Question 1

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 2

XYZ Industries has 10 million shares of stock outstanding selling at $10 per share and an issue of $30 million in 8.5 percent,annual coupon bonds with a maturity of 25 years,selling at 102 percent of par ($1,000).If XYZ's weighted average tax rate is 40 percent and its cost of equity is 15 percent,what is XYZ's WACC?

Accepted Answer

A)  8.06 percent 
B)  11.75 percent 
C)  12.65 percent 
D)  13.43 percent

Question 3

Suppose that Beach Blanket's common shares sell for $55 per share,are expected to set their next annual dividend at $3.00 per share,and that all future dividends are expected to grow by 8 percent per year,indefinitely.If Beach faces a flotation cost of 10 percent on new equity issues,what will be the flotation-adjusted cost of equity?

Accepted Answer

A)  5.45 percent 
B)  8.06 percent 
C)  13.45 percent 
D)  14.06 percent

Question 4

Amino Industries common shares sell for $100 per share.Amino expects to set their next annual dividend at $4.00 per share.If Amino expects future dividends to grow at 5 percent per year,indefinitely,the current risk-free rate is 2 percent,the expected rate on the market is 7 percent,and the stock has a beta of 1.5,what should be the best estimate of the firm's cost of equity?

Accepted Answer

A)  18.50 percent 
B)  13.25 percent 
C)  9.25 percent 
D)  7.27 percent

Question 5

Suppose that TNT,Inc.has a capital structure of 43 percent equity,23 percent preferred stock,and 34 percent debt.If the before-tax component costs of equity,preferred stock and debt are 15.4 percent,10 percent and 7 percent,respectively,what is TNT's WACC if the firm faces an average tax rate of 28 percent?

Accepted Answer

A)  9.45 percent 
B)  10.64 percent 
C)  10.80 percent 
D)  11.30 percent

Question 6

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

Question 7

Apple's 9 percent annual coupon bond has 10 years until maturity and the bonds are selling in the market for $1,190.If the firm's after-tax cost of debt is 5 percent,what was the firm's tax rate?

Accepted Answer

A)  21.51 percent 
B)  34.50 percent 
C)  44.50 percent 
D)  36.50 percent

Question 8

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 9

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 semi-annually.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 10

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 semi-annually.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 11

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 12

Suppose that T-shirts,Inc.'s capital structure features 25 percent equity,75 percent debt,and that its before-tax cost of debt is 8 percent,while its cost of equity is 12 percent.If the appropriate weighted average tax rate is 30 percent,what will be T-shirts' WACC?

Accepted Answer

A)  9.00 percent 
B)  7.20 percent 
C)  5.10 percent 
D)  4.75 percent

Question 13

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 14

Which of these makes this a true statement? The WACC formula:

Accepted Answer

A)  is not impacted by taxes. 
B)  uses the after-tax costs of capital to compute the firm's weighted average cost of debt financing. 
C)  uses the pre-tax costs of capital to compute the firm's weighted average cost of debt financing. 
D)  focuses on operating costs only to keep them separate from financing costs.

Question 15

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 16

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 17

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 18

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 19

Which of the following statements is correct?

Accepted Answer

A)  The WACC measures the before-tax cost of capital. 
B)  An increase in the firm's marginal corporate tax rate will decrease the weighted average cost of capital. 
C)  Flotation costs can decrease the weighted average cost of capital. 
D)  None of the options are correct.

Question 20

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

Exam 11: Calculating the Cost of Capital