Question 1

You are analyzing the cost of capital for a firm that is financed with $300 million of equity and $200 million of debt. The cost of debt capital for the firm is 9 percent, while the cost of equity capital is 19 percent. What is the overall cost of capital for the firm? Assume there are no taxes.

Accepted Answer

The overall cost of capital is calculated using the weighted average cost of capital (WACC) formula: WACC = (E/V * Re) + (D/V * Rd), where E is equity, D is debt, V is total value (E+D), Re is cost of equity, and Rd is cost of debt. Here, E = $300 million, D = $200 million, V = $500 million, Re = 19%, and Rd = 9%. WACC = ($300/$500 * 19%) + ($200/$500 * 9%) = 15%.

Question 2

Maloney's, Inc. has found that its cost of common equity capital is 17 percent and its cost of debt capital is 6 percent. The firm is financed with $3,000,000 of common shares (market value) and $2,000,000 of debt. What is the after-tax weighted average cost of capital for Maloney's, if it is subject to a 40 percent marginal tax rate?

Accepted Answer

1. Calculate the weight of equity and debt:
    Weight of equity = $3,000,000 / ($3,000,000 + $2,000,000) = 0.6 or 60%
    Weight of debt = $2,000,000 / ($3,000,000 + $2,000,000) = 0.4 or 40%
2. Calculate the after-tax cost of debt:
    After-tax cost of debt = Cost of debt x (1 - tax rate) = 6% x (1 - 0.4) = 3.6%
3. Calculate the weighted average cost of capital:
    Weighted average cost of capital = (Weight of equity x Cost of equity) + (Weight of debt x After-tax cost of debt)
                                     = (0.6 x 17%) + (0.4 x 3.6%)
                                     = 11.64% 
Therefore, the best choice is C, 11.64%.

Question 3

Stryder, Inc. has 3 million shares outstanding at a current price of $15 per share. The book value of the shares is $10 per share. The firm also has $30 million in par value of bonds outstanding. The bonds are selling at a price equal to 101 percent of par. What is the market value of the firm?

Accepted Answer

The market value of the equity can be calculated as: 
Market value of equity = Current price per share x Number of shares outstanding = $15 x 3,000,000 = $45,000,000

The market value of the bonds can be calculated as: 
Market value of bonds = Bond price x Par value of bonds = 1.01 x $30,000,000 = $30,300,000

Therefore, the market value of the firm is the sum of the market values of equity and bonds: 
Market value of firm = Market value of equity + Market value of bonds = $45,000,000 + $30,300,000 = $75,300,000

Thus, the correct answer is D) $75.3 million.

Question 4

Oasis, Inc. has common shares with a price of $21.12 per share. The firm is expected to pay a dividend of $1.75 one year from today, and dividends are expected to grow at 10 percent for two years after that and then at 5 percent thereafter. What is the implied cost of common equity capital for Oasis? Round your final answer to nearest percentage.

Accepted Answer

The answer of Oasis, Inc. has common shares with a...

Question 5

If the market risk premium is currently 6 percent and the risk-free rate of return is 4 percent, then what is the expected return on a common share with a beta equal to 2?

Accepted Answer

The expected return using the Capital Asset Pricing Model (CAPM) is calculated as follows: Expected return = Risk-Free Rate + Beta x Market Risk Premium = 4% + 2 x 6% = 4% + 12% = 16%. Therefore, the correct answer is D, 16.0%.

Question 6

The WACC for a firm is 13.00 percent. You know that the firm's cost of debt capital is 10 percent and the cost of equity capital is 20%. What proportion of the firm is financed with debt? Assume there are no taxes.

Accepted Answer

The answer of The WACC for a firm is 13.00...

Question 7

In order to use a firm's WACC to evaluate its future project's flows, which of the following must hold?

Accepted Answer

Both A and B must hold in order to use the firm's WACC to evaluate a future project's flows.

A) The project must be financed with the same proportion of debt and equity as the firm because the WACC is a weighted average of the cost of debt and the cost of equity, and these costs are influenced by the firm's capital structure.

B) The systematic risk of the project must be the same as the overall systematic risk of the firm because the WACC is the required rate of return that investors demand to invest in the firm, and this required rate of return is affected by the overall risk of the firm.

C) Conventional cash flows are not a requirement for using the WACC to evaluate a project's flows, as long as the project's cash flows are discounted at the appropriate rate based on their risk.

Question 8

Swirlpool, Inc. has found that its cost of common equity capital is 18 percent, and its cost of debt capital is 8 percent. The firm is financed with 60 percent common shares and 40 percent debt. What is the after-tax weighted average cost of capital for Swirlpool, if it is subject to a 40 percent marginal tax rate?

Accepted Answer

First, we need to calculate the weighted average cost of capital before taxes (WACC):

WACC = (E/V x Re) + (D/V x Rd) x (1 - Tc)

Where:
E = market value of equity
V = total market value of the firm (equity + debt)
D = market value of debt
Re = cost of equity
Rd = cost of debt
Tc = corporate tax rate

Given the information:

Re = 18%
Rd = 8%
E/V = 0.6
D/V = 0.4
Tc = 40%

To calculate E and D, we need additional information. Let's assume:

E = $500 million
D = $333 million

With this information, we can calculate V:

V = E + D
V = $500 million + $333 million
V = $833 million

Now we can calculate WACC:

WACC = (E/V x Re) + (D/V x Rd) x (1 - Tc)
WACC = (0.6 x 0.18) + (0.4 x 0.08) x (1 - 0.4)
WACC = 0.108 + 0.024
WACC = 0.132 or 13.20%

The after-tax WACC is simply the pre-tax WACC multiplied by (1 - Tc):

After-tax WACC = 0.132 x (1 - 0.4)
After-tax WACC = 0.0792 or 7.92%

However, the answer choices are given in percentage format, so we need to multiply by 100 to get the final answer:

After-tax WACC = 7.92% x 100
After-tax WACC = 12.72%

Question 9

Tranquility, Inc. has common shares with a price of $18.37 per share. The firm paid a dividend of $1.50 yesterday, and dividends are expected to grow at 9 percent for three years and then at 2 percent thereafter. What is the implied cost of common equity capital for Tranquility? Round your final percentage answer to 1 decimal place.

Accepted Answer

We can use the dividend discount model to calculate the implied cost of common equity capital (i.e. the required rate of return that investors expect to earn on their investment in Tranquility):

Ke = (D1 / P0) + g

Where:
Ke = implied cost of common equity capital
D1 = expected dividend in one year
P0 = current stock price
g = expected growth rate of dividends

We are given the following information:
P0 = $18.37
D1 = $1.50 * (1 + 0.09) = $1.635
g = 9% for 3 years, and 2% thereafter

Now we can plug in the values and solve for Ke:

Ke = ($1.635 / $18.37) + 0.09 = 0.1775 or 17.75%

Since we were asked to round to one decimal place, the answer is 11.8%, which is closest to choice C (11.5%). Therefore, we choose option C as the best choice.

Question 10

The WACC for a firm is 19.75 percent. You know that the firm is financed with $75 million of equity and $25 million of debt. The cost of debt capital is 7 percent. What is the cost of equity for the firm? Assume there are no taxes.

Accepted Answer

WACC = (E/V) x Re + (D/V) x Rd x (1-T)
where, 
E = Equity
D = Debt
V = Total value of firm (V = E + D)
Re = Cost of Equity
Rd = Cost of Debt
T = Tax Rate (assumed to be zero in this question)

Given, WACC = 19.75%
E = $75 million
D = $25 million
Rd = 7%

Since we have to find Re, let's rearrange the WACC equation as follows:

Re = (WACC x V - Rd x D) / E
= (0.1975 x ($75+$25) - 0.07 x $25) / $75
= 0.24 or 24.00%

Hence, the cost of equity (Re) for the firm is 24.00%.

Question 11

UltraFlex Diving Boards, Inc. just paid a dividend of $1.50. If the firm's growth in dividends is expected to remain at a flat 4 percent forever, then what is the cost of equity capital for Ultra Flex Diving Boards if the price of its common shares is currently $26.00?

Accepted Answer

The answer of UltraFlex Diving Boards, Inc. just paid a...

Question 12

The Diverse Co. has invested 40 percent of the firm's assets in a project with a beta of 0.4 and the remaining assets in a project with a beta of 1.8. What is the beta of the firm?

Accepted Answer

Given, the weight of the first project (w1) = 0.4 and weight of the second project (w2) = 0.6 (as the remaining assets are in the second project)
The formula to calculate the portfolio beta (βp) is: 
βp = w1 * β1 + w2 *β2 
where β1 and β2 are the beta of the first project and second project respectively.

Substituting the values, 
βp = 0.4 * 0.4 + 0.6 * 1.8 = 1.28

Therefore, the beta of the firm is 1.28. 
Hence, the correct answer is option C.

Question 13

Ronnie's Comics has found that its cost of common equity capital is 15 percent and its cost of debt capital is 12 percent. The firm is financed with $250,000,000 of common shares (market value) and $750,000,000 of debt. What is the after-tax weighted average cost of capital for Ronnie's, if it is subject to a 35 percent marginal tax rate?

Accepted Answer

The answer of Ronnie's Comics has found that its cost...

Question 14

The Dedus Shoes, Inc. has common shares with a price of $28.76 per share. The firm paid a dividend of $1.00 yesterday, and dividends are expected to grow at 10 percent for two years and then at 5 percent, thereafter. What is the implied cost of common equity capital for Dedus? Round your final percentage answer to 1 decimal place.

Accepted Answer

To calculate the cost of equity using the Dividend Discount Model (DDM), we can use the following formula:

Cost of Equity = (Next Year's Dividend / Current Stock Price) + Growth Rate

We know that the current stock price is $28.76 and that the dividend for next year will be $1 x (1 + 10%) = $1.10. Thus,

Cost of Equity = ($1.10 / $28.76) + 10% = 13.8%

However, we need to apply the constant growth rate assumption to calculate the present value of all future dividends. Therefore, we need to adjust the cost of equity using the Gordon Growth Model:

Cost of Equity = (Dividend Yield) + Growth Rate

where Dividend Yield = Next Year's Dividend / Current Stock Price

and Growth Rate = Annual Dividend Growth Rate

After two years, the dividends will grow at a rate of 5%, so we need to add this to the formula:

Cost of Equity = ($1.10 / $28.76) + 5% = 9%

Therefore, the implied cost of common equity capital for Dedus is 9%. The answer is C.

Question 15

Wally's War Duds has a preferred share issue outstanding with a current price of $26.57. The firm is expected to pay a dividend of $1.86 per share a year from today. What is the firm's cost of preferred equity? Round your final answer to nearest percentage.

Accepted Answer

The cost of preferred equity can be calculated using the following formula:
Cost of Preferred Equity = Dividend/Current Price of Preferred Stock

Plugging in the given values, we get:

Cost of Preferred Equity = 1.86/26.57 = 0.070 (rounded to three decimal places)

Therefore, the firm's cost of preferred equity is 7.0%, which corresponds to choice B.

Question 16

Billy's Goat Coats has a preferred share issue outstanding with a current price of $38.89. The firm last paid a dividend on the issue of $3.50 per share. What is the firm's cost of preferred equity? Round your final answer to nearest percentage.

Accepted Answer

The cost of preferred equity is calculated as the dividend payment divided by the current price of the shares. In this case, the cost of preferred equity is ($3.50 / $38.89) = 0.09 or 9%. Therefore, the best choice is C.

Question 17

What is the beta of a firm whose equity has an expected return of 21.3 percent when the risk-free rate of return is 7.0 percent and the expected return on the market is 18.0 percent?

Accepted Answer

Using the capital asset pricing model (CAPM): 
Expected return of the firm's equity = Risk-free rate + Beta * (Expected return on market - Risk-free rate)
21.3% = 7.0% + Beta * (18.0% - 7.0%)
Beta = (21.3% - 7.0%) / (18.0% - 7.0%) = 1.30
Therefore, the answer is B.

Question 18

Melba's Toast has a preferred share issue outstanding with a current price of $19.50. The firm is expected to pay a dividend of $2.34 per share a year from today. What is the firm's
Cost of preferred equity?

Accepted Answer

The cost of preferred equity can be calculated using the formula:
Cost of preferred equity = Dividend per share / Net proceeds per share

Net proceeds per share can be found by subtracting flotation costs from the current market price:
Net proceeds per share = Current market price - Flotation costs

Since no information is given about flotation costs, it is assumed to be zero. Thus, the net proceeds per share is equal to the current market price.

Plugging in the values, we get:

Cost of preferred equity = $2.34 / $19.50 = 0.12 = 12%

Therefore, the best choice is C.

Question 19

Turquoise Electronics, Inc. paid a dividend of $1.87 last year. If the firm's growth in dividends is expected to be 10 percent next year and then zero thereafter, then what is its cost of equity capital if the price of its common shares is currently $25.71?

Accepted Answer

The formula for the cost of equity capital using the dividend growth model is:
Cost of Equity Capital = (Dividend Next Year / Current Stock Price) + Expected Growth Rate of Dividends

We are given:
- Dividend Last Year = $1.87
- Expected Growth Rate of Dividends for next year = 10%
- Expected Growth Rate of Dividends thereafter = 0%
- Current Stock Price = $25.71

Using the formula, we can calculate the cost of equity capital as follows:

Cost of Equity Capital = ($1.87 x 1.10) / $25.71 + 0.10
Cost of Equity Capital = $2.057 / $25.71 + 0.10
Cost of Equity Capital = 0.0800 or 8.00%

Therefore, the best choice is B, with an 8.00% cost of equity capital.

Question 20

Gangland Water Guns, Inc. is expected to pay a dividend of $2.10 one year from today. If the firm's growth in dividends is expected to remain at a flat 3 percent forever, then what is the cost of equity capital for Gangland if the price of its common shares is currently $17.50?

Accepted Answer

The answer of Gangland Water Guns, Inc. is expected to...

Quiz 13: The Cost of Capital