Question 1

Lumber Jack Log Homes has 30,000 bonds outstanding that are selling at par. Bonds with similar characteristics are yielding 7.8 %. The company also has 1.5 million shares of common stock outstanding. The stock has a beta of 1.4 and sells for $36 a share. Treasury bills are yielding 4.5 % and the market risk premium is 8.6 %. Jack's tax rate is 34 %. What is Jack's weighted average cost of capital?

Accepted Answer

The correct answer is A because the weighted average cost of capital is 12.47%.

Question 2

Given the following information for Jano Corp. find the WACC. Assume the company's tax rate is 35%. Bonds: 10,000 7% coupon bonds outstanding, $1,000 par value, 20 years to maturity, selling for 102 % of par; the bonds make semi-annual payments. Common Shares: 400,000 shares outstanding, selling for $50 per share; the beta is 1.15. Preferred shares: 25,000 shares of 5% preferred stock outstanding, currently selling for $65 per share. 8% market risk premium and 4% risk-free rate.

Accepted Answer

The correct answer is A because the WACC is 9.97%. The WACC is calculated as follows:WACC = (E/V) * Re + (D/V) * Rd * (1 - Tc) + (P/V) * Rpwhere:E = market value of equityV = total value of the firmRe = cost of equityD = market value of debtRd = cost of debtTc = corporate tax rateP = market value of preferred stockRp = cost of preferred stockIn this case, we have:E = 400,000 * $50 = $20,000,000V = $20,000,000 + $10,000,000 + $1,625,000 = $31,625,000Re = 8% + 1.15 * 4% = 12.6%D = $10,000,000Rd = 7% / 2 = 3.5%Tc = 35%P = 25,000 * $65 = $1,625,000Rp = 5%Therefore, the WACC is:WACC = (20,000,000/31,625,000) * 12.6% + (10,000,000/31,625,000) * 3.5% * (1 - 0.35) + (1,625,000/31,625,000) * 5%= 9.97%

Question 3

Given the following information, what is your best estimate for the firm's cost of equity on January 2, 2007 the stock sells for $60 on that day?

Accepted Answer

The answer of Given the following information, what is your...

Question 4

Rudolph's Transportation has an overall cost of equity of 14.8 % and a beta of 1.4. The firm is financed solely with common stock. The risk-free rate of return is 3.5 %. What is an appropriate cost of capital for a division within the firm that has an estimated beta of 1.3?

Accepted Answer

The answer of Rudolph's Transportation has an overall cost of...

Question 5

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 % and the market risk premium is 6.5 %. What should Delta use as its cost of equity if it decides to purchase some land and create a new residential community?

Accepted Answer

The answer of The Delta Co. owns retail stores that...

Question 6

Wilson's Clothing has 8 % preferred stock outstanding which is selling for $58 a share. What is Wilson's cost of preferred stock if the tax rate is 34 %?

Accepted Answer

The cost of preferred stock is calculated as the dividend divided by the current price. The tax rate does not affect the cost of preferred stock. The dividend is 8% of the par value (assumed to be $100), which is $8. The cost is $8 / $58 = 13.79%.

Question 7

Outside Johnnie's has a beta of 1.3 and a cost of equity of 12.3 %. The risk-free rate of return is 4.5 %. Johnnie's is considering a project with a beta of 1.4 and a project life of six years. An appropriate discount rate for the project is:

Accepted Answer

The answer of Outside Johnnie's has a beta of 1.3...

Question 8

Sun Lee Importers has a cost of debt of 9 %, a cost of equity of 14 %, and a cost of preferred stock of 10 %. The firm has 87,000 shares of common stock outstanding at a market price of $27 a share. There are 30,000 shares of preferred stock outstanding at a market price of $41 a share. The bond issue has a total face value of $750,000 and sells at 99 % of face value. The company's tax rate is 35 %. What is the weighted average cost of capital for Sun Lee Importers?

Accepted Answer

The weighted average cost of capital (WACC) is calculated using the formula: WACC = (E/V * Re) + (P/V * Rp) + (D/V * Rd * (1-Tc)), where E is the market value of equity, P is the market value of preferred stock, D is the market value of debt, V is the total market value of the firm's financing (E + P + D), Re is the cost of equity, Rp is the cost of preferred stock, Rd is the cost of debt, and Tc is the tax rate. Calculating each component and substituting into the formula gives a WACC of approximately 11.46%.

Question 9

Treasury bills currently have a return of 3.5% and the market risk premium is 8%. If a firm has a beta of 1.6, what is its cost of equity?

Accepted Answer

The cost of equity can be calculated using the Capital Asset Pricing Model (CAPM): Cost of Equity = Risk-Free Rate + Beta * Market Risk Premium. Here, it is 3.5% + 1.6 * 8% = 16.3%.

Question 10

The market value of DRK Inc.'s debt is $200 million and the total market value of the firm is $600 million. The cost of equity is 15%, the cost of debt is 8%, and the tax rate is 34%. What is this firm's WACC?

Accepted Answer

The Weighted Average Cost of Capital (WACC) is calculated using the formula: WACC = (E/V) * Re + (D/V) * Rd * (1 - Tc), where E is the market value of the firm's equity, D is the market value of the firm's debt, V is the total market value of the firm (E + D), Re is the cost of equity, Rd is the cost of debt, and Tc is the corporate tax rate. Given that the market value of equity (E) is $400 million (calculated as total firm value $600 million - debt $200 million), the market value of debt (D) is $200 million, and the total market value (V) is $600 million, the cost of equity (Re) is 15%, the cost of debt (Rd) is 8%, and the tax rate (Tc) is 34%, the WACC can be calculated as follows: WACC = ($400M/$600M) * 15% + ($200M/$600M) * 8% * (1 - 34%) = 0.6667 * 15% + 0.3333 * 8% * 0.66 = 10% + 1.76% = 11.76%.

Question 11

Antonio's Pizzeria has 8 % preferred stock outstanding that sells for $71 a share. This stock was originally issued at $58 per share. What is Antonio's cost of preferred stock?

Accepted Answer

The cost of preferred stock is calculated as the dividend per share divided by the current price per share. Since the preferred stock has an 8% dividend rate and it sells for $71 a share, the cost of preferred stock is 8% of the original issue price ($58), which equals $4.64 per share in dividends. Therefore, the cost of preferred stock is $4.64 / $71 = 0.06535 or 6.535%, which is not an option provided. However, the correct approach to find the cost of preferred stock is to use the dividend rate directly since the question implies the 8% is the dividend yield based on the original issue price. The correct calculation is the dividend ($58 * 8%) divided by the current price ($71), which equals $4.64 / $71 = 0.06535 or 6.535%. It seems there was a mistake in my initial explanation. The cost of preferred stock should be calculated directly from the given information without assuming the dividend is based on the original issue price for this calculation. The correct calculation is the dividend yield (8%) divided by the current price ($71), but since the dividend yield is already given as a percentage of the original issue price, the calculation provided was incorrect. The correct answer should be based on the formula: Cost of Preferred Stock = Dividend per share / Current price per share. However, without the correct calculation provided in the options or a misunderstanding in the explanation, there seems to be a mistake in the interpretation of the question or the calculation. The correct formula to use is indeed Cost of Preferred Stock = Dividend per share / Current price per share, but the dividend per share should be considered as the amount that results in an 8% yield on the original issue price, which is not directly provided in the question. The explanation mistakenly calculated the dividend based on a misunderstanding of how the dividend yield applies. The correct approach is to recognize that the 8% preferred stock means the stock pays an annual dividend equal to 8% of the par value, and the cost of preferred stock is then calculated based on the current market price. Without the par value specified, we assume the 8% refers to the dividend rate on its face value or par value, typically $100 for preferred stock, leading to an annual dividend of $8 per share. The cost of preferred stock is then $8 / $71 = 11.27%. My initial explanation contained errors in the calculation and interpretation of the dividend and its application.

Question 12

Jeb's Automotive has a beta of 1.0 and a cost of equity of 14 %. The risk-free rate of return is 5 %. Jeb's is considering a project with a beta of.75. An appropriate discount rate for the project is:

Accepted Answer

The appropriate discount rate can be calculated using the Capital Asset Pricing Model (CAPM): Discount Rate = Risk-free rate + Beta * (Market return - Risk-free rate). Assuming the market return is implied by Jeb's cost of equity, 14%, the calculation is: 5% + 0.75 * (14% - 5%) = 11.75%.

Question 13

Northeast Realtors has a beta of 1.21 and a cost of equity of 14.2 %. The risk-free rate of return is 4.25 %. The firm is considering a project with a beta of 1.1 and a project life of 8 years. An appropriate discount rate for the project is _____ %.

Accepted Answer

The answer of Northeast Realtors has a beta of 1.21...

Question 14

Stromboli Corporation has a current stock price of $24 and has just provided a $3 dividend. Dividends are expected to grow at 4%. If the company's Beta is 1.3 and the risk free rate is 4%, determine the expected stock market return.

Accepted Answer

The answer of Stromboli Corporation has a current stock price...

Question 15

Benson's, Inc. has an overall cost of equity of 10.24 % and a beta of 1.2. The firm is financed 100 % with common stock. The risk-free rate of return is 4 %. What is an appropriate cost of capital for a division within the firm that has an estimated beta of 1.5?

Accepted Answer

The answer of Benson's, Inc. has an overall cost of...

Question 16

Given the following information, what is JEM Inc.'s weighted average cost of capital? Market value of equity = $50 million; market value of debt = $30 million; cost of equity = 16%; cost of debt = 8%; equity beta = 1.25; tax rate = 34%.

Accepted Answer

The correct answer is A because the weighted average cost of capital (WACC) is calculated as follows:WACC = (E/V) * Re + (D/V) * Rd * (1 - T)where:E = market value of equityV = total value of the firm (E + D)Re = cost of equityD = market value of debtRd = cost of debtT = tax ratePlugging in the given values, we get:WACC = (50/80) * 0.16 + (30/80) * 0.08 * (1 - 0.34)= 0.1198 or 11.98%

Question 17

Given the following information for Groto Corp. find the WACC. Assume the company's tax rate is 30%. Bonds: 10,000 9% coupon bonds outstanding, $1,000 par value, 25 years to maturity, selling for 98% of par; the bonds make semi-annual payments. Common shares: 300,000 shares outstanding, selling for $40 per share; the beta is 0.95. Preferred shares: 55,000 shares of 6% preferred stock outstanding, currently selling for $100 per share. 10% market risk premium and 3% risk-free rate.

Accepted Answer

The answer of Given the following information for Groto Corp....

Question 18

Rattle me Bones, Inc.'s common stock is currently selling for $66.25 per share. You expect the next dividend to be $5.30 per share. If the firm has a dividend growth rate of 4% that is expected to remain constant indefinitely, what is the firm's cost of equity?

Accepted Answer

The cost of equity is calculated using the dividend growth model:Cost of equity = (Dividend / Price) + Dividend growth rate= (5.30 / 66.25) + 0.04= 0.123, or 12.3%

Question 19

By-Way Trucking has a 9 % preferred stock outstanding that is currently selling for $52 a share. The market rate of return is 12 % and the firm's tax rate is 35 %. What is By-Way's cost of preferred stock?

Accepted Answer

The answer of By-Way Trucking has a 9 % preferred...

Question 20

Given the following information, what is WBM Corporation's WACC?

Common Stock: 1 million shares outstanding, $40 per share, $1 par value, beta = 1.3
Bonds: 10,000 bonds outstanding, $1,000 face value each, 8% annual coupon, 22 years to maturity, market price = $1,101.23 per bond
Market risk premium = 8. 6%, risk-free rate = 4. 5%, marginal tax rate = 34%

Accepted Answer

The answer of Given the following information, what is WBM...

Quiz 14: Cost of Capital