Deck 11: Cost of Capital

Question 1

Use the data provided on Cadbury to answer the question below.The risk free rate is 4.25%.The expected return on the market portfolio is 9.75%.The corporate tax rate is 40%.The face value of Cadbury's outstanding bonds is 2.450 billion pounds sterling.The coupon rate on Cadbury's bonds is 4.5%.Assume that the bonds pay annual coupons.The yield to maturity on Cadbury's bonds is 4.5%.Cadbury's bonds mature in 7 years.Cadbury has 1.650 billion common shares outstanding.The market price of Cadbury's common shares as of Dec 31,2008 is 6.25 pounds sterling.Cadbury's Beta is 0.8.What is Cadbury's cost of debt (after-tax)?

A) 2.70%
B) 4.50%
C) 7.80%
D) 8.65%
E) 8.70%

Answer 1

2.70%

Question 2

A firm can raise its value without earning at least the WACC.

Answer 2

False

Question 3

The weighted average of the firm's costs of equity,preferred stock,and after tax debt is the:

A) reward to risk ratio for the firm.
B) expected capital gains yield for the stock.
C) expected capital gains yield for the firm.
D) portfolio beta for the firm.
E) weighted average cost of capital (WACC).

Answer 3

weighted average cost of capital (WACC).

Question 4

Pan American Airlines' shares are currently trading at $69.25 each.The yield on Pan Am's debt is 4% and the firm's beta is 0.7.The T-Bill rate is 4% and the expected return on the market (E (k_M))is 9%.The company's target capital structure is 25% debt and 75% equity.Pan American Airlines pays a combined federal and state tax rate of 35%.What is Pan Am's cost of equity?

A) 7.0%
B) 7.5%
C) 8.0%
D) 8.5%
E) 9.0%

Question 5

Katie's Boutique has zero-coupon bonds outstanding that mature in four years.The bonds have a face value of $1,000 and a current market price of $820.What is the company's pre-tax cost of debt?

A) 5.01 percent
B) 5.09 percent
C) 5.18 percent
D) 5.36 percent
E) 5.49 percent

Question 6

The discount rate assigned to an individual project should be based on:

A) the firm's weighted average cost of capital.
B) the actual sources of funding used for the project.
C) an average of the firm's overall cost of capital for the past five years.
D) the current risk level of the overall firm.
E) the risk level of the project itself.

Question 7

The return that shareholders require on their investment in the firm is called the:

A) dividend yield.
B) cost of equity.
C) capital gains yield.
D) cost of capital.
E) income return.

Question 8

Which of the following statements is incorrect?

A) The cost of debt changes when market yields change.
B) The cost of debt should only be adjusted when the firm sells new bonds.
C) The cost of debt should always incorporate the net proceeds from bond sales.
D) The cost of debt reflects the borrowing costs at current market interest rates.
E) The cost of debt should include any broker's fees incurred when selling new bonds.

Question 9

Assigning separate discount rates to individual projects when determining which projects should be accepted by the firm:

A) may cause the firm's overall weighted average cost of capital to vary over time if the projects accepted change the overall risk level of the firm.
B) will cause the firm's overall cost of capital to remain constant over time.
C) will cause the firm's overall cost of capital to decrease over time.
D) will change the debt-equity ratio of the firm over time.
E) negates the principle goal of creating the most value for the shareholders.

Question 10

The opportunity cost associated with the firm's capital investment in a project is called its:

A) cost of capital.
B) beta coefficient.
C) capital gains yield.
D) sunk cost.
E) internal rate of return.

Question 11

The Delta Co.owns retail stores that market home building supplies.Largo,Inc.builds single family homes in residential developments.Delta has a beta of 1.22 and Largo has a beta of 1.34.The risk-free rate of return is 4 percent and the market risk premium is 6.5 percent.What should Delta use as their cost of equity if they decide to purchase some land and create a new residential community?

A) 11.93 percent
B) 12.32 percent
C) 12.43 percent
D) 12.57 percent
E) 12.71 percent

Question 12

Pan American Airlines' shares are currently trading at $69.25 each.The yield on Pan Am's debt is 4% and the firm's beta is 0.7.The T-Bill rate is 4% and the expected return on the market (E (k_M))is 9%.The company's target capital structure is 25% debt and 75% equity.Pan American Airlines pays a combined federal and state tax rate of 35%.What is Pan Am's cost of debt (after tax)?

A) 2.6%
B) 3.0%
C) 3.3%
D) 3.5%
E) 4.0%

Question 13

Ernst's Electrical has a bond issue outstanding with ten years to maturity.These bonds have a $1,000 face value,a 5 percent coupon,and pay interest semi-annually.The bonds are currently quoted at 96 percent of face value.What is Ernst's pre-tax cost of debt?

A) 4.47 percent
B) 4.97 percent
C) 5.33 percent
D) 5.53 percent
E) 5.94 percent

Question 14

Wilson's Cabinets has bonds outstanding that mature in eight years,have a 6 percent coupon and pay interest annually.These bonds have a face value of $1,000 and a current market price of $1,020.What is the company's pre-tax cost of debt?

A) 5.68 percent
B) 6.19 percent
C) 6.34 percent
D) 6.82 percent
E) 7.57 percent

Question 15

A firm's cost of debt often differs from the yield reported on its bonds because

A) the firm's cost of debt is unknown when the bonds are first sold.
B) the underwriting costs for new bond issues are not tax deductible, raising the cost of debt relative to bond yields.
C) the cost of debt changes infrequently since bond rating agencies do not change their recommendations often.
D) the interest paid on corporate bonds is tax deductible.
E) speculators can drive the cost of debt down so that bond yields exceed it.

Question 16

The overall cost of capital for a retail store:

A) is equivalent to the after-tax cost of the firm's liabilities.
B) should be used as the required return when analyzing a potential acquisition of a wholesale distributor.
C) reflects the return investors require on the total assets of the firm.
D) remains constant even when the debt-equity ratio changes.
E) is unaffected by changes in corporate tax rates.

Question 17

The Bet-r-Bilt Company has a six-year bond outstanding with a 5 percent coupon.Interest payments are paid semi-annually.The face amount of the bond is $1,000.This bond is currently selling for 98 percent of its face value.What is the company's pre-tax cost of debt?

A) 4.72 percent
B) 5.31 percent
C) 5.35 percent
D) 5.39 percent
E) 5.42 percent

Question 18

The cost of capital:

A) will decrease as the risk level of a firm increases.
B) is primarily dependent on the source of the funds used in a project.
C) implies that a project will produce a positive net present value only when the rate of return on the project is less than the cost of capital.
D) remains constant for all projects sponsored by the same firm.
E) depends on how the funds are going to be utilized.

Question 19

The cost of capital assigned to an individual project should be that rate which:

A) corresponds to the risk level of the firm's division which has responsibility for the project.
B) corresponds to the source of the funds used for the project.
C) corresponds to the latest pre-tax cost of debt and equity for the overall firm.
D) is the firm's current weighted average cost of capital.
E) considers both the nature and the characteristics of the actual project.

Question 20

When evaluating a project,a firm's managers should select projects whose cash flows

A) exceed some target cash flow level set by management.
B) result in a return that exceeds the cost of funds to finance the project.
C) have the lowest NPVs after discounting cash flows by the project's capital cost.
D) are subject to less risk than competing projects.
E) produce higher returns than the firm's average cost of capital.

Question 21

The outstanding bonds of The Purple Fiddle are priced at $898 and mature in nine years.These bonds have a 6 percent coupon and pay interest annually.The firm's tax rate is 35 percent.What is the firm's after-tax cost of debt?

A) 4.94 percent
B) 5.24 percent
C) 5.30 percent
D) 7.18 percent
E) 7.61 percent

Question 22

The dividend just paid on Thompson Industry stock was $2 per share and it is expected to grow 8% each year.If the stock is currently selling at $30 per share,what is Thompson's cost of equity? (Round to the nearest percent.)

A) 13%
B) 18%
C) 12%
D) 15%
E) 21%

Question 23

A $1,000 par bond is currently selling for $1,100.It has a 9% coupon rate,fifteen years remaining to maturity,and pays interest semi-annually.If the firm's tax rate is 35%,what is the after-tax cost of debt?

A) 9.00%
B) 7.84%
C) 6.07%
D) 5.85%
E) 5.10%

Question 24

Ray Stokes is raising capital for a new company called NO Balloons Inc.NO Balloons will manufacture and sell festive balloons.Because of the shortage of helium,the balloons will be filled with nitrous oxide instead.NO Balloons plans to finance the business with common equity and long-term debt.It plans to sell 12 million shares of common stock and 200,000 bonds.Each bond will have a coupon rate of 5%,will pay its coupons semi-annually and will have a face value of $1,000.The common stock will be issued at a price of $19.5 a share and has a beta of 1.1.The bonds will sell for 89% of face value and have a 6.25% yield to maturity.The market risk premium is 5.25%,T-bills are yielding 3.5%,and NO Balloons' tax rate is 36%.What is NO Balloons' cost of debt (after tax)?

A) 3.6%
B) 4.0%
C) 4.3%
D) 5.3%
E) 6.3%

Question 25

Tom's Ventures has a zero coupon bond issue outstanding that matures in thirteen years.The bonds are selling at 48 percent of par value.The company's tax rate is 34 percent.What is the company's after-tax cost of debt?

A) 3.83 percent
B) 4.11 percent
C) 4.73 percent
D) 4.80 percent
E) 5.81 percent

Question 26

Donnelly and Son pay $8 as the annual dividend on their preferred stock.Currently,this stock is selling for $72 a share.What is Donnelly's cost of preferred stock?

A) 7.78 percent
B) 9.00 percent
C) 9.72 percent
D) 11.11 percent
E) 11.99 percent

Question 27

Swiss Cheeses,Inc.has paid annual dividends of $1.00,$1.04,$1.09,and $1.15 per share over the last four years,respectively.The stock is currently selling for $42 a share.What is this firm's cost of equity?

A) 7.45 percent
B) 7.64 percent
C) 7.83 percent
D) 7.87 percent
E) 8.02 percent

Question 28

Blackwater Adventures has a bond issue outstanding that matures in sixteen years.The bonds pay interest semi-annually.Currently,the bonds are quoted at 103 percent of face value and carry a 9 percent coupon.The firm's tax rate is 34 percent.What is the firm's after-tax cost of debt?

A) 5.19 percent
B) 5.71 percent
C) 7.86 percent
D) 8.65 percent
E) 11.41 percent

Question 29

What is the after-tax cost of preferred stock if its price is $25 per share and it pays a $1 per share dividend? Assume the firm's marginal tax rate is 25% and there are no flotation costs.

A) 5%
B) 9%
C) 3%
D) 4%
E) 1%

Question 30

If investors require a 10% after-tax return from a firm's preferred stock and its dividend is $5.00 per share,what is the price per share assuming a marginal tax rate of 25% and no flotation costs?

A) $50.00
B) $12.50
C) $37.50
D) $18.75
E) $20.00

Question 31

Jensen's Travel Agency has a 7 percent preferred stock outstanding that is currently selling for $48 a share.The preferred stock has a $100 par value.The market rate of return is 10 percent and the firm's tax rate is 34 percent.What is the Jensen's cost of preferred stock?

A) 8.75 percent
B) 9.62 percent
C) 11.98 percent
D) 13.25 percent
E) 14.58 percent

Question 32

If Fluppy Dog Grooming shareholders require a 20% return,what is the dividend growth rate if the dividend yield is 12%?

A) 32%
B) 6%
C) 20%
D) 12%
E) 8%

Question 33

Rekall Inc.,the memory implant company,has 7 million shares of common stock outstanding and 100,000 semi-annual bonds.The bonds have 6 years to maturity,a 9.05% coupon rate and a face value of $1,000 each.The common stock currently sells for $29.94 and just paid a dividend of $2.50.Dividends are paid annually and are expected to grow in perpetuity at 3%.The bonds sell for 94% of face value and have a 10.42% yield to maturity.The market risk premium is 5.5%,T-bills are yielding 5% and the tax rate is 30%.What is Rekall's cost of debt (after-tax)? Round to one decimal place.

A) 7.3%
B) 7.8%
C) 8.6%
D) 9.4%
E) 10.4%

Question 34

Gaunt Computer Displays plans to issue bonds to finance research and development for computer monitors that can be read while sleeping.The firm's investment bankers report that the bonds should be sold to yield 10%.What is Gaunt's cost of debt if its marginal tax rate is 30%?

A) 3.0%
B) 9.3%
C) 9.0%
D) 7.0%
E) 10.0%

Question 35

Neeson Co.paid dividends in the last three years of $3.00,$3.15,and $3.31,respectively.The current stock price of Neeson is $30.00.Assuming the next dividend will grow at the same rate as the last three years,what is Neeson's cost of equity?

A) 16.62%
B) 10.00%
C) 11.59%
D) 16.03%
E) 12.52%

Question 36

Rekall Inc.,the memory implant company,has 7 million shares of common stock outstanding and 100,000 semi-annual bonds.The bonds have 6 years to maturity,a 9.05% coupon rate and a face value of $1,000 each.The common stock currently sells for $29.94 and just paid a dividend of $2.50.Dividends are paid annually and are expected to grow in perpetuity at 3%.The bonds sell for 94% of face value and have a 10.42% yield to maturity.The market risk premium is 5.5%,T-bills are yielding 5% and the tax rate is 30%.What is Rekall's cost of equity?

A) 8.6%
B) 10.4%
C) 10.5%
D) 11.4%
E) 11.6%

Question 37

Neal Enterprises common stock is currently priced at $36.80 a share.The company is expected to pay $1.20 per share next month as their annual dividend.The dividends have been increasing by 2 percent annually and are expected to continue doing so.What is the cost of equity for Neal Enterprises?

A) 5.18 percent
B) 5.22 percent
C) 5.26 percent
D) 5.33 percent
E) 5.67 percent

Question 38

Ben's Ice Cream just paid their annual dividend of $.75 a share.The stock has a market price of $32 and a beta of .90.The return on the U.S.Treasury bill is 4 percent and the market has a 12 percent rate of return.What is the cost of equity?

A) 7.24 percent
B) 8.67 percent
C) 11.20 percent
D) 12.92 percent
E) 14.80 percent

Question 39

Teri's Tires has 7 percent preferred stock outstanding that sells for $68 a share.The preferred stock has a $100 par value.What is Teri's cost of preferred stock?

A) 9.52 percent
B) 9.71 percent
C) 10.29 percent
D) 10.78 percent
E) 11.76 percent

Question 40

The common stock of Big Birds Unlimited has a required return of 8 percent and a growth rate of 4 percent.The last annual dividend was $.60 a share.What is the current price of this stock?

A) $7.50
B) $7.80
C) $10.00
D) $15.00
E) $15.60

Question 41

A firm's pre-tax cost of debt is 10%.If the firm is of average risk,what is the cost of equity using the bond yield plus premium approach?

A) 15%
B) 13%
C) 14%
D) 10%
E) 11%

Question 42

Myopia Camera Stores has a cost of equity of 18% and the market return is 12%.What is the firm's beta if the risk-free rate is 6%?

A) 2.0
B) 1.0
C) 0.8
D) 2.3
E) 1.3

Question 43

The cost of equity for a firm is:

A) determined by directly observing the rate of return required by equity investors.
B) based on estimates derived from financial models.
C) equivalent to a leveraged firm's cost of capital.
D) equal to the risk-free rate of return plus the market risk premium.
E) equal to the risk-free rate of return plus the dividend growth rate.

Question 44

The market yield on Spice Grills' bonds is 15%,and the firm's marginal tax rate is 33%.What is their shareholders' required return if the equity risk premium is 4%?

A) 15%
B) 11%
C) 14%
D) 19%
E) 12%

Question 45

Rosie's Grill has a beta of 1.2,a stock price of $26 and an expected annual dividend of $1.30 a share which is to be paid next month.The dividend growth rate is 4 percent.The market has a 10 percent rate of return and a risk premium of 6 percent.What is the average expected cost of equity for Rosie's Grill?

A) 9.20 percent
B) 9.70 percent
C) 10.10 percent
D) 10.30 percent
E) 11.40 percent

Question 46

On-line broker Swab-Qtips has a beta of 1.1,and its market return and risk-free rates are 15% and 5%,respectively.What is Swab's cost of equity?

A) 18%
B) 10%
C) 25%
D) 16%
E) 26%

Question 47

The market risk premium:

A) varies over time as both the risk-free rate of return and the market rate of return vary.
B) plus the risk-free rate of return equals the cost of capital for any firm with a beta of zero.
C) is equal to one percent for a risk-free asset.
D) is equal to the risk-free rate of return multiplied by the beta of a firm.
E) is modified by the standard deviation when computing the cost of equity.

Question 48

Martha' s Interiors has a current beta of 1.2.The market risk premium is 6 percent and the risk-free rate of return is 4 percent.By how much will the cost of equity increase if the company completes an acquisition such that their company beta rises to 1.4?

A) 0.12 percent
B) 0.24 percent
C) 1.20 percent
D) 2.40 percent
E) 2.47 percent

Question 49

Which component of a firm's capital structure is the most difficult to estimate?

A) Preferred stock
B) Equity
C) Bank loans
D) Bond-financed debt
E) Private placements of debt

Question 50

The constant dividend growth model:

A) generally produces the same estimated cost of equity for a firm regardless of the source of information used to predict the rate of growth.
B) can only be used if historical dividend information is available.
C) ignores the risk that future dividends may vary from their estimated values.
D) assumes that both the dividend amount and the stock price are not constant over time.
E) uses beta to measure the systematic risk of the firm.

Question 51

The return on the market is 11%.A firm's beta is 1.4,and the risk-free rate is 6%.The stock is currently selling for $18 and the next dividend is expected to be $1.75.The firm's growth rate is 5%.The pre-tax cost of debt is 10% and the equity risk premium is 5%.Estimate the cost of equity by taking an average of the three methods to determine the cost of equity.

A) 15.0%
B) 14.2%
C) 13.0%
D) 14.7%
E) 11.5%

Question 52

The pre-tax cost of debt for a firm:

A) is equal to the yield to maturity on the outstanding bonds of the firm.
B) is equal to the coupon rate of the outstanding bonds of the firm.
C) is equivalent to the current yield on the outstanding bonds of the firm.
D) is based on the yield to maturity that existed when the currently outstanding bonds were originally issued.
E) has to be estimated as it cannot be directly observed in the market.

Question 53

Ray Stokes is raising capital for a new company called NO Balloons Inc.NO Balloons will manufacture and sell festive balloons.Because of the shortage of helium,the balloons will be filled with nitrous oxide instead.NO Balloons plans to finance the business with common equity and long-term debt.It plans to sell 12 million shares of common stock and 200,000 bonds.Each bond will have a coupon rate of 5%,will pay its coupons semi-annually and will have a face value of $1,000.The common stock will be issued at a price of $19.5 a share and has a beta of 1.1.The bonds will sell for 89% of face value and have a 6.25% yield to maturity.The market risk premium is 5.25%,T-bills are yielding 3.5%,and NO Balloons' tax rate is 36%.What is NO Balloons' cost of equity?

A) 5.25%
B) 7.75%
C) 8.75%
D) 9.28%
E) 9.63%

Question 54

The constant dividend growth model:

A) can be used to estimate the cost of equity for any corporation.
B) is applicable only to firms that pay a constant dividend.
C) is highly dependent upon the estimated rate of growth.
D) is considered quite complex.
E) considers the risk of the firm.

Question 55

When using the bond yield plus risk premium approach to estimating the cost of equity,the equity risk premium is usually about:

A) 3-5%.
B) 8-10%.
C) 20-25%.
D) 10-15%.
E) 30-33%.

Question 56

The return that lenders require on their loaned funds to the firm is called the:

A) coupon rate.
B) current yield.
C) cost of debt.
D) capital gains yield.
E) cost of capital.

Question 57

Use the data provided on Cadbury to answer the question below.The risk free rate is 4.25%.The expected return on the market portfolio is 9.75%.The corporate tax rate is 40%.The face value of Cadbury's outstanding bonds is 2.450 billion pounds sterling.The coupon rate on Cadbury's bonds is 4.5%.Assume that the bonds pay annual coupons.The yield to maturity on Cadbury's bonds is 4.5%.Cadbury's bonds mature in 7 years.Cadbury has 1.650 billion common shares outstanding.The market price of Cadbury's common shares as of Dec 31,2008 is 6.25 pounds sterling.Cadbury's Beta is 0.8.What is Cadbury's cost of equity?

A) 4.20%
B) 4.40%
C) 7.80%
D) 8.65%
E) 8.70%

Question 58

Daniel's Enterprises has a beta of 1.98 and a growth rate of 12 percent.The stock is currently selling for $12 a share.The overall stock market has an 11 percent rate of return and a risk premium of 8 percent.What is the expected rate of return on Daniel's Enterprises stock?

A) 10.00 percent
B) 15.85 percent
C) 16.67 percent
D) 18.84 percent
E) 19.06 percent

Question 59

Martin Industries just paid an annual dividend of $1.20 a share.The market price of the stock is $26.60 and the growth rate is 4 percent.What is the firm's cost of equity?

A) 8.38 percent
B) 8.51 percent
C) 8.57 percent
D) 8.69 percent
E) 8.74 percent

Question 60

Which method is best to compute a firm's cost of equity?

A) CAPM
B) Bond yield plus risk premium
C) Constant growth model
D) All of these methods
E) None of these methods; use the current market price per share.

Question 61

The proportions of the market value of the firm's assets financed via debt,common stock,and preferred stock are called the firm's:

A) financing costs.
B) portfolio weights.
C) beta coefficients.
D) capital structure weights.
E) costs of capital.

Question 62

Use the data provided on Cadbury to answer the question below.The risk free rate is 4.25%.The expected return on the market portfolio is 9.75%.The corporate tax rate is 40%.The face value of Cadbury's outstanding bonds is 2.450 billion pounds sterling.The coupon rate on Cadbury's bonds is 4.5%.Assume that the bonds pay annual coupons.The yield to maturity on Cadbury's bonds is 4.5%.Cadbury's bonds mature in 7 years.Cadbury has 1.650 billion common shares outstanding.The market price of Cadbury's common shares as of Dec 31,2008 is 6.25 pounds sterling.Cadbury's Beta is 0.8.What is the capital structure weight for equity?

A) 0.149
B) 0.192
C) 0.808
D) 0.851
E) 0.862

Question 63

Initech has 7 million shares of common stock outstanding and 50,000 bonds outstanding.The bonds pay semi-annual coupons at an annual rate of 9.05%,have 6 years to maturity and a face value of $1,000 each.The common stock currently sells for $30 a share and has a beta of 1.The bonds sell for 94% of face value and have a 10.42% yield to maturity.The market risk premium is 5.5%,T-bills are yielding 5% and the tax rate is 30%.What is the firm's capital structure weight for debt?

A) 18.3%
B) 19.3%
C) 20.3%
D) 21.3%
E) 22.3%

Question 64

The weighted average cost of capital for a firm is the:

A) discount rate which the firm should apply to all of the projects it undertakes.
B) overall rate which the firm must earn on its existing assets to maintain the value of its stock.
C) rate the firm should expect to pay on its next bond issue.
D) maximum rate which the firm should require on any projects it undertakes.
E) rate of return that the firm's preferred stockholders should expect to earn over the long term.

Question 65

Gillian's Boutique has 850,000 shares of common stock outstanding at a market price of $16 a share.The company also has 15,000 bonds outstanding that are quoted at 98 percent of face value.What weight should be given to the common stock when Gillian's computes their weighted average cost of capital? Round answer to nearest percent.

A) 48 percent
B) 49 percent
C) 50 percent
D) 51 percent
E) 52 percent

Question 66

Pan American Airlines' shares are currently trading at $69.25 each.The yield on Pan Am's debt is 4% and the firm's beta is 0.7.The T-Bill rate is 4% and the expected return on the market (E (k_M))is 9%.Pan American Airlines pays a combined federal and state tax rate of 35%.The company's target capital structure is 25% debt and 75% equity.Pan Am's cost of debt is 2.6% and the company's cost of equity is 7.5%.What is the weighted average cost of capital for Pan Am?

A) 2.6%
B) 4.3%
C) 5.3%
D) 6.3%
E) 7.5%

Question 67

The cost of preferred stock:

A) is equal to the dividend yield on the stock.
B) is equal to the yield to maturity.
C) is highly dependent on the growth rate.
D) varies directly with the stock's price.
E) is difficult to determine.

Question 68

Watson's Automotive has a $400,000 bond issue outstanding that is selling at 102 percent of face value.Watson's also has 4,500 shares of preferred stock and 21,000 shares of common stock outstanding.The preferred stock has a market price of $44 a share compared to a price of $21 a share for the common stock.What is the weight of the debt as it relates to the firm's weighted average cost of capital? Round answer to nearest percent.

A) 38 percent
B) 39 percent
C) 40 percent
D) 41 percent
E) 42 percent

Question 69

The Auto Group has 1,200 bonds outstanding that are selling for $980 each.The company also has 7,500 shares of preferred stock at a market price of $40 each.The common stock is priced at $32 a share and there are 32,000 shares outstanding.What is the weight of the preferred stock as it relates to the firm's weighted average cost of capital?

A) 10 percent
B) 12 percent
C) 14 percent
D) 16 percent
E) 18 percent

Question 70

Rekall Inc.,the memory implant company,has 7 million shares of common stock outstanding and 100,000 semi-annual bonds.The bonds have 6 years to maturity,a 9.05% coupon rate and a face value of $1,000 each.The common stock currently sells for $29.94 and just paid a dividend of $2.50.Dividends are paid annually and are expected to grow in perpetuity at 3%.The bonds sell for 94% of face value and have a 10.42% yield to maturity.The after-tax cost of debt is 7.294%,and the cost of equity is 11.6%.What is Rekall's WACC?

A) 7.09%
B) 9.51%
C) 9.94%
D) 10.27%
E) 11.24%

Question 71

Ray Stokes is raising capital for a new company called NO Balloons Inc.NO Balloons will manufacture and sell festive balloons.Because of the shortage of helium,the balloons will be filled with nitrous oxide instead.NO Balloons plans to finance the business with common equity and long-term debt.It plans to sell 12 million shares of common stock and 200,000 bonds.Each bond will have a coupon rate of 5% and will have a face value of $1,000.The common stock will be issued at a price of $19.5 a share.The bonds will sell for 89% of face value.The after-tax cost of debt is 4% and the cost of equity of 9.275%.What is NO Balloons' WACC?

A) 5%
B) 6%
C) 7%
D) 8%
E) 9%

Question 72

Rekall Inc.,the memory implant company,has 7 million shares of common stock outstanding and 100,000 semi-annual bonds.The bonds have 6 years to maturity,a 9.05% coupon rate and a face value of $1,000 each.The common stock currently sells for $29.94 and just paid a dividend of $2.50.Dividends are paid annually and are expected to grow in perpetuity at 3%.The bonds sell for 94% of face value and have a 10.42% yield to maturity.The market risk premium is 5.5%,T-bills are yielding 5% and the tax rate is 30%.What is the capital structure weight for equity?

A) 0.67
B) 0.68
C) 0.69
D) 0.70
E) 0.71

Question 73

Ray Stokes is raising capital for a new company called NO Balloons Inc.NO Balloons will manufacture and sell festive balloons.Because of the shortage of helium,the balloons will be filled with nitrous oxide instead.NO Balloons plans to finance the business with common equity and long-term debt.It plans to sell 12 million shares of common stock and 200,000 bonds.Each bond will have a coupon rate of 5%,will pay its coupons semi-annually and will have a face value of $1,000.The common stock will be issued at a price of $19.5 a share and has a beta of 1.1.The bonds will sell for 89% of face value and have a 6.25% yield to maturity.The market risk premium is 5.25%,T-bills are yielding 3.5%,and NO Balloons' tax rate is 36%.What is the capital structure weight for equity for NO Balloons?

A) 57%
B) 58%
C) 59%
D) 60%
E) 61%

Question 74

Use the data provided on Cadbury to answer the question below.The risk free rate is 4.25%.The expected return on the market portfolio is 9.75%.The corporate tax rate is 40%.The face value of Cadbury's outstanding bonds is 2.450 billion pounds sterling.The coupon rate on Cadbury's bonds is 4.5%.Assume that the bonds pay annual coupons.The yield to maturity on Cadbury's bonds is 4.5%.Cadbury's bonds mature in 7 years.Cadbury has 1.650 billion common shares outstanding.The market price of Cadbury's common shares as of Dec 31,2008 is 6.25 pounds sterling.Cadbury's Beta is 0.8.Cadbury's cost of debt (after-tax)is 2.7%.Cadbury's cost of equity is 8.65%.What is Cadbury's WACC?

A) 6.37%
B) 7.51%
C) 7.76%
D) 8.02%
E) 8.16%

Question 75

Jack's Construction Co.has 80,000 bonds outstanding that are selling at par value.Bonds with similar characteristics are yielding 8.5 percent.The company also has 4 million shares of common stock outstanding.The stock has a beta of 1.1 and sells for $40 a share.The U.S.Treasury bill is yielding 4 percent and the market risk premium is 8 percent.Jack's tax rate is 35 percent.What is Jack's weighted average cost of capital?

A) 7.10 percent
B) 7.39 percent
C) 10.38 percent
D) 10.65 percent
E) 11.37 percent

Question 76

Utility Muffin Research Kitchen Inc.is financed with debt,preferred stock and common equity.Selected information for each of the securities is provided in the table below.Calculate the capital structure weights which would be used to calculate the weighted average cost of capital.
Long-term Debt:
$5M Face Value,Coupon Rate = 3.5%,Annual Coupons,Time to Maturity = 10 Years,YTM = 5%.
Preferred Shares:
0)5M Shares outstanding,Par Value = $10 per share,Dividend Rate (Annual)= 4%,Equivalent preferred shares yield 7%.
Common Shares:
0)5M Shares outstanding,Market price per share = $20.

A) W_d = 0.26, W_p = 0.17, W_e = 0.58
B) W_d = 0.22, W_p = 0.28, W_e = 0.50
C) W_d = 0.41, W_p = 0.13, W_e = 0.46
D) W_d = 0.36, W_p = 0.23, W_e = 0.41
E) W_d = 0.35, W_p = 0.20, W_e = 0.45

Question 77

The cost of preferred stock is computed the same as:

A) the pre-tax cost of debt.
B) an annuity.
C) the after-tax cost of debt.
D) a perpetuity.
E) an irregular growth common stock.

Question 78

Preferred stock constitutes what percentage of the average firm's capital structure?

A) 50%
B) 25%
C) 5%
D) 10%
E) 75%

Question 79

As a newly hired financial analyst,your first job at VersaLife Corporation is to calculate the company's cost of capital.The present capital structure,which is considered optimal,is as follows:

If VersaLife Corporation issues new debt,then the bond market expects a yield of 7.5%.Preferred stock is trading for $96,has a $100 par value and pays an annual dividend of 8% (the next dividend is due in one year).Common equity has a beta of 1.20,the market risk premium is 5%,and the risk-free rate is 3%.If the firm's tax rate is 40%,what is the weighted average cost of capital? Round answers to the nearest tenth.

A) 7.2%
B) 7.5%
C) 8.2%
D) 8.5%
E) 9.0%

Question 80

Use the data provided on Cadbury to answer the question below.The risk free rate is 4.25%.The expected return on the market portfolio is 9.75%.The corporate tax rate is 40%.The face value of Cadbury's outstanding bonds is 2.450 billion pounds sterling.The coupon rate on Cadbury's bonds is 4.5%.Assume that the bonds pay annual coupons.The yield to maturity on Cadbury's bonds is 4.5%.Cadbury's bonds mature in 7 years.Cadbury has 1.650 billion common shares outstanding.The market price of Cadbury's common shares as of Dec 31,2008 is 6.25 pounds sterling.Cadbury's Beta is 0.8.What is the market value of Cadbury's bonds?

A) £0.13B
B) £1.65B
C) £1.80B
D) £2.45B
E) £2.49B