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Exam 12: Cost of Capital

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Question 21

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Swizer Industries has two separate divisions.Division X has less risk so its projects are assigned a discount rate equal to the firm's WACC minus 0.5 percent.Division Y has more risk and its projects are assigned a rate equal to the firm's WACC plus 1 percent.The company has a debt-equity ratio of 0.45 and a tax rate of 35 percent.The cost of equity is 14.7 percent and the aftertax cost of debt is 5.1 percent.Presently,each division is considering a new project.Division Y's project provides a 12.3 percent rate of return and Division X's project provides an 11.64 percent return.Which projects,if any,should the company accept?

A) Accept both X and Y
B) Accept X and reject Y
C) Reject X and accept Y
D) Reject both X and Y
E) The answer cannot be determined based on the information provided.

F) B) and C)
G) A) and B)

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Question 22

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Judy's Boutique just paid an annual dividend of $1.65 on its common stock.The firm increases its dividend by 2.5 percent annually.What is the rate of return on this stock if the current stock price is $38.20 a share?

A) 6.93 percent
B) 7.37 percent
C) 7.54 percent
D) 8.19 percent
E) 8.33 percent

F) D) and E)
G) A) and D)

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Question 23

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The 7.5 percent preferred stock of Rock Bottom Floors is selling for $60 a share.What is the firm's cost of preferred stock if the tax rate is 35 percent and the par value per share is $100?

USA Manufacturing issued 30-year,8.5 percent semiannual bonds 6 years ago.The bonds currently sell at 101 percent of face value.What is the firm's aftertax cost of debt if the tax rate is 30 percent?

Kim's Bridal Shoppe has 15,000 shares of common stock outstanding at a price of $11 a share.It also has 2,000 shares of preferred stock outstanding at a price of $34 a share.There are 50 bonds outstanding that have a 7.5 percent semiannual coupon.The bonds mature in six years,have a face value of $1,000,and sell at 96 percent of par.What is the capital structure weight of the common stock?

You are given the following information concerning Around Town Tours: Debt: 8,500,7.1 percent coupon bonds outstanding,with 14 years to maturity and a quoted price of 102.6.These bonds pay interest semiannually. Common stock: 265,000 shares of common stock selling for $76 per share.The stock has a beta of 0.92 and will pay a dividend of $2.48 next year.The dividend is expected to grow by 4 percent per year indefinitely. Preferred stock: 7,500 shares of 6 percent preferred stock selling at $88 per share. Market: A 13.2 percent expected return,a 4.5 percent risk-free rate,and a 34 percent tax rate. Calculate the WACC for this firm.

Cromwell's Interiors is considering a project that is equally as risky as the firm's current operations.The firm has a cost of equity of 13.7 percent and a pretax cost of debt of 8.4 percent.The debt-equity ratio is .65 and the tax rate is 40 percent.What is the cost of capital for this project?

Santa Claus Enterprises has 174,000 shares of common stock outstanding at a current price of $46 a share.The firm also has two bond issues outstanding.The first bond issue has a total face value of $250,000,pays 7.7 percent interest annually,and currently sells for 102.5 percent of face value.The second bond issue consists of 5,000 bonds that are selling for $993 each.These bonds pay 6.5 percent interest annually and mature in eight years.The tax rate is 34 percent.What is the capital structure weight of the firm's debt?

Explain the concept of the subjective approach to assigning a required return to a project.

Gulf Coast Tours currently has a weighted average cost of capital of 11.3 percent based on a combination of debt and equity financing.The firm has no preferred stock.The current debt-equity ratio is 0.58 and the aftertax cost of debt is 6.4 percent.The company just hired a new president who is considering eliminating all debt financing.All else constant,what will the firm's cost of capital be if the firm switches to an all-equity firm?

Katie owns 100 shares of ABC stock.Which one of the following terms is used to refer to the return that Katie and the other shareholders require on their investment in ABC?

Ted is trying to decide what cost of capital he should assign to a project.Which one of the following should be his primary consideration in this decision?

Healthy Snacks,Inc.has a target capital structure of 55 percent common stock,5 percent preferred stock,and 40 percent debt.Its cost of equity is 14.3 percent,the cost of preferred stock is 8.9 percent,and the pretax cost of debt is 8.1 percent.What is the company's WACC if the applicable tax rate is 35 percent?

Western Electric has 23,000 shares of common stock outstanding at a price per share of $57 and a rate of return of 14.2 percent.The firm has 6,000 shares of 7 percent preferred stock outstanding at a price of $48 a share.The preferred stock has a par value of $100.The outstanding debt has a total face value of $350,000 and currently sells for 102 percent of face.The yield to maturity on the debt is 8.49 percent.What is the firm's weighted average cost of capital if the tax rate is 34 percent?

Lawler's is considering a new project.The company has a debt-equity ratio of 0.72.The company's cost of equity is 15.1 percent,and the aftertax cost of debt is 7.2 percent.The firm feels that the project is riskier than the company as a whole and that it should use an adjustment factor of +3 percent.What is the WACC it should use for the project?

The preferred stock of Dolphin Pools pays an annual dividend of $6.25 a share and sells for $42 a share.The tax rate is 35 percent.What is the firm's cost of preferred stock?

Farm Equipment,Inc.announced this morning that its next annual dividend will be decreased to $1.80 a share and that all future dividends will be decreased by an additional 1.5 percent annually.What is the current value per share of this stock if the required return is 16.5 percent?

Farmer's Supply,Inc.is considering opening a clothing store,which would be a new line of business for the firm.Management has decided to use the cost of capital of a similar clothing store as the discount rate that should be used to evaluate this proposed expansion.Which one of the following terms is used to describe the approach Farmer's Supply is taking to establish an appropriate discount rate for the project?

The aftertax cost of which of the following is affected by a change in a firm's tax rate? I.Preferred stock II.Debt III.Equity IV.Capital

A firm wants to create a WACC of 10.4 percent.The firm's cost of equity is 14.5 percent and its pretax cost of debt is 8.5 percent.The tax rate is 34 percent.What does the debt-equity ratio need to be for the firm to achieve its target WACC?