Question 1

Bermuda Cruises issues only common stock and coupon bonds.The firm has a debt-equity ratio of .45.The cost of equity is 17.6 percent and the pretax cost of debt is 8.9 percent.What is the capital structure weight of the firm's equity if the firm's tax rate is 35 percent?

Accepted Answer

The answer of Bermuda Cruises issues only common stock and...

Question 2

Gulf Coast Tours currently has a weighted average cost of capital of 12.4 percent based on a combination of debt and equity financing.The firm has no preferred stock.The current debt-equity ratio is .47 and the aftertax cost of debt is 6.1 percent.The company just hired a new president who is considering eliminating all debt financing.All else constant, what will the firm's cost of capital be if the firm switches to an all-equity firm?

Accepted Answer

The answer of Gulf Coast Tours currently has a weighted...

Question 3

The Five and Dime Store has a cost of equity of 14.8 percent, a pretax cost of debt of 6.7 percent, and a tax rate of 34 percent.What is the firm's weighted average cost of capital if the debt-equity ratio is .46?

Accepted Answer

The correct answer is C.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 firmRe = cost of equityD = market value of debtRd = cost of debtT = tax rateIn this case, the debt-equity ratio is 0.46, which means that the market value of debt is 0.46 * V and the market value of equity is 0.54 * V. The cost of equity is 14.8 percent, the pretax cost of debt is 6.7 percent, and the tax rate is 34 percent. Therefore, the WACC is:WACC = (0.54 * V) * 0.148 + (0.46 * V) * 0.067 * (1 - 0.34)WACC = 0.0804 + 0.0294WACC = 0.1153 or 11.53 percent

Question 4

Cromwell's Interiors is considering a project that is equally as risky as the firm's current operations.The firm has a cost of equity of 15.4 percent and a pretax cost of debt of 8.9 percent.The debt-equity ratio is .46 and the tax rate is 34 percent.What is the cost of capital for this project?

Accepted Answer

The answer of Cromwell's Interiors is considering a project that...

Question 5

Piedmont Hotels is an all-equity firm with 48,000 shares of stock outstanding.The stock has a beta of 1.19 and a standard deviation of 14.8 percent.The market risk premium is 7.8 percent and the risk-free rate of return is 4.1 percent.The company is considering a project that it considers riskier than its current operations so has assigned an adjustment of 1.35 percent to the project's discount rate.What should the firm set as the required rate of return for the project?

Accepted Answer

The answer of Piedmont Hotels is an all-equity firm with...

Question 6

A firm wants to create a WACC of 11.2 percent.The firm's cost of equity is 16.8 percent and its pretax cost of debt is 8.7 percent.The tax rate is 35 percent.What does the debt-equity ratio need to be for the firm to achieve its target WACC?

Accepted Answer

The answer of A firm wants to create a WACC...

Question 7

The 5.25 percent preferred stock of Robert Bruce Security is selling for $50.26 a share.What is the firm's cost of preferred stock if the tax rate is 21 percent and the par value per share is $100?

Accepted Answer

The answer of The 5.25 percent preferred stock of Robert...

Question 8

Santa Claus Enterprises has 87,000 shares of common stock outstanding at a current price of $39 a share.The firm also has two bond issues outstanding.The first bond issue has a total face value of $230,000, pays 7.1 percent interest annually, and currently sells for 103.1 percent of face value.The second bond issue consists of 5,000 bonds that are selling for $887 each.These bonds pay 6.5 percent interest annually and mature in eight years.The tax rate is 35 percent.What is the capital structure weight of the firm's debt?

Accepted Answer

The correct answer is A because the capital structure weight of the firm's debt is 57.93 percent.

Question 9

Orchard Farms has a pretax cost of debt of 7.29 percent and a cost of equity of 16.3 percent.The firm uses the subjective approach to determine project discount rates.Currently, the firm is considering a project to which it has assigned an adjustment factor of 1.25 percent.The firm's tax rate is 35 percent and its debt-equity ratio is .48.The project has an initial cost of $3.9 million and produces cash inflows of $1.26 million a year for 5 years.What is the net present value of the project?

Accepted Answer

To find the NPV, first calculate the weighted average cost of capital (WACC) using the firm's cost of debt, cost of equity, tax rate, and debt-equity ratio. Adjust the WACC by the project's adjustment factor. Then, discount the project's cash inflows at this adjusted WACC and subtract the initial cost. The correct NPV is $446,556.

Question 10

The Color Box uses a combination of common stock, preferred stock, and debt financing.The company wants preferred stock to represent 7 percent of the total financing.It also wants to structure the firm in a manner that will produce a weighted average cost of capital of 9.5 percent.The aftertax cost of debt is 4.8 percent, the cost of preferred is 8.9 percent, and the cost of common stock is 14.7 percent.What percentage of the firm's capital funding should be debt financing?

Accepted Answer

To find the percentage of debt financing, we use the weighted average cost of capital (WACC) formula: WACC = (E/V) * Re + (P/V) * Rp + (D/V) * Rd. Given: WACC = 9.5%, Re = 14.7%, Rp = 8.9%, Rd = 4.8%, and P/V = 7%. Solving for D/V, we find it to be approximately 48.42%.

Question 11

Western Electric has 21,000 shares of common stock outstanding at a price per share of $61 and a rate of return of 15.6 percent.The firm has 11,000 shares of $8 preferred stock outstanding at a price of $48 a share.The outstanding debt has a total face value of $275,000 and currently sells for 104 percent of face.The yield to maturity on the debt is 8.81 percent.What is the firm's weighted average cost of capital if the tax rate is 35 percent?

Accepted Answer

The answer of Western Electric has 21,000 shares of common...

Question 12

Design Interiors has a cost of equity of 14.9 percent and a pretax cost of debt of 8.6 percent.The firm's target weighted average cost of capital is 11 percent and its tax rate is 34 percent.What is the firm's target debt-equity ratio?

Accepted Answer

The answer of Design Interiors has a cost of equity...

Question 13

S&W has 21,000 shares of common stock outstanding at a price of $29 a share.It also has 2,000 shares of preferred stock outstanding at a price of $71 a share.The firm has 7 percent, 12-year bonds outstanding with a total market value of $386,000.The bonds are currently quoted at 100.6 percent of face and pay interest semiannually.What is the capital structure weight of the firm's preferred stock if the tax rate is 34 percent?

Accepted Answer

The correct answer is A because the capital structure weight of the firm's preferred stock is 12.49 percent. This is calculated by dividing the market value of the preferred stock by the total market value of the firm's capital. The market value of the preferred stock is $2,000 * $71 = $142,000. The total market value of the firm's capital is $21,000 * $29 + $142,000 + $386,000 = $860,000. Therefore, the capital structure weight of the firm's preferred stock is $142,000 / $860,000 = 12.49 percent.

Question 14

Great Lakes Packing has two bond issues outstanding.The first issue has a coupon rate of8 percent, matures in 6 years, has a total face value of $5 million, and is quoted at 101.2 percent of face value.The second issue has a 7.5 percent coupon, matures in 13 years, has a total face value of $18 million, and is quoted at 99 percent of face value.Both bonds pay interest semiannually.What is the firm's weighted average aftertax cost of debt if the tax rate is 34 percent?

Accepted Answer

The correct answer is A because the weighted average aftertax cost of debt is 5.05 percent.

Question 15

City Rentals has 44,000 shares of common stock outstanding at a market price of $32 a share.The common stock just paid a $1.50 annual dividend and has a dividend growth rate of 2.5 percent.There are 7,500 shares of $9 preferred stock outstanding at a market price of $72 a share.The outstanding bonds mature in 11 years, have a total face value of $825,000, a face value per bond of $1,000, and a market price of $989 each, and a pretax yield to maturity of 8.3 percent.The tax rate is 35 percent.What is the firm's weighted average cost of capital?

Accepted Answer

The correct answer is A because the weighted average cost of capital is 7.76 percent.

Question 16

Country Cook's cost of equity is 16.2 percent and its aftertax cost of debt is 5.8 percent.What is the firm's weighted average cost of capital if its debt-equity ratio is .42 and the tax rate is 34 percent?

Accepted Answer

The answer of Country Cook's cost of equity is 16.2...

Question 17

The 7 percent preferred stock of Midwest Muffler and Towing is selling for $65 per share.What is the firm's cost of preferred stock if the tax rate is 21 percent and the par value per share is $100?

Accepted Answer

The cost of preferred stock is calculated as the dividend divided by the current price. The dividend is 7% of the par value, which is $7. The cost of preferred stock is $7 / $65 = 10.77%. The tax rate does not affect the cost of preferred stock.

Question 18

The preferred stock of Dolphin Pools pays an annual dividend of $5.25 a share and sells for $48a share.The tax rate is 35 percent.What is the firm's cost of preferred stock?

Accepted Answer

The cost of preferred stock is calculated as the dividend divided by the price per share. So, $5.25 / $48 = 0.109375 or 10.94 percent. The tax rate does not affect the cost of preferred stock.

Question 19

Dee's Dress Emporium has 50,000 shares of common stock outstanding at a price of $27 a share.It also has 1000 shares of preferred stock outstanding at a price of $20 a share.There are 800bonds outstanding that have a semiannual coupon payment of $25.The bonds mature in four years, have a face value of $1,000, and sell at 97 percent of par.What is the capital structure weight of the common stock?

Accepted Answer

The answer of Dee's Dress Emporium has 50,000 shares of...

Question 20

Beta Industries is considering a project with an initial cost of $6.9 million.The project will produce cash inflows of $1.52 million a year for seven years.The firm uses the subjective approach to assign discount rates to projects.For this project, the subjective adjustment is +2.2 percent.The firm has a pretax cost of debt of 9.1 percent and a cost of equity of 17.7 percent.The debt-equity ratio is .57 and the tax rate is 34 percent.What is the net present value of the project? (Round the answer to the nearest $100.)

Accepted Answer

The answer of Beta Industries is considering a project with...

Quiz 12: Cost of Capital