Deck 13: The Cost of Capital

Question 1

TLS expects to pay a dividend of $4 next year and expects these dividends to grow at 7% a year? The price of TLS is $90 per share. What is TLS' cost of equity capital?

A) 10.89%
B) 11.44%
C) 10.23%
D) 9.65%

Answer 1

11.44%

Question 2

Outstanding debt of Flight Centre (FLT) trades with a yield to maturity of 6%. The tax rate of FLT is 40%. What is the effective cost of debt of FLT?

A) 5.3%
B) 3.6%
C) 5.7%
D) 4.5%

Answer 2

3.6%

Question 3

Green Motors expects a new hybrid-engine project to produce incremental cash flows of $45million each year, and expects these to grow at 5% each year. The upfront project costs are $380 million and Green's weighted average cost of capital is 8%. If the issuance costs for external finances are $10 million, what is the net present value (NPV) of the project?

A) $990 million
B) $1200 million
C) $1110 million
D) $1125 million

Answer 3

$1110 million

Question 4

The fact that the after-tax cost of debt is lower than the pretax cost of debt implicitly assumes thatinterest expense can be

A) refinanced.
B) margined.
C) expensed.
D) none of the above

Question 5

Brisbane Broncos Limited has raised all its capital via equity rather than debt. Such a firm is also referred to as a(n) firm.

A) margined
B) unlevered
C) risk less
D) levered

Question 6

Different divisions with differing lines of business use different costs of capital because their cost ofcould be different.

A) equity
B) assets
C) debt
D) capital

Question 7

A firm has $2 million market value and it sells preference shares for $100 per share. If the annualdividend on the preference share is $8 and it trades at $90, what is the cost of preference share capital?

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

Question 8

For an unlevered firm, the cost of capital for the firm can be determined by using th?

A) preferred stock yield.
B) yield on the traded debt.
C) Capital Asset Pricing Model.
D) dividend yield.

Question 9

The firm's overall cost of capital that is a blend of the costs of the different sources of capital is known as the firm's

A) cost of debt.
B) cost of preferred stock.
C) cost of equity infusion.
D) weighted average cost of capital.

Question 10

Outstanding debt of Flight Centre (FLT) trades with a yield to maturity of 8%. The tax rate of FLT is 35%. What is the effective cost of debt of FLT?

A) 5.2%
B) 6.2%
C) 5.8%
D) 6.5%

Question 11

A levered firm is one that ha?

A) preferred stock
B) equity
C) equity options
D) debt

Question 12

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

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

Question 13

The relative proportion of debt, equity, and other securities that a firm has outstanding constitute
its

A) asset ratio.
B) capital structure.
C) current ratio.
D) none of the above

Question 14

Sirtex Medical has $10 million of outstanding equity and $10 million of bank debt. The bank debt costs 7% per year. The estimated equity beta is 2. If the market risk premium is 6% and the risk-free rate is 5%, compute the weighted average cost of capital if the firm's tax rate is 30%.

A) 11.45%
B) 9.56%
C) 10.21%
D) 10.95%

Question 15

Green Motors expects a new hybrid-engine project to produce incremental cash flows of $60 million each year, and expects these to grow at 4% each year. The upfront project costs are $420 million and Green's weighted average cost of capital is 9%. If the issuance costs for external finances are $15 million, what is the net present value (NPV) of the project?

A) $710 million
B) $765 million
C) $805 million
D) $790 million

Question 16

A firm has outstanding debt with a coupon rate of 9%, nine years maturity, and a price of $1000 per $1000 face value. What is the after-tax cost of debt if the marginal tax rate of the firm is 30%?

A) 6.3%
B) 5.8%
C) 4.9%
D) 5.9%

Question 17

Green Motors expects a new hybrid-engine project to produce incremental cash flows of $100 million each year and expects these to grow at 4% each year. The upfront project costs are $900 million and Green's weighted average cost of capital is 9%. If the issuance costs for external finances are $10 million, what is the net present value (NPV) of the project?

A) $1090 million
B) $1800 million
C) $1290 million
D) $1100 million

Question 18

A firm has $3 million market value and it sells preference shares at $100 per share. If the annualdividend on the preference share is $9 and it trades at $95, what is the cost of preference share capital?

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

Question 19

Assume JBH has debt with a book value of $20 million, trading at 120% of par value. The bonds have a yield to maturity of 6%. The firm has book equity of $20 million, and 2 million shares trading at $18 per share. The firm's cost of equity is 12%. What is JBH's WACC if the firm's marginal tax rate is 30%?

A) 9.00%
B) 8.88%
C) 9.60%
D) 6.24%

Question 20

Epiphany is an all-equity firm with an estimated market value of $300,000. The firm sells $100,000 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.

A) 0.25, 0.75
B) 0.2, 0.8
C) 0.5, 0.5
D) 0.67, 0.33

Question 21

Verano Inc. has two business divisions - a software product line and a waste water clean-up product line. The software business has a cost of equity capital of 12% and the waste water clean-up business has a cost of equity capital of 8%. Verano has 50% of its revenue from software and the rest from the waste water business. Verano is considering a purchase of another company in the waste water business using equity financing. What is the appropriate cost of capital to evaluate the business?

A) 10%
B) 11%
C) 12%
D) 8%

Question 22

The outstanding debt of Billabong has ten years to maturity, a current yield of 7%, and a price of $95. What is the pretax cost of debt if the tax rate is 30%?

A) 4.9%
B) 7.0%
C) 6.5%
D) 7.37%

Question 23

Your estimate of the market risk premium is 6%. The risk-free rate of return is 5% and Virgin Australia has a beta of 1.2. What is Virgin's cost of equity capital?

A) 12.9%
B) 12.2%
C) 11.4%
D) 11.8%

Question 24

The total market value of Downunder Minerals is $10 billion. The company has a market value of $7 billion of equity and a face value of $10 billion of debt. What are the weights in equity and debt that are used for calculating the WACC?

A) 0.3, 0.7
B) 0.7, 0.3
C) 0.6, 0.4
D) cannot be determined

Question 25

MetalMouth received a $1.5 million government innovation grant. MetalMouth invested the grant money and developed a system to remove metal contaminants from storm water in shipyards. The firm estimates that each shipyard spends $400,000 a year on storm water clean-up efforts. If MetalMouth is able to sign up and retain four shipyards in the first year onwards, what is the present value (PV) of the project (net of investment) if the cost of capital for MetalMouth is 16% per year? Assume a cost of operations and other costs for SAP equal 60% of revenue.

A) $1.9 million
B) $2.5 million
C) $2..1 million
D) $2.3 million

Question 26

Holding everything else constant, an increase in cas?

A) will have no impact on
B) will increase
C) will decrease
D) may increase or decrease

Question 27

Outstanding debt of Flight Centre (FLT) trades with a yield to maturity of 7%. The tax rate of FLT is 30%. What is the effective cost of debt of FLT?

A) 4.9%
B) 6.3%
C) 5.2%
D) 7%

Question 28

Verano Ltd. has two business divisions - a software product line and a waste water clean-up product line. The software business has a cost of equity capital of 11% and the waste water clean-up business has a cost of equity capital of 6%. Verano has 50% of its revenue from software and the rest from the waste water business. Verano is considering a purchase of another company in the waste water business using equity financing. What is the appropriate cost of capital to evaluate the business?

A) 8.5%
B) 9.3%
C) 11%
D) 6%

Question 29

The book value of equity of a firm is $100 million and the market value of equity is $200 million. The face value of debt of the firm is $50 million and the market value of debt is $60 million. What is the market value of assets of the firm?

A) $250 million
B) $160 million
C) $260 million
D) $150 million

Question 30

Th?

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

Question 31

A company has a market value of $8 billion of equity and a market value of $12 billion of debt. What are the weights in equity and debt that are used for calculating the WACC?

A) 0.8, 0.2
B) 0.6, 0.4
C) 0.4, 0.6
D) 0.5, 0.5

Question 32

When corporate tax rates decline, the net cost of debt financin?

A) decreases.
B) increases.
C) is unchanged.
D) none of the above

Question 33

MetalMouth received a $1 million government innovation grant. MetalMouth 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 MetalMouth 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 MetalMouth is 18% per year? Assume a cost of operations and other costs for MetalMouth equal 50% of revenue.

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

Question 34

A firm has $1 million market value and it sells preference shares for $100 per share. If the annual dividend on the preference share is $7 and it trades at $95, what is the cost of preference share capital?

A) 7.15%
B) 7.21%
C) 7.37%
D) 6.75%

Question 35

Divisional costs of capital are more appropriate when evaluating a project for a line of business when the types of business in a firm are

A) different.
B) similar.
C) mature businesses.
D) new businesses.

Question 36

Leverage is the amount o?

A) preferred stock
B) debt
C) equity
D) none of the above

Question 37

Qantas is discussing new ways to recapitalise the firm and raise additional capital. Its current capital structure has a 10% weight in ordinary shares, 20% in preference shares, and 70% in debt. The cost of equity capital is 15%, the cost of preference shares is 10%, and the pretax cost of debt is 8%. What is the weighted average cost of capital for Qantas if its marginal tax rate is 30%?

A) 7.98%
B) 7.42%
C) 8.01%
D) 7.01%

Question 38

Coca-Cola Amatil (CCL) has a weighted average cost of capital of 11%. CCL is considering investing in a new plant that will save the company $30 million over each of the first two years, and then $25 million each year thereafter. If the investment is $150 million, what is the net present value (NPV) of the project?

A) -$51 million
B) -$41 million
C) $86 million
D) $45 million

Question 39

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

A) is always greater than
B) is always less than
C) may be greater than or less than
D) is always equal to

Question 40

Massive Inc shares have a market capitalisation of $60 billion. The company is expected to pay a dividend of $0.35 per share and each share trades for $30. The growth rate in dividends is expected to be 8% per year. Also, Massive has $15 billion of debt that trades with a yield to maturity of 7%. If the firm's tax rate is 30%, compute the WACC.

A) 8.31%
B) 8.11%
C) 7.45%
D) 7.91%

Question 41

A firm has outstanding debt with a coupon rate of 6%, ten years maturity, and a price of $1000 per $1000 face value. What is the after-tax cost of debt if the marginal tax rate of the firm is 30%?

A) 4.2%
B) 3.9%
C) 2.9%
D) 3.2%

Question 42

A firm has a capital structure with $100 million in equity and $100 million of debt. The cost of equity capital is 14% and the pretax cost of debt is 8%. If the marginal tax rate of the firm is 30%, compute the weighted average cost of capital of the firm.

A) 10.3%
B) 9.8%
C) 11.1%
D) 11.7%

Question 43

A firm has a pretax cost of debt of 8.5%. If the firm has a marginal tax rate of 30%, what is its effective cost of debt?

A) 6.0%
B) 8.1%
C) 8.5%
D) 3.4%

Question 44

When calculating the WACC, it is standard practice to subtract _ to compute the net debt outstanding.

A) coupons
B) cash and risk-free securities
C) equity
D) dividends

Question 45

Preference shares of Dunmovin pay a dividend of $4 each year and trade at a price of $30. What is the cost of preference share capital for Dunmovin?

A) 15.5%
B) 13.3%
C) 16.2%
D) 14.5%

Question 46

Preference shares of Dunmovin pay a dividend of $3.5 each year and trade at a price of $25. What is the cost of preference share capital for Dunmovin?

A) 14.0%
B) 12.8%
C) 13.5%
D) 12.6%

Question 47

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.

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

Question 48

Which of the following statements is FALSE?

A) Issuance costs increase the WACC.
B) Issuance costs should be treated as cash outflows in NPV analysis.
C) External equity is less expensive than retained earnings.
D) A project that can be financed with internal funds will be less costly than the same project if it were financed with external funds.

Question 49

A company has a book value of $8 billion of equity and a face value of $12 billion of debt. What are the weights in debt and equity that are used for calculating the WACC?

A) 0.6, 0.4
B) 0.5, 0.5
C) 0.4, 0.6
D) cannot be determined

Question 50

Which of the following is NOT a step in the WACC valuation method?

A) Discount the incremental free cash flows of the investment using the weighted average cost of capital.
B) Compute the weighted average cost of capital.
C) Determine the mean weighted average cost of capital for the firm's industry.
D) Determine the incremental free cash flows of the investment.

Question 51

The after-tax cost of equity i?

A) the same as
B) higher than
C) lower than
D) none of the above

Question 52

Preference shares of Dunmovin pay a dividend of $2.5 each year and trade at a price of $25. What is the cost of preference share capital for Dunmovin?

A) 10%
B) 11%
C) 9%
D) 8%

Question 53

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.

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

Question 54

Massive Inc shares have a market capitalisation of $55 billion. The company just paid a dividend of $0.35 per share and each share trades for $35. The growth rate in dividends is expected to be 6.5% per year. Also, Massive has $20 billion of debt that trades with a yield to maturity of 7%. If the firm's tax rate is 30%, compute the WACC.

A) 7.45%
B) 6.85%
C) 7.93%
D) 6.81%

Question 55

Verano Ltd. has two business divisions - a software product line and a waste water clean-up product line. The software business has a cost of equity capital of 10% and the waste water clean-up business has a cost of equity capital of 7%. Verano has 50% of its revenue from software and the rest from the waste water business. Verano is considering a purchase of another company in the waste water business using equity financing. What is the appropriate cost of capital to evaluate the business?

A) 8.5%
B) 10%
C) 9%
D) 7%

Question 56

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?

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

Question 57

Sirtex Medical has $4 million of outstanding equity and $12 million of bank debt. The bank debt costs 5% per year. The estimated equity beta is 1. If the market risk premium is 7% and the risk-free rate is 4%, compute the weighted average cost of capital if the firm's tax rate is 30%.

A) 5.38%
B) 5.98%
C) 4.65%
D) 5.01%

Question 58

As a firm increases its level of debt relative to its level of equity, the firm i?

A) decreasing its leverage.
B) increasing the fraction of the firm financed with equity.
C) increasing its leverage.
D) decreasing the fraction of the firm financed with debt.

Question 59

A firm has outstanding debt with a coupon rate of 7%, seven years maturity, and a price of $1000 per $1000 face value. What is the after-tax cost of debt if the marginal tax rate of the firm is 30%?

A) 5.5%
B) 5.9%
C) 4.9%
D) 5.2%

Question 60

MetalMouth received a $2 million government innovation grant. MetalMouth invested the grant money and developed a system to remove metal contaminants from storm water in shipyards. The firm estimates that each shipyard spends $600,000 a year on storm water clean-up efforts. If MetalMouth 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 MetalMouth is 15% per year? Assume a cost of operations and other costs for SAP equal 40% of revenue.

A) $6.3 million
B) $7.9 million
C) $7.6 million
D) $6.7 million

Question 61

A firm's sources of financing, which usually consists of debt and equity, represent it?

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

Question 62

The outstanding debt of Billabong has five years to maturity, a current yield of 6%, and a price of $95. What is the pretax cost of debt if the tax rate is 30%?

A) 4.8%
B) 6.9%
C) 4.2%
D) more information needed

Question 63

Massive Inc shares have a market capitalisation of $50 billion. The company is expected to pay a dividend of $0.30 per share and each share trades for $30. The growth rate in dividends is expected to be 7% per year. Also, Massive has $15 billion of debt that trades with a yield to maturity of 8%. If the firm's tax rate is 30%, what is the WACC?

A) 7.24%
B) 7.91%
C) 6.55%
D) 7.45%

Question 64

TLS expects to pay a dividend of $3 next year and expects these dividends to grow at 8% a year. The price of TLS is $95 per share. What is TLS' cost of equity capital?

A) 3.16%
B) 8%
C) 4.84%
D) 11.16%

Question 65

The outstanding debt of Billabong has eight years to maturity, a current yield of 8%, and a price of $95. What is the pretax cost of debt if the tax rate is 30%?

A) 5.6%
B) 8.5%
C) 6.5%
D) more information needed

Question 66

A firm is considering investing in a new project with an upfront cost of $400 million. The project will generate an incremental free cash flow of $50 million in the first year and this cashflow is expected to grow at an annual rate of 4% forever. If the firm's WACC is 13%, what is the value of this project?

A) $177.8 million
B) $577.8 million
C) $155.6 million
D) $555.6 million

Question 67

SupUp, a manufacturer of beverages, is planning to purchase Six Flags theme parks. SupUp should use the to evaluate the business of Six Flags.

A) average market return
B) WACC of SupUp
C) WACC of Six Flags
D) none of the above

Question 68

Qantas is discussing new ways to recapitalise the firm and raise additional capital. Its current capital structure has a 30% weight in ordinary shares, 10% in preference shares, and 60% in debt. The cost of equity capital is 17%, the cost of preference shares is 11%, and the pretax cost of debt is 8%. What is the weighted average cost of capital for Qantas if its marginal tax rate is 30%?

A) 10.25%
B) 10.73%
C) 9.56%
D) 9.96%

Question 69

When we use the WACC to assess a project, we assume that th?

A) risk to reward
B) reward to systematic risk
C) volatility to systematic risk
D) debt-to-equity

Question 70

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.

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

Question 71

TLS just paid a dividend of $3.5 and expects these dividends to grow at 9% a year. The price of TLS is $100 per share. What is TLS' cost of equity capital?

A) 3.5%
B) 12.82%
C) 9%
D) 12.5%

Question 72

Sirtex Medical has $10 million of outstanding equity and $5 million of bank debt. The bank debt costs 5% per year. The estimated equity beta is 2. If the market risk premium is 7% and the risk-free rate is 4%, compute the weighted average cost of capital if the firm's tax rate is 30%.

A) 14.21%
B) 13.52%
C) 13.76%
D) 13.16%

Question 73

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.

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

Question 74

Coca-Cola Amatil (CCL) has a weighted average cost of capital of 10%. CCL is considering investing in a new plant that will save the company $20 million over each of the first two years, and then $15 million each year thereafter. If the investment is $150 million, what is the net present value (NPV) of the project?

A) $7.3 million
B) $6.6 million
C) $7.9 million
D) $8.7 million

Question 75

The market value of Fortescue's ordinary shares, preference shares, and debt are $6 billion, $2 billion, and $15 billion, respectively. Fortescue has a beta of 1.5, the market risk premium is 7%, and the risk-free rate of interest is 4%. Fortescue's preference shares pays a dividend of $3 each year and trades at a price of $27 per share. Fortescue's debt trades with a yield to maturity of 8.5%. What is Fortescue's weighted average cost of capital if its tax rate is 30%?

A) 10.13%
B) 9.56%
C) 8.63%
D) 8.87%

Question 76

Your estimate of the market risk premium is 7%. The risk-free rate of return is 4% and Virgin Australia has a beta of 1.5. What is Virgin's cost of equity capital?

A) 14.8%
B) 14.5%
C) 13.9%
D) 13.5%

Question 77

A firm is considering acquiring a competitor. The firm plans on offering $200 million for the competitor. The firm will need to issue new debt and equity to finance the acquisition. You estimate the issuance costs to be $10 million. The acquisition will generate an incremental free cash flow of $25 million in the first year and this cash flow is expected to grow at an annual rate of 3% forever. If the firm's WACC is 13%, what is the value of this project?

A) $40 million
B) $60 million
C) $50 million
D) $70 million

Question 78

The market value of Fortescue's ordinary shares, preference shares and debt are $8 billion, $4 billion and $12 billion respectively. Fortescue has a beta of 1.3, the market risk premium is 7% and the risk-free rate of interest is 4%. Fortescue's preference shares pays a dividend of $4 each year and trades at a price of $30 per share. Fortescue's debt trades with a yield to maturity of 8.5%. What is Fortescue's weighted average cost of capital if its tax rate is 30%?

A) 9.56%
B) 8.34%
C) 8.01%
D) 9.46%

Question 79

A firm incurs $50,000 in interest expenses each year. If the tax rate of the firm is 30%, what is the effective after-tax interest rate expense for the firm?

A) $35,000
B) $32,000
C) $29,000
D) $27,000

Question 80

Many financial managers use market risk premiums that are closer to 5%, which is lower than historical averages, because investors require a _ risk premium for holding risky securities than in the past.

A) lower
B) similar
C) higher
D) none of the above