Question 1

The cost of debt, rd, is normally less than rs, so rd(1 - T) will normally be much less than rs. Therefore, as long as the firm is not completely debt financed, the weighted average cost of capital (WACC) will normally be greater than rd(1 - T).

Accepted Answer

A) True 
 B)False

Question 2

Sapp Trucking'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 balance sheet also shows that 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 40%. 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)   1.55%
B)   1.72%
C)   1.91%
D)   2.13%
E)   2.36%F) D) and E)
G) B) and C)

Question 3

The component costs of capital are market-determined variables in the sense that they are based on investors' required returns.

Accepted Answer

A) True 
 B)False

Question 4

Bouchard and Company hired you as a consultant to help estimate its cost of common equity. You have obtained the following data: D0 = $0.85; P0 = $22.00; and g = 6.00% (constant) . The CEO thinks, however, that the stock price is temporarily depressed, and that it will soon rise to $40.00. Based on the DCF approach, by how much would the cost of common from retained earnings change if the stock price changes as the CEO expects?

Accepted Answer

A)   -1.49%
B)   -1.66%
C)   -1.84%
D)   -2.03%
E)   -2.23%F) B) and E)
G) All of the above

Question 5

Bolster Foods' (BF)  balance sheet shows a total of $25 million long-term debt with a coupon rate of 8.50%. The yield to maturity on this debt is 8.00%, and the debt has a total current market value of $27 million. The balance sheet also shows that the company has 10 million shares of stock, and the stock has a book value per share of $5.00. The current stock price is $20.00 per share, and stockholders' required rate of return, rs, is 12.25%. The company recently decided that its target capital structure should have 35% debt, with the balance being common equity. The tax rate is 40%. Calculate WACCs based on book, market, and target capital structures. What is the sum of these three WACCs?

Accepted Answer

A)   28.36%
B)   29.54%
C)   30.77%
D)   32.00%
E)   33.28%F) C) and D)
G) A) and B)

Question 6

The cost of preferred stock to a firm must be adjusted to an after-tax figure because 70% of dividends received by a corporation may be excluded from the receiving corporation's taxable income.

Accepted Answer

A) True 
 B)False

Question 7

Several years ago the Jakob Company sold a $1,000 par value, noncallable bond that now has 20 years to maturity and a 7.00% annual coupon that is paid semiannually. The bond currently sells for $925 and the company's tax rate is 40%. What is the component cost of debt for use in the WACC calculation?

Accepted Answer

A)   4.28%
B)   4.46%
C)   4.65%
D)   4.83%
E)   5.03%F) B) and C)
G) A) and D)

Question 8

If a firm is privately owned, and its stock is not traded in public markets, then we cannot measure its beta for use in the CAPM model, we cannot observe its stock price for use in the DCF model, and we don't know what the risk premium is for use in the bond-yield-plus-risk-premium method. All this makes it especially difficult to estimate the cost of equity for a private company.

Accepted Answer

A) True 
 B)False

Question 9

Which of the following statements is CORRECT?

Accepted Answer

A)   When calculating the cost of preferred stock, a company needs to adjust for taxes, because preferred stock dividends are deductible by the paying corporation.
B)   All else equal, an increase in a company's stock price will increase its marginal cost of retained earnings, rs.
C)   All else equal, an increase in a company's stock price will increase its marginal cost of new common equity, re.
D)   Since the money is readily available, the after-tax cost of retained earnings is usually much lower than the after-tax cost of debt.
E)   If a company's tax rate increases but the YTM on its noncallable bonds remains the same, the after-tax cost of its debt will fall.F) B) and D)
G) A) and B)

Question 10

Suppose the debt ratio (D/TA) is 50%, the interest rate on new debt is 8%, the current cost of equity is 16%, and the tax rate is 40%. An increase in the debt ratio to 60% would decrease the weighted average cost of capital (WACC).

Accepted Answer

A) True 
 B)False

Question 11

A company's perpetual preferred stock currently sells for $92.50 per share, and it pays an $8.00 annual dividend. If the company were to sell a new preferred issue, it would incur a flotation cost of 5.00% of the issue price. What is the firm's cost of preferred stock?

Accepted Answer

A)   7.81%
B)   8.22%
C)   8.65%
D)   9.10%
E)   9.56%F) B) and D)
G) D) and E)

Question 12

Which of the following statements is CORRECT?

Accepted Answer

A)   In the WACC calculation, we must adjust the cost of preferred stock (the market yield)  to reflect the fact that 70% of the dividends received by corporate investors are excluded from their taxable income.
B)   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.
C)   The cost of new equity (re)  could possibly be lower than the cost of retained earnings (rs)  if the market risk premium, risk-free rate, and the company's beta all decline by a sufficiently large amount.
D)   A firm's cost of retained earnings is the rate of return stockholders require on a firm's common stock.
E)   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.F) All of the above
G) A) and E)

Exam 9: The Cost of Capital

A company's perpetual preferred stock currently sells for $92.50 per share, and it pays an $8.00 annual dividend. If the company were to sell a new preferred issue, it would incur a flotation cost of 5.00% of the issue price. What is the firm's cost of preferred stock?

Correct Answer
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Correct Answer
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Correct Answer
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The cost of debt, rd, is normally less than rs, so rd(1 - T) will normally be much less than rs. Therefore, as long as the firm is not completely debt financed, the weighted average cost of capital (WACC) will normally be greater than rd(1 - T).

Correct Answer
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Correct Answer
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Correct Answer
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The component costs of capital are market-determined variables in the sense that they are based on investors' required returns.

Correct Answer
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Which of the following statements is CORRECT?

Correct Answer
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Suppose the debt ratio (D/TA) is 50%, the interest rate on new debt is 8%, the current cost of equity is 16%, and the tax rate is 40%. An increase in the debt ratio to 60% would decrease the weighted average cost of capital (WACC).

Correct Answer
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Correct Answer
verified

The cost of preferred stock to a firm must be adjusted to an after-tax figure because 70% of dividends received by a corporation may be excluded from the receiving corporation's taxable income.

Correct Answer
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Which of the following statements is CORRECT?

Correct Answer
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Exam 9: The Cost of Capital

A company's perpetual preferred stock currently sells for $92.50 per share, and it pays an $8.00 annual dividend. If the company were to sell a new preferred issue, it would incur a flotation cost of 5.00% of the issue price. What is the firm's cost of preferred stock?

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

The cost of debt, rd, is normally less than rs, so rd(1 - T) will normally be much less than rs. Therefore, as long as the firm is not completely debt financed, the weighted average cost of capital (WACC) will normally be greater than rd(1 - T).

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

The component costs of capital are market-determined variables in the sense that they are based on investors' required returns.

Correct AnswerverifiedShow Answer

Which of the following statements is CORRECT?

Correct AnswerverifiedShow Answer

Suppose the debt ratio (D/TA) is 50%, the interest rate on new debt is 8%, the current cost of equity is 16%, and the tax rate is 40%. An increase in the debt ratio to 60% would decrease the weighted average cost of capital (WACC).

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

The cost of preferred stock to a firm must be adjusted to an after-tax figure because 70% of dividends received by a corporation may be excluded from the receiving corporation's taxable income.

Correct AnswerverifiedShow Answer

Which of the following statements is CORRECT?

Correct AnswerverifiedShow Answer

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Correct Answer
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Correct Answer
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