Question 1

Bartlett Company's target capital structure is 40% debt,15% preferred,and 45% common equity.The after-tax cost of debt is 6.00%,the cost of preferred is 7.50%,and the cost of common using reinvested earnings is 12.75%.The firm will not be issuing any new stock.You were hired as a consultant to help determine their cost of capital.What is its WACC?

Accepted Answer

11ea42d0_c087_8978_9abf_07abd69fbb2e_TB2090_00

Question 2

As a consultant to Basso Inc.,you have been provided with the following data: D₁ = $0.67; P₀ = $27.50; and g = 8.00% (constant).What is the cost of common from reinvested earnings based on the DCF approach?

Accepted Answer

$$\begin{array} { l r } 
D _ { 1 } & \text { \$0.67 } \
P _ { 0 } & \text { \$27.50 } \
g & \text { 8.00\%} \
I _ { 5 } = D _ { 1 } / p _ { 0 } + \text { g} & 1 0 .44 \%
\end{array}$$

Question 3

Your consultant firm has been hired by Eco Brothers Inc.to help them estimate the cost of common equity.The yield on the firm's bonds is 8.75%,and your firm's economists believe that the cost of common can be estimated using a risk premium of 3.85% over a firm's own cost of debt.What is an estimate of the firm's cost of common from reinvested earnings?

Accepted Answer

Band yield  $ \quad $$ \quad $$ \quad $$ \quad $$ \quad $$ \quad $$ \quad $8. $75 \%$
Risk premium $ \quad $$ \quad $$ \quad $$ \quad $$ \quad $$ \quad $$3.85 \%$
$ r_{c}=r_{d}+ $ Pisk premium  $ \quad $$ \quad $$ 12.60 \% $

Question 4

Perpetual preferred stock from Franklin Inc.sells for $97.50 per share,and it pays an $8.50 annual dividend.If the company were to sell a new preferred issue,it would incur a flotation cost of 4.00% of the price paid by investors.What is the company's cost of preferred stock for use in calculating the WACC?

Accepted Answer

$$\begin{array} { l r } 
\text { Preferted stack price } & \$ 97.50 \
\text { Preferted thividend } & 4.50 \
\text { Fatatian cost } & 4.00 \% \
\mathrm { r } _ { \mathrm { p } } = \mathrm { D } _ { \mathrm { F } } \left( \mathrm { p } _ { \mathrm { p } } ( 1 - \mathrm { F } ) \right) & \mathrm { 9.08 } \%
\end{array}$$

Question 5

You are a finance intern at Chambers and Sons and they have asked you to help estimate the company's cost of common equity.You obtained the following data: D₁ = $1.25; P₀ = $27.50; g = 5.00% (constant); and F = 6.00%.What is the cost of equity raised by selling new common stock?

Accepted Answer

$$\begin{array} { l r } 
\mathrm { P } _ { 1 } & \$ 1.25 \
\mathrm { P } _ { 0 } & \$ 27.50 \
\mathrm {g} & 5.00 \% \
\mathrm {F} & 6.00 \% \
\mathrm { I } _ { 1 } = \mathrm { D } _ { 1 } / \left( \mathrm { P } _ { 0 } \times ( 1 - \mathrm { F } ) + \mathrm { g } = \right. & 9.84 \%
\end{array}$$

Question 6

A company's perpetual preferred stock currently sells for $92.50 per share,and it pays an $8.00 annual dividend.If the company were to sell a new preferred issue,it would incur a flotation cost of 5.00% of the issue price.What is the firm's cost of preferred stock?

Accepted Answer

$$\begin{array} { l r } 
\text { Preferted stack price } & \$ 92.50\
\text { Preferted thividend } & \$ 8.00 \
\text { Fatatian cost } & 50 \%  \
\mathrm { r } _ { \mathrm { p } } = \mathrm { D } _ { \mathrm { F } } \left( \mathrm { p } _ { \mathrm { p } } ( 1 - \mathrm { F } ) \right) &  9.10 \%
\end{array}$$

Question 7

As the assistant to the CFO of Johnstone Inc.,you must estimate its cost of common equity.You have been provided with the following data: D₀ = $0.80; P₀ = $22.50; and g = 8.00% (constant).Based on the DCF approach,what is the cost of common from reinvested earnings?

Accepted Answer

$$\begin{array} { l r } 
D_ { 0 } &  \$0.08\
P _ { 0 } & \$ 22.50 \
\text { g } & 8.00\% \
D _ { 1 } = D _ { 0 } \times ( 1 + \mathrm { g } )  & \$ 0.864 \
r_{s}=D_{1} / P_{0}+g& 11.84 \%
\end{array}$$

Question 8

Which of the following statements is CORRECT?

Accepted Answer

Statement d is true.The firm would receive no tax savings on interest,so its cost of debt would not be reduced by the tax factor.However,corporate investors would be able to deduct 70% of the preferred dividends they receive,which would make them willing to accept a lower before-tax yield on preferred stock than on bonds.Put another way,the market yield on this firm's preferred could be lower than the interest rate on its debt because of the 70% exclusion; however,with a zero tax rate there would be no reduction in the firm's cost of debt.

Question 9

Quinlan Enterprises stock trades for $52.50 per share.It is expected to pay a $2.50 dividend at year end (D₁ = $2.50),and the dividend is expected to grow at a constant rate of 5.50% a year.The before-tax cost of debt is 7.50%,and the tax rate is 40%.The target capital structure consists of 45% debt and 55% common equity.What is the company's WACC if all the equity used is from reinvested earnings?

Accepted Answer

$$\begin{array}{l}
\begin{array} { l } 
D_{1} \
g \
P_{0} \
r_{d} \
\text { Tax rate } \
W_{d} \
w_{s} \
r_{d}(1-T) \
r_{s}=D_{1} / P_{0}+g \
WACC=w_{d}\left(r_{d}\right)(1-T)+w_{s}\left(r_{s}\right)=
\end{array}
\begin{array} { l } 
\$ 2.50 \
5.50 \% \
\$ 52.50 \
7.50 \% \
40 \% \
45 \% \
55 \% \
4.50 \% \
10.26 \% \
7.67\% 
\end{array}
\end{array}$$

Question 10

Which of the following statements is CORRECT? Assume that the firm is a publicly-owned corporation and is seeking to maximize shareholder wealth.

Accepted Answer

The fact that A's returns are negatively correlated means that it serves as a sort of insurance policy to the firm.The fact that its SD is high is actually good,because the negative correlation will cause the project's beta versus the market and also with the firm's other assets to be relatively low,denoting a low risk and thus justifying a relatively low cost of capital.This answer is theoretically always true,and it is especially true if the firm is large,has many projects,and Project A is not a "bet the company" project.

Question 11

Avery Corporation's target capital structure is 35% debt,10% preferred,and 55% common equity.The interest rate on new debt is 6.50%,the yield on the preferred is 6.00%,the cost of common from reinvested earnings is 11.25%,and the tax rate is 40%.The firm will not be issuing any new common stock.What is Avery's WACC?

Accepted Answer

Tax rate = 40%
 $$\begin{array} { l r r r } 
& \text { Weifhts } & r _ { \text {d } } & \text { AT Casts } \
\hline \text { Debt } & 35 \% & 6.50 \% & 3.90 \% \
\text { Preferted } & 10 \% & &6.00 \% \
\text { Camnon } & 55 \% & &11.25 \% \
\text { WACC } & 100 \% && 0.15 \%
\end{array}$$

Question 12

You have been hired as a consultant by Feludi Inc.'s CFO,who wants you to help her estimate the cost of capital.You have been provided with the following data: r_RF = 4.10%; RP_M = 5.25%; and b = 1.30.Based on the CAPM approach,what is the cost of common from reinvested earnings?

Accepted Answer

$$\begin{array} { l r } 
\mathrm { I } _ { \mathrm { R } } & 4.10 \% \
\mathrm { R } P _ { \mathrm { M } } & 5.25 \% \
\mathrm {b} & 1.30 \
\mathrm { r } _ { \mathrm { s } } = r _ { \mathrm { RF } } + \left( R P _ { \mathrm { M } } \times \mathrm { b } \right) & 10.925 \%
\end{array}$$

Question 13

To help estimate its cost of common equity,Maxwell and Associates recently hired you.You have obtained the following data: D₀ = $0.90; P₀ = $27.50; and g = 7.00% (constant).Based on the DCF approach,what is the cost of common from reinvested earnings?

Accepted Answer

$$\begin{array} { l r } 
D_ { 0 } &  \$0.90\
P _ { 0 } & \$ 27.50 \
\text { g } & 7.00\% \
D _ { 1 } = D _ { 0 } \times ( 1 + \mathrm { g } )  & \$ 0.963 \
r_{s}=D_{1} / P_{0}+g& 10.50 \%
\end{array}$$

Question 14

Trahern Baking Co.common stock sells for $32.50 per share.It expects to earn $3.50 per share during the current year,its expected dividend payout ratio is 65%,and its expected constant dividend growth rate is 6.0%.New stock can be sold to the public at the current price,but a flotation cost of 5% would be incurred.What would be the cost of equity from new common stock?

Accepted Answer

$\begin{array}{lr}
\text { Expected } \mathrm{EPS}_{1} & \$ 3.50 \
\text { Payout ratio } & 65 \% \
\text { Expected dividend, } \mathrm{D}_{1}=\mathrm{EPS} \times \text { Payout } & \$ 2.275 \
\text { Current stock price } & \$ 32.50 \
\mathrm{~g} & 6.00 \% \
\mathrm{~F} &  \mathrm{5} .00 \% \
\mathrm{r}_{\mathrm{e}}=\mathrm{D}_{1} /\left(\mathrm{P}_{0} \times(1-\mathrm{F})\right)+\mathrm{g} & 13.37 \%
\end{array}$

Question 15

Firm J's earnings and stock price tend to move up and down with other firms in the S&P 500,while Firm F's earnings and stock price move counter cyclically with J and other S&P companies.Both J and F estimate their costs of equity using the CAPM,they have identical market values,their standard deviations of returns are identical,and they both finance only with common equity.Which of the following statements is CORRECT?

Accepted Answer

Statement b is true.The merged firm would have a beta that is a simple average of J's and F's betas,and that would result in a cost of equity that is an average of the two firms' costs of equity.Since they are financed only with equity,their WACCs could also be averaged to find the merged firm's WACC.

Question 16

Adams Inc.has the following data: r_RF = 5.00%; RP_M = 6.00%; and b = 1.05.What is the firm's cost of common from reinvested earnings based on the CAPM?

Accepted Answer

$$\begin{array} { l r } 
\mathrm {r} _ { \mathrm { RF } } & 5.00 \% \
\mathrm { R } P _ { \mathrm { M } } & 6.00 \% \
\mathrm {b} & 1.05 \
\mathrm { r } _ { \mathrm { s } } = r _ { \mathrm { RF } } + \left( R P _ { \mathrm { M } } \times \mathrm { b } \right) & 11.30 \%
\end{array}$$

Question 17

The Lincoln Company sold a $1,000 par value,noncallable bond several years ago that now has 20 years to maturity and a 7.00% annual coupon that is paid semiannually.The bond currently sells for $925 and the company's tax rate is 40%.What is the component cost of debt for use in the WACC calculation?

Accepted Answer

Coupon rate $ \quad $ $ \quad $$ 7.00 \% $
Periodslyear $ \quad $$ \quad $$ \quad $$ 2 $
Maturity $( y )$ $ \quad $$ \quad $$ 20$
Bond price $ \quad $$ \quad $$\$ 925.00$
Par value $ \quad $$ \quad $$ \quad $$1,000$
 Tax rate  $ \quad $$ \quad $$ \quad $$ 40 \% $ $\begin{array}{l}
\text { Calculator inputs: }\
\begin{array}{l}
\mathrm{N}=\text { Periods/year } \times \text { Maturity } & 40\
\mathrm{PV}=\text { Bond's price } & -\$ 925.00 \
\mathrm{PMT}=\text { Coupon rate } \times \mathrm{Par} / 2 &\$ 35\
\mathrm{FV}=\text { Par }=\text { Maturity value } & \$ 1,000 \
\mathrm{I} / \mathrm{YR}&  3.87 \%  \
\text { Times periods/yr }=\text { before-tax cost of debt } &  7.74 \%\
=r_{d}(1-T) \text { for use in WACC } & 4.65\%
\end{array}
\end{array}$

Question 18

Kenny Electric Company's noncallable bonds were issued several years ago and now have 20 years to maturity.These bonds have a 9.25% annual coupon,paid semiannually,sells at a price of $1,075,and has a par value of $1,000.If the firm's tax rate is 40%,what is the component cost of debt for use in the WACC calculation?

Accepted Answer

Caupan rate $ \quad $$ \quad $$ \quad $9.25%
Periods/year $ \quad $$ \quad $$ \quad $2
Maturity $( yr )$ $ \quad $$ \quad $20
Bond price$ \quad $$ \quad $$ \quad $$107500
Par value $ \quad $$ \quad $$ \quad $$ \quad $$1,000 
Tax rate $ \quad $ $ \quad $$ \quad $$ \quad $40% $$\begin{array}{l}
\text { Calculatar inputs: }\
\begin{array} { l r } 
\mathrm { N } = \text { Periodislyear } \times \text { Maturity } & 40 \
\text { pV = Bond's price } & - \$ 1,075.00 \
\text { pMT = Coupon rate } \times \text { Parl2 } & \$ 46.25 \
\mathrm {~V} = \text { Par } = \text { Maturity value } & \$ 1,000 \
\text { Calculator autput: I/YR, 5amiarnual rate } & 4.23 \% \
\text { Annual rate } = 2 \times ( 1 / Y R ) = \text { Befare-tax cost of debt } & 8.47 \% \
= r _ { \text {d } } ( 1 - T ) \text { far use in WACC } & 5.08 \%
\end{array}
\end{array}$$

Question 19

To help them estimate the company's cost of capital,Smithco has hired you as a consultant.You have been provided with the following data: D₁ = $1.45; P₀ = $22.50; and g = 6.50% (constant).Based on the DCF approach,what is the cost of common from reinvested earnings?

Accepted Answer

$\begin{array}{lr}
\mathrm{D}_{1} & \$ 1.45 \
P_{0} & \$ 22.50 \
\mathrm{~g} & 6.50 \% \
\mathrm{r}_{\mathrm{s}}=\mathrm{D}_{1} / \mathrm{P}_{0}+\mathrm{g} & 12.94 \%
\end{array}$

Question 20

You were recently hired by Garrett Design,Inc.to estimate its cost of common equity.You obtained the following data: D₁ = $1.75; P₀ = $42.50; g = 7.00% (constant); and F = 5.00%.What is the cost of equity raised by selling new common stock?

Accepted Answer

$$\begin{array} { l r } 
\mathrm { P } _ { 1 } & \$ 11.75 \
\mathrm { P } _ { 0 } & \$ 42.50 \
\mathrm {g} & 7.00 \% \
\mathrm {F} & 5.00 \% \
\mathrm { r } _ { e } = \mathrm { D } _ { 1 } / \left( \mathrm { P } _ { 0 } \times ( 1 - \mathrm { F } ) + \mathrm { g } \right. & 11.33 \%
\end{array}$$

Quiz 9: The Cost of Capital

As a consultant to Basso Inc.,you have been provided with the following data: D₁ = $0.67; P₀ = $27.50; and g = 8.00% (constant) .What is the cost of common from reinvested earnings based on the DCF approach?

You are a finance intern at Chambers and Sons and they have asked you to help estimate the company's cost of common equity.You obtained the following data: D₁ = $1.25; P₀ = $27.50; g = 5.00% (constant) ; and F = 6.00%.What is the cost of equity raised by selling new common stock?

A company's perpetual preferred stock currently sells for $92.50 per share,and it pays an $8.00 annual dividend.If the company were to sell a new preferred issue,it would incur a flotation cost of 5.00% of the issue price.What is the firm's cost of preferred stock?

As the assistant to the CFO of Johnstone Inc.,you must estimate its cost of common equity.You have been provided with the following data: D₀ = $0.80; P₀ = $22.50; and g = 8.00% (constant) .Based on the DCF approach,what is the cost of common from reinvested earnings?

Which of the following statements is CORRECT?

Which of the following statements is CORRECT? Assume that the firm is a publicly-owned corporation and is seeking to maximize shareholder wealth.

You have been hired as a consultant by Feludi Inc.'s CFO,who wants you to help her estimate the cost of capital.You have been provided with the following data: r_RF = 4.10%; RP_M = 5.25%; and b = 1.30.Based on the CAPM approach,what is the cost of common from reinvested earnings?

To help estimate its cost of common equity,Maxwell and Associates recently hired you.You have obtained the following data: D₀ = $0.90; P₀ = $27.50; and g = 7.00% (constant) .Based on the DCF approach,what is the cost of common from reinvested earnings?

Adams Inc.has the following data: r_RF = 5.00%; RP_M = 6.00%; and b = 1.05.What is the firm's cost of common from reinvested earnings based on the CAPM?

The Lincoln Company sold a $1,000 par value,noncallable bond several years ago that now has 20 years to maturity and a 7.00% annual coupon that is paid semiannually.The bond currently sells for $925 and the company's tax rate is 40%.What is the component cost of debt for use in the WACC calculation?

To help them estimate the company's cost of capital,Smithco has hired you as a consultant.You have been provided with the following data: D₁ = $1.45; P₀ = $22.50; and g = 6.50% (constant) .Based on the DCF approach,what is the cost of common from reinvested earnings?

You were recently hired by Garrett Design,Inc.to estimate its cost of common equity.You obtained the following data: D₁ = $1.75; P₀ = $42.50; g = 7.00% (constant) ; and F = 5.00%.What is the cost of equity raised by selling new common stock?

Quiz 9: The Cost of Capital

As a consultant to Basso Inc.,you have been provided with the following data: D1 = $0.67; P0 = $27.50; and g = 8.00% (constant) .What is the cost of common from reinvested earnings based on the DCF approach?

You are a finance intern at Chambers and Sons and they have asked you to help estimate the company's cost of common equity.You obtained the following data: D1 = $1.25; P0 = $27.50; g = 5.00% (constant) ; and F = 6.00%.What is the cost of equity raised by selling new common stock?

A company's perpetual preferred stock currently sells for $92.50 per share,and it pays an $8.00 annual dividend.If the company were to sell a new preferred issue,it would incur a flotation cost of 5.00% of the issue price.What is the firm's cost of preferred stock?

As the assistant to the CFO of Johnstone Inc.,you must estimate its cost of common equity.You have been provided with the following data: D0 = $0.80; P0 = $22.50; and g = 8.00% (constant) .Based on the DCF approach,what is the cost of common from reinvested earnings?

Which of the following statements is CORRECT?

Which of the following statements is CORRECT? Assume that the firm is a publicly-owned corporation and is seeking to maximize shareholder wealth.

You have been hired as a consultant by Feludi Inc.'s CFO,who wants you to help her estimate the cost of capital.You have been provided with the following data: rRF = 4.10%; RPM = 5.25%; and b = 1.30.Based on the CAPM approach,what is the cost of common from reinvested earnings?

To help estimate its cost of common equity,Maxwell and Associates recently hired you.You have obtained the following data: D0 = $0.90; P0 = $27.50; and g = 7.00% (constant) .Based on the DCF approach,what is the cost of common from reinvested earnings?

Adams Inc.has the following data: rRF = 5.00%; RPM = 6.00%; and b = 1.05.What is the firm's cost of common from reinvested earnings based on the CAPM?

To help them estimate the company's cost of capital,Smithco has hired you as a consultant.You have been provided with the following data: D1 = $1.45; P0 = $22.50; and g = 6.50% (constant) .Based on the DCF approach,what is the cost of common from reinvested earnings?

You were recently hired by Garrett Design,Inc.to estimate its cost of common equity.You obtained the following data: D1 = $1.75; P0 = $42.50; g = 7.00% (constant) ; and F = 5.00%.What is the cost of equity raised by selling new common stock?

As a consultant to Basso Inc.,you have been provided with the following data: D₁ = $0.67; P₀ = $27.50; and g = 8.00% (constant) .What is the cost of common from reinvested earnings based on the DCF approach?

You are a finance intern at Chambers and Sons and they have asked you to help estimate the company's cost of common equity.You obtained the following data: D₁ = $1.25; P₀ = $27.50; g = 5.00% (constant) ; and F = 6.00%.What is the cost of equity raised by selling new common stock?

As the assistant to the CFO of Johnstone Inc.,you must estimate its cost of common equity.You have been provided with the following data: D₀ = $0.80; P₀ = $22.50; and g = 8.00% (constant) .Based on the DCF approach,what is the cost of common from reinvested earnings?

You have been hired as a consultant by Feludi Inc.'s CFO,who wants you to help her estimate the cost of capital.You have been provided with the following data: r_RF = 4.10%; RP_M = 5.25%; and b = 1.30.Based on the CAPM approach,what is the cost of common from reinvested earnings?

To help estimate its cost of common equity,Maxwell and Associates recently hired you.You have obtained the following data: D₀ = $0.90; P₀ = $27.50; and g = 7.00% (constant) .Based on the DCF approach,what is the cost of common from reinvested earnings?

Adams Inc.has the following data: r_RF = 5.00%; RP_M = 6.00%; and b = 1.05.What is the firm's cost of common from reinvested earnings based on the CAPM?

To help them estimate the company's cost of capital,Smithco has hired you as a consultant.You have been provided with the following data: D₁ = $1.45; P₀ = $22.50; and g = 6.50% (constant) .Based on the DCF approach,what is the cost of common from reinvested earnings?

You were recently hired by Garrett Design,Inc.to estimate its cost of common equity.You obtained the following data: D₁ = $1.75; P₀ = $42.50; g = 7.00% (constant) ; and F = 5.00%.What is the cost of equity raised by selling new common stock?