Question 1

CTO Transport has an aftertax cost of debt of 5.6 percent,a cost of equity of 13.7 percent,and a cost of preferred stock of 7.8 percent.The firm has 60,000 shares of common stock outstanding at a market price of $45 a share.There are 12,000 shares of preferred stock outstanding at a market price of $52 a share.The bond issue has a total face value of $400,000 and sells at 102 percent of face value.The tax rate is 35 percent.What is the company's WACC?

Accepted Answer

The WACC is calculated by weighting the cost of each component by its proportion in the firm's capital structure. The market value of equity is 60,000 shares * $45 = $2,700,000. The market value of preferred stock is 12,000 shares * $52 = $624,000. The market value of debt is $400,000 * 1.02 = $408,000. The total market value is $2,700,000 + $624,000 + $408,000 = $3,732,000. The weights are: equity = $2,700,000 / $3,732,000, preferred = $624,000 / $3,732,000, debt = $408,000 / $3,732,000. WACC = (equity weight * cost of equity) + (preferred weight * cost of preferred) + (debt weight * after-tax cost of debt). Calculating gives WACC ≈ 11.83%.

Question 2

Asian Foods needs $110,000 for a new project.The firm has a target capital structure of 30 percent debt and 70 percent external equity.The flotation cost of debt is 5.25 percent compared to 10.15 percent for equity.What amount does the firm need to raise?

Accepted Answer

To find the amount the firm needs to raise, we calculate the weighted average flotation cost and adjust the project cost accordingly. The weighted flotation cost is (0.30 * 5.25%) + (0.70 * 10.15%) = 8.365%. The amount to raise is $110,000 / (1 - 0.08365) = $120,455.54.

Question 3

The Red Hen currently has a debt-to-equity ratio of 0.45,its cost of equity is 13.3 percent,and its beta is 1.49.The pretax cost of debt is 7.2 percent,the tax rate is 35 percent,and the risk-free rate is 3.1 percent.The firm's target debt-to-equity ratio is 0.4.What discount rate should be assigned to a new project the firm is considering if the project is equally as risky as the overall firm and will be financed solely with debt?

Accepted Answer

The answer of The Red Hen currently has a debt-to-equity...

Question 4

Finally There! has 1,500 bonds outstanding with a $1,000 par value,a yield to maturity of 6.4 percent,and a market price of $989 each.The firm also has 74,000 shares of common stock outstanding at a price per share of $35 and a beta of 1.08.The risk-free rate is 2 percent,the market risk premium is 7 percent,and the tax rate is 34 percent.What is the company's WACC?

Accepted Answer

The WACC is calculated using the formula: WACC = (E/V * Re) + (D/V * Rd * (1-Tc)), where E is the market value of equity, V is the total market value of the firm's financing (equity + debt), Re is the cost of equity, D is the market value of debt, Rd is the cost of debt, and Tc is the tax rate. The cost of equity (Re) is calculated using the CAPM formula: Re = risk-free rate + beta * market risk premium. The cost of debt (Rd) is the yield to maturity. Plugging in the given values, the WACC is approximately 7.62%.

Question 5

Jeanette's Medical Supply has a beta of 1.47 and its R_WACC is 11.8 percent.The market risk premium is 7.4 percent,and the risk-free rate is 3.6 percent.The firm's cash flow at Time 3 is $73,900 with a growth rate of 2.2 percent.What is the terminal value of the firm at Time 3?

Accepted Answer

TV₃ = [$73,900(1 + 0.022)] / (0.118 − 0.022)= $786,727.08

Question 6

A levered firm has a target capital structure of 30 percent debt and 70 percent equity.The aftertax cost of debt is 5.1 percent,the tax rate is 35 percent,and the cost of equity is 13.1 percent.The firm is considering a project that is equally as risky as the overall firm.The project has an initial cash outflow of $1.2 million and annual cash inflows of $516,000 at the end of each year for 3 years.What is the NPV of the project?

Accepted Answer

The answer of A levered firm has a target capital...

Question 7

Green Roof Foods currently has a debt-to-equity ratio of 0.53,its cost of equity is 14.2 percent,and its pretax cost of debt is 6.8 percent.The tax rate is 35 percent,and the risk-free rate is 3.1 percent.The firm's preferred capital structure consists of 35 percent debt.What discount rate should be assigned to a new project the firm is considering if the project is equally as risky as the overall firm and will be financed solely with equity?

Accepted Answer

Discount rate = (1 − 0.35)(0.142)+ 0.35(0.068)(1 − 0.35)= 0.1078,or 10.78%

Question 8

A firm has net income of $21,350,depreciation of $2,780,interest of $640,and taxes of $10,990.The EBITDA multiple is 10.2.What is the value of the firm?

Accepted Answer

EV = ($21,350 + $2,780 + $640 + $10,990)(10.2)= $364,752

Question 9

JJ's Ice Cream has 1,800 bonds outstanding that are selling for $1,015 each,mature in 11 years,and have an aftertax rate of return of 6.2 percent.There are 45,000 shares of common stock outstanding with a market price of $50 a share.The next annual dividend will be $2.40 per share with annual increases thereafter of 2.5 percent.The risk-free rate is 4 percent,the market risk premium is 7 percent,and the tax rate is 35 percent.What is the company's WACC?

Accepted Answer

The answer of JJ's Ice Cream has 1,800 bonds outstanding...

Question 10

The Flying Dove has 1,600 bonds outstanding with a $1,000 par value,a coupon rate of 5.5 percent,12 years to maturity,annual interest payments,and a market price equal to par.The firm also has 52,000 shares of common stock outstanding at a price per share of $43 and a beta of 1.3.The risk-free rate is 3 percent,the market risk premium is 7 percent,and the tax rate is 35 percent.What is the company's WACC?

Accepted Answer

The correct answer is A.The WACC is calculated as follows:WACC = (E/V) * Re + (D/V) * Rd * (1 - Tc)where:E = market value of equityV = total value of the firmRe = cost of equityD = market value of debtRd = cost of debtTc = tax rateIn this case, we have:E = 52,000 * $43 = $2,224,000V = E + D = $2,224,000 + $1,600,000 * $1,000 = $3,824,000Re = 3% + 1.3 * 7% = 12.1%D = $1,600,000 * $1,000 = $1,600,000Rd = 5.5%Tc = 35%Therefore, the WACC is:WACC = (2,224,000/3,824,000) * 12.1% + (1,600,000/3,824,000) * 5.5% * (1 - 0.35) = 8.54%

Question 11

NuPress Valet has a proposed investment with an initial cost of $62 million and cash flows of $12.5 million for 5 years.Debt represents 44 percent of the capital structure.The cost of equity is 13.7 percent,the pretax cost of debt is 8.5 percent,and the tax rate is 34 percent.What is the company's WACC?

Accepted Answer

WACC = (1 − 0.44)(0.137)+ 0.44(0.085)(1 − 0.34)= 0.1014,or 10.14%

Question 12

Leo's Cars has a beta of 1.1 and its R_WACC is 13.6 percent.The market risk premium is 7.2 percent,and the risk-free rate is 2.3 percent.The firm's cash flow at Time 4 is $28,800 with a growth rate of 2.1 percent.What is the value of the firm at Time 4?

Accepted Answer

TV₄ = [$28,800 × (1 + 0.021)] / (0.136 − 0.021)= $255,693.91

Question 13

Golden Eagle has 1,250 bonds outstanding with a market value of $980 each.The pretax cost of debt is 7.2 percent.The firm also has 46,000 shares of common stock outstanding at a price per share of $32 and a beta of 1.21.The risk-free rate is 2.4 percent,the market risk premium is 7.3 percent,and the tax rate is 34 percent.What is the company's WACC?

Accepted Answer

The WACC is calculated using the formula: WACC = (E/V * Re) + (D/V * Rd * (1-Tc)), where E is the market value of equity, V is the total market value of the firm's financing (equity + debt), Re is the cost of equity, D is the market value of debt, Rd is the cost of debt, and Tc is the tax rate. The cost of equity (Re) is calculated using the CAPM formula: Re = risk-free rate + beta * market risk premium. Plugging in the values: Re = 2.4% + 1.21 * 7.3% = 11.233%. The market value of equity (E) is 46,000 * $32 = $1,472,000. The market value of debt (D) is 1,250 * $980 = $1,225,000. The total value (V) is $1,472,000 + $1,225,000 = $2,697,000. The after-tax cost of debt is 7.2% * (1 - 0.34) = 4.752%. Therefore, WACC = ($1,472,000/$2,697,000 * 11.233%) + ($1,225,000/$2,697,000 * 4.752%) = 10.09%.

Question 14

Alaskan Markets has a target capital structure of 40 percent debt and 60 percent equity.The pretax cost of debt is 6.3 percent,the tax rate is 35 percent,and the cost of equity is 14.6 percent.The firm is considering a project that is equally as risky as the overall firm.The project has an initial cash outflow of $1.92 million and annual cash inflows of $562,000 at the end of each year for 4 years.What is the NPV of the project?

Accepted Answer

1. Calculate the Weighted Average Cost of Capital (WACC):
WACC = (0.4 x 6.3%) x (1-0.35) + (0.6 x 14.6%) = 9.24%

2. Calculate the present value of cash inflows:
PV = (562,000 / 1.0924) + (562,000 / (1.0924)^2) + (562,000 / (1.0924)^3) + (562,000 / (1.0924)^4) = $1,784,087.95

3. Calculate the NPV:
NPV = PV - Initial Investment = $1,784,087.95 - $1,920,000 = $-135,912.05

Since the NPV is negative, the project should be rejected.

Question 15

Buster's target debt-to-equity ratio is 0.65,its cost of equity is 13.7 percent,and its beta is 0.9.The after-tax cost of debt is 5.8 percent,the tax rate is 34 percent,and the risk-free rate is 2.3 percent.What discount rate should be assigned to a new project the firm is considering if the project's beta is estimated at 0.87?

Accepted Answer

The discount rate for the project can be calculated using the Capital Asset Pricing Model (CAPM) formula: Cost of Equity = Risk-free rate + Beta * (Market return - Risk-free rate). Adjust the cost of equity for the project's beta and use the weighted average cost of capital (WACC) formula to find the discount rate.

Question 16

The UpTowner has a beta of 1.18,a debt-to-equity ratio of 0.36,and a cost of equity of 11.74 percent.The market rate of return is 10.4 percent,and the tax rate is 35 percent.If the pretax cost of debt is 6.9 percent,what is the company's WACC?

Accepted Answer

R_WACC= (1 / 1.36)(0.1174)+ (0.36 / 1.36)(0.069)(1 - 0.35)= 0.0982,or 9.82%

Question 17

A firm has an EBIT of $41,300,depreciation of $1,200,interest of $850,and taxes of $210.The EBITDA multiple is 9.6.What is the value of the firm?

Accepted Answer

EV = ($41,300 + $1,200)(9.6)= $408,000

Question 18

The Bird Carver has a target WACC of 9.5 percent.The firm has an aftertax cost of debt of 5.4 percent and a cost of equity of 14 percent.What debt-to-equity ratio is needed for the firm to achieve its target WACC?

Accepted Answer

The correct answer is A.The debt-to-equity ratio is calculated as follows:Debt-to-equity ratio = (After-tax cost of debt * Debt) / (Cost of equity * Equity)Substituting the given values, we get:Debt-to-equity ratio = (5.4% * Debt) / (14% * Equity)We want the target WACC to be 9.5%, which can be expressed as:WACC = (After-tax cost of debt * Debt-to-equity ratio) + (Cost of equity * (1 - Debt-to-equity ratio))Substituting the given values, we get:9.5% = (5.4% * Debt-to-equity ratio) + (14% * (1 - Debt-to-equity ratio))Solving for Debt-to-equity ratio, we get:Debt-to-equity ratio = 0.75

Question 19

Zee's Toy Store needs $242,000 for expansion.The firm has a target capital structure of 45 percent debt and 55 percent external equity.The flotation cost of debt is 5.2 percent compared to 8.5 percent for equity.What amount does the firm need to raise to fund the expansion?

Accepted Answer

First, we need to calculate the amount of debt and equity needed.

Debt = 0.45 x $242,000 = $108,900 
Equity = 0.55 x $242,000 = $133,100

Next, we need to adjust for the flotation costs.

Flotation cost of debt = 5.2%
Flotation cost of equity = 8.5%

Adjusted debt = $108,900 / (1 - 0.052) = $114,835 
Adjusted equity = $133,100 / (1 - 0.085) = $145,205

Total amount needed = $114,835 + $145,205 = $260,040

So, the closest answer choice is C: $260,257.03.

Question 20

Taylor's has a beta of 0.97 and a debt-to-equity ratio of 0.46.The market rate of return is 11.3 percent,the tax rate is 34 percent,and the risk-free rate is 2.2 percent.The pretax cost of debt is 6.4 percent.What is the firm's WACC?

Accepted Answer

The answer of Taylor's has a beta of 0.97 and...

Quiz 12: Risk, Cost of Capital, and Valuation