Question 1

When we compute the cost of equity capital for a project we assume that the ________ of the project is equivalent to the average risk of the firm's investments.

Accepted Answer

A) diversifiable risk 
B) market risk 
C) non-systematic risk 
D) volatility 
E) standard deviation

Question 2

Epiphany is an all-equity firm with an estimated market value of $400,000.The firm sells $300,000 of debt and uses the proceeds to purchase outstanding equity.Compute the weight in equity and the weight in debt after the proposed financing and repurchase of equity.

Accepted Answer

A) 0.2,0.8 
B) 0.25,0.75 
C) 0.4,0.6 
D) 0.5,0.5 
E) 0.1,0.3

Question 3

A firm has $3 million market value and it sells preferred stock with a par value of $100.If the coupon rate on the preferred stock is 9% and the preferred stock trades at $95,what is the cost of preferred stock financing?

Accepted Answer

A) 8.75% 
B) 9.47% 
C) 10.21% 
D) 10.41% 
E) 10.44%

Question 4

The costs of external financing must be deducted from the net present value (NPV)of a project to evaluate if it is worth undertaking.

Accepted Answer

A) True 
 B)False

Question 5

What types of adjustment to debt are prevalent in practice?

Accepted Answer

The answer of What types of adjustment to debt are...

Question 6

Different divisions with differing lines of business use different costs of capital because their cost of equity is different and also because the ________ could be different.

Accepted Answer

A) optimal volatility 
B) optimal current ratio 
C) optimal asset mix 
D) optimal debt-equity ratio 
E) cost of debt

Question 7

The ________ of a firm's debt can be used as the firm's current cost of debt.

Accepted Answer

A) current yield 
B) coupon rate 
C) yield to maturity 
D) discount yield 
E) amount

Question 8

Billy Burger Corp has a market value of debt of $245 million,and a market value of equity of $815 million.What weights should Billy Burger use for debt and equity in calculating its WACC?

Accepted Answer

A) 0.30,0.70 
B) 0.23,0.77 
C) 0.70,0.30 
D) 0.5,0.5 
E) 0.6,0.4

Question 9

A firm has $50 million of common stock,$10 million of preferred stock,and $15 million of debt.The cost of equity is 9%,the cost of preferred stock is 7%,and the pretax cost of debt is 4%.If the firm's tax rate is 25%,what is the firm's WACC?

Accepted Answer

A) 6.67% 
B) 6.33% 
C) 7.73% 
D) 5.16% 
E) 7.53%

Question 10

Your estimate of the market risk premium is 6%.The risk-free rate of return is 4.5% and General Motors has a beta of 1.6.What is General Motors' cost of equity capital?

Accepted Answer

A) 14.1% 
B) 13.5% 
C) 13.9% 
D) 14.4% 
E) 14.8%

Question 11

Assume JUP has debt with a book value of $20 million,trading at 120% of par value.The firm has book equity of $20 million,and 2 million shares trading at $18 per share.What weights should JUP use in calculating its WACC?

Accepted Answer

A) 40% for debt,60% for equity 
B) 50% for debt,50% for equity 
C) 36% for debt,64%% for equity 
D) 45% for debt,55% for equity 
E) 30% for debt,70% for equity

Question 12

Lululemon Athletica is considering introducing a new line of yoga wear that is expected to increase the company's sales by $10 million in the first year,and growing by 3% every year thereafter.If the cost of introducing the new product line is $40 million today,and Lululemon's WACC is 9.4%,what is the NPV of the project?

Accepted Answer

A) $196.25 million 
B) $66.38 million 
C) $116.25 million 
D) $468.75 million 
E) $319.15 million

Question 13

The after-tax cost of debt ________ the before-tax cost of debt for a firm that has a positive marginal tax rate.

Accepted Answer

A) is always greater than 
B) is always equal to 
C) is always less than 
D) may be greater than or less than 
E) is never less than

Question 14

Power Financial Corp has a current share price of $34,and a market capitalization of $24 billion.The company is expected to pay a dividend of $0.37 per share,with a dividend growth rate of 4% per year.The firm has $18 billion of debt with a yield to maturity of 6%.If the firm's tax rate is 30%,what is Power Financial's WACC?

Accepted Answer

A) 5.00% 
B) 4.65% 
C) 4.71% 
D) 5.49% 
E) 5.55%

Question 15

A firm's sources of financing,which usually consists of debt and equity,represent its:

Accepted Answer

A) total assets. 
B) capital. 
C) total liabilities. 
D) current liabilities. 
E) current assets.

Question 16

SAP Inc.received a $1 million grant under its Small Business Innovation program.SAP invested the grant money and developed a system to remove metal contaminants from storm water in shipyards.The firm estimates that each shipyard spends $500,000 a year on storm water clean-up efforts.If SAP is able to sign up and retain four shipyards from the first year onwards,what is the present value (PV)of the project (net of investment)if the cost of capital for SAP is 18% per year? Assume a cost of operations and other costs for SAP equal 50% of revenue.

Accepted Answer

A) $4.56 million 
B) $4.98 million 
C) $5.32 million 
D) $5.87 million 
E) $6.12 million

Question 17

A firm has $2 million market value and it sells preferred stock with a par value of $100.If the coupon rate on the preferred stock is 8% and the preferred stock trades at $90,what is the cost of preferred stock financing?

Accepted Answer

A) 8.75% 
B) 8.89% 
C) 9.21% 
D) 9.35% 
E) 10.16%

Question 18

New Flyer Industries has decided to expand its production of hybrid transit buses.The firm expects incremental cash flows of $20 million in the first year,growing by 2% every year thereafter.The upfront cost of the expansion is $95 million,and there are additional issuance costs for external financing of $12 million.If the New Flyer's WACC is 6.2%,what is the NPV of the project?

Accepted Answer

A) $228 million 
B) $357 million 
C) $381 million 
D) $216 million 
E) $369 million

Question 19

Epiphany is an all-equity firm with an estimated market value of $500,000.The firm sells $200,000 of debt and uses the proceeds to purchase outstanding equity.Compute the weight in equity and the weight in debt after the proposed financing and repurchase of equity.

Accepted Answer

A) 0.2,0.8 
B) 0.25,0.75 
C) 0.4,0.6 
D) 0.6,0.4 
E) 0.5,0.5

Question 20

What is the difference between the effective cost of debt and the cost of debt?

Accepted Answer

The answer of What is the difference between the effective...

Exam 12: Determining the Cost of Capital