's beta
E) A decrease in the market rate of interest

Question 18

The cost of capital for a new project:

A) is determined by the overall risk level of the firm.
B) is dependent upon the source of the funds obtained to fund that project.
C) is dependent upon the firm's overall capital structure.
D) should be applied as the discount rate for all other projects considered by the firm.
E) depends upon how the funds raised for that project are going to be spent.

Question 19

The dividend growth model:

A) is only as reliable as the estimated rate of growth.
B) can only be used if historical dividend information is available.
C) considers the risk that future dividends may vary from their estimated values.
D) applies only when a company is currently paying dividends.
E) is based solely on historical dividend information.

Question 20

The aftertax cost of debt:

A) varies inversely to changes in market interest rates.
B) will generally exceed the cost of equity if the relevant tax rate is zero.
C) will generally equal the cost of preferred if the tax rate is zero.
D) is unaffected by changes in the market rate of interest.
E) is highly dependent upon a company's tax rate.

Question 21

When computing the adjusted cash flow from assets, the tax amount is calculated as:

A) EBT(TC).
B) (EBT − Depreciation)(TC).
C) (EBIT + Depreciation − Change in NWC − Capital spending)(TC).
D) EBIT(TC).
E) (EBIT − Depreciation − Change in NWC − Capital spending)(TC).

Question 22

Preston Industries has two separate divisions. Each division is in a separate line of business. Division A is the largest division and represents 65 percent of the company's overall sales. Division A is also the riskier of the two divisions. When management is deciding which of the various divisional projects should be accepted, the managers should:

A) allocate more funds to Division A since it is the larger of the two divisions.
B) fund all of Division B's projects first since they tend to be less risky and then allocate the remaining funds to the Division A projects that have the highest net present values.
C) allocate the company's funds to the projects with the highest net present values based on the company's weighted average cost of capital.
D) assign appropriate, but differing, discount rates to each project and then select the projects with the highest net present values.
E) fund the highest net present value projects from each division based on an allocation of 65 percent of the funds to Division A and 35 percent of the funds to Division B.

Question 23

Why does the tax amount need to be adjusted when valuing a firm using the cash flow from assets approach?

A) The tax effect of the dividend payments must be eliminated.
B) Only straight-line depreciation can be used when computing taxes for valuation purposes.
C) Taxes must be computed for valuation purposes based solely on the marginal tax rate.
D) The tax effect of the interest expense must be removed.
E) The taxes must be computed for valuation purposes based on the average tax rate for the past ten years.

Question 24

The average of a company's cost of equity, cost of preferred, and aftertax cost of debt that is weighted based on the company's capital structure is called the:

A) reward-to-risk ratio.
B) weighted capital gains rate.
C) structured cost of capital.
D) subjective cost of capital.
E) weighted average cost of capital.

Question 25

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

A) the company's overall weighted average cost of capital.
B) the actual sources of funding used for the project.
C) an average of the company's overall cost of capital for the past five years.
D) the current risk level of the overall firm.
E) the risks associated with the use of the funds required by the project.

Question 26

When a manager develops a cost of capital for a specific project based on the cost of capital for another firm that has a similar line of business as the project, the manager is utilizing the ________ approach.

A) subjective risk
B) pure play
C) divisional cost of capital
D) capital adjustment
E) security market line

Question 27

When a firm has flotation costs equal to 8.3 percent of the funding need, project analysts should:

A) increase the project's discount rate to offset these expenses by multiplying the company's WACC by 1.083.
B) increase the project's discount rate to offset these expenses by dividing the company's WACC by (1 − .083).
C) add 8.3 percent to the company's firm's WACC to determine the discount rate for the project.
D) increase the initial project cost by multiplying that cost by 1.083.
E) increase the initial project cost by dividing that cost by (1 − .083).

Question 28

The flotation cost for a company is computed as:

A) the arithmetic average of the flotation costs of both debt and equity.
B) the weighted average of the flotation costs associated with each form of financing.
C) the geometric average of the flotation costs associated with each form of financing.
D) one-half of the flotation cost of debt plus one-half of the flotation cost of equity.
E) a weighted average based on the book values of the company's outstanding securities.

Question 29

Which one of the following statements is correct?

A) The subjective approach assigns a discount rate to each project based on other companies in the same category as the project.
B) Overall, a company makes better decisions when it uses the subjective approach than when it uses its WACC as the discount rate for all projects.
C) Companies will correctly accept or reject every project if they adopt the subjective approach.
D) Mandatory projects should only be accepted if they produce a positive NPV when the overall company WACC is used as the discount rate.
E) The pure play approach should only be used with low-risk projects.

Question 30

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:

A) receive less project funding if its line of business is riskier than that of the other divisions.
B) avoid risky projects so it can receive more project funding.
C) become less risky over time based on the projects that are accepted.
D) have an equal probability with all the other divisions of receiving funding.
E) prefer higher risk projects over lower risk projects.

Question 31

Which one of the following statements is correct?

A) Firms should accept low-risk projects prior to funding high-risk projects.
B) Making subjective adjustments to a company's WACC when determining project discount rates unfairly punishes low-risk divisions within the company.
C) A project that is unacceptable today might be acceptable tomorrow given a change in market returns.
D) The pure play method is most frequently used for projects involving the expansion of a company's current operations.
E) Companies that elect to use the pure play method for determining a discount rate for a project cannot subjectively adjust the pure play rate.

Question 32

The weighted average cost of capital for a company is least dependent upon the:

A) company's beta.
B) coupon rate of the company's outstanding bonds.
C) growth rate of the company's dividends.
D) company's marginal tax rate.
E) standard deviation of the company's common stock.

Question 33

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.

Question 34

Incorporating flotation costs into the analysis of a project will:

A) cause the project to be improperly evaluated.
B) increase the net present value of the project.
C) increase the project's rate of return.
D) increase the initial cash outflow of the project.
E) have no effect on the present value of the project.

Question 35

Flotation costs for a levered firm should be:

A) ignored when analyzing a project because they are a sunk cost.
B) spread over the life of a project thereby reducing the cash flows for each year of the project.
C) considered only when two projects are mutually exclusive.
D) weighted and included in the initial cash flow.
E) totally ignored when internal equity funding is utilized.

Question 36

The subjective approach to project analysis:

A) is used only when a firm has an all-equity capital structure.
B) uses the WACC of Firm X as the basis for the discount rate for a project under consideration by Firm Y.
C) assigns discount rates to projects based on the discretion of the senior managers of a firm.
D) allows managers to randomly adjust the discount rate assigned to a project once the project's standard deviation has been determined.
E) applies a lower discount rate to projects that are financed totally with equity as compared to those that are partially financed with debt.

Question 37

If a company uses its WACC as the discount rate for all of the projects it undertakes then the company will tend to:

A) accept all positive net present value projects.
B) increase the average risk level of the company over time.
C) reject all high-risk projects.
D) reject all negative net present value projects.
E) favor low-risk projects over high-risk projects.

Question 38

The Road Stop is a national hotel chain with a cost of capital of 12.4 percent. This chain is considering opening a high-end resort that is expected to have a cost of capital that is at least 13 percent. The estimated net present value of the resort project is $500 when discounted at 12.4 percent. The best representation of this situation is that the resort project should:

A) be accepted immediately.
B) be financed solely with debt in order for the project to have a positive NPV.
C) probably be put on hold until its cost of capital can be lowered.
D) be permanently rejected.
E) probably be expanded.

Question 39

The weighted average cost of capital for a firm with debt is the:

A) discount rate that the firm should apply to all of the projects it undertakes.
B) rate of return a company must earn on its existing assets to maintain the current value of its stock.
C) coupon rate the firm should expect to pay on its next bond issue.
D) minimum discount rate the firm should require on any new project.
E) rate of return debtholders should expect to earn on their investment in this firm.

Question 40

Assigning discount rates to individual projects based on the risk level of each project:

A) may cause the company's overall weighted average cost of capital to either increase or decrease over time.
B) will prevent the company's overall cost of capital from changing over time.
C) will cause the company's overall cost of capital to decrease over time.
D) decreases the value of the company over time.
E) negates the company's goal of creating the most value for its shareholders.

Question 41

National Home Rentals has a beta of 1.06, a stock price of $17, and recently paid an annual dividend of $.92 a share. The dividend growth rate is 2.2 percent. The market has a rate of return of 11.2 percent and a risk premium of 7.3 percent. What is the estimated cost of equity using the average return of the CAPM and the dividend discount model?

A) 10.05 percent
B) 8.67 percent
C) 9.13 percent
D) 10.30 percent
E) 9.68 percent

Question 42

Handy Man, Inc., has zero coupon bonds outstanding that mature in 4 years. The bonds have a face value of $1,000 and a current market price of $798. What is the pretax cost of debt? (Use semiannual compounding.)

A) 6.55 percent
B) 5.91 percent
C) 5.72 percent
D) 6.31 percent
E) 6.48 percent

Question 43

Stock in Country Road Industries has a beta of 1.62. The market risk premium is 8.2 percent while T-bills are currently yielding 2.9 percent. Country Road's last paid annual dividend was $1.87 per share and dividends are expected to grow at an annual rate of 3.8 percent indefinitely. The stock sells for $25 a share. What is the estimated cost of equity using the average return of the CAPM and the dividend discount model?

A) 13.87 percent
B) 14.06 percent
C) 14.23 percent
D) 13.38 percent
E) 14.50 percent

Question 44

The common stock of Metal Molds has a negative growth rate of 1.63 percent and a required return of 18.21 percent. The current stock price is $9.82. What was the amount of the last dividend paid?

A) $1.07
B) $2.11
C) $1.64
D) $1.73
E) $1.98

Question 45

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?

A) 7.00 percent
B) 7.64 percent
C) 8.39 percent
D) 8.05 percent
E) 7.54 percent

Question 46

The Shoe Outlet has paid annual dividends of $.58, $.66, $.72, and $.75 per share over the last four years, respectively. The stock is currently selling for $10.08 a share. What is the cost of equity?

A) 18.74 percent
B) 17.13 percent
C) 10.38 percent
D) 19.53 percent
E) 11.79 percent

Question 47

Tidewater Fishing has a current beta of 1.16. The market risk premium is 6.8 percent and the risk-free rate of return is 2.9 percent. By how much will the cost of equity increase if the company expands its operations such that the company beta rises to 1.18?

A) .28 percent
B) .14 percent
C) .26 percent
D) .12 percent
E) .43 percent

Question 48

Dee's Fashions has a growth rate of 3.2 percent and is equally as risky as the market while its stock is currently selling for $32 a share. The overall stock market has a return of 10.9 percent and a risk premium of 6.8 percent. What is the expected rate of return on this stock?

A) 10.0 percent
B) 9.2 percent
C) 10.9 percent
D) 11.3 percent
E) 11.7 percent

Question 49

Fashion Wear has bonds outstanding that mature in 11 years, pay interest annually, and have a coupon rate of 6.45 percent. These bonds have a face value of $1,000 and a current market price of $994. What is the company's aftertax cost of debt if its tax rate is 21 percent?

A) 4.86 percent
B) 4.28 percent
C) 5.16 percent
D) 5.21 percent
E) 4.53 percent

Question 50

Street Corporation's common stock has a beta of 1.33. The risk-free rate is 3.4 percent and the expected return on the market is 10.97 percent. What is the cost of equity?

A) 12.49 percent
B) 12.84 percent
C) 13.47 percent
D) 14.07 percent
E) 13.33 percent

Question 51

The Pet Market has $1,000 face value bonds outstanding with 21 years to maturity, a coupon rate of 6.4 percent, annual interest payments, and a current price of $892. What is the aftertax cost of debt if the combined tax rate is 24 percent?

A) 6.79 percent
B) 7.43 percent
C) 4.61 percent
D) 7.08 percent
E) 5.65 percent

Question 52

Jay's Bakery has a bond issue outstanding that matures in eight years. The bonds pay interest semiannually. Currently, the bonds are quoted at 97.8 percent of face value and carry a coupon rate of 5.7 percent. What is the aftertax cost of debt if the tax rate is 21 percent?

A) 4.88 percent
B) 4.16 percent
C) 5.87 percent
D) 4.78 percent
E) 6.05 percent 

Question 53

Hydro Systems has bonds outstanding with a face value of $1,000, 13 years to maturity, and a coupon rate of 6.5 percent, paid annually. What is the company's pretax cost of debt if the bonds currently sell for $1,056?

A) 5.87 percent
B) 6.42 percent
C) 4.71 percent
D) 5.36 percent
E) 5.55 percent

Question 54

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?

A) 4.30 percent
B) 4.92 percent
C) 4.17 percent
D) 5.43 percent
E) 5.58 percent

Question 55

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?

A) 9.98 percent
B) 10.04 percent
C) 10.17 percent
D) 10.30 percent
E) 10.45 percent

Question 56

The outstanding bonds of Tech Express are priced at $1,023 and mature in 13 years. These bonds have a face value of $1,000, a coupon rate of 6.5 percent, and pay interest semiannually. The tax rate is 21 percent. What is the aftertax cost of debt?

A) 4.28 percent
B) 4.22 percent
C) 4.35 percent
D) 4.93 percent
E) 4.41 percent 

Question 57

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?

A) 4.96 percent
B) 4.78 percent
C) 4.15 percent
D) 4.12 percent
E) 3.86 percent

Question 58

Highway Express has paid annual dividends of $1.32, $1.33, $1.38, $1.40, and $1.42 over the past five years, respectively. What is the average dividend growth rate?

A) 1.85 percent
B) 2.16 percent
C) 1.98 percent
D) 2.47 percent
E) 2.39 percent

Question 59

Chelsea Fashions is expected to pay an annual dividend of $1.26 a share next year. The market price of the stock is $24.09 and the growth rate is 2.6 percent. What is the cost of equity?

A) 9.77 percent
B) 7.91 percent
C) 9.24 percent
D) 7.83 percent
E) 7.54 percent

Question 60

Sweet Treats common stock is currently priced at $36.72 a share. The company just paid $2.18 per share as its annual dividend. The dividends have been increasing by 2.2 percent annually and are expected to continue doing the same. What is the cost of equity?

A) 9.41 percent
B) 9.51 percent
C) 8.47 percent
D) 8.27 percent
E) 8.82 percent

Question 61

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

Question 62

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?

A) 9.89 percent
B) 10.43 percent
C) 11.02 percent
D) 11.38 percent
E) 12.17 percent

Question 63

Rosa's has a weighted average cost of capital of 11.73 percent. The cost of equity is 15.8 percent and the pretax cost of debt is 7.6 percent. The tax rate is 21 percent. What is the target debt-equity ratio?

A) .89
B) 1.87
C) 1.41
D) .53
E) .71

Question 64

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?

A) 8.41 percent
B) 6.71 percent
C) 7.52 percent
D) 6.58 percent
E) 6.59 percent

Question 65

The Dry Well has 6.85 percent preferred stock outstanding with a market value per share of $79, a stated value of $100 per share,  and a book value per share of $29. What is the cost of preferred stock?

A) 8.50 percent
B) 8.88 percent
C) 8.67 percent
D) 9.29 percent
E) 9.00 percent

Question 66

Cookie Dough Manufacturing has a target debt-equity ratio of .76. Its cost of equity is 15.3 percent, and its pretax cost of debt is 9 percent. What is the WACC given a tax rate of 21 percent?

A) 11.76 percent
B) 12.78 percent
C) 13.11 percent
D) 11.48 percent
E) 12.53 percent

Question 67

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?

A) 11.22 percent
B) 10.94 percent
C) 10.45 percent
D) 11.05 percent
E) 11.37 percent

Question 68

Granite Works maintains a debt-equity ratio of .58 and has a tax rate of 21 percent. The pretax cost of debt is 8.9 percent. There are 18,000 shares of stock outstanding with a beta of 1.42 and a market price of $23 a share. The current market risk premium is 7.8 percent and the current risk-free rate is 3.1 percent. This year, the firm paid an annual dividend of $1.68 a share and expects to increase that amount by 2 percent each year. Using an average expected cost of equity, what is the weighted average cost of capital?

A) 8.44 percent
B) 9.78 percent
C) 8.96 percent
D) 9.13 percent
E) 10.06 percent

Question 69

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?

A) 15.15 percent
B) 15.04 percent
C) 14.68 percent
D) 14.79 percent
E) 14.40 percent

Question 70

Florida Groves has a $380,000 bond issue outstanding that is selling at 97.4 percent of face value. The firm also has 2,600 shares of preferred stock valued at $61 a share and 37,500 shares of common stock valued at $19 a share. What weight should be assigned to the common stock when computing the weighted average cost of capital?

A) 55.75 percent
B) 62.20 percent
C) 58.75 percent
D) 61.03 percent
E) 57.40 percent

Question 71

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?

A) 10.07 percent
B) 10.32 percent
C) 12.36 percent
D) 11.29 percent
E) 11.47 percent

Question 72

Simple Foods has a zero coupon bond issue outstanding that matures in 14 years. The bonds are selling at 56 percent of par value. What is the company's aftertax cost of debt if the combined tax rate is 23 percent? (Use semiannual compounding.)

A) 4.48 percent
B) 3.13 percent
C) 3.22 percent
D) 3.73 percent
E) 2.88 percent

Question 73

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?

A) 6.08 percent
B) 5.40 percent
C) 6.67 percent
D) 5.00 percent
E) 5.75 percent

Question 74

Grill Works has 6 percent preferred stock outstanding that is currently selling for $49 a share. The market rate of return is 14 percent and the tax rate is 21 percent. What is the cost of preferred stock if its stated value is $100 per share?

A) 12.77 percent
B) 12.29 percent
C) 12.67 percent
D) 12.24 percent
E) 12.54 percent

Question 75

Kelso's has a debt-equity ratio of .62 and a tax rate of 21 percent. The firm does not issue preferred stock. The cost of equity is 16.3 percent and the aftertax cost of debt is 5.21 percent. What is the weighted average cost of capital?

A) 10.96 percent
B) 11.67 percent
C) 12.06 percent
D) 11.38 percent
E) 11.57 percent

Question 76

Phillips Equipment has 6,500 bonds outstanding that are selling at 96.5 percent of par. Bonds with similar characteristics are yielding 6.7 percent, pretax. The company also has 48,000 shares of 5.5 percent preferred stock and 75,000 shares of common stock outstanding. The preferred stock sells for $64 a share. The common stock has a beta of 1.32 and sells for $41 a share. The preferred stock has a stated value of $100. The U.S. Treasury bill is yielding 2.2 percent and the return on the market is 10.6 percent. The corporate tax rate is 21 percent. What is the weighted average cost of capital?

A) 8.09 percent
B) 8.64 percent
C) 10.18 percent
D) 9.30 percent
E) 10.56 percent

Question 77

Central Systems desires a weighted average cost of capital of 12.7 percent. The firm has an aftertax cost of debt of 4.8 percent and a cost of equity of 15.4 percent. What debt-equity ratio is needed for the firm to achieve its targeted weighted average cost of capital?

A) .37
B) .42
C) .56
D) .34
E) .44

Question 78

Deep Mines has 43,800 shares of common stock outstanding with a beta of 1.54 and a market price of $51 a share. There are 10,000 shares of 7 percent preferred stock outstanding with a stated value of $100 per share and a market value of $83 a share. The 8 percent semiannual bonds have a face value of $1,000 and are selling at 96 percent of par. There are 5,000 bonds outstanding that mature in 13 years. The market risk premium is 7.5 percent, T-bills are yielding 3.6 percent, and the tax rate is 21 percent. What discount rate should the firm apply to a new project's cash flows if the project has the same risk as the company's typical project?

A) 9.59 percent
B) 8.72 percent
C) 9.17 percent
D) 8.28 percent
E) 9.30 percent

Question 79

Wayco Industrial Supply has a pretax cost of debt of 8.3 percent, a cost of equity of 14.7 percent, and a cost of preferred stock of 8.9 percent. The firm has 165,000 shares of common stock outstanding at a market price of $33 a share. There are 15,000 shares of preferred stock outstanding at a market price of $43 a share. The bond issue has a face value of $750,000 and a market quote of 101. The company's tax rate is 21 percent. What is the weighted average cost of capital?

A) 12.18 percent
B) 10.84 percent
C) 14.32 percent
D) 12.60 percent
E) 13.25 percent

Question 80

The Downtowner has 168,000 shares of common stock outstanding valued at $53 a share along with 13,000 bonds selling for $1,008 each. What weight should be given to the debt when the company computes its weighted average cost of capital?

A) 46.67 percent
B) 65.05 percent
C) 51.79 percent
D) 59.54 percent
E) 48.27 percent