Question 1

Suppose that PAW, Inc. has a capital structure of 60 percent equity, 10 percent preferred stock, and 30 percent debt. If the before-tax component costs of equity, preferred stock and debt are 17.5 percent, 12 percent and 6.5 percent, respectively, what is PAW's WACC if the firm faces an average tax rate of 28 percent?

Accepted Answer

A) 10.71 percent 
B) 12.00 percent 
C) 13.10 percent 
D) 13.65 percent

Question 2

OMG Inc. has 4 million shares of common stock outstanding, 3 million shares of preferred stock outstanding, and 5 thousand bonds. If the common shares sell for $17 per share, the preferred shares sell for $126 per share, and the bonds sell for 117 percent of par ($1,000), what weight should you use for preferred stock in the computation of OMG's WACC?

Accepted Answer

A) 28.91 percent 
B) 31.58 percent 
C) 47.91 percent 
D) 83.66 percent

Question 3

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

Question 4

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 5

When calculating the weighted average cost of capital, weights are based on:

Accepted Answer

A) book values. 
B) book weights. 
C) market values. 
D) market betas.

Question 6

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 7

TJ Industries has 7 million shares of common stock outstanding with a market price of $20.00 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 95 percent of par value. The cost of equity is 12 percent, the cost of preferred is 10 percent, and the cost of debt is 6.45 percent. If TJ's tax rate is 34 percent, what is the WACC?

Accepted Answer

A) 8.92 percent 
B) 9.76 percent 
C) 12.59 percent 
D) 13.43 percent

Question 8

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 statements are equally correct.

Question 9

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 a $1,000 face value and selling at 96 percent of par value. The cost of equity is 19 percent, the cost of preferred 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 10

A firm uses only debt and equity in its capital structure. The firm's weight of debt is 40 percent. The firm could issue new bonds at a yield to maturity of 9 percent and the firm has a tax rate of 30 percent. If the firm's WACC is 11 percent, what is the firm's cost of equity?

Accepted Answer

A) 15.92 percent 
B) 14.13 percent 
C) 15.03 percent 
D) 15.68 percent

Question 11

Bill's Boards has 20 million shares of common stock outstanding, 4 million shares of preferred stock outstanding, and 20 thousand bonds. If the common shares are selling for $30 per share, the preferred shares are selling for $17 per share, and the bonds are selling for 96 percent of par, what would be the weight used for debt in the computation of Bill's WACC?

Accepted Answer

A) 0.83 percent 
B) 2.79 percent 
C) 2.87 percent 
D) 3.33 percent

Question 12

An all-equity firm is considering the projects shown as follows. The T-bill rate is 3 percent and the market risk premium is 6 percent. If the firm uses its current WACC of 12 percent to evaluate these projects, which project(s), if any, will be incorrectly rejected? $$\begin{array} { | l | l | l | } 
\hline \text { Project } & \text { Expected Return } & \text { Beta } \
\hline \mathrm { A } & 9.0 \% & 0.8 \
\hline \mathrm { B } & 20.0 \% & 1.2 \
\hline \mathrm { C } & 13.0 \% & 1.4 \
\hline \mathrm { D } & 17.0 \% & 1.5 \
\hline
\end{array}$$

Accepted Answer

A) Only Project A would be incorrectly rejected. 
B) Both Projects A and C would be incorrectly rejected. 
C) Projects A, B, and C would be incorrectly rejected. 
D) None of the projects would be incorrectly rejected.

Question 13

TellAll has 10 million shares of common stock outstanding, 20 million shares of preferred stock outstanding, and 100 thousand bonds. If the common shares are selling for $32 per share, the preferred shares are selling for $20 per share, and the bonds are selling for 106 percent of par, what would be the weight used for preferred stock in the computation of TellAll's WACC?

Accepted Answer

A) 33.33 percent 
B) 48.43 percent 
C) 55.55 percent 
D) 66.45 percent

Question 14

Sports Corp. has 10 million shares of common stock outstanding, 5 million shares of preferred stock outstanding, and 1 million bonds. If the common shares are selling for $25 per share, the preferred shares are selling for $12.50 per share, and the bonds are selling for 97 percent of par, what would be the weight used for equity in the computation of Sports' WACC?

Accepted Answer

A) 18.59 percent 
B) 19.49 percent 
C) 62.50 percent 
D) 79.75 percent

Question 15

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 16

Suppose that Tan Lines' common shares sell for $20 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 5 percent per year, indefinitely. If Tan Lines faces a flotation cost of 10 percent on new equity issues, what will be the flotation-adjusted cost of equity?

Accepted Answer

A) 5.06 percent 
B) 5.50 percent 
C) 10.00 percent 
D) 10.56 percent

Question 17

Diddy Corp. stock has a beta of 1.0, the current risk-free rate is 5 percent, and the expected return on the market is 15.5 percent. What is Diddy's cost of equity?

Accepted Answer

A) 15.50 percent 
B) 14.20 percent 
C) 18.50 percent 
D) 16.30 percent

Question 18

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 19

Carrie D's has 6 million shares of common stock outstanding, 2 million shares of preferred stock outstanding, and 10 thousand bonds. If the common shares are selling for $15 per share, the preferred shares are selling for $28 per share, and the bonds are selling for 109 percent of par, what would be the weight used for equity in the computation of Carrie D's WACC?

Accepted Answer

A) 33.33 percent 
B) 57.36 percent 
C) 61.64 percent 
D) 75.00 percent

Question 20

OMG Inc. has 4 million shares of common stock outstanding, 3 million shares of preferred stock outstanding, and 50 thousand bonds. If the common shares are selling for $21 per share, the preferred shares are selling for $10 per share, and the bonds are selling for 111 percent of par ($1,000), what weight should you use for debt in the computation of OMG's WACC?

Accepted Answer

A) 32.74 percent 
B) 29.86 percent 
C) 25.79 percent 
D) 21.86 percent

Exam 11: Calculating the Cost of Capital