Question 1

Accessory Industries has 2 million shares of common stock outstanding, 1 million shares of preferred stock outstanding, and 100 thousand bonds. If the common shares are selling for $22 per share, the preferred shares are selling for $10.50 per share, and the bonds are selling for 96 percent of par ($1,000), what would be the weights used in the calculation of Accessory's WACC for common stock, preferred stock, and bonds, respectively?

Accepted Answer

A) 33.33 percent, 33.33 percent, 33.33 percent 
B) 29.23 percent, 6.98 percent, 63.79 percent 
C) 64.52 percent, 32.26 percent, 3.22 percent 
D) 17.12 percent, 8.17 percent, 74.71 percent

Question 2

Which of the following is most correct?

Accepted Answer

A) When comparing two firms within the same industry, most analysts calculate the weighted average cost of capital on a before-tax basis to facilitate comparisons. 
B) Firms should use historical costs rather than marginal costs of capital. 
C) An increase in the risk-free rate will increase the cost of equity. 
D) All of these choices are correct.

Question 3

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

Accepted Answer

A) the risk-free rate 
B) beta 
C) expected return on the market 
D) all of these choices are correct.

Question 4

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?

Accepted Answer

A) 16.09 percent 
B) 15.63 percent 
C) 15.21 percent 
D) 14.57 percent

Question 5

An all-equity firm is considering the projects shown as follows. 
The T-bill rate is 4 percent and the market risk premium is 8 percent. If the firm uses its current WACC of 13 percent to evaluate these projects, which project(s) will be incorrectly accepted?

Accepted Answer

A) Project A 
B) Project C 
C) Project D 
D) Projects C and D

Question 6

A firm has 1,000,000 shares of common stock outstanding, each with a market price of $10.00 per share. It has 15,000 bonds outstanding, each selling for $900 (with a face value of $1,000). The bonds mature in 15 years, have a coupon rate of 10 percent, and pay coupons semiannually. The firm's equity has a beta of 1.5, and the expected market return is 20 percent. The tax rate is 35 percent and the WACC is 16 percent. What is the risk-free rate?

Accepted Answer

A) 4.8 percent 
B) 11.4 percent 
C) 27.6 percent 
D) 30.0 percent

Question 7

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 semiannually. 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.

Accepted Answer

A) 27.68 percent 
B) 1.79 percent 
C) 2.32 percent 
D) 2.12 percent

Question 8

The reason that we do not use an after-tax cost of preferred stock is

Accepted Answer

A) because preferred dividends are paid out of before-tax income. 
B) because most of the investors in preferred stock do not pay tax on the dividends. 
C) because we can only estimate the marginal tax rate of the preferred stockholders. 
D) none of these choices are correct.

Question 9

Which of these is an estimated WACC computed using some sort of proxy for the average equity risk of the projects in a particular division?

Accepted Answer

A) average WACC 
B) divisional WACC 
C) proxy WACC 
D) pure-play WACC

Question 10

Which of the following is a true statement?

Accepted Answer

A) To estimate the before-tax cost of debt, we need to solve for the Yield to Maturity (YTM) on the firm's existing debt. 
B) To estimate the before-tax cost of debt, we need to solve for the Yield to Call (YT
C)  on the firm's existing debt. 
C) To estimate the before-tax cost of debt, we use the coupon rate on the firm's existing debt. 
D) To estimate the before-tax cost of debt, we use the average rate on the firm's existing debt.

Question 11

Paper Exchange has 80 million shares of common stock outstanding, 60 million shares of preferred stock outstanding, and 50 thousand bonds. If the common shares are selling for $20 per share, the preferred shares are selling for $10 per share, and the bonds are selling for 105 percent of par, what would be the weight used for preferred stock in the computation of Paper's WACC?

Accepted Answer

A) 26.64 percent 
B) 27.27 percent 
C) 33.33 percent 
D) 42.84 percent

Question 12

Which of the following is a principle of capital budgeting which states that the calculations of cash flows should remain independent of financing?

Accepted Answer

A) generally accepted accounting principle 
B) financing principle 
C) separation principle 
D) WACC principle

Question 13

Which of the following is a true statement regarding the appropriate tax rate to be used in the WACC?

Accepted Answer

A) One would use the marginal tax rate that the firm paid the prior year. 
B) One would use the average tax rate that the firm paid the prior year. 
C) One would use the weighted average of the marginal tax rates that would have been paid on the taxable income shielded by the interest deduction. 
D) One would use the marginal tax rates that would have been paid on the taxable income shielded by the interest deduction.

Question 14

Suppose that Glamour Nails, Inc.'s capital structure features 30 percent equity, 70 percent debt, and that its before-tax cost of debt is 4 percent, while its cost of equity is 10 percent. If the appropriate weighted average tax rate is 34 percent, what will be Glamour Nails' WACC?

Accepted Answer

A) 4.78 percent 
B) 4.85 percent 
C) 5.80 percent 
D) 7.00 percent

Question 15

KatyDid Clothes has a $150 million ($1,000 face value) 15-year bond issue selling for 106 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) 3.67 percent 
B) 7.34 percent 
C) 8.12 percent 
D) 7.09 percent

Question 16

JaiLai Cos. stock has a beta of 1.7, the current risk-free rate is 6.2 percent, and the expected return on the market is 11 percent. What is JaiLai's cost of equity?

Accepted Answer

A) 13.81 percent 
B) 15.19 percent 
C) 13.41 percent 
D) 14.36 percent

Question 17

Rose has preferred stock selling for 99 percent of par that pays a 9 percent annual coupon. What would be Rose's component cost of preferred stock?

Accepted Answer

A) 4.55 percent 
B) 8.91 percent 
C) 9.00 percent 
D) 9.09 percent

Question 18

Which statement makes this a false statement? When a firm pays commissions to underwriting firms that float the issuance of new stock

Accepted Answer

A) the component cost will need to be integrated to figure project WACCs. 
B) the component cost will need to be integrated only for the firm's WACC. 
C) the firm can increase the project's WACC to incorporate the flotation costs' impact. 
D) the firm can leave the WACC alone and adjust the project's initial investment upwards.

Question 19

What is the theoretical minimum for the weighted average cost of capital?

Accepted Answer

A) the after-tax cost of debt 
B) the cost of preferred stock 
C) CAPM 
D) the cost of equity

Question 20

TJ Co. stock has a beta of 1.45, the current risk-free rate is 5.75, and the expected return on the market is 14 percent. What is TJ Co's cost of equity?

Accepted Answer

A) 17.71 percent 
B) 21.20 percent 
C) 26.05 percent 
D) 28.64 percent

Exam 11: Calculating the Cost of Capital