Deck 12: Cost of Capital

Question 1

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 WACC?

A) 12.4 percent because it is lower than 18.7 percent
B) 18.7 percent because it is higher than 12.4 percent
C) The arithmetic average of 12.4 percent and 18.7 percent
D) The arithmetic average of 12.4 percent, 13.5 percent, and 18.7 percent
E) 13.5 percent

Answer 1

The arithmetic average of 12.4 percent and 18.7 percent

Question 2

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) Decrease in a bond's yield-to-maturity

Answer 2

Increase in tax rates

Question 3

Which one of the following statements is correct related to the dividend growth model approach to computing the cost of equity?

A) The rate of growth must exceed the required rate of return.
B) The rate of return must be adjusted for taxes.
C) The annual dividend used in the computation must be for year one if you are using today's stock price to compute the return.
D) The cost of equity is equal to the return on the stock plus the risk-free rate.
E) The cost of equity is equal to the return on the stock multiplied by the stock's beta.

Answer 3

The annual dividend used in the computation must be for year one if you are using today's stock price to compute the return.

Question 4

In an efficient market, the cost of equity for a risky firm does which one of the following according to the security market line?

A) Produces a return that will be less than the market rate but higher than the risk-free rate
B) Equals the market rate of return for all stocks
C) Has a maximum cost equal to the market rate of return
D) Decreases as the beta of the firm's stock increases
E) Increases in direct relation to the stock's systematic risk

Question 5

Which one of the following statements is correct?

A) An increase in the market value of preferred stock will increase a firm's weighted average cost of capital.
B) The cost of preferred stock is unaffected by the issuer's tax rate.
C) Preferred stock is generally the cheapest source of capital for a firm.
D) The cost of preferred stock remains constant from year to year.
E) Preferred stock is valued using the capital asset pricing model.

Question 6

Farmer's Supply, Inc. is considering opening a clothing store, which would be a new line of business for the firm. Management has decided to use the cost of capital of a similar clothing store as the discount rate that should be used to evaluate this proposed expansion. Which one of the following terms is used to describe the approach Farmer's Supply is taking to establish an appropriate discount rate for the project?

A) Equity approach
B) Aftertax approach
C) Subjective approach
D) Market play
E) Pure play approach

Question 7

The cost of preferred stock:

A) increases when a firm's tax rate decreases.
B) is constant over time.
C) is unaffected by changes in the market price.
D) is equal to the stock's dividend yield.
E) increases as the price of the stock increases.

Question 8

The weighted average cost of capital is defined as the weighted average of a firm's:

A) return on its investments.
B) cost of equity and its aftertax cost of debt.
C) pretax cost of debt and equity securities.
D) bond coupon rates.
E) dividend and capital gains yields.

Question 9

All else constant, an increase in a firm's cost of debt:

A) could be caused by an increase in the firm's tax rate.
B) will result in an increase in the firm's cost of capital.
C) will lower the firm's weighted average cost of capital.
D) will lower the firm's cost of equity.
E) will increase the firm's capital structure weight of debt.

Question 10

All else constant, which of the following will increase the aftertax cost of debt for a firm? I. increase in the yield to maturity of the firm's outstanding debt
II) decrease in the yield to maturity of the firm's outstanding debt
III) increase in the firm's tax rate
IV) decrease in the firm's tax rate

A) I only
B) I and III only
C) I and IV only
D) II and III only
E) II and IV only

Question 11

Which of the following features are advantages of the dividend growth model? I. easy to understand
II) model simplicity
III) constant dividend growth rate
IV) model's applicability to all common stocks

A) II only
B) I and III only
C) II and IV only
D) I and II only
E) I, II, and III only

Question 12

Which of the following are weaknesses of the dividend growth model? I. market risk premium fluctuations
II) lack of dividends for some firms
III) reliance on historical beta
IV) sensitivity of model to dividend growth rate

A) II only
B) I and II only
C) I and III only
D) II and IV only
E) I, II, III, and IV

Question 13

Kate is the CFO of a major firm and has the job of assigning discount rates to each project that is under consideration. Kate's method of doing this is to assign an incrementally higher rate as the risk level of the project increases over that of the current firm. Likewise, she assigns lower rates as the risk level declines. Which one of the following approaches is Kate using to assign the discount rates?

A) Pure play approach
B) Divisional rating
C) Subjective approach
D) Straight WACC approach
E) Equity rating

Question 14

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:

A) pure play cost.
B) cost of debt.
C) weighted average cost of capital.
D) subjective cost.
E) cost of equity.

Question 15

Which of the following will increase the cost of equity for a firm with a beta of 1.1? I. decrease in the security's beta
II) decrease in the market risk premium
III) decrease in the risk-free rate
IV) increase in the risk-free rate

A) II only
B) III only
C) I and II only
D) II and III only
E) I and IV only

Question 16

Which one of the following will increase the cost of equity, all else held constant?

A) Increase in the dividend growth rate
B) Decrease in beta
C) Decrease in future dividends
D) Increase in stock price
E) Decrease in market risk premium

Question 17

Katie owns 100 shares of ABC stock. Which one of the following terms is used to refer to the return that Katie and the other shareholders require on their investment in ABC?

A) Weighted average cost of capital
B) Pure play cost
C) Cost of equity
D) Subjective cost
E) Cost of debt

Question 18

Which one of the following is the pre-tax cost of debt?

A) Average coupon rate on the firm's outstanding bonds
B) Coupon rate on the firm's latest bond issue
C) Weighted average yield-to-maturity on the firm's outstanding debt
D) Average current yield on the firm's outstanding debt
E) Annual interest divided by the market price per bond for the latest bond issue

Question 19

Ted is trying to decide what cost of capital he should assign to a project. Which one of the following should be his primary consideration in this decision?

A) Amount of debt used to finance the project
B) Use, or lack thereof, of preferred stock to finance the project
C) Mix of funds used to finance the project
D) Risk level of the project
E) Length of the project's life

Question 20

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

A) Firm's overall source of funds
B) Source of the funds used to build the facility
C) Current tax rate
D) The nature of the investment
E) Firm's historical average rate of return

Question 21

When using the pure play approach for a proposed investment, a firm is primarily seeking a rate of return which:

A) is based on the actual source of funds that will be used to fund the project.
B) creates a positive net present value for the project.
C) reflects the size and life of the project.
D) most closely correlates with the proposed investment's internal rate of return.
E) best matches the risk level of the proposed investment.

Question 22

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

A) Source of funds used for the project
B) Division within the firm that undertakes the project
C) Project's modified internal rate of return
D) How the project uses its funds
E) Project's fixed costs

Question 23

Which one of the following statements is accurate for a levered firm?

A) WACC should be used as the required return for all proposed investments.
B) A firm's WACC will decrease whenever the firm's tax rate decreases.
C) An increase in the market risk premium will decrease a firm's WACC.
D) The subjective approach totally ignores a firm's own WACC.
E) A reduction in the risk level of a firm will tend to decrease the firm's WACC.

Question 24

Boone Brothers remodels homes and replaces windows. Ace Builders constructs new homes. If Boone Brothers considers expanding into new home construction, it should evaluate the expansion project using which one of the following as the required return for the project?

A) Boone Brothers' cost of capital
B) Ace Builders' cost of capital
C) Average of Boone Brothers' and Ace Builders' cost of capital
D) Lower of Boone Brothers' or Ace Builders' cost of capital
E) Higher of Boone Brothers' or Ace Builders' cost of capital

Question 25

Old Town Industries has three divisions. Division X has been in existence the longest and has the most stable sales. Division Y has been in existence for five years and is slightly less risky than the overall firm. Division Z is the research and development side of the business. When allocating funds, the firm should probably:

A) require the highest rate of return from division X since it has been in existence the longest.
B) assign the highest cost of capital to division Z because it is most likely the riskiest of the three divisions.
C) use the firm's WACC as the cost of capital for division Z as it provides analysis for the entire firm.
D) use the firm's WACC as the cost of capital for divisions A and B because they are part of the revenue-producing operations of the firm.
E) allocate capital funds evenly amongst the divisions to maintain the current capital structure of the firm.

Question 26

A firm that uses its weighted average cost of capital as the required return for all of its investments will:

A) maintain a constant value for its shareholders.
B) increase the risk level of the firm over time.
C) make the best possible accept and reject decisions related to those investments.
D) find that its cost of capital declines over time.
E) accept only the projects that add value to the firm's shareholders.

Question 27

The aftertax cost of which of the following are affected by a change in a firm's tax rate? I. preferred stock
II) debt
III) equity
IV) capital

A) I and III only
B) II and IV only
C) I, II, and IV only
D) II, III, and IV only
E) I, II, III, and IV

Question 28

Which one of the following will affect the capital structure weights used to compute a firm's weighted average cost of capital?

A) Decrease in the book value of a firm's equity
B) Decrease in a firm's tax rate
C) Increase in the market value of the firm's common stock
D) Increase in the market risk premium
E) Increase in the firm's beta

Question 29

Which one of the following is most apt to cause a wise manager to increase a project's cost of capital? Assume the firm is levered.

A) Management decides to issue new stock to finance the project.
B) The initial cash outlay requirement is reduced.
C) She learns the project is riskier than previously believed.
D) The aftertax cost of debt just decreased.
E) The project's life is shortened.

Question 30

Which one of the following statements is correct, all else held constant?

A) Beta is used to compute the return on equity and the standard deviation is used to compute the return on preferred.
B) A decrease in a firm's WACC will increase the attractiveness of the firm's investment options.
C) The aftertax cost of debt increases when the market price of a bond increases.
D) If you have both the dividend growth and the security market line's costs of equity, you should use the higher of the two estimates when computing WACC.
E) WACC is only applicable to firms that issue both common and preferred stock.

Question 31

Which one of the following represents the rate of return a firm must earn on its assets if it is to maintain the current value of its securities?

A) Cost of equity
B) Internal rate of return
C) Aftertax cost of debt
D) Weighted average cost of capital
E) Debt-equity ratio

Question 32

Which one of the following statements is correct? Assume the pre-tax cost of debt is less than the cost of equity.

A) A firm may change its capital structure if the government changes its tax policies.
B) A decrease in the dividend growth rate increases the cost of equity.
C) A decrease in the systematic risk of a firm will increase the firm's cost of capital.
D) A decrease in a firm's debt-equity ratio will decrease the firm's cost of capital.
E) The cost of preferred stock decreases when the tax rate increases.

Question 33

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?

A) Kurt tends to overestimate the projected cash inflows on his projects.
B) Kurt tends to underestimate the variable costs of his projects.
C) Kurt has the most efficiently managed division.
D) Kurt's division is less risky than the other divisions.
E) Kurt's projects are generally financed with debt while the other divisions' projects are financed with equity.

Question 34

A firm has a cost of equity of 13 percent, a cost of preferred of 11 percent, and an aftertax cost of debt of 6 percent. Given this, which one of the following will increase the firm's weighted average cost of capital?

A) Increasing the firm's tax rate
B) Issuing new bonds at par
C) Redeeming shares of common stock
D) Increasing the firm's beta
E) Increasing the debt-equity ratio

Question 35

You need to use the pure play approach to assign a cost of capital to a proposed investment. Which one of the following characteristics should you most concentrate on as you search for an appropriate pure play firm?

A) Firm size
B) Firm location
C) Firm experience
D) Firm operations
E) Firm management

Question 36

All else constant, the weighted average cost of capital for a risky, levered firm will decrease if:

A) the firm's bonds start selling at a premium rather than at a discount.
B) the market risk premium increases.
C) the firm replaces some of its debt with preferred stock.
D) corporate taxes are eliminated.
E) the dividend yield on the common stock increases.

Question 37

A firm uses its weighted average cost of capital to evaluate the proposed projects for all of its varying divisions. By doing so, the firm:

A) automatically gives preferential treatment in the allocation of funds to its riskiest division.
B) encourages the division managers to only recommend their most conservative projects.
C) maintains the current risk level and capital structure of the firm.
D) automatically maximizes the total value created for its shareholders.
E) allocates capital funds evenly amongst its divisions.

Question 38

. Marine Expeditors has three divisions. Division A is the core of the business and represents 80 percent of the firm's operations. Division B is involved only with contractual short-term projects and therefore has about 8 percent less risk than division A. Division C develops and markets new products and is about 12 percent riskier than division A and about equal in size to division B. The manager of division A has suggested that the operations of his division be increased by 10 percent next year. The proposed project should probably be assigned a required return that is equal to _____ percent of the firm's weighted average cost of

A) 40
B) 59
C) 78
D)100
E)110

Question 39

Which one of the following is the primary determinant of an investment's cost of capital?

A) Life of investment
B) Initial cash outlay
C) Level of risk
D) Source of funds used for the investment
E) Investment's net present value

Question 40

Which one of the following statements is correct concerning capital structure weights?

A) Target rates are less relevant to a project than are historical rates.
B) The weights are unaffected when a bond issue matures.
C) An increase in the debt-equity ratio will increase the weight of the common stock.
D) The repurchase of preferred stock will increase the weight of debt.
E) The issuance of additional shares of common stock will increase the weight of the preferred stock.

Question 41

Appalachian Mountain Goods has paid increasing dividends of $.0.12, $0.18, $0.20, and $0.25 a share over the past four years, respectively. The firm estimates that future increases in its dividends will be equal to the arithmetic average growth rate over these past four years. The stock is currently selling for $12.60 a share. The risk-free rate is 3.2 percent and the market risk premium is 9.1 percent. What is the cost of equity for this firm if its beta is 1.26?

A) 14.34 percent
B) 16.91 percent
C) 19.78 percent
D) 22.96 percent
E) 24.03 percent

Question 42

Hi Tech Products has 35,000 bonds outstanding that are currently quoted at 102.3. The bonds mature in 11 years and carry a 9 percent annual coupon. What is the firm's aftertax cost of debt if the applicable tax rate is 35 percent?

A) 4.47 percent
B) 4.79 percent
C) 5.63 percent
D) 5.98 percent
E) 6.31 percent

Question 43

The market rate of return is 14.8 percent and the risk-free rate is 4.45 percent. Galaxy Co. has 54 percent more systematic risk than the overall market and has a dividend growth rate of 5.5 percent. The firm's stock is currently selling for $39 a share and has a dividend yield of 3.6 percent. What is the firm's cost of equity?

A) 14.73 percent
B) 15.31 percent
C) 15.82 percent
D) 16.28 percent
E) 16.73 percent

Question 44

Catnip Stores has a $20 million bond issue outstanding that currently has a market value of $18.6 million. The bonds mature in 6.5 years and pay semiannual interest payments of $30 each. What is the firm's pre-tax cost of debt?

A) 6.99 percent
B) 7.37 percent
C) 7.58 percent
D) 7.74 percent
E) 7.80 percent

Question 45

The Green Balloon just paid its first annual dividend of $0.12 a share. The firm plans to increase the dividend by 3.5 percent per year indefinitely. What is the firm's cost of equity if the current stock price is $6.50 a share?

A) 5.35 percent
B) 5.41 percent
C) 14.42 percent
D) 18.79 percent
E) 19.98 percent

Question 46

Kelly's uses the firm's weighted average cost of capital (WACC) as the required return for some of its projects. For other projects, the firms uses a rate equal to WACC plus 1 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 the project a discount rate?

A) Firm beta
B) Date for project commencement
C) Risk level of project
D) Division within the firm that will be assigned to manage the project
E) Current debt-equity ratio

Question 47

The common stock of Yanderloft and Sons has a beta that is 25 percent larger than the overall market beta. Currently, the market risk premium is 9.2 percent while the U.S. Treasury bill is yielding 4.7 percent. What is the cost of equity for this firm?

A) 13.76 percent
B) 14.96 percent
C) 15.80 percent
D) 16.20 percent
E) 17.85 percent

Question 48

High Valley Antiques would like to issue new equity shares if its cost of equity declines to 10.5 percent. The company pays a constant annual dividend of $1.60 per share. What does the market price of the stock need to be for the firm to issue the new shares?

A) $14.48
B) $14.83
C) $15.24
D) $15.92
E) $16.80

Question 49

Winter Wear, Inc. has 6 percent bonds outstanding that mature in 13 years. The bonds pay interest semiannually and have a face value of $1,000. Currently, the bonds are selling for $993 each. What is the firm's pre-tax cost of debt?

A) 5.97 percent
B) 6.08 percent
C) 6.14 percent
D) 6.31 percent
E) 6.40 percent

Question 50

The computation of which one of the following requires assigning every proposed investment to a particular risk class?

A) Pure play cost of capital
B) Cost of equity
C) Aftertax cost of debt
D) WACC
E) Subjective cost of capital

Question 51

Derek's is a brick-and-mortar toy store. The firm is considering expanding its operations to include Internet sales. Which one of the following would be the best firm to use in a pure play approach to analyzing this proposed expansion?

A) Another brick-and-mortar store that also sells online
B) A wholesale toy distributor
C) A toy store that only sells online
D) The oldest online retailer of any product
E) Derek's own store

Question 52

The Cracker Mill has a beta of 0.97, a dividend growth rate of 3.2 percent, a stock price of $33 a share, and an expected annual dividend of $1.06 per share next year. The market rate of return is 11.2 percent and the risk-free rate is 3.7 percent. What is the firm's cost of equity?

A) 7.74 percent
B) 8.69 percent
C) 9.30 percent
D) 9.72 percent
E) 10.01 percent

Question 53

Four years ago, the Moore Co. issued 15-year, 7.5 percent semiannual coupon bonds at par. Today, the bonds are quoted at 101.6. What is this firm's pre-tax cost of debt?

A) 6.97 percent
B) 7.08 percent
C) 7.29 percent
D) 7.33 percent
E) 7.39 percent

Question 54

A firm has multiple divisions of similar nature, yet varying degrees of risk. Which one of the following would be the most appropriate, yet relatively easy, means of assigning discount rates to each of its proposed investments?

A) Assign every project a rate equal to the firm's cost of equity
B) Assign every firm a random rate that varies between the firm's cost of debt and its cost of equity
C) Assign every project a rate equal to the firm's WACC plus or minus a subjective adjustment
D) Determine the best pure play rate for each project
E) Assign every project a rate equal to the market rate of return at the time of the proposal

Question 55

Farm Equipment, Inc. announced this morning that its next annual dividend will be decreased to $1.80 a share and that all future dividends will be decreased by an additional 1.5 percent annually. What is the current value per share of this stock if the required return is 16.5 percent?

A) $8
B) $10
C) $12
D) $14
E) $16

Question 56

Musical Charts just paid an annual dividend of $2.45 per share. This dividend is expected to increase by 3.3 percent annually. Currently, the firm has a beta of 1.09 and a stock price of $36 a share. The risk-free rate is 4.2 percent and the market rate of return is 12.6 percent. What is the cost of equity capital for this firm?

A) 10.28 percent
B) 11.84 percent
C) 12.29 percent
D) 12.95 percent
E) 13.42 percent

Question 57

Birds and Yards has 10-year bonds outstanding that carry an annual coupon of 8 percent. The bonds mature in 7 years and are currently priced at 108.4 percent of face value. What is the firm's pre-tax cost of debt?

A) 6.47 percent
B) 6.82 percent
C) 7.34 percent
D) 7.70 percent
E) 8.23 percent

Question 58

Jet Setters has a cost of equity of 17.8 percent. The market risk premium is 10.2 percent and the risk-free rate is 4.4 percent. The company is acquiring a competitor, which will increase the company's beta to 1.6. What effect, if any, will the acquisition have on the firm's cost of equity capital?

A) No effect
B) Decrease of 3.39 percent
C) Decrease of 0.84 percent
D) Increase of 2.92 percent
E) Increase of 4.13 percent

Question 59

Judy's Boutique just paid an annual dividend of $1.65 on its common stock. The firm increases its dividend by 2.5 percent annually. What is the rate of return on this stock if the current stock price is $38.20 a share?

A) 6.93 percent
B) 7.37 percent
C) 7.54 percent
D) 8.19 percent
E) 8.33 percent

Question 60

The common stock of Modern Interiors has a beta of 1.61 and a standard deviation of 27.4 percent. The market rate of return is 13.2 percent and the risk-free rate is 4.8 percent. What is the cost of equity for this firm?

A) 18.32 percent
B) 19.97 percent
C) 21.08 percent
D) 24.40 percent
E) 26.05 percent

Question 61

Western Electric has 23,000 shares of common stock outstanding at a price per share of $57 and a rate of return of 14.2 percent. The firm has 6,000 shares of 7 percent preferred stock outstanding at a price of $48 a share. The preferred stock has a par value of $100. The outstanding debt has a total face value of $350,000 and currently sells for 102 percent of face. The yield-to-maturity on the debt is 8.49 percent. What is the firm's weighted average cost of capital if the tax rate is 34 percent?

A) 12.69 percent
B) 13.44 percent
C) 14.19 percent
D) 14.47 percent
E) 14.92 percent

Question 62

Great Lakes Packing has two bond issues outstanding. The first issue has a coupon rate of 9 percent, matures in 3 years, has a total face value of $6 million, and is quoted at 108 percent of face value. The second issue has a 7.5 percent coupon, matures in 16 years, has a total face value of $18 million, and is quoted at 97 percent of face value. Both bonds pay interest semiannually. What is the firm's weighted average aftertax cost of debt if the tax rate is 35 percent?

A) 4.78 percent
B) 5.12 percent
C) 5.63 percent
D) 5.95 percent
E) 6.08 percent

Question 63

Sunshine Cruises issues only common stock and coupon bonds. The firm has a debt-equity ratio of 0.55. The cost of equity is 16.3 percent and the pre-tax cost of debt is 9.9 percent. What is the capital structure weight of the firm's equity if the firm's tax rate is 34 percent?

A) 46.75 percent
B) 49.97 percent
C) 52.93 percent
D) 61.08 percent
E) 64.52 percent

Question 64

Claus Enterprises has 174,000 shares of common stock outstanding at a current price of $46 a share. The firm also has two bond issues outstanding. The first bond issue has a total face value of $250,000, pays 7.7 percent interest annually, and currently sells for 102.5 percent of face value. The second bond issue consists of 5,000 bonds that are selling for $993 each. These bonds pay 6.5 percent interest annually and mature in 8 years. The tax rate is 34 percent. What is the capital structure weight of the firm's common stock?

A) 47.78 percent
B) 51.39 percent
C) 55.50 percent
D) 60.52 percent
E) 71.86 percent

Question 65

Orchard Farms has a pre-tax cost of debt of 7.68 percent and a cost of equity of 15.2 percent. The firm uses the subjective approach to determine project discount rates. Currently, the firm is considering a project to which it has assigned an adjustment factor of -0.5 percent. The firm's tax rate is 34 percent and its debt-equity ratio is 0.45. The project has an initial cost of $4.3 million and produces cash inflows of $1.27 million a year for 5 years. What is the net present value of the project?

A) $121,619
B) $328,895
C) $514,370
D) $561,027
E) $628,721

Question 66

A firm wants to create a weighted average cost of capital (WACC) of 10.4 percent. The firm's cost of equity is 14.5 percent and its pre-tax cost of debt is 8.5 percent. The tax rate is 34 percent. What does the debt-equity ratio need to be for the firm to achieve its target WACC?

A) 0.51
B) 0.57
C) 0.62
D) 0.70
E) 0.86

Question 67

Alpha Industries is considering a project with an initial cost of $7.4 million. The project will produce cash inflows of $1.54 million a year for 7 years. The firm uses the subjective approach to assign discount rates to projects. For this project, the subjective adjustment is +1.5 percent. The firm has a pre-tax cost of debt of 8.6 percent and a cost of equity of 13.7 percent. The debt-equity ratio is .0.65 and the tax rate is 35 percent. What is the net present value of the project?

A) -$372,951
B) -$187,016
C) $48,209
D) $133,333
E) $269,480

Question 68

Dallas Interiors has a cost of equity of 18.6 percent and a pre-tax cost of debt of 9.7 percent. The firm's target weighted average cost of capital is 10.8 percent and its tax rate is 35 percent. What is the firm's target debt-equity ratio?

A) 0.81
B) 0.87
C) 1.18
D) 1.32
E) 1.74

Question 69

The 7.5 percent preferred stock of Tanners Floors is selling for $57 a share. What is the firm's cost of preferred stock if the tax rate is 35 percent and the par value per share is $100?

A) 11.69 percent
B) 12.81 percent
C) 13.16 percent
D) 13.79 percent
E) 14.14 percent

Question 70

Christie's Train Shoppe has 15,000 shares of common stock outstanding at a price of $11 a share. It also has 2,000 shares of preferred stock outstanding at a price of $34 a share. There are 50 bonds outstanding that have a 7.5 percent semiannual coupon. The bonds mature in 6 years, have a face value of $1,000, and sell at 96 percent of par. What is the capital structure weight of the preferred stock?

A) 20.50 percent
B) 21.68 percent
C) 23.15 percent
D) 24.20 percent
E) 26.23 percent

Question 71

The preferred stock of Pollard's Pools pays an annual dividend of $5.50 a share and sells for $42 a share. The tax rate is 34 percent. What is the firm's cost of preferred stock?

A) 12.28 percent
B) 13.10 percent
C) 15.07 percent
D) 15.59 percent
E) 16.47 percent

Question 72

Aaron's Rentals has 58,000 shares of common stock outstanding at a market price of $36 a share. The common stock just paid a $1.64 annual dividend and has a dividend growth rate of 2.8 percent. There are 12,000 shares of 6 percent preferred stock outstanding at a market price of $51 a share. The preferred stock has a par value of $100. The outstanding bonds mature in 17 years, have a total face value of $750,000, a face value per bond of $1,000, and a market price of $1,011 each. The bonds pay 8 percent interest, semiannually. The tax rate is 34 percent. What is the firm's weighted average cost of capital?

A) 7.74 percent
B) 8.68 percent
C) 9.29 percent
D) 9.97 percent
E) 10.30 percent

Question 73

Bruceton Hotels is an all-equity firm with 60,000 shares of stock outstanding. The stock has a beta of 1.27 and a standard deviation of 13.8 percent. The market risk premium is 9.1 percent and the risk-free rate of return is 4.2 percent. The company is considering a project that it considers riskier than its current operations so it wants to apply an adjustment of 1 percent to the project's discount rate. What should the firm set as the required rate of return for the project?

A) 12.54 percent
B) 13.92 percent
C) 15.39 percent
D) 16.76 percent
E) 17.03 percent

Question 74

Fancee Restaurant's cost of equity is 15.3 percent and its aftertax cost of debt is 6.1 percent. What is the firm's weighted average cost of capital if its debt-equity ratio is 0.58 and the tax rate is 30 percent?

A) 8.94 percent
B) 10.36 percent
C) 11.92 percent
D) 12.28 percent
E) 13.01 percent

Question 75

Major Manufacturing issued 30-year, 8.5 percent semiannual bonds 6 years ago. The bonds currently sell at 101 percent of face value. What is the firm's aftertax cost of debt if the tax rate is 35 percent?

A) 5.46 percent
B) 5.62 percent
C) 5.76 percent
D) 6.59 percent
E) 6.83 percent

Question 76

Southwest Tours currently has a weighted average cost of capital of 11.3 percent based on a combination of debt and equity financing. The firm has no preferred stock. The current debt-equity ratio is 0.58 and the aftertax cost of debt is 6.4 percent. The company just hired a new president who is considering eliminating all debt financing. All else constant, what will the firm's cost of capital be if the firm switches to an all-equity firm?

A) 11.45 percent
B) 12.62 percent
C) 12.89 percent
D) 13.37 percent
E) 14.14 percent

Question 77

The Color Box uses a combination of common stock, preferred stock, and debt financing. The company wants preferred stock to represent 8 percent of the total financing. It also wants to structure the firm in a manner that will produce a weighted average cost of capital of 10.25 percent. The aftertax cost of debt is 5.1 percent, the cost of preferred is 9.3 percent, and the cost of common stock is 15.6 percent. What percentage of the firm's capital funding should be debt financing?

A) 46.12 percent
B) 52.03 percent
C) 54.15 percent
D) 58.78 percent
E) 63.21 percent

Question 78

The 7.5 percent preferred stock of Home Town Brews is selling for $43 a share. What is the firm's cost of preferred stock if the tax rate is 34 percent and the par value per share is $100?

A) 14.47 percent
B) 15.92 percent
C) 16.17 percent
D) 16.52 percent
E) 17.44 percent

Question 79

The General Store has a cost of equity of 15.8 percent, a pre-tax cost of debt of 7.7 percent, and a tax rate of 32 percent. What is the firm's weighted average cost of capital if the debt-equity ratio is 0.40?

A) 10.18 percent
B) 11.72 percent
C) 12.78 percent
D) 13.30 percent
E) 14.93 percent

Question 80

Chesterfield and Weston has 55,000 shares of common stock outstanding at a price of $31 a share. It also has 3,000 shares of preferred stock outstanding at a price of $62 a share. The firm has 8 percent, 12-year bonds outstanding with a total face value of $400,000. The bonds are currently quoted at 101.2 percent of face and pay interest semiannually. What is the capital structure weight of the firm's debt if the tax rate is 35 percent?

A) 14.49 percent
B) 15.20 percent
C) 15.67 percent
D) 16.84 percent
E) 17.63 percent