Question 1

Suppose that Tan Lotion's common shares sell for $18 per share, are expected to set their next annual dividend at $1.00 per share, and that all future dividends are expected to grow by 7 percent per year, indefinitely. If Tan Lotion faces a flotation cost of 12 percent on new equity issues, what will be the flotation-adjusted cost of equity?

Accepted Answer

A)  6.37 percent
B)  7.06 percent
C)  12.56 percent
D)  13.31 percent D

Question 2

Suppose your firm has decided to use a divisional WACC approach to analyze projects. The firm currently has four divisions, A through D, with average betas for each division of 0.5, 1.0, 1.3 and 1.6, 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 7 percent) is 14 percent and the after-tax yield on the company's bonds is 8 percent, what are the WACCs for divisions A through D?

Accepted Answer

A)  9.00 percent; 10.25 percent; 12.95 percent; 13.15 percent
B)  9.75 percent; 12.00 percent; 12.65 percent; 13.75 percent
C)  9.25 percent; 11.00 percent; 12.05 percent; 13.10 percent
D)  8.95 percent; 10.15 percent; 12.50 percent; 13.45 percent C

Question 3

The ____________ approach to computing a divisional weighted average cost of capital (WACC) requires only that WACCs for "risky" and "relatively safe" divisions be adjusted.

Accepted Answer

A)  subjective
B)  objective
C)  firmwide
D)  implicit A

Question 4

An average of which of the following will give a fairly accurate estimate of what a project's beta will be?

Accepted Answer

A)  flotation beta
B)  proxy beta
C)  pure-play proxies
D)  weighted average beta

Question 5

FarCry Industries, a maker of telecommunications equipment, has 26 million shares of common stock outstanding, 1 million shares of preferred stock outstanding, and 10 thousand bonds. If the common shares sell for $12 per share, the preferred shares sell for $114.50 per share, and the bonds sell for 98 percent of par ($1,000), what weight should you use for preferred stock in the computation of FarCry's WACC?

Accepted Answer

A)  28.52 percent
B)  27.51 percent
C)  26.24 percent
D)  25.01 percent

Question 6

A firm uses only debt and equity in its capital structure. The firm's weight of equity is 70 percent. The firm's cost of equity is 13 percent and it has a tax rate of 30 percent. If the firm's WACC is 11 percent, what is the firm's before-tax cost of debt?

Accepted Answer

A)  7.17 percent
B)  9.05 percent
C)  6.38 percent
D)  5.36 percent

Question 7

ADK Industries common shares sell for $40 per share. ADK expects to set their next annual dividend at $1.75 per share. If ADK expects future dividends to grow at 7 percent per year, indefinitely, the current risk-free rate is 4 percent, the expected rate on the market is 11 percent, and the stock has a beta of 1.2, what should be the best estimate of the firm's cost of equity?

Accepted Answer

A)  11.89 percent
B)  11.38 percent
C)  12.40 percent
D)  12.71 percent

Question 8

Suppose a new project was going to be financed partially with retained earnings. What flotation costs should you use for retained earnings?

Accepted Answer

A)  use the same flotation cost that would be used to issue new common stock
B)  use an average of the flotation costs for debt, preferred and common stock
C)  use the industry average flotation cost for common stock
D)  zero

Question 9

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?

Accepted Answer

A)  6.73 percent
B)  10.07 percent
C)  15.71 percent
D)  16.72 percent

Question 10

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

Accepted Answer

A)  a simple average of the capital components costs.
B)  a sum of the capital components costs.
C)  a weighted average of the capital components costs.
D)  they apply to each asset as they are purchased with their respective forms of debt or equity.

Question 11

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?

Accepted Answer

A)  9.19 percent
B)  12.36 percent
C)  12.50 percent
D)  12.98 percent

Question 12

Pumpkin Pie Industries has 5 million shares of common stock outstanding, 1 million shares of preferred stock outstanding, and 10 thousand bonds. If the common shares are selling for $50 per share, the preferred shares are selling for $31 per share, and the bonds are selling for 98 percent of par ($1,000), what would be the weights used in the calculation of Pumpkin Pie's WACC for common stock, preferred stock, and bonds, respectively?

Accepted Answer

A)  33.33 percent, 33.33 percent, 33.33 percent
B)  83.19 percent, 16.64 percent, 0.17 percent
C)  85.97 percent, 10.67 percent, 3.38 percent
D)  27.93 percent, 17.32 percent, 54.75 percent

Question 13

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?

Accepted Answer

A)  33.33 percent, 33.33 percent, 33.33 percent
B)  74.07 percent, 22.22 percent, 3.71 percent
C)  66.61 percent, 33.31 percent, 0.08 percent
D)  17.86 percent, 10.71 percent, 71.43 percent

Question 14

KatyDid Clothes has a $150 million ($1,000 face value) 15-year bond issue selling for 86 percent of par that carries a coupon rate of 8 percent, paid semiannually. What would be KatyDid's before-tax component cost of debt?

Accepted Answer

A)  4.90 percent
B)  8.13 percent
C)  9.80 percent
D)  7.09 percent

Question 15

Why do we use market-value weights instead of book-value weights?

Accepted Answer

A)  Because firms often "window-dress" their financial statements.
B)  Because we are interested in determining what the cost of financing the firm's assets would be given today's market situation and the component costs the firm currently faces, not what the historical prices would have been.
C)  Because it is required in the Sarbanes-Oxley regulations.
D)  None of these choices are correct.

Question 16

FarCry Industries, a maker of telecommunications equipment, has 26 million shares of common stock outstanding, 1 million shares of preferred stock outstanding, and 10 thousand bonds. If the common shares sell for $15 per share, the preferred shares sell for $114.50 per share, and the bonds sell for 101 percent of par ($1,000), what weight should you use for preferred stock in the computation of FarCry's WACC?

Accepted Answer

A)  28.52 percent
B)  27.51 percent
C)  26.24 percent
D)  22.25 percent

Question 17

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?

Accepted Answer

A)  7.75 percent; 12.25 percent
B)  8.75 percent; 12.00 percent
C)  9.25 percent; 11.00 percent
D)  8.95 percent; 10.15 percent

Question 18

A firm uses only debt and equity in its capital structure. The firm's weight of equity is 35 percent. The firm's cost of equity is 14 percent and it has a tax rate of 30 percent. If the firm's WACC is 11 percent, what is the firm's before-tax cost of debt?

Accepted Answer

A)  13.41 percent
B)  6.10 percent
C)  5.50 percent
D)  (-3.00 percent)

Question 19

PAW Industries has 5 million shares of common stock outstanding with a market price of $8.00 per share. The company also has outstanding preferred stock with a market value of $10 million, and 100,000 bonds outstanding, each with face value $1,000 and selling at 96 percent of par value. The cost of equity is 19 percent, the cost of preferred stock is 15 percent, and the cost of debt is 9 percent. If PAW's tax rate is 34 percent, what is the WACC?

Accepted Answer

A)  10.14 percent
B)  10.38 percent
C)  12.51 percent
D)  14.33 percent

Question 20

WC Inc. has a $10 million (face value), 10-year bond issue selling for 99 percent of par that pays an annual coupon of 9 percent. What would be WC's before-tax component cost of debt?

Accepted Answer

A)  9.00 percent
B)  9.10 percent
C)  9.16 percent
D)  18.32 percent

Exam 11: Calculating the Cost of Capital