Question 1

Bartlett Company's target capital structure is 40% debt, 15% preferred, and 45% common equity.The after-tax cost of debt is 6.00%, the cost of preferred is 7.50%, and the cost of common using reinvested earnings is 12.75%.The firm will not be issuing any new stock.You were hired as a consultant to help determine their cost of capital.What is its WACC?

Accepted Answer

A)   8.98%
B)   9.26%
C)   9.54%
D)   9.83%
E)   10.12%F) B) and C)
G) D) and E)

Question 2

The cost of perpetual preferred stock is found as the preferred's annual dividend divided by the market price of the preferred stock.No adjustment is needed for taxes because preferred dividends, unlike interest on debt, is not deductible by the issuing firm.

Accepted Answer

A) True 
 B)False

Question 3

Which of the following is NOT a capital component when calculating the weighted average cost of capital (WACC)  for use in capital budgeting?

Accepted Answer

A)   Accounts payable.
B)   Common stock "raised" by reinvesting earnings.
C)   Common stock raised by new issues.
D)   Preferred stock.
E)   Long-term debt.F) A) and E)
G) B) and D)

Question 4

With its current financial policies, Flagstaff Inc.will have to issue new common stock to fund its capital budget.Since new stock has a higher cost than reinvested earnings, Flagstaff would like to avoid issuing new stock.Which of the following actions would REDUCE its need to issue new common stock?

Accepted Answer

A)   Increase the percentage of debt in the target capital structure.
B)   Increase the proposed capital budget.
C)   Reduce the amount of short-term bank debt in order to increase the current ratio.
D)   Reduce the percentage of debt in the target capital structure.
E)   Increase the dividend payout ratio for the upcoming year.F) C) and D)
G) A) and D)

Question 5

Which of the following statements is CORRECT?

Accepted Answer

A)   The percentage flotation cost associated with issuing new common equity is typically smaller than the flotation cost for new debt.
B)   The WACC as used in capital budgeting is an estimate of the cost of all the capital a company has raised to acquire its assets.
C)   There is an "opportunity cost" associated with using reinvested earnings, hence they are not "free."
D)   The WACC as used in capital budgeting would be simply the after-tax cost of debt if the firm plans to use only debt to finance its capital budget during the coming year.
E)   The WACC as used in capital budgeting is an estimate of a company's before-tax cost of capital.F) A) and B)
G) A) and C)

Question 6

To estimate the company's WACC, Marshall Inc.recently hired you as a consultant.You have obtained the following information.(1)  The firm's noncallable bonds mature in 20 years, have an 8.00% annual coupon, a par value of $1,000, and a market price of $1,050.00.(2)  The company's tax rate is 25%.(3)  The risk-free rate is 4.50%, the market risk premium is 5.50%, and the stock's beta is 1.20.(4)  The target capital structure consists of 35% debt and the balance is common equity.The firm uses the CAPM to estimate the cost of common stock, and it does not expect to issue any new shares.What is its WACC?

Accepted Answer

A)   7.48%
B)   7.88%
C)   8.29%
D)   8.73%
E)   9.19%F) B) and C)
G) B) and D)

Question 7

Suppose you are the president of a small, publicly-traded corporation.Since you believe that your firm's stock price is temporarily depressed, all additional capital funds required during the current year will be raised using debt.In this case, the appropriate marginal cost of capital for use in capital budgeting during the current year is the after-tax cost of debt.

Accepted Answer

A) True 
 B)False

Question 8

Which of the following statements is CORRECT?

Accepted Answer

A)   WACC calculations should be based on the before-tax costs of all the individual capital components.
B)   Flotation costs associated with issuing new common stock normally reduce the WACC.
C)   If a company's tax rate increases, then, all else equal, its weighted average cost of capital will decline.
D)   An increase in the risk-free rate will normally lower the marginal costs of both debt and equity financing.
E)   A change in a company's target capital structure cannot affect its WACC.F) B) and D)
G) None of the above

Question 9

Your consultant firm has been hired by Eco Brothers Inc.to help them estimate the cost of common equity.The yield on the firm's bonds is 8.75%, and your firm's economists believe that the cost of common can be estimated using a risk premium of 3.85% over a firm's own cost of debt.What is an estimate of the firm's cost of common from reinvested earnings?

Accepted Answer

A)   12.60%
B)   13.10%
C)   13.63%
D)   14.17%
E)   14.74%F) B) and D)
G) A) and E)

Question 10

Which of the following statements is CORRECT?

Accepted Answer

A)   The dividend growth model is generally preferred by academics and financial executives over other models for estimating the cost of equity.This is because of the dividend growth model's logical appeal and also because accurate estimates for its key inputs, the dividend yield and the growth rate, are easy to obtain.
B)   The bond-yield-plus-risk-premium approach to estimating the cost of equity may not always be accurate, but it has the advantage that its two key inputs, the firm's own cost of debt and its risk premium, can be found by using standardized and objective procedures.
C)   Surveys indicate that the CAPM is the most widely used method for estimating the cost of equity.However, other methods are also used because CAPM estimates may be subject to error, and people like to use different methods as checks on one another.If all of the methods produce similar results, this increases the decision maker's confidence in the estimated cost of equity.
D)   The dividend growth model model is preferred by academics and finance practitioners over other cost of capital models because it correctly recognizes that the expected return on a stock consists of a dividend yield plus an expected capital gains yield.
E)   Although some methods used to estimate the cost of equity are subject to severe limitations, the CAPM is a simple, straightforward, and reliable model that consistently produces accurate cost of equity estimates.In particular, academics and corporate finance people generally agree that its key inputs⎯beta, the risk-free rate, and the market risk premium⎯can be estimated with little error.F) A) and B)
G) A) and C)

Question 11

Suppose Acme Industries correctly estimates its WACC at a given point in time and then uses that same cost of capital to evaluate all projects for the next 10 years, then the firm will most likely

Accepted Answer

A)   become less risky over time, and this will maximize its intrinsic value.
B)   accept too many low-risk projects and too few high-risk projects.
C)   become more risky and also have an increasing WACC.Its intrinsic value will not be maximized.
D)   continue as before, because there is no reason to expect its risk position or value to change over time as a result of its use of a single cost of capital.
E)   become riskier over time, but its intrinsic value will be maximized.F) B) and C)
G) A) and E)

Question 12

You have been hired as a consultant by Feludi Inc.'s CFO, who wants you to help her estimate the cost of capital.You have been provided with the following data: rRF = 4.10%; RPM = 5.25%; and b = 1.30.Based on the CAPM approach, what is the cost of common from reinvested earnings?

Accepted Answer

A)   9.67%
B)   9.97%
C)   10.28%
D)   10.60%
E)   10.93%F) C) and E)
G) A) and E) E

Question 13

Which of the following statements is CORRECT? Assume a company's target capital structure is 50% debt and 50% common equity.

Accepted Answer

A)   The WACC is calculated on a before-tax basis.
B)   The WACC exceeds the cost of equity.
C)   The cost of equity is always equal to or greater than the cost of debt.
D)   The cost of reinvested earnings typically exceeds the cost of new common stock.
E)   The interest rate used to calculate the WACC is the average after-tax cost of all the company's outstanding debt as shown on its balance sheet.F) C) and D)
G) A) and B)

Question 14

Which of the following statements is CORRECT?

Accepted Answer

A)   We should use historical measures of the component costs from prior financings that are still outstanding when estimating a company's WACC for capital budgeting purposes.
B)   The cost of new equity (re)  could possibly be lower than the cost of reinvested earnings (rs)  if the market risk premium, risk-free rate, and the company's beta all decline by a sufficiently large amount.
C)   A company must try to adjust its current actual market value weights toward its target weights.
D)   The component cost of preferred stock is expressed as rp(1 − T) , because preferred stock dividends are treated as fixed charges, similar to the treatment of interest on debt.
E)   In the WACC calculation, we must adjust the cost of preferred stock (the market yield)  to reflect the fact that 50% of the dividends received by corporate investors are excluded from their taxable income.F) C) and D)
G) A) and E) C

Question 15

As the assistant to the CFO of Johnstone Inc., you must estimate its cost of common equity.You have been provided with the following data: D0 = $0.80; P0 = $22.50; and gL = 8.00% (constant) .Based on the dividend growth model, what is the cost of common from reinvested earnings?

Accepted Answer

A)   10.69%
B)   11.25%
C)   11.84%
D)   12.43%
E)   13.05%F) D) and E)
G) A) and D)

Question 16

In general, firms should use their weighted average cost of capital (WACC) to evaluate capital budgeting projects because most projects are funded with general corporate funds, which come from a variety of sources.However, if the firm plans to use only debt or only equity to fund a particular project, it should use the after-tax cost of that specific type of capital to evaluate that project.

Accepted Answer

A) True 
 B)False

Question 17

Which of the following statements is CORRECT?

Accepted Answer

A)   When calculating the cost of preferred stock, companies must adjust for taxes, because dividends paid on preferred stock are deductible by the paying corporation.
B)   Because of tax effects, an increase in the risk-free rate will have a greater effect on the after-tax cost of debt than on the cost of common stock as measured by the CAPM.
C)   If a company's beta increases, this will increase the cost of equity used to calculate the WACC, but only if the company does not have enough reinvested earnings to take care of its equity financing and hence must issue new stock.
D)   Higher flotation costs reduce investors' expected returns, and that leads to a reduction in a company's WACC.
E)   When calculating the cost of debt, a company needs to adjust for taxes, because interest payments are deductible by the paying corporation.F) All of the above
G) B) and E)

Question 18

The president and CFO of Spellman Transportation are having a disagreement about whether to use market value or book value weights in calculating the WACC.Spellman's balance sheet shows a total of noncallable $45 million long-term debt with a coupon rate of 7.00% and a yield to maturity of 6.00%.This debt currently has a market value of $50 million.The company has 10 million shares of common stock, and the book value of the common equity (common stock plus retained earnings)  is $65 million.The current stock price is $22.50 per share; stockholders' required return, rs, is 14.00%; and the firm's tax rate is 25%.The CFO thinks the WACC should be based on market value weights, but the president thinks book weights are more appropriate.What is the difference between these two WACCs?

Accepted Answer

A)   1.42%
B)   1.57%
C)   1.75%
D)   1.94%
E)   2.16%F) B) and E)
G) B) and C)

Question 19

Bloom and Co.has no debt or preferred stock⎯it uses only equity capital, and has two equally-sized divisions.Division X's cost of capital is 10.0%, Division Y's cost is 14.0%, and the corporate (composite)  WACC is 12.0%.All of Division X's projects are equally risky, as are all of Division Y's projects.However, the projects of Division X are less risky than those of Division Y.Which of the following projects should the firm accept?

Accepted Answer

A)   A Division Y project with a 12% return.
B)   A Division X project with an 11% return.
C)   A Division X project with a 9% return.
D)   A Division Y project with an 11% return.
E)   A Division Y project with a 13% return.F) C) and E)
G) A) and B) B

Question 20

Collins Group
The Collins Group, a leading producer of custom automobile accessories, has hired you to estimate the firm's weighted average cost of capital.The balance sheet and some other information are provided below.
   Assets  Current assets $38,000,000 Net plant, property, and equipment 101,000,000 Total assets $139,000,000 Liabilities and Equity  Accounts payable $10,000,000 Accruals 9,000,000 Current liabilities $19,000,000 Long-term debt ( 40,000 bonds, $1,000 par value)  40,000,000 Total liabilities $59,000,000 Common stock (10,000,000 shares)  30,000,000 Retained earnings 50,000,000 Total shareholders’ equity $0,000,000 Total liabilities and shareholders’ equity $139,000,000\begin{array}{lr}	ext { Assets } \	ext { Current assets } & \$ 38,000,000 \	ext { Net plant, property, and equipment } & 101,000,000 \	ext { Total assets } & \$ 139,000,000\\	ext { Liabilities and Equity }\	ext { Accounts payable } & \$ 10,000,000 \	ext { Accruals } & 9,000,000 \	ext { Current liabilities } & \$ 19,000,000 \	ext { Long-term debt ( } 40,000 	ext { bonds, } \$ 1,000 	ext { par value)  } & 40,000,000 \	ext { Total liabilities } & \$ 59,000,000 \	ext { Common stock (10,000,000 shares)  } & 30,000,000 \	ext { Retained earnings } & 50,000,000 \	ext { Total shareholders&#x27; equity } & \$ 0,000,000 \	ext { Total liabilities and shareholders&#x27; equity } & \$ 139,000,000\end{array} Assets  Current assets  Net plant, property, and equipment  Total assets  Liabilities and Equity  Accounts payable  Accruals  Current liabilities  Long-term debt ( 40,000 bonds, $1,000 par value)   Total liabilities  Common stock (10,000,000 shares)   Retained earnings  Total shareholders’ equity  Total liabilities and shareholders’ equity ​$38,000,000101,000,000$139,000,000$10,000,0009,000,000$19,000,00040,000,000$59,000,00030,000,00050,000,000$0,000,000$139,000,000​ 
 The stock is currently selling for $15.25 per share, and its noncallable $1,000 par value, 20-year, 7.25% bonds with semiannual payments are selling for $875.00.The beta is 1.25, the yield on a 6-month Treasury bill is 3.50%, and the yield on a 20-year Treasury bond is 5.50%.The required return on the stock market is 11.50%, but the market has had an average annual return of 14.50% during the past 5 years.The firm's tax rate is 25%.
-Refer to the data for the Collins Group.What is the best estimate of the firm's WACC?

Accepted Answer

A)   11.08%
B)   11.42%
C)   11.77%
D)   12.13%
E)   12.49% F) A) and D)
G) B) and C)

Exam 9: The Cost of Capital

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The cost of perpetual preferred stock is found as the preferred's annual dividend divided by the market price of the preferred stock.No adjustment is needed for taxes because preferred dividends, unlike interest on debt, is not deductible by the issuing firm.

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Which of the following is NOT a capital component when calculating the weighted average cost of capital (WACC) for use in capital budgeting?

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Which of the following statements is CORRECT?

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Which of the following statements is CORRECT?

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Which of the following statements is CORRECT?

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Suppose Acme Industries correctly estimates its WACC at a given point in time and then uses that same cost of capital to evaluate all projects for the next 10 years, then the firm will most likely

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You have been hired as a consultant by Feludi Inc.'s CFO, who wants you to help her estimate the cost of capital.You have been provided with the following data: r_RF = 4.10%; RP_M = 5.25%; and b = 1.30.Based on the CAPM approach, what is the cost of common from reinvested earnings?

Correct Answer
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E

Which of the following statements is CORRECT? Assume a company's target capital structure is 50% debt and 50% common equity.

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Which of the following statements is CORRECT?

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C

As the assistant to the CFO of Johnstone Inc., you must estimate its cost of common equity.You have been provided with the following data: D₀ = $0.80; P₀ = $22.50; and g_L = 8.00% (constant) .Based on the dividend growth model, what is the cost of common from reinvested earnings?

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Which of the following statements is CORRECT?

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B

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Exam 9: The Cost of Capital

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The cost of perpetual preferred stock is found as the preferred's annual dividend divided by the market price of the preferred stock.No adjustment is needed for taxes because preferred dividends, unlike interest on debt, is not deductible by the issuing firm.

Correct AnswerverifiedShow Answer

Which of the following is NOT a capital component when calculating the weighted average cost of capital (WACC) for use in capital budgeting?

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Which of the following statements is CORRECT?

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Which of the following statements is CORRECT?

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Which of the following statements is CORRECT?

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Suppose Acme Industries correctly estimates its WACC at a given point in time and then uses that same cost of capital to evaluate all projects for the next 10 years, then the firm will most likely

Correct AnswerverifiedShow Answer

You have been hired as a consultant by Feludi Inc.'s CFO, who wants you to help her estimate the cost of capital.You have been provided with the following data: rRF = 4.10%; RPM = 5.25%; and b = 1.30.Based on the CAPM approach, what is the cost of common from reinvested earnings?

Correct AnswerverifiedE

Which of the following statements is CORRECT? Assume a company's target capital structure is 50% debt and 50% common equity.

Correct AnswerverifiedShow Answer

Which of the following statements is CORRECT?

Correct AnswerverifiedC

As the assistant to the CFO of Johnstone Inc., you must estimate its cost of common equity.You have been provided with the following data: D0 = $0.80; P0 = $22.50; and gL = 8.00% (constant) .Based on the dividend growth model, what is the cost of common from reinvested earnings?

Correct AnswerverifiedShow Answer

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Which of the following statements is CORRECT?

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Correct AnswerverifiedB

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You have been hired as a consultant by Feludi Inc.'s CFO, who wants you to help her estimate the cost of capital.You have been provided with the following data: r_RF = 4.10%; RP_M = 5.25%; and b = 1.30.Based on the CAPM approach, what is the cost of common from reinvested earnings?

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E

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C

As the assistant to the CFO of Johnstone Inc., you must estimate its cost of common equity.You have been provided with the following data: D₀ = $0.80; P₀ = $22.50; and g_L = 8.00% (constant) .Based on the dividend growth model, what is the cost of common from reinvested earnings?

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B

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