Question 1

Which of the following statements is CORRECT?

Accepted Answer

A)   The cost of capital used to evaluate a project should be the cost of the specific type of financing used to fund that project,i.e. ,it is the after-tax cost of debt if debt is to be used to finance the project or the cost of equity if the project will be financed with equity.
B)   The after-tax cost of debt that should be used as the component cost when calculating the WACC is the average after-tax cost of all the firm's outstanding debt.
C)   Suppose some of a publicly-traded firm's stockholders are not diversified;they hold only the one firm's stock.In this case,the CAPM approach will result in an estimated cost of equity that is too low in the sense that if it is used in capital budgeting,projects will be accepted that will reduce the firm's intrinsic value.
D)   The cost of equity is generally harder to measure than the cost of debt because there is no stated,contractual cost number on which to base the cost of equity.
E)   The bond-yield-plus-risk-premium approach is the most sophisticated and objective method for estimating a firm's cost of equity capital.

Question 2

Weaver Chocolate Co.expects to earn $3.50 per share during the current year,its expected dividend payout ratio is 65%,its expected constant dividend growth rate is 6.0%,and its common stock currently sells for $30.00 per share.New stock can be sold to the public at the current price,but a flotation cost of 5% would be incurred.What would be the cost of equity from new common stock? Do not round your intermediate calculations.

Accepted Answer

A)   13.98%
B)   16.36%
C)   13.70%
D)   11.33%
E)   11.47%

Question 3

Assume that you are a consultant to Broske Inc. ,and you have been provided with the following data: D1 = $0.67;P0 = $45.00;and g = 8.00% (constant) .What is the cost of equity from retained earnings based on the DCF approach?

Accepted Answer

A)   7.59%
B)   9.49%
C)   11.10%
D)   10.15%
E)   8.63%

Question 4

LaPango Inc.estimates that its average-risk projects have a WACC of 10%,its below-average risk projects have a WACC of 8%,and its above-average risk projects have a WACC of 12%.Which of the following projects (A,B,and C) should the company accept?

Accepted Answer

A)   Project B,which is of below-average risk and has a return of 8.5%.
B)   Project C,which is of above-average risk and has a return of 11%.
C)   Project A,which is of average risk and has a return of 9%.
D)   None of the projects should be accepted.
E)   All of the projects should be accepted.

Question 5

If the expected dividend growth rate is zero,then the cost of external equity capital raised by issuing new common stock (re)is equal to the cost of equity capital from retaining earnings (rs)divided by one minus the percentage flotation cost required to sell the new stock, (1 - F).If the expected growth rate is not zero,then the cost of external equity must be found using a different formula.

Accepted Answer

A) True 
 B)False

Question 6

Schalheim Sisters Inc.has always paid out all of its earnings as dividends,hence the firm has no retained earnings.This same situation is expected to persist in the future.The company uses the CAPM to calculate its cost of equity,its target capital structure consists of common stock,preferred stock,and debt.Which of the following events would REDUCE its WACC?

Accepted Answer

A)   The market risk premium declines.
B)   The flotation costs associated with issuing new common stock increase.
C)   The company's beta increases.
D)   Expected inflation increases.
E)   The flotation costs associated with issuing preferred stock increase.

Question 7

The higher the firm's flotation cost for new common equity,the more likely the firm is to use preferred stock,which has no flotation cost,and retained earnings,whose cost is the average return on the assets that are acquired.

Accepted Answer

A) True 
 B)False

Question 8

The cost of common equity obtained by retaining earnings is the rate of return the marginal stockholder requires on the firm's common stock.

Accepted Answer

A) True 
 B)False

Question 9

The cost of debt is equal to one minus the marginal tax rate multiplied by the interest rate on new debt.

Accepted Answer

A) True 
 B)False

Question 10

If investors' aversion to risk rose,causing the slope of the SML to increase,this would have a greater impact on the required rate of return on equity,rs,than on the interest rate on long-term debt,rd,for most firms.Other things held constant,this would lead to an increase in the use of debt and a decrease in the use of equity.However,other things would not stay constant if firms used a lot more debt,as that would increase the riskiness of both debt and equity and thus limit the shift toward debt.

Accepted Answer

A) True 
 B)False

Question 11

Assume that you are on the financial staff of Vanderheiden Inc. ,and you have collected the following data: The yield on the company's outstanding bonds is 7.75%,its tax rate is 40%,the next expected dividend is $0.65 a share,the dividend is expected to grow at a constant rate of 6.00% a year,the price of the stock is $17.00 per share,the flotation cost for selling new shares is F = 10%,and the target capital structure is 45% debt and 55% common equity.What is the firm's WACC,assuming it must issue new stock to finance its capital budget?

Accepted Answer

A)   9.51%
B)   6.65%
C)   6.18%
D)   5.80%
E)   7.73%

Question 12

If a typical U.S.company 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 riskier over time,but its intrinsic value will be maximized.
B)   become less risky over time,and this will maximize its intrinsic value.
C)   accept too many low-risk projects and too few high-risk projects.
D)   become more risky and also have an increasing WACC.Its intrinsic value will not be maximized.
E)   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.

Question 13

To help finance a major expansion,Castro Chemical Company sold a noncallable bond several years ago that now has 20 years to maturity.This bond has a 9.25% annual coupon,paid semiannually,sells at a price of $1,025,and has a par value of $1,000.If the firm's tax rate is 40%,what is the component cost of debt for use in the WACC calculation? Do not round your intermediate calculations.

Accepted Answer

A)   5.93%
B)   5.93%.
C)   5.39%
D)   6.09%
E)   4.69%

Question 14

Firm M's earnings and stock price tend to move up and down with other firms in the S&P 500,while Firm W's earnings and stock price move counter cyclically with M and other S&P companies.Both M and W estimate their costs of equity using the CAPM,they have identical market values,their standard deviations of returns are identical,and they both finance only with common equity.Which of the following statements is CORRECT?

Accepted Answer

A)   M should have the lower WACC because it is like most other companies,and investors like that fact.
B)   M and W should have identical WACCs because their risks as measured by the standard deviation of returns are identical.
C)   If M and W merge,then the merged firm MW should have a WACC that is a simple average of M's and W's WACCs.
D)   Without additional information,it is impossible to predict what the merged firm's WACC would be if M and W merged.
E)   Since M and W move counter cyclically to one another,if they merged,the merged firm's WACC would be less than the simple average of the two firms' WACCs.

Exam 10: The Cost of Capital

Correct Answer
verified

Correct Answer
verified

Assume that you are a consultant to Broske Inc. ,and you have been provided with the following data: D₁ = $0.67;P₀ = $45.00;and g = 8.00% (constant) .What is the cost of equity from retained earnings based on the DCF approach?

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

The cost of debt is equal to one minus the marginal tax rate multiplied by the interest rate on new debt.

Correct Answer
verified

LaPango Inc.estimates that its average-risk projects have a WACC of 10%,its below-average risk projects have a WACC of 8%,and its above-average risk projects have a WACC of 12%.Which of the following projects (A,B,and C) should the company accept?

Correct Answer
verified

Which of the following statements is CORRECT?

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

The cost of common equity obtained by retaining earnings is the rate of return the marginal stockholder requires on the firm's common stock.

Correct Answer
verified

If a typical U.S.company 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 Answer
verified

The higher the firm's flotation cost for new common equity,the more likely the firm is to use preferred stock,which has no flotation cost,and retained earnings,whose cost is the average return on the assets that are acquired.

Correct Answer
verified

Correct Answer
verified

Exam 10: The Cost of Capital

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Assume that you are a consultant to Broske Inc. ,and you have been provided with the following data: D1 = $0.67;P0 = $45.00;and g = 8.00% (constant) .What is the cost of equity from retained earnings based on the DCF approach?

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

The cost of debt is equal to one minus the marginal tax rate multiplied by the interest rate on new debt.

Correct AnswerverifiedShow Answer

LaPango Inc.estimates that its average-risk projects have a WACC of 10%,its below-average risk projects have a WACC of 8%,and its above-average risk projects have a WACC of 12%.Which of the following projects (A,B,and C) should the company accept?

Correct AnswerverifiedShow Answer

Which of the following statements is CORRECT?

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

The cost of common equity obtained by retaining earnings is the rate of return the marginal stockholder requires on the firm's common stock.

Correct AnswerverifiedShow Answer

If a typical U.S.company 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

The higher the firm's flotation cost for new common equity,the more likely the firm is to use preferred stock,which has no flotation cost,and retained earnings,whose cost is the average return on the assets that are acquired.

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Correct Answer
verified

Correct Answer
verified

Assume that you are a consultant to Broske Inc. ,and you have been provided with the following data: D₁ = $0.67;P₀ = $45.00;and g = 8.00% (constant) .What is the cost of equity from retained earnings based on the DCF approach?

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified