Question 1

Sheepdog Rescue just paid its first annual dividend of $1.95 a share.The firm plans to increase the dividend by 1.75 percent per year indefinitely.What is the firm's cost of equity if the current stock price is $31.45 per share?

Accepted Answer

A) 6.31 percent 
B) 8.06 percent 
C) 10.38 percent 
D) 4.93 percent 
E) 5.94 percent

Question 2

Lawler's is considering a new project.The company has a debt-equity ratio of .64.The company's cost of equity is 14.9 percent, and the aftertax cost of debt is 5.3 percent.The firm feels that the project is riskier than the company as a whole and that it should use an adjustment factor of +1.8 percent.What is the project cost of capital if the tax rate is 34 percent?

Accepted Answer

A) 12.53 percent 
B) 12.98 percent 
C) 12.95 percent 
D) 15.14 percent 
E) 15.68 percent

Question 3

When evaluating a project, the dividend growth model:

Accepted Answer

A) can only be used by firms that pay increasing dividends. 
B) must be used by all dividend-paying firms. 
C) is only applicable when the growth rate of the project exceeds the dividend growth rate. 
D) is relatively simple to use. 
E) must use the growth rate of the project as the rate of growth in the formula.

Question 4

Cromwell's Interiors is considering a project that is equally as risky as the firm's current operations.The firm has a cost of equity of 15.4 percent and a pretax cost of debt of 8.9 percent.The debt-equity ratio is .46 and the tax rate is 34 percent.What is the cost of capital for this project?

Accepted Answer

A) 11.97 percent 
B) 12.40 percent 
C) 11.02 percent 
D) 11.62 percent 
E) 12.38 percent

Question 5

The common stock of Shaky Building Supply has a beta that is 22 percent greater than the overall market beta.Currently, the market risk premium is 9.56 percent while the U.S.Treasury bill is yielding 3.3 percent.What is the cost of equity for this firm?

Accepted Answer

A) 15.16 percent 
B) 14.36 percent 
C) 15.31 percent 
D) 14.96 percent 
E) 14.25 percent

Question 6

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?

Accepted Answer

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

Question 7

The common stock of Pedestrian Automotive has a beta of 0.89 and a standard deviation of 15.8 percent.The market rate of return is 12.25 percent and the risk-free rate is 2.9 percent.What is the cost of equity for this firm?

Accepted Answer

A) 11.22 percent 
B) 9.16 percent 
C) 9.48 percent 
D) 11.80 percent 
E) 10.45 percent

Question 8

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:

Accepted Answer

A) automatically gives preferential treatment in the allocation of funds to its riskiest division. 
B) encourages the division managers to recommend only 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 among its divisions.

Question 9

Santa Claus Enterprises has 87,000 shares of common stock outstanding at a current price of $39 a share.The firm also has two bond issues outstanding.The first bond issue has a total face value of $230,000, pays 7.1 percent interest annually, and currently sells for 103.1 percent of face value.The second bond issue consists of 5,000 bonds that are selling for $887 each.These bonds pay 6.5 percent interest annually and mature in eight years.The tax rate is 35 percent.What is the capital structure weight of the firm's debt?

Accepted Answer

A) 57.93 percent 
B) 51.39 percent 
C) 55.50 percent 
D) 60.52 percent 
E) 71.86 percent

Question 10

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.Given this, the firm should probably:

Accepted Answer

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 11

Design Interiors has a cost of equity of 14.9 percent and a pretax cost of debt of 8.6 percent.The firm's target weighted average cost of capital is 11 percent and its tax rate is 34 percent.What is the firm's target debt-equity ratio?

Accepted Answer

A) 1.37 
B) .87 
C) .98 
D) 1.02 
E) .73

Question 12

The preferred stock of Dolphin Pools pays an annual dividend of $5.25 a share and sells for $48a share.The tax rate is 35 percent.What is the firm's cost of preferred stock?

Accepted Answer

A) 9.67 percent 
B) 10.94 percent 
C) 15.07 percent 
D) 15.59 percent 
E) 16.47 percent

Question 13

Precision Cuts has a target debt-equity ratio of .48.Its cost of equity is 16.4 percent, and its pretax cost of debt is 8.2 percent.If the tax rate is 34 percent, what is the company's WACC?

Accepted Answer

A) 13.20 percent 
B) 11.72 percent 
C) 12.91 percent 
D) 11.28 percent 
E) 12.84 percent

Question 14

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

Accepted Answer

A) Cost of equity 
B) Pretax cost of debt 
C) Aftertax cost of debt 
D) Weighted average cost of capital 
E) Weighted average cost of preferred and common stock

Question 15

Tim's Tools just issued a dividend of $2.22 per share on its common stock.The company is expected to maintain a constant 2.8 percent growth rate in its dividends indefinitely.If the stock sells for $19 a share, what is the company's cost of equity?

Accepted Answer

A) 12.81 percent 
B) 13.37 percent 
C) 9.94 percent 
D) 14.81 percent 
E) 10.46 percent

Question 16

Spartans has 6.5 percent bonds outstanding that mature in 18 years.The bonds pay interest semiannually and have a face value of $1,000.Currently, the bonds are selling for $985 each.What is the firm's pretax cost of debt?

Accepted Answer

A) 6.77 percent 
B) 6.64 percent 
C) 6.94 percent 
D) 7.11 percent 
E) 6.20 percent

Question 17

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

Accepted Answer

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 18

Which one of the following will decrease the aftertax cost of debt for a firm?

Accepted Answer

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) Increase in a bond's yield to maturity

Question 19

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?

Accepted Answer

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

Question 20

Fire Hydrant Pet Supply just paid its first annual dividend of $0.75 a share.The firm plans to increase the dividend by 2.9 percent per year indefinitely.What is the firm's cost of equity if the current stock price is $16.90 per share?

Accepted Answer

A) 14.64 percent 
B) 7.47 percent 
C) 9.78 percent 
D) 4.33 percent 
E) 5.34 percent

Exam 12: Cost of Capital