Deck 12: Determining the Cost of Capital

Question 1

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

Answer 1

0.6,0.4

Question 2

GM 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)0.5,0.5
B)0.6,0.4
C)0.4,0.6
D)0.8,0.2
E)0.8,1.2

Answer 2

0.4,0.6

Question 3

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)$150 million
B)$160 million
C)$260 million
D)$250 million
E)$110 million

Answer 3

$260 million

Question 4

A levered firm is one that has ________ outstanding.

A)debt
B)equity
C)preferred stock
D)equity options
E)accounts receivable

Question 5

Barley Corp has debt with a book value of $19 million,currently trading at 90% of book value.It also has book value of equity of $15 million,and 10 million shares of common stock trading at $2.45 per share.What weights should Barley Corp use for debt and equity in calculating its WACC?

A)0.56,0.44
B)0.44,0.56
C)0.41,0.59
D)0.5,0.5
E)0.6,0.4

Question 6

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)0.2,0.8
B)0.25,0.75
C)0.4,0.6
D)0.5,0.5
E)0.1,0.3

Question 7

To attract capital from outside investors,a firm must offer potential investors an expected return that is commensurate with the level of risk that they can bear.

Question 8

Asterix Corp has debt with a book value of $20 million,currently trading at 85% of book value.It also has book value of equity of $30 million,and 2 million shares of common stock trading at $4.75 per share.What weights should Asterix use for debt and equity in calculating its WACC?

A)0.64,0.36
B)0.4,0.6
C)0.68,0.32
D)0.5,0.5
E)0.6,0.4

Question 9

The total market value of General Motors (GM)is $10 billion.GM 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)0.6,0.4
B)0.7,0.3
C)0.3,0.7
D)0.5,0.5
E)0.4,0.6

Question 10

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

Question 11

For an unlevered firm,the cost of capital of the firm can be determined by using the:

A)yield on the traded debt.
B)Capital Asset Pricing Model.
C)dividend yield.
D)preferred stock yield.
E)market value of equity.

Question 12

Apple computers has raised all its capital via equity rather than debt.Such a firm is also referred to as a(n)________ firm.

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

Question 13

Billy Burger Corp has a market value of debt of $245 million,and a market value of equity of $815 million.What weights should Billy Burger use for debt and equity in calculating its WACC?

A)0.30,0.70
B)0.23,0.77
C)0.70,0.30
D)0.5,0.5
E)0.6,0.4

Question 14

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

Question 15

Financial managers do not need to use all sources of financing in order to determine the cost of capital.

Question 16

Timbuktu Corp has a market value of debt of $2.5 billion,and a market value of equity of $1.5 billion.What weights should Timbuktu use for debt and equity in calculating its WACC?

A)0.375,0.625
B)0.5,0.5
C)0.4,0.6
D)0.625,0.375
E)0.6,0.4

Question 17

A firm's sources of financing,which usually consists of debt and equity,represent its:

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

Question 18

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

A)asset ratio.
B)current ratio.
C)capital structure.
D)value structure.
E)enterprise value.

Question 19

One should use accounting-based book values rather than market values of debt and equity to determine the weights for the different sources of capital.

Question 20

Leverage is the amount of ________ on a firm's balance sheet.

A)equity
B)debt
C)preferred stock
D)assets
E)liabilities

Question 21

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

A)40% for debt,60% for equity
B)50% for debt,50% for equity
C)36% for debt,64%% for equity
D)45% for debt,55% for equity
E)30% for debt,70% for equity

Question 22

Portentious Door Company has outstanding corporate debt paying a 5% semiannual coupon,with a current yield to maturity of 6%.If the firm's tax rate is 15%,what is its effective cost of debt?

A)5%
B)4.25%
C)5.1%
D)6%
E)5.5%

Question 23

Manitou Inc has preferred stock paying an annual dividend of $2.25,and common stock paying an annual dividend of $0.85.If the current preferred stock price is $18.75,what is Manitou's cost of preferred stock capital?

A)11%
B)12%
C)4.5%
D)10%
E)13%

Question 24

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)$27,000
B)$29,000
C)$32,000
D)$35,000
E)$39,000

Question 25

A firm incurs $70,000 in interest expenses each year.If the tax rate of the firm is 20%,what is the effective after-tax interest rate expense for the firm?

A)$37,000
B)$49,000
C)$56,000
D)$65,000
E)$72,000

Question 26

The ________ of a firm's debt can be used as the firm's current cost of debt.

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

Question 27

The fact that the interest paid on debt is a tax-deductible expense increases the cost of debt financing.

Question 28

As a firm increases its level of debt relative to its level of equity,the firm is:

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

Question 29

Outstanding debt of Home Depot trades with a yield to maturity of 7%.The tax rate of Home Depot is 30%.What is the effective cost of debt of Home Depot?

A)5.2%
B)7%
C)6.3%
D)4.9%
E)2.1%

Question 30

A firm incurs $40,000 in interest expenses each year.If the tax rate of the firm is 40%,what is the effective after-tax interest rate expense for the firm?

A)$22,000
B)$24,000
C)$27,000
D)$29,000
E)$33,000

Question 31

Preferred stock of Ford Motors pays a dividend of $4 each year and trades at a price of $30.What is the cost of preferred stock capital for Ford?

A)13.3%
B)14.5%
C)15.5%
D)16.2%
E)16.5%

Question 32

Why do we use market values rather than book values in calculation of WACC?

Question 33

Garwood Garages will pay a dividend of $2.55 next year,and expects its dividends to grow at 3% per year.The current price of Garwood stock is $18.25 per share.What is Garwood's cost of equity?

A)17%
B)14%
C)15%
D)13%
E)20%

Question 34

Why do we use leverage if it increases the risk of a firm?

Question 35

A firm's cost of debt is the rate of interest it would have to pay to refinance its existing debt.

Question 36

Xcom Industries will pay a dividend of $0.44 next year,and expects its dividends to grow at 8% per year.The current price of Xom stock is $6.45 per share.What is Xom's cost of equity?

A)17%
B)14.8%
C)6.8%
D)7.4%
E)15.4%

Question 37

Starling Capital has outstanding corporate debt paying a 10% coupon,with a current yield to maturity of 8%.If Starling's tax rate is 35%,what is the firm's effective cost of debt?

A)5.2%
B)6.5%
C)10%
D)8%
E)5.85%

Question 38

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

A)12.2%
B)11.8%
C)12.9%
D)11.4%
E)10.8%

Question 39

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

A)9.65%
B)10.23%
C)10.89%
D)11.44%
E)12.36%

Question 40

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

A)deducted.
B)margined.
C)refinanced.
D)salvaged.
E)ignored.

Question 41

The outstanding debt of Berstin Corp.has eight years to maturity,a current yield of 8%,and a price of $95.Assume the debt has a face value of $100.What is the pretax cost of debt if the tax rate is 30%?

A)5.6%
B)6.5%
C)8.5%
D)7.2%
E)7.9%

Question 42

A firm has $3 million market value and it sells preferred stock with a par value of $100.If the coupon rate on the preferred stock is 9% and the preferred stock trades at $95,what is the cost of preferred stock financing?

A)8.75%
B)9.47%
C)10.21%
D)10.41%
E)10.44%

Question 43

What is the difference between the effective cost of debt and the cost of debt?

Question 44

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 equal to
C)is always less than
D)may be greater than or less than
E)is never less than

Question 45

A firm has $2 million market value and it sells preferred stock with a par value of $100.If the coupon rate on the preferred stock is 8% and the preferred stock trades at $90,what is the cost of preferred stock financing?

A)8.75%
B)8.89%
C)9.21%
D)9.35%
E)10.16%

Question 46

An all-equity firm produced a dividend flow of $20,000 last year.The market value of the firm is $650,000 and the dividend is expected to increase at 4% each year.What is the cost of equity capital for this firm?

A)5.5%
B)6.2%
C)7.2%
D)7.8%
E)8.1%

Question 47

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

A)13.5%
B)14.5%
C)13.9%
D)14.8%
E)15.1%

Question 48

Is it incorrect to use the coupon rate of debt toward cost of debt?

Question 49

A firm has outstanding debt paying annual coupons,with a coupon rate of 5%,and 10 years to maturity.The firm's bonds are currently trading at a price of $950 per $1000 face value.What is the firm's cost of debt if it has a tax rate of 15%?

A)5.7%
B)5%
C)4.8%
D)4.25%
E)5.4%

Question 50

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)14.1%
B)13.5%
C)13.9%
D)14.4%
E)14.8%

Question 51

A firm has $1 million market value and it sells preferred stock with a par value of $100.If the coupon rate on the preferred stock is 7% and the preferred stock trades at $95,what is the cost of preferred stock financing?

A)6.75%
B)7.15%
C)7.21%
D)7.37%
E)8.12%

Question 52

An all-equity firm produced a dividend flow of $40,000 last year.The market value of the firm is $800,000 and the dividend is expected to increase at 5% each year.What is the cost of equity capital for this firm?

A)9.18%
B)9.75%
C)10.25%
D)11.89%
E)12.05%

Question 53

A firm has a pre-tax cost of debt of 8.5%.If the firm has a marginal tax rate of 40%,what is its effective cost of debt?

A)5.1%
B)3.4%
C)8.5%
D)8.1%
E)7.2%

Question 54

The outstanding debt of Berstin Corp.has five years to maturity,a current yield of 6%,and a price of $95.Assume the debt has a face value of $100.What is the pretax cost of debt if the tax rate is 30%?

A)4.2%
B)4.8%
C)6.9%
D)7.3%
E)7.7%

Question 55

An all-equity firm produced a dividend flow of $30,000 last year.The market value of the firm is $875,000 and the dividend is expected to increase at 3% each year.What is the cost of equity capital for this firm?

A)6.53%
B)6.91%
C)7.45%
D)7.89%
E)8.17%

Question 56

A firm has outstanding debt paying annual coupons,with a coupon rate of 10%,and 8 years to maturity.The firm's bonds are currently trading at a price of $875.50 per $1000 face value.What is the firm's cost of debt if it has a tax rate of 25%?

A)7.5%
B)10%
C)9.4%
D)12.6%
E)11.2%

Question 57

Should a firm with high retained earnings have a lower cost of equity?

Question 58

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)4.9%
B)5.2%
C)5.5%
D)5.9%
E)6.3%

Question 59

Between the two models Constant Dividend Growth Model (CDGM)and Capital Asset Pricing Model (CAPM),which is a better method for computation of the cost of equity?

Question 60

The outstanding debt of Berstin Corp.has ten years to maturity,a current yield of 7%,and a price of $95.Assume the debt has a face value of $100.What is the pretax cost of debt if the tax rate is 30%.

A)4.9%
B)6.5%
C)7.0%
D)7.37%
E)8.15%

Question 61

Rogers Communications is currently financed with 60% equity,20% preferred stock,and 20% debt.It has a cost of equity capital of 8.5%,a cost of preferred stock of 6%,and its pretax cost of debt is 7%.If the firm has a tax rate of 25%,what is Rogers's WACC?

A)7.04%
B)6.58%
C)7.17%
D)7.7%
E)7.35%

Question 62

Which of the three costs-debt,preferred stock,and common equity-is most difficult to estimate?

Question 63

A firm has $30 million of common stock,$20 million of preferred stock,and $40 million of debt.The cost of equity is 8.5%,the cost of preferred stock is 9.5%,and the pretax cost of debt is 7%.If the firm's tax rate is 30%,what is the firm's WACC?

A)8.33%
B)6.44%
C)7.12%
D)8.06%
E)7.75%

Question 64

Power Financial Corp has a current share price of $30,and a market capitalization of $20 billion.The firm's beta is 0.93,the risk-free rate is 3.2%,and the market risk premium is 7%.The firm has $12 billion of debt with a yield to maturity of 5%.If the firm's tax rate is 20%,what is Power Financial's WACC?

A)5.43%
B)5.71%
C)7.94%
D)6.55%
E)7.57%

Question 65

Lululemon Athletica has a current share price of $52.50,and a market capitalization of $7 billion.The company is expected to pay a dividend of $0.20 per share,with a dividend growth rate of 3% per year.The firm has $4 billion of debt with a yield to maturity of 7%.If the firm's tax rate is 25%,what is Lululemon's WACC?

A)4.07%
B)4.33%
C)3.82%
D)4.71%
E)3.94%

Question 66

A firm has $56 million of common stock and $32 million of debt.The cost of equity is 11.4%,and the pretax cost of debt is 5.7%.If the firm's tax rate is 20%,what is the firm's WACC?

A)8.91%
B)9.33%
C)8.55%
D)7.98%
E)10.13%

Question 67

Ford Motor Company is discussing new ways to recapitalize the firm and raise additional capital.Its current capital structure has a 30% weight in equity,10% in preferred stock,and 60% in debt.The cost of equity capital is 17%,the cost of preferred stock is 11%,and the pretax cost of debt is 8%.What is the weighted average cost of capital for Ford if its marginal tax rate is 30%?

A)9.56%
B)9.96%
C)10.25%
D)10.73%
E)11.54%

Question 68

Shaw Communications is currently financed with 30% equity,10% preferred stock,and 60% debt.It has a cost of equity capital of 11%,a cost of preferred stock of 7.5%,and its pretax cost of debt is 6%.If the firm has a tax rate of 30%,what is Shaw's WACC?

A)7.57%
B)8.17%
C)5.82%
D)6.57%
E)7.65%

Question 69

Ford Motor Company is discussing new ways to recapitalize the firm and raise additional capital.Its current capital structure has a 20% weight in equity,10% in preferred stock,and 70% in debt.The cost of equity capital is 14%,the cost of preferred stock is 10%,and the pretax cost of debt is 9%.What is the weighted average cost of capital for Ford if its marginal tax rate is 30%?

A)7.87%
B)8.21%
C)8.89%
D)9.21%
E)10.14%

Question 70

Lululemon Athletica has a current share price of $50,and a market capitalization of $7 billion.The firm's beta is 0.27,the risk-free rate is 2.4%,and the market risk premium is 6%.The firm has $4 billion of debt with a yield to maturity of 8%.If the firm's tax rate is 35%,what is Lululemon's WACC?

A)7.24%
B)4.45%
C)4.61%
D)4.71%
E)6.01%

Question 71

Assume JUP 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 JUP's WACC if the firm's marginal tax rate is 35%?

A)9.60%
B)8.76%
C)9.00%
D)6.24%
E)7.34%

Question 72

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

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

Question 73

Bell Media has common stock trading at a price of $74,and a market capitalization of $23 billion.The firm also has preferred stock worth a total of $6 billion,currently trading at $54 per share and paying a dividend of $4.50 per share.The firm's beta is 1.2,the risk-free rate is 2.4%,and the market risk premium is 6%.The firm has $28 billion of debt with a yield to maturity of 4%.If the firm's tax rate is 30%,what is Bell's WACC?

A)6.41%
B)7.19%
C)6.61%
D)7.31%
E)7.71%

Question 74

Ford Motor Company is discussing new ways to recapitalize the firm and raise additional capital.Its current capital structure has a 10% weight in equity,20% in preferred stock,and 70% in debt.The cost of equity capital is 15%,the cost of preferred stock is 10%,and the pretax cost of debt is 8%.What is the weighted average cost of capital for Ford if its marginal tax rate is 30%?

A)7.01%
B)7.42%
C)7.98%
D)8.01%
E)8.73%

Question 75

Power Financial Corp has a current share price of $34,and a market capitalization of $24 billion.The company is expected to pay a dividend of $0.37 per share,with a dividend growth rate of 4% per year.The firm has $18 billion of debt with a yield to maturity of 6%.If the firm's tax rate is 30%,what is Power Financial's WACC?

A)5.00%
B)4.65%
C)4.71%
D)5.49%
E)5.55%

Question 76

A firm has $8 billion of common stock and $14 billion of debt.The cost of equity is 7.5%,and the pretax cost of debt is 3.8%.If the firm's tax rate is 30%,what is the firm's WACC?

A)4.84%
B)3.6%
C)5.15%
D)4.42%
E)5.65%

Question 77

A firm has $50 million of common stock,$10 million of preferred stock,and $15 million of debt.The cost of equity is 9%,the cost of preferred stock is 7%,and the pretax cost of debt is 4%.If the firm's tax rate is 25%,what is the firm's WACC?

A)6.67%
B)6.33%
C)7.73%
D)5.16%
E)7.53%

Question 78

The WACC does not depend on the risk of a company's line of business.

Question 79

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)higher
C)similar
D)specific
E)consistent

Question 80

Bombardier Inc has common stock trading at a price of $15,and a market capitalization of $8 billion.The firm also has preferred stock worth a total of $2 billion,currently trading at $23 per share and paying a dividend of $2.75 per share.The firm's beta is 0.93,the risk-free rate is 3.2%,and the market risk premium is 7%.The firm has $12 billion of debt with a yield to maturity of 5%.If the firm's tax rate is 20%,what is Bombardier's WACC?

A)4.12%
B)6.8%
C)8.56%
D)7.3%
E)7.57%