Question 1

Madison Square Stores has a $20 million bond issue outstanding that currently has a market value of $19.4 million.The bonds mature in 6.5 years and pay semiannual interest payments of $35 each.What is the firm's pretax cost of debt?

Accepted Answer

A)  8.21 percent
B)  7.59 percent
C)  7.08 percent
D)  7.74 percent
E)  7.80 percent B

Question 2

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 A

Question 3

The Color Box uses a combination of common stock,preferred stock,and debt financing.The company wants preferred stock to represent 7 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 9.5 percent.The aftertax cost of debt is 4.8 percent,the cost of preferred is 8.9 percent,and the cost of common stock is 14.7 percent.What percentage of the firm's capital funding should be debt financing?

Accepted Answer

A)  48.42 percent
B)  52.03 percent
C)  54.15 percent
D)  44.78 percent
E)  39.21 percent A

Question 4

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 5

Assume a firm has a beta of 1.2.All else held constant,the cost of equity for this firm will increase if the:

Accepted Answer

A)  market risk premium decreases.
B)  risk-free rate decreases.
C)  market rate of return decreases.
D)  beta decreases.
E)  either the risk-free rate or the market rate of return decreases.

Question 6

Electronic Products has 22,500 bonds outstanding that are currently quoted at 101.6.The bonds mature in 8 years and pay an annual coupon payment of $90.What is the firm's aftertax cost of debt if the applicable tax rate is 34 percent?

Accepted Answer

A)  5.47 percent
B)  4.79 percent
C)  5.75 percent
D)  6.98 percent
E)  6.67 percent

Question 7

Bruceton's is a specialty retailer with multiple brick-and-mortar stores and a cost of capital of 16.4 percent.Specialty Imports is a wholesaler of specialty items and has a cost of capital of 12.6 percent.Both firms are considering opening a new store in downtown Chicago at a cost of $1.1 million.Because this type of store would be trendy,it would have a life of only 8 years and no salvage value.The expected annual net cash flow is $229,000,regardless of which firm opens the store.Which company(ies),if either,should open the Chicago store?

Accepted Answer

A)  Bruceton's only
B)  Specialty Imports only
C)  Neither company
D)  Both companies
E)  The answer cannot be determined based on the information provided.

Question 8

Judy's Boutique just paid an annual dividend of $1.48 on its common stock and increases its dividend by 2.2 percent annually.What is the rate of return on this stock if the current stock price is $29.60 a share?

Accepted Answer

A)  7.31 percent
B)  8.37 percent
C)  7.54 percent
D)  8.19 percent
E)  8.33 percent

Question 9

Big Tree Inn has an EBIT of $121,318,a decrease in net working capital of $1,204,interest expense of $5,200,net capital spending of $5,200,and a tax rate of 35 percent.The firm&#8217;s WACC is 12.6 percent and its growth rate is 2.7 percent.What is the adjusted value of the firm?

Accepted Answer

A)  $694,311.08
B)  $708,007.49
C)  $756,168.69
D)  $733,333.33
E)  $789,022.15

Question 10

Donut Delites has a beta of 1.06,a dividend growth rate of 1.2 percent,a stock price of $12a share,and an expected annual dividend of $.68 per share next year.The market rate of return is 11.4 percent and the risk-free rate is 3.8 percent.What is the firm's cost of equity?

Accepted Answer

A)  7.74 percent
B)  9.36 percent
C)  9.30 percent
D)  9.72 percent
E)  7.46 percent

Question 11

Traditional Bank has an issue of preferred stock with an annual dividend of $7.50 that just sold for $62 a share.What is the bank's cost of preferred stock?

Accepted Answer

A)  12.91 percent
B)  12.10 percent
C)  11.23 percent
D)  13.47 percent
E)  11.32 percent

Question 12

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 13

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 14

A firm has a cost of equity of 13 percent,a cost of preferred of 11 percent,an aftertax cost of debt of 5.2 percent,and a tax rate of 35 percent.Given this,which one of the following will increase the firm's weighted average cost of capital?

Accepted Answer

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 15

The 7.5 percent preferred stock of Rock Bottom Floors is selling for $84 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?

Accepted Answer

A)  7.50 percent
B)  8.13 percent
C)  8.93 percent
D)  10.79 percent
E)  9.14 percent

Question 16

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 17

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 numerous proposed investments?

Accepted Answer

A)  Assign every project a rate equal to the firm's cost of equity
B)  Assign every investment 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 18

Gulf Coast Tours currently has a weighted average cost of capital of 12.4 percent based on a combination of debt and equity financing.The firm has no preferred stock.The current debt-equity ratio is .47 and the aftertax cost of debt is 6.1 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?

Accepted Answer

A)  15.45 percent
B)  12.92 percent
C)  12.89 percent
D)  13.37 percent
E)  15.36 percent

Question 19

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

Accepted Answer

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 20

USA Manufacturing issued 30-year,7.5 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?

Accepted Answer

A)  4.82 percent
B)  5.62 percent
C)  3.76 percent
D)  3.59 percent
E)  4.40 percent

Exam 12: Cost of Capital