Question 1

The Market Outlet is an all-equity financed firm with a beta of 1.08 and a cost of equity of 12.58 percent. The risk-free rate of return is 3.6 percent. What discount rate should the firm assign to a new project that has a beta of 1.22?

Accepted Answer

The discount rate can be calculated using the Capital Asset Pricing Model (CAPM): Cost of Equity = Risk-Free Rate + Beta * (Market Risk Premium). First, find the Market Risk Premium: 12.58% - 3.6% = 8.98%. Then, apply the new beta: 3.6% + 1.22 * 8.98% = 13.74%.

Question 2

Mullineaux Corporation has a target capital structure of 46 percent common stock, 5 percent preferred stock, and the balance in debt. Its cost of equity is 15.8 percent, the cost of preferred stock is 8.3 percent, and the aftertax cost of debt is 6.8 percent. What is the WACC given a tax rate of 23 percent?

Accepted Answer

To calculate the WACC, we need to first find the weights of each component of the capital structure:
- Common stock: 46%
- Preferred stock: 5%
- Debt: 100% - 46% - 5% = 49%

Next, we need to calculate the cost of each component, adjusted for taxes:
- Cost of equity: 15.8%
- Cost of preferred stock: 8.3% x (1-0.23) = 6.38%
- Aftertax cost of debt: 6.8% x (1-0.23) = 5.23%

Now we can use the WACC formula:

WACC = (weight of common stock x cost of equity) + (weight of preferred stock x cost of preferred stock) + (weight of debt x aftertax cost of debt)
     = (0.46 x 0.158) + (0.05 x 0.0638) + (0.49 x 0.0523)
     = 0.07268
     = 7.27%

However, the answer options are provided in percentage terms, so we need to multiply by 100 to get the final answer:

WACC = 7.27% x 100 = 11.02%

Therefore, the best choice is C.

Question 3

Rosa's has a weighted average cost of capital of 11.73 percent. The cost of equity is 15.8 percent and the pretax cost of debt is 7.6 percent. The tax rate is 21 percent. What is the target debt-equity ratio?

Accepted Answer

The weighted average cost of capital (WACC) formula is: WACC = (E/V) * Re + (D/V) * Rd * (1-Tc). Solving for the debt-equity ratio (D/E) using the given values, we find that the target debt-equity ratio is approximately 0.71.

Question 4

AZ Products has 140,000 shares of common stock outstanding at a market price of $27 a share. Next year's annual dividend is expected to be $1.43 a share and the dividend growth rate is 2 percent. The company also has 2,500 bonds outstanding with a face value of $1,000 per bond. The bonds have a pretax yield of 7.35 percent and sell at 98.2 percent of face value. The company's tax rate is 21 percent. What is the weighted average cost of capital?

Accepted Answer

The answer of AZ Products has 140,000 shares of common...

Question 5

The Dry Well has 6.85 percent preferred stock outstanding with a market value per share of $79, a stated value of $100 per share,  and a book value per share of $29. What is the cost of preferred stock?

Accepted Answer

The cost of preferred stock is calculated as the annual dividend divided by the market value per share. The annual dividend is the stated value multiplied by the dividend rate. The dividend rate is 6.85%. The stated value is $100 per share. The market value per share is $79. Therefore, the annual dividend is $6.85. The cost of preferred stock is $6.85 / $79 = 8.67%.

Question 6

Cookie Dough Manufacturing has a target debt-equity ratio of .76. Its cost of equity is 15.3 percent, and its pretax cost of debt is 9 percent. What is the WACC given a tax rate of 21 percent?

Accepted Answer

The correct answer is A.The WACC is calculated as follows:WACC = (E/V) * Re + (D/V) * Rd * (1 - T)where:E = market value of equityV = market value of the firmRe = cost of equityD = market value of debtRd = cost of debtT = tax rateIn this case, we have:E/V = 1 / (1 + .76) = 0.5714D/V = .76 / (1 + .76) = 0.4286Re = 15.3%Rd = 9%T = 21%Plugging these values into the formula, we get:WACC = (0.5714 * 15.3%) + (0.4286 * 9% * (1 - 0.21))WACC = 11.76%

Question 7

The Well Derrick has 6.3 percent preferred stock outstanding that sells for $57 a share. This stock was originally issued at $45 per share and has a stated value of $100 per share. What is the cost of preferred stock if the relevant combined tax rate is 23 percent?

Accepted Answer

The cost of preferred stock is calculated as the dividend divided by the current price. The dividend is 6.3% of the stated value ($100), which is $6.30. The cost is $6.30 / $57 = 0.1105 or 11.05%. The tax rate does not affect the cost of preferred stock.

Question 8

Granite Works maintains a debt-equity ratio of .58 and has a tax rate of 21 percent. The pretax cost of debt is 8.9 percent. There are 18,000 shares of stock outstanding with a beta of 1.42 and a market price of $23 a share. The current market risk premium is 7.8 percent and the current risk-free rate is 3.1 percent. This year, the firm paid an annual dividend of $1.68 a share and expects to increase that amount by 2 percent each year. Using an average expected cost of equity, what is the weighted average cost of capital?

Accepted Answer

The answer of Granite Works maintains a debt-equity ratio of...

Question 9

Dee's Toys has a target debt-equity ratio of .62. Its WACC is 11.3 percent and the tax rate is 21 percent. What is the cost of equity if the aftertax cost of debt is 6.3 percent?

Accepted Answer

The answer of Dee's Toys has a target debt-equity ratio...

Question 10

Florida Groves has a $380,000 bond issue outstanding that is selling at 97.4 percent of face value. The firm also has 2,600 shares of preferred stock valued at $61 a share and 37,500 shares of common stock valued at $19 a share. What weight should be assigned to the common stock when computing the weighted average cost of capital?

Accepted Answer

The answer of Florida Groves has a $380,000 bond issue...

Question 11

Delta Lighting has 24,500 shares of common stock outstanding at a market price of $19 a share. This stock was originally issued at $21 per share. The firm also has a bond issue outstanding with a total face value of $250,000 which is selling for 94 percent of par. The cost of equity is 12.6 percent while the aftertax cost of debt is 5.8 percent. The firm has a beta of 1.33 and a tax rate of 23 percent. What is the weighted average cost of capital?

Accepted Answer

First, let's calculate the market value of equity:

24,500 shares x $19 per share = $465,500

The market value of equity is lower than the book value of equity:

24,500 shares x $21 per share = $514,500

This indicates that investors have a lower expectation of the firm's future earnings compared to when the stock was first issued.

Next, let's calculate the market value of debt:

$250,000 x 0.94 = $235,000

Now, we can calculate the weights of equity and debt:

Weight of equity = $465,500 / ($465,500 + $235,000) = 0.664

Weight of debt = $235,000 / ($465,500 + $235,000) = 0.336

Using the given information, we can now calculate the WACC:

WACC = (0.664 x 0.126) + (0.336 x 0.058 x (1 - 0.23)) x 1.33

WACC = 0.084 + 0.013 x 1.33

WACC = 0.10232 or 10.32%

Therefore, the best choice is B, which is the closest to the result of 10.32%.

Question 12

Simple Foods has a zero coupon bond issue outstanding that matures in 14 years. The bonds are selling at 56 percent of par value. What is the company's aftertax cost of debt if the combined tax rate is 23 percent? (Use semiannual compounding.)

Accepted Answer

The first step is to calculate the yield to maturity (YTM) of the bond. Since the bond is selling at 56% of par value, this means that the present value of the bond's cash flows is 56% of its face value.

To calculate the YTM, we need to use an online financial calculator or a spreadsheet function such as the RATE function. Using semiannual compounding, the YTM is 6.44%.

Next, we need to calculate the aftertax cost of debt. Since the bonds are zero coupon bonds, there are no interest payments to deduct for tax purposes. Therefore, the aftertax cost of debt is simply the YTM multiplied by (1 - tax rate).

Aftertax cost of debt = 6.44% x (1 - 0.23) = 4.96%

Therefore, the answer is C) 3.22%, which is the semiannual aftertax cost of debt.

Question 13

Theresa's Flower Garden has 650 bonds outstanding that are selling for $1,007 each, 2,100 shares of preferred stock with a market price of $68 a share, and 42,000 shares of common stock valued at $44 a share. What weight should be assigned to the preferred stock when computing the weighted average cost of capital?

Accepted Answer

To calculate the weight of the preferred stock in the capital structure, first determine the market value of each component: bonds, preferred stock, and common stock. Then, calculate the proportion of the preferred stock's value to the total market value.- Bonds: 650 bonds * $1,007 = $654,550- Preferred Stock: 2,100 shares * $68 = $142,800- Common Stock: 42,000 shares * $44 = $1,848,000Total Market Value = $654,550 (bonds) + $142,800 (preferred stock) + $1,848,000 (common stock) = $2,645,350Weight of Preferred Stock = $142,800 / $2,645,350 = 0.054 or 5.40 percent

Question 14

Grill Works has 6 percent preferred stock outstanding that is currently selling for $49 a share. The market rate of return is 14 percent and the tax rate is 21 percent. What is the cost of preferred stock if its stated value is $100 per share?

Accepted Answer

The answer of Grill Works has 6 percent preferred stock...

Question 15

Kelso's has a debt-equity ratio of .62 and a tax rate of 21 percent. The firm does not issue preferred stock. The cost of equity is 16.3 percent and the aftertax cost of debt is 5.21 percent. What is the weighted average cost of capital?

Accepted Answer

Weighted Average Cost of Capital (WACC) = E/(E+D)*Re + D/(E+D)*Rd*(1-Tc)
where,
E = Equity
D = Debt
Re = Cost of equity
Rd = Cost of debt
Tc = Tax rate

Given,
Debt-equity ratio = D/E = 0.62
Tax rate (Tc) = 21%
Cost of equity (Re) = 16.3%
After-tax cost of debt (Rd) = 5.21%

Let us assume that the total value of the firm is $100. Then,
Equity (E) = $100/(1+0.62) = $61.73
Debt (D) = $100 - $61.73 = $38.27

Substituting the given values in the formula, we get:
WACC = (61.73/100)*16.3% + (38.27/100)*5.21%*(1-21%)
= 12.06%

Therefore, the answer is C.

Question 16

Phillips Equipment has 6,500 bonds outstanding that are selling at 96.5 percent of par. Bonds with similar characteristics are yielding 6.7 percent, pretax. The company also has 48,000 shares of 5.5 percent preferred stock and 75,000 shares of common stock outstanding. The preferred stock sells for $64 a share. The common stock has a beta of 1.32 and sells for $41 a share. The preferred stock has a stated value of $100. The U.S. Treasury bill is yielding 2.2 percent and the return on the market is 10.6 percent. The corporate tax rate is 21 percent. What is the weighted average cost of capital?

Accepted Answer

To calculate the weighted average cost of capital (WACC), we need to find the costs of debt, preferred stock, and equity, and then weight them according to the market values of debt, preferred stock, and equity.1. Cost of Debt (Rd):Given that the bonds are selling at 96.5% of par, and they have a yield of 6.7%, we can use the yield as the cost of debt before taxes. The after-tax cost of debt is then calculated as Rd(1-Tc), where Tc is the corporate tax rate.Rd = 6.7% * (1 - 0.21) = 6.7% * 0.79 = 5.293%2. Cost of Preferred Stock (Rp):The cost of preferred stock is the dividend divided by the current price. The dividend is 5.5% of the $100 par value, so $5.50 per share. The price is $64.Rp = $5.50 / $64 = 8.59%3. Cost of Equity (Re) using CAPM:Re = Rf + Beta * (Rm - Rf), where Rf is the risk-free rate, Beta is the beta of the stock, and Rm is the return on the market.Re = 2.2% + 1.32 * (10.6% - 2.2%) = 2.2% + 1.32 * 8.4% = 2.2% + 11.088% = 13.288%4. Market Values:- Debt: 6,500 bonds * $1,000 * 96.5% = $6,272,500- Preferred Stock: 48,000 shares * $64 = $3,072,000- Common Equity: 75,000 shares * $41 = $3,075,000Total Market Value = $6,272,500 + $3,072,000 + $3,075,000 = $12,419,5005. Weights:- Wd = $6,272,500 / $12,419,500 = 0.505- Wp = $3,072,000 / $12,419,500 = 0.247- We = $3,075,000 / $12,419,500 = 0.2486. WACC:WACC = (Wd * Rd) + (Wp * Rp) + (We * Re) = (0.505 * 5.293%) + (0.247 * 8.59%) + (0.248 * 13.288%) = 2.67% + 2.12% + 3.29% = 8.09%Therefore, the correct answer is A) 8.09 percent.

Question 17

Central Systems desires a weighted average cost of capital of 12.7 percent. The firm has an aftertax cost of debt of 4.8 percent and a cost of equity of 15.4 percent. What debt-equity ratio is needed for the firm to achieve its targeted weighted average cost of capital?

Accepted Answer

To find the debt-equity ratio, we need to use the weighted average cost of capital formula:

WACC = (E/V * Re) + (D/V * Rd * (1-Tc))

Where: 
E = Market value of equity
D = Market value of debt
V = Total value of firm (E + D)
Re = Cost of equity
Rd = Cost of debt
Tc = Corporate tax rate

We know that:
WACC = 12.7%
Rd = 4.8%
Re = 15.4%

Let x be the debt-equity ratio:

x = D/E

1 + x = V/D

Substituting the known values in the WACC equation:

0.127 = [(E/V) * 0.154] + [(D/V) * 0.048 * (1-0.3)]

0.127 = [(1/(1+x)) * 0.154] + [(x/(1+x)) * 0.048 * 0.7]

Solving for x:
x = 0.34 or 34%

Therefore, Central Systems needs a debt-equity ratio of 34% to achieve its targeted weighted average cost of capital of 12.7%. 
The answer is D.

Question 18

Deep Mines has 43,800 shares of common stock outstanding with a beta of 1.54 and a market price of $51 a share. There are 10,000 shares of 7 percent preferred stock outstanding with a stated value of $100 per share and a market value of $83 a share. The 8 percent semiannual bonds have a face value of $1,000 and are selling at 96 percent of par. There are 5,000 bonds outstanding that mature in 13 years. The market risk premium is 7.5 percent, T-bills are yielding 3.6 percent, and the tax rate is 21 percent. What discount rate should the firm apply to a new project's cash flows if the project has the same risk as the company's typical project?

Accepted Answer

The answer of Deep Mines has 43,800 shares of common...

Question 19

Wayco Industrial Supply has a pretax cost of debt of 8.3 percent, a cost of equity of 14.7 percent, and a cost of preferred stock of 8.9 percent. The firm has 165,000 shares of common stock outstanding at a market price of $33 a share. There are 15,000 shares of preferred stock outstanding at a market price of $43 a share. The bond issue has a face value of $750,000 and a market quote of 101. The company's tax rate is 21 percent. What is the weighted average cost of capital?

Accepted Answer

The answer of Wayco Industrial Supply has a pretax cost...

Question 20

The Downtowner has 168,000 shares of common stock outstanding valued at $53 a share along with 13,000 bonds selling for $1,008 each. What weight should be given to the debt when the company computes its weighted average cost of capital?

Accepted Answer

The answer of The Downtowner has 168,000 shares of common...

Quiz 14: Cost of Capital