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Chapter 11 - Calculating the Cost of CapitalChapter 11 Calculating the Cost of Capital Multiple Choice Questions 1. When calculating the weighted average cost of capital, weights are based on A. book values. B. book weights. C. market values. D. market betas. 2. Which of these completes this statement to make it true? The constant growth model is A. always going to have assumptions that will hold true. B. able to be adjusted for stocks that don't expect constant growth without sizeable errors. C. only going to be appropriate for the limited number of stocks that just happen to expect constant growth. D. only going to be appropriate for the limited number of stocks that just happen to expect nonconstant growth. 3. Which of the following is a true statement? A. To estimate the before-tax cost of debt, we need to solve for the Yield to Maturity (YTM) on the firm's existing debt. B. To estimate the before-tax cost of debt, we need to solve for the Yield to Call (YTC) on the firm's existing debt. C. To estimate the before-tax cost of debt, we use the coupon rate on the firm's existing debt. D. To estimate the before-tax cost of debt, we use the average rate on the firm's existing debt. 4. Which of the following is a true statement regarding the appropriate tax rate to be used in the WACC? A. One would use the marginal tax rate that the firm paid the prior year. B. One would use the average tax rate that the firm paid the prior year. C. One would use the weighted average of the marginal tax rates that would have been paid on the taxable income shielded by the interest deduction. D. One would use the marginal tax rates that would have been paid on the taxable income shielded by the interest deduction. 11-1 Chapter 11 - Calculating the Cost of Capital 5. Which of these statements is true regarding calculating weights for WACC? A. If we are calculating WACC for the firm, then equity, preferred stock and debt would be the entire book value of each source of capital. B. If we are calculating WACC for the firm, then equity, preferred stock and debt would be the entire market value of each source of capital. C. If we are calculating WACC for a project, then equity, preferred stock and debt would be the entire book value of each source of capital. D. If we are calculating WACC for a project, then equity, preferred stock and debt would be the entire market value of each source of capital. 6. Which of the following statements is true? A. If the new project is riskier than the firm's existing projects, then it should be charged a higher cost of capital. B. If the new project is riskier than the firm's existing projects, then it should be charged a lower cost of capital. C. If the new project is riskier than the firm's existing projects, then it should be charged the firm's cost of capital. D. The new project's risk is not a factor in determining its cost of capital. 7. Which of the following makes this a true statement? If the new project does significantly increase the firm's overall risk, A. the increased risk will be borne equally amongst the bond holders, preferred stockholders, and common stockholders. B. the increased risk will be borne disproportionately by bond holders. C. the increased risk will be borne disproportionately by preferred stockholders. D. the increased risk will be borne disproportionately by common stockholders. 8. An average of which of the following will give a fairly accurate estimate of what a project's beta will be? A. flotation beta B. proxy beta C. pure-play proxies D. weighted average beta 11-2 Chapter 11 - Calculating the Cost of Capital 9. Which of the following makes this a true statement? Ideally, when searching for a beta for a new line of business A. one could find other firms engaged in the proposed new line of business and use their betas as proxies to estimate the project's risk. B. one would like to find at least three or four pure-play proxies. C. two, or even one, proxies might represent a suitable sample if their line of business resembles the proposed new project closely enough. D. All the answers make this a true statement. 10. This is an estimated WACC computed using some sort of proxy for the average equity risk of the projects in a particular division. A. Average WACC B. Divisional WACC C. Proxy WACC D. Pure-play WACC 11. Which of these statements is true regarding divisional WACC? A. Using a divisional WACC vs a WACC for the firm's current operations will result in quite a few incorrect decisions. B. Using a simple firmwide WACC to evaluate new projects would give an unfair advantage to projects that present more risk than the firm's average beta. C. Using a simple firmwide WACC to evaluate new projects would give an unfair advantage to projects that present less risk than the firm's average beta. D. Using a firmwide WACC to evaluate new projects would have no impact on projects that present less risk than the firm's average beta. 12. An objective approach to calculating divisional WACCs would be done by A. simply considering the project's risk relative to the firm's lines of business and adjusting upward or downward to account for subjective opinions of project risk. B. computing the average beta for the firm, the firm's CAPM formula, and the firm's WACC. C. computing the average beta per division, using these figures for each division in the CAPM formula, and then constructing divisional WACCs. D. simply averaging out all the WACCs for all the firm's projects. 11-3 Chapter 11 - Calculating the Cost of Capital 13. Which statement makes this a false statement? When a firm pays commissions to underwriting firms that float the issuance of new stock, A. the component cost will need to be integrated to figure project WACCs. B. the component cost will need to be integrated only for the firm's WACC. C. the firm can increase the project's WACC to incorporate the flotation costs' impact. D. the firm can leave the WACC alone and adjust the project's initial investment upwards. 14. This is a principle of capital budgeting which states that the calculations of cash flows should remain independent of financing. A. generally accepted accounting principle B. financing principle C. separation principle D. WACC principle 15. Which of these makes this a true statement? The WACC formula A. is not impacted by taxes. B. uses the after-tax costs of capital to compute the firm's weighted average cost of debt financing. C. uses the pre-tax costs of capital to compute the firm's weighted average cost of debt financing. D. focuses on operating costs only to keep them separate from financing costs. 16. Which of these makes this a true statement? When determining the appropriate weights used in calculating a WACC, it should reflect A. the relative sizes of the total book capitalizations for each kind of security that the firm issues. B. the relative sizes of the total market capitalizations for each kind of security that the firm issues. C. only the market after-tax cost of debt. D. only the market after-tax cost of equity. 11-4 Chapter 11 - Calculating the Cost of Capital 17. These are fees paid by firms to investment bankers for issuing new securities. A. flotation costs B. interest expense C. seller financing charges D. user fees 18. FlavR Co stock has a beta of 2.0, the current risk-free rate is 2, and the expected return on the market is 9 percent. What is FlavR Co's cost of equity? A. 11% B. 13% C. 16% D. 20% 19. TJ Co stock has a beta of 1.45, the current risk-free rate is 5.75, and the expected return on the market is 14 percent. What is TJ Co's cost of equity? A. 17.71% B. 21.20% C. 26.05% D. 28.64% 20. CJ Co stock has a beta of 0.9, the current risk-free rate is 5.6, and the expected return on the market is 13 percent. What is CJ Co's cost of equity? A. 12.26% B. 17.30% C. 19.50% D. 22.34% 21. WC Inc. has a $10 million (face value), 10-year bond issue selling for 99 percent of par that pays an annual coupon of 9 percent. What would be WC's before-tax component cost of debt? A. 9.00% B. 9.10% C. 9.16% D. 18.32% 11-5 Chapter 11 - Calculating the Cost of Capital 22. IVY has preferred stock selling for 98 percent of par that pays a 7 percent annual coupon. What would be IVY's component cost of preferred stock? A. 6.86% B. 7.00% C. 7.14% D. 14.00% 23. Fern has preferred stock selling for 95 percent of par that pays an 8 percent annual coupon. What would be Fern's component cost of preferred stock? A. 7.60% B. 8.00% C. 8.42% D. 9.00% 24. Rose has preferred stock selling for 99 percent of par that pays a 9 percent annual coupon. What would be Rose's component cost of preferred stock? A. 4.55% B. 8.91% C. 9.00% D. 9.09% 25. Sports Corp has 10 million shares of common stock outstanding, 5 million shares of preferred stock outstanding, and 1 million bonds. If the common shares are selling for $25 per share, the preferred share are selling for $12.50 per share, and the bonds are selling for 97 percent of par, what would be the weight used for equity in the computation of Sports's WACC? A. 18.59% B. 19.49% C. 62.50% D. 79.75% 11-6 the preferred share are selling for $13. 91. Carrie D's has 6 million shares of common stock outstanding.42% D.88% C.33% B. 57. 33. 61. If the common shares are selling for $13 per share. and 10 thousand bonds. what would be the weight used for equity in the computation of JackIT's WACC? A.36% C. 80. and 20 thousand bonds. the preferred shares are selling for $30 per share. 83. 44. If the common shares are selling for $28 per share.33% B.64% D. 4 million shares of preferred stock outstanding. JackITs has 5 million shares of common stock outstanding. what would be the weight used for equity in the computation of Carrie D's WACC? A. If the common shares are selling for $15 per share. and the bonds are selling for 98 percent of par.08% D.00% 28.Calculating the Cost of Capital 26. and the bonds are selling for 105 percent of par. 46. 33.35% C. the preferred shares are selling for $28 per share.19% 27. 66.50 per share. 75.Chapter 11 . Solar Shades has 8 million shares of common stock outstanding. 1 million shares of preferred stock outstanding. 2 million shares of preferred stock outstanding. and 10 thousand bonds. and the bonds are selling for 109 percent of par. what would be the weight used for equity in the computation of Solar Shades' WACC? A.33% B. 33.61% 11-7 . and the bonds are selling for 106 percent of par. and 100 thousand bonds. what would be the weight used for preferred stock in the computation of TellAll's WACC? A.45% 30. what would be the weight used for preferred stock in the computation of Paper's WACC? A.12% C. 3.33% B. 48. TellAll has 10 million shares of common stock outstanding. 33. and 50 thousand bonds. If the common shares are selling for $32 per share. If the common shares are selling for $28 per share.02% B. 66. 60 million shares of preferred stock outstanding.55% D. and the bonds are selling for 105 percent of par. 27. 3. 3. Paper Exchange has 80 million shares of common stock outstanding. 3. 55.84% 31.27% C. 20 million shares of preferred stock outstanding. what would be the weight used for debt in the computation of Town Crier's WACC? A. the preferred shares are selling for $20 per share. the preferred shares are selling for $15. 2 million shares of preferred stock outstanding.33% 11-8 .50 per share. and 10 thousand bonds.43% C.Calculating the Cost of Capital 29. 26.33% D. If the common shares are selling for $20 per share.20% D. and the bonds are selling for 97 percent of par.64% B. the preferred shares are selling for $10 per share. 42.Chapter 11 . Town Crier has 10 million shares of common stock outstanding. 33. Chapter 11 .00% 35. If the common shares are selling for $30 per share. 24. If the appropriate weighted average tax rate is 34 percent. and that its before-tax cost of debt is 5 percent. the preferred shares are selling for $17 per share. 7. and that its before-tax cost of debt is 6 percent. 16. 8. Inc. 55 percent debt.80% D. 40 percent debt. 5.87% D. 8.56% C.Calculating the Cost of Capital 32. and 20 thousand bonds. while its cost of equity is 10 percent. 2.40% D. and the bonds are selling for 96 percent of par. 2. Suppose that Model Nails. Inc.'s capital structure features 60 percent equity. 11. 6.33% 33. If the appropriate weighted average tax rate is 28 percent.00% C. Suppose that TipsNToes. 60 percent debt.70% C.83% B.'s capital structure features 40 percent equity. while its cost of equity is 15 percent.'s capital structure features 45 percent equity. 3.18% B. 4 million shares of preferred stock outstanding.73% B.36% B.00% 11-9 .40% D. 0. and that its before-tax cost of debt is 9 percent. Inc. what will be Hanna Nails' WACC? A.79% C. 7. Suppose that Hanna Nails. If the appropriate weighted average tax rate is 40 percent. what will be TipsNToes' WACC? A.00% 34. what would be the weight used for debt in the computation of Bill's WACC? A. Bill's Boards has 20 million shares of common stock outstanding. 9. what will be Model Nails' WACC? A. 9. while its cost of equity is 9 percent. 5. 45%. The company also has outstanding preferred stock with a market value of $50 million.85% C. 13. The company also has outstanding preferred stock with a market value of $10 million. If PNB's tax rate is 40%.000 and selling at 95% of par value. what is the WACC? A.'s capital structure features 30 percent equity. and 500.47% C.50%. 7.Chapter 11 .Calculating the Cost of Capital 36. 11. what is the WACC? A. 70 percent debt.78% B. each with face value $1. and the cost of debt is 6. Suppose that Glamour Nails. The cost of equity is 15%.43% 38. 8.92% B. 4. PNB Industries has 20 million shares of common stock outstanding with a market price of $18. 4.83% 11-10 . The cost of equity is 12%.76% C. the cost of preferred is 12%. each with face value $1.00 per share.80% D. the cost of preferred is 10%.31% D. Inc.05% B. and 100. 5. and that its before-tax cost of debt is 4 percent. TJ Industries has 7 million shares of common stock outstanding with a market price of $20. 7. 11.00% 37. what will be Glamour Nails' WACC? A. 9.000 bonds outstanding.59% D. while its cost of equity is 10 percent. If the appropriate weighted average tax rate is 34 percent. If TJ's tax rate is 34%.000 bonds outstanding. and the cost of debt is 8. 12.000 and selling at 97% of par value. 9.00 per share. Suppose that TNT. Inc. Inc.65% 42. what is TNT's WACC if the firm faces an average tax rate of 28%? A. 11. and 60 percent debt. 10. 12 percent and 6. Suppose that TW.38% C. has a capital structure of 60 percent equity. respectively. 9.5 percent. 12. preferred stock and debt are 15.48% C. what is PAW's WACC if the firm faces an average tax rate of 28%? A. 23 percent preferred stock. and the cost of debt is 9%.71% B. Suppose that PAW.000 and selling at 96% of par value. and 34 percent debt. 10. what is the WACC? A. 13. preferred stock and debt are 13. The company also has outstanding preferred stock with a market value of $10 million. Inc. 10. 13.00% C. and 100.5 percent and 4 percent.4 percent. If the before-tax component costs of equity. 10.Calculating the Cost of Capital 39. and 30 percent debt. If PAW's tax rate is 34%. 9. 10 percent preferred stock. the cost of preferred is 15%. 9. 6. respectively. 10.0% 41. 6. each with face value $1. 7. what is TW's WACC if the firm faces an average tax rate of 30%? A. 10 percent and 7 percent.Chapter 11 . 12.14% B. preferred stock and debt are 17.2% D. 14.51% D.19% B.64% C. The cost of equity is 19%.80% D. 15 percent preferred stock. has a capital structure of 25 percent equity.33% 40. PAW Industries has 5 million shares of common stock outstanding with a market price of $8. respectively.00 per share. If the before-tax component costs of equity. has a capital structure of 43 percent equity.5 percent.5 percent.30% 11-11 .10% D.000 bonds outstanding.45% B. If the before-tax component costs of equity. 14. 12.5 percent. 8.19% B. what is FDR's WACC? A. 13. what is JAK's WACC? A. annual coupon bonds with a maturity of 10 years.64% D.79% 11-12 .00 per share. and all future dividends are expected to grow at 4 percent per year.Chapter 11 . selling at 98 percent of par ($1000). its next dividend is expected to be $2.Calculating the Cost of Capital 43. annual coupon bonds with a maturity of 25 years.43% 46. Cup Cake Ltd. If XYZ's weighted average tax rate is 40 percent and its cost of equity is 15 percent.36% C.5 percent. XYZ Industries has 10 million shares of stock outstanding selling at $10 per share and an issue of $30 million in 8. has 20 million shares of stock outstanding selling at $25 per share and an issue of $30 million in 8 percent. what is XYZ's WACC? A. JAK Industries has 5 million shares of stock outstanding selling at $25 per share and an issue of $40 million in 8 percent. 7. 11.75% C. 12. 12. annual coupon bonds with a maturity of 16 years. 14.11% 45.98% 44.81% C.50% D.94% B. what is its WACC? A. 11. If JAK's weighted average tax rate is 34 percent and its cost of equity is 15 percent. 12. FDR Industries has 50 million shares of stock outstanding selling at $30 per share and an issue of $200 million in 9. 12. selling at 108 percent of par ($1000).00% C. selling at 102 percent of par ($1000).65% D. If FDR's weighted average tax rate is 28 percent and its cost of equity is 16 percent. 9. selling at 105 percent of par ($1000). indefinitely. 15.06% B.88% D. If Cup Cake's weighted average tax rate is 34 percent. 11. annual coupon bonds with a maturity of 15 years.75% B. 10. 83. 1 million shares of preferred stock outstanding.17% C. Sea Shell Industries has 50 million shares of common stock outstanding.33%. 82.33%. 6. preferred stock. 11. respectively? A. 33. 33. respectively? A. Pumpkin Pie Industries has 5 million shares of common stock outstanding.93%. and all future dividends are expected to grow at 5 percent per year.17% C. 10 million shares of preferred stock outstanding. what would be the weights used in the calculation of Sea Shell's WACC for common stock.92%. what would be the weights used in the calculation of Pumpkin Pie's WACC for common stock.64%. If Crab Cakes' weighted average tax rate is 30 percent. 10. 0. annual coupon bonds with a maturity of 25 years. 8. 3. 11.33%. and the bonds are selling for 97 percent of par ($1000). what is its WACC? A. preferred stock. 16.26%.00 per share.42% B.57% 11-13 . and 100 thousand bonds.50 per share. and bonds. 27. and 10 thousand bonds. 33. 17. 0. 10. 33.33%.33% B. its next dividend is expected to be $1.97%. 16.67%.19%.Calculating the Cost of Capital 47.19%. the preferred shares are selling for $8. If the common shares are selling for $19 per share.51%.38% D. 83. and bonds.32%. 15.64%.52% 48. has 5 million shares of stock outstanding selling at $15 per share and an issue of $10 million in 10 percent. selling at 97 percent of par ($1000). indefinitely. and the bonds are selling for 98 percent of par ($1000).Chapter 11 . 8.83%. 33.75% 49. Crab Cakes Ltd. 54. the preferred shares are selling for $31 per share. 7. 33.84% C.91% D. 77. If the common shares are selling for $50 per share. 85.16% D.33% B. and 50 thousand bonds.22%.56% 11-14 . 66. 5. 3.33%. respectively? A.43% 51.Calculating the Cost of Capital 50. respectively? A. 33.31%.71%. 33. 33.61%. 17. If the common shares are selling for $25 per share. 6.26%. the preferred shares are selling for $15 per share.22% D. Rings N Things Industries has 40 million shares of common stock outstanding. and the bonds are selling for 96 percent of par ($1000).33%. 20 million shares of preferred stock outstanding. and bonds.71% 52. 3. 5.50% C. 64. the preferred shares are selling for $10. and that all future dividends are expected to grow by 5 percent per year. preferred stock. 33.Chapter 11 .71% C. 74. 0. Suppose that Tan Lines' common shares sell for $20 per share. what will be the flotation-adjusted cost of equity? A. 33. preferred stock. and the bonds are selling for 100 percent of par ($1000). If Tan Lines faces a flotation cost of 10% on new equity issues.17%.23%.98%.33% B. 32. 63. 8. 29. 22.50 per share.52%. 33. what would be the weights used in the calculation of Accessory's WACC for common stock.86%.79% C. 10. and 100 thousand bonds. Accessory Industries has 2 million shares of common stock outstanding.33%. are expected to set their next annual dividend at $1. 10. If the common shares are selling for $22 per share.12%. what would be the weights used in the calculation of Ring's WACC for common stock. 1 million shares of preferred stock outstanding.00% D.33%.33% B. and bonds. 33.06% B.08% D.07%. 74.00 per share. 10. 17. indefinitely. 71. 00 per share. 8. 16. Suppose that Tan Lotion's common shares sell for $18 per share. 14. It has 15. and the expected market return is 20%. and that all future dividends are expected to grow by 8 percent per year. 10.06% 55. 6. 27. indefinitely.Chapter 11 . 11.56% D.5.000 shares of common stock outstanding. are expected to set their next annual dividend at $2. 15. Suppose that Wave Runners' common shares sell for $35 per share. and pay coupons semi- annually.06% C.6% D.000). 13. What is the risk-free rate? A.000 bonds outstanding. what will be the flotation-adjusted cost of equity? A. The tax rate is 35% and the WACC is 16%. If Tan Lotion faces a flotation cost of 12% on new equity issues. 7.37% B.72% 54. each with a market price of $10. 30. each selling for $900 (with a face value of $1.45% B. The bonds mature in 15 years. If Wave faces a flotation cost of 15% on new equity issues. A firm has 1. what will be the flotation-adjusted cost of equity? A.71% D.4% C. The firm's equity has a beta of 1. 5. are expected to set their next annual dividend at $1.00 per share. 12. what will be the flotation-adjusted cost of equity? A. 13.06% C. have a coupon rate of 10%. and that all future dividends are expected to grow by 7 percent per year. 4.07% C. If Beach faces a flotation cost of 10% on new equity issues.000.45% D.31% 56. Suppose that Beach Blanket's common shares sell for $55 per share. are expected to set their next annual dividend at $3.73% B. and that all future dividends are expected to grow by 10 percent per year.00 per share.0% 11-15 .Calculating the Cost of Capital 53. 6.00 per share. indefinitely. indefinitely.8% B. The T-bill rate is 4 percent and the market risk premium is 8 percent. 8. which project(s) will be incorrectly accepted? A. have a coupon rate of 9%.000 bonds outstanding.36% 58. It has 25. An all-equity firm is considering the projects shown below. The bonds mature in 20 years. Projects B and C C. Project A B. A firm has 4. The T-bill rate is 3 percent and the market risk premium is 6 percent. Project C C.22% D. What is the risk-free rate? A. The firm's equity has a beta of 1. Project D D. Project A B. and the expected market return is 15%.000. 6. An all-equity firm is considering the projects shown below. 19.Calculating the Cost of Capital 57. Project D D. each with a market price of $12. Projects C and D 11-16 .000 shares of common stock outstanding. Project B 59. and pay coupons semi-annually. which project(s) will be incorrectly rejected? A. each selling for $980. 9.00% C. If the firm uses its current WACC of 12 percent to evaluate these projects.Chapter 11 .28% B.5. If the firm uses its current WACC of 13 percent to evaluate these projects. The tax rate is 30% and the WACC is 15%.00 per share. Project A B.Chapter 11 .25%. 13.50% B.50% D. What is JaiLai's cost of equity? A. 8. If the firm uses its current WACC of 14 percent to evaluate these projects. Diddy Corp stock has a beta of 1. 6.41% D. What would be Oberon's before-tax component cost of debt? A. which project(s) will be incorrectly rejected? A.30% 62. the current risk-free rate is 5%.7.2%.40% D. The T-bill rate is 4 percent and the market risk premium is 9 percent.20% C. JaiLai Cos. the current risk-free rate is 6. 16.36% 63. 18.02% C. 15. Project C D. Project D 61.81% B. and the expected return on the market is 11%. 7. 15. 14.0. An all-equity firm is considering the projects shown below.Calculating the Cost of Capital 60. stock has a beta of 1. Project B C.12% B. 14.5%. and the expected return on the market is 15. What is Diddy's cost of equity? A. 7. has a $20 million ($1000 face value) 10-year bond issue selling for 99% of par that pays an annual coupon of 7. Oberon Inc.19% C.15% 11-17 . 13. KatyDid Clothes has a $150 million ($1000 face value) 15-year bond issue selling for 106% of par that carries a coupon rate of 8%.03% C.93% B.67% B. Marme Inc.09% 65. the preferred shares are selling for $15 per share. 5. KatyDid Clothes has a $150 million ($1000 face value) 15-year bond issue selling for 86% of par that carries a coupon rate of 8%. has preferred stock selling for 137% of par that pays an 11% annual dividend. 6.13% C. 9.16% 67. paid semi-annually.07% C. a maker of telecommunications equipment. paid semi-annually. FarCry Industries. what weight should you use for debt in the computation of FarCry's WACC? A. and 10 thousand bonds.Calculating the Cost of Capital 64. What would be Marme's component cost of preferred stock? A. 8. 7. If the common shares are selling for $27 per share. 11. 7.17% D. 7.09% 66.00% B. 8. 4. 4. 10. 5. What would be KatyDid's before-tax component cost of debt? A.90% B. 8.12% D. 1 million shares of preferred stock outstanding. What would be KatyDid's before-tax component cost of debt? A. 8. and the bonds are selling for 119% of par ($1000).81% D. has 6 million shares of common stock outstanding.Chapter 11 .80% D.34% C. 3.30% 11-18 . 28. 26.24% D.25% 11-19 .52% B. 3 million shares of preferred stock outstanding.86% C. has 26 million shares of common stock outstanding.74% B.01% 70. 1 million shares of preferred stock outstanding. If the common shares sell for $12 per share. and 10 thousand bonds. and the bonds are selling for 111% of par ($1000). a maker of telecommunications equipment. has 4 million shares of common stock outstanding. what weight should you use for debt in the computation of OMG's WACC? A. has 26 million shares of common stock outstanding. 25.86% 69. 25. and the bonds sell for 98% of par ($1000). 27. OMG Inc. 28. and the bonds sell for 101% of par ($1000).52% B. and 50 thousand bonds.50 per share. 1 million shares of preferred stock outstanding. what weight should you use for preferred stock in the computation of FarCry's WACC? A.51% C. the preferred shares sell for $114. FarCry Industries. 29. the preferred shares sell for $114. 26.Calculating the Cost of Capital 68. what weight should you use for preferred stock in the computation of FarCry's WACC? A.79% D.51% C.50 per share. If the common shares sell for $15 per share.24% D. 22. 21. a maker of telecommunications equipment. and 10 thousand bonds. FarCry Industries. 27. the preferred shares are selling for $10 per share. If the common shares are selling for $21 per share.Chapter 11 . 32. If TAFKAP's weighted average tax rate is 34% and its cost of equity is 12.58% C.91% D. 11. what is TAFKAP's WACC? A. each with face value $1. If JLP's tax rate is 34%. TAFKAP Industries has 8 million shares of stock outstanding selling at $17 per share and an issue of $20 million in 7.66% 72. what is the WACC? A. If the common shares sell for $17 per share. The cost of equity is 14%.5%.000 bonds outstanding.98% C.02% B.16% D.5 million shares of common stock outstanding with a market price of $20. selling at 109% of par ($1000). what weight should you use for preferred stock in the computation of OMG's WACC? A.000 and selling at 90% of par value. and 25. has 4 million shares of common stock outstanding.72% 73.37% C. 11.83% 11-20 . OMG Inc. 12.91% B. 28. 12. The company also has outstanding preferred stock with a market value of $10 million. annual coupon bonds with a maturity of 15 years. 3 million shares of preferred stock outstanding. 12. and the bonds sell for 117% of par ($1000). 12.5%. 13. the preferred shares sell for $126 per share. 13. JLP Industries has 6. the cost of preferred is 10%.Calculating the Cost of Capital 71.Chapter 11 . and 5 thousand bonds.39% B.13% D.25%. 31. and the cost of debt is 6. 47.00 per share. 83. has 10 million shares of stock outstanding selling at $20 per share and an issue of $50 million in 8%. and all future dividends are expected to grow at 5% per year. Johnny Cake Ltd. 13. annual coupon bonds with a maturity of 13 years. each with a market price of $8.Chapter 11 .00 per share. and pay coupons semi- annually. Calculate the risk-free rate. have a coupon rate of 8%. indefinitely. The firm's equity has a beta of 1.68% B. If Johnny Cake's weighted average tax rate is 34%. each with a market price of $10.00 per share.000 bonds outstanding.19% 76.Calculating the Cost of Capital 74. and the expected market return is 15%. A firm has 5.18% D.5% of par ($1000).12% 11-21 .000 bonds outstanding. and the expected market return is 15%. and pay coupons semi- annually. 20. 13. 2.000 shares of common stock outstanding. The bonds mature in 15 years.05% B. selling at 93. A.0. The firm's equity has a beta of 2. 2.18% C. It has 55. 12.64% B. 15. The tax rate is 35% and the WACC is 16%. 14. 1. each selling for $990 with a $1000 face value.06% 75. It has 25.000 shares of common stock outstanding.32% D.26% D.4.000. each selling for $1100 with a $1000 face value. A firm has 5. Calculate the risk-free rate. what is its WACC? A.00 per share. its next dividend is expected to be $2. The bonds mature in 12 years.27% C. have a coupon rate of 9%. 1.000. A.79% C. 27. The tax rate is 35% and the WACC is 14%. 2. The T-bill rate is 4% and the market risk premium is 7%. C. B and C would be incorrectly rejected. Projects A. If the firm uses its current WACC of 12% to evaluate these projects. An all-equity firm is considering the projects shown below. Both Projects A and C would be incorrectly rejected. will be incorrectly rejected? A. B. An all-equity firm is considering the projects shown below.Chapter 11 . which project(s). if any. If the firm uses its current WACC of 12% to evaluate these projects. D. which project(s). Project A will be incorrectly rejected and Project B would be incorrectly accepted. Both Projects A and C would be incorrectly rejected. D. None of the projects would be incorrectly rejected. Project A would be incorrectly rejected. if any. None of the projects will be incorrectly accepted or rejected. 11-22 .Calculating the Cost of Capital 77. Only Project A would be incorrectly rejected. will be incorrectly accepted or rejected? A. The T-bill rate is 3% and the market risk premium is 6%. 78. C. B. 13. 10.25% B.75%.3 and 1. All of these statements are correct. B.95%. If all current and future projects will be financed with half debt and half equity. 11.45% 80. 7. The firm currently has 2 divisions. 9. and if the current cost of equity (based on an average firm beta of 1. with betas for each division of 0.6. respectively.00% D. The weighted average cost of capital is calculated on a before-tax basis. Suppose your firm has decided to use a divisional WACC approach to analyze projects. what are the WACCs for divisions A through D? A. Suppose your firm has decided to use a divisional WACC approach to analyze projects. D. 12.75% C.15% B. and if the current cost of equity (based on an average firm beta of 1. 12. 8.5. A through D. 8.25%. A and B.0 and a current risk-free rate of 5%) is 14% and the after-tax yield on the company's bonds is 6%. 12. 13.00%.95%. The weights of debt and equity should be based on the balance sheet because this is the most accurate assessment of the valuation.5. C. respectively. The firm currently has 4 divisions. 1.0. 12.10% D.65%.95%. 8.05%. 9. 12. An increase in the market risk premium is likely to increase the weighted average cost of capital.25%. what are the WACCs for divisions A and B? A. 9.75%. with average betas for each division of 0. If all current and future projects will be financed with half debt and half equity. 10. 10. 13. 1.15% 81.00%. Which of the following statements is correct? A.Chapter 11 . 9.5 and 1.15%. 12.Calculating the Cost of Capital 79.00%.00% C. 13.50%.25%. 12.75%. 11-23 .0 and a current risk-free rate of 7%) is 14% and the after-tax yield on the company's bonds is 8%. 11. Which of the following statements is correct? A. 12. None of these statements is correct.88% D. 15. 12. the current risk-free rate is 4%. and therefore float costs reduce the weighted average cost of capital.71% 85. Investor returns are reduced when float costs increase.40% D. what should be the best estimate of the firm's cost of equity? A. 11.Calculating the Cost of Capital 82.Chapter 11 . Beta C.2. the current risk-free rate is 4%. ADK Industries common shares sell for $40 per share.89% B.75 per share. Expected return on the market D. The risk-free rate B. indefinitely. 11.50% C. 15. The weighted average cost of capital is a historical cost. the expected rate on the market is 11%. All of these 84. ADK expects to set their next annual dividend at $1.5. If ADK expects future dividends to grow at 9% per year.03% 11-24 . 14. C. ADK Industries common shares sell for $60 per share. ADK expects to set their next annual dividend at $3.25% B. If the risk-free rate increases. and the stock has a beta of 1. B. indefinitely. Which of the following will impact the cost of equity component in the weighted average cost of capital? A. what should be the best estimate of the firm's cost of equity? A. the expected rate on the market is 11%. If ADK expects future dividends to grow at 7% per year. it will have no impact on the weighted average cost of capital.75 per share. D. and the stock has a beta of 1. 83.38% C. 14. Which of the following will directly impact the cost of equity? A. ADK has 30. Business unit WACC B.61% B. what will be the before-tax and after-tax component cost of debt? A.06% C. Profit margins 87. Coupon Rate D. 7. Capital Structure B. 6. Expected future tax rates C.02% C.Calculating the Cost of Capital 86.000 15-year 9% semi-annual coupon bonds outstanding. 4. 7. 8.32%. Which of the following will directly impact the cost of debt? A.000 15-year 9% annual coupon bonds outstanding. 5. Pure play beta C. 11.76% 89. ADK has 30. Debt Ratio C.88% 90.70% D.95% B. 9%. A. If the bonds currently sell for 111% of par and the firm pays an average tax rate of 36%. Stock price D.12%. Expected growth rate in sales B.85%. 7.74%. Divisional WACC D.19%. 9. 5. 7. 10.15% D.91%. Competition within the industry 88. 5. 10.Chapter 11 . what will be the before-tax and after-tax component cost of debt? A. If the bonds currently sell for 90% of par and the firm pays an average tax rate of 32%.05%. Component cost 11-25 . An estimated WACC computed using some sort of proxy for the average equity risk of the projects in a particular business unit is known as the ____________. 6. CAPM D. Which of the following statements is correct? A. subjective B. implicit 92. The cost of equity 11-26 . What is the theoretical minimum for the weighted average cost of capital? A. objective C. 95. The flotation-adjusted cost of equity will always be less than the cost of equity that has not been adjusted for flotation costs. A.Calculating the Cost of Capital 91. subjective B. firmwide D. insignificant and can be assumed away B. implicit 93. The ____________ approach to computing a divisional weighted average cost of capital (WACC) requires only that WACCs for "risky" and "relatively safe" divisions be adjusted. Flotation costs are _______________. The ___________ approach to computing a divisional weighted average cost of capital (WACC) uses the average beta of projects in each division to calculate the WACC. The flotation-adjusted cost of equity may be more than or less than the cost of equity that has not been adjusted for flotation costs. B.Chapter 11 . A. The flotation-adjusted cost of equity will always be more than the cost of equity that has not been adjusted for flotation costs. A. objective C. The after-tax cost of debt B. firmwide D. D. The cost of preferred stock C. None of these statements is correct. the difference between the bid-ask spread on the sale of the security C. 94. C. None of these answers are correct. commissions to the underwriting firm that floats the issue D. When the firm has a low beta. Suppose a new project was going to be financed partially with retained earnings. B. not what the historical prices would have been. Because we are interested in determining what the cost of financing the firm's assets would be given today's market situation and the component costs the firm currently faces. Which of the following is a situation in which you would want to use the constant growth model approach for estimating the component cost of equity? A. Use the same flotation cost that would be used to issue new common stock. B. because preferred dividends are paid out of before-tax income B.Calculating the Cost of Capital 96. When the firm's stock is expected to experience constant dividend growth. Because often-times firms "window-dress" their financial statements. None of these answers is correct. When the firm pays a constant dividend.Chapter 11 . preferred and common stock. 98. What flotation costs should you use for retained earnings? A. D. Which of following is a situation in which you would want to use the CAPM approach for estimating the component cost of equity? A. C. Use an average of the flotation costs for debt. When you are able to estimate the market risk premium with certainty. Why do we use market-value weights instead of book-value weights? A. D. 99. B. Because it is required in the Sarbanes-Oxley regulations. D. because we can only estimate the marginal tax rate of the preferred stockholders D. Use the industry average flotation cost for common stock. because most of the investors in preferred stock do not pay tax on the dividends C. When the firm has multiple divisions. The reason that we do not use an after-tax cost of preferred stock is __________. 100. Zero. When you are able to estimate the firm's beta with certainty. 97. When the firm has a high level of financial leverage. C. B. 11-27 . C. D. When you are able to estimate the risk-free rate with certainty. C. A. None of these answers is correct. B. A proxy beta is _________________. C. the risk of that division may be significantly different than the risk of the project. then it should be expect to be "charged" a higher cost of capital than the firm's overall WACC. B. B. None of these statements is correct. implying that the project will be evaluated with a divisional cost of capital that is much different from what a project-specific cost of capital would be. The project's risk and the cost of capital to which it is compared are independent. A. None of these answers is correct. 104. 11-28 . D. If a new project is riskier than the firm's existing projects. It is common that the after-tax cost of debt exceeds the cost of equity. the beta used when the firm has a great deal of business risk D. The expected return of the new project may be incorrect. D. The WACC measures the marginal cost of capital. None of these answers is correct. 102. then it should be expect to be "charged" a lower cost of capital than the firm's overall WACC. D. If a new project is riskier than the firm's existing projects. None of these answers is correct. the average beta of firms that are only engaged in the proposed new line of business B. Which of the following statements is correct? A.Calculating the Cost of Capital 101. Managers in different divisions may use different methods to calculate the WACC. The WACC is a measure of the before-tax cost of capital. Which of the following statements is correct? A.Chapter 11 . 103. C. Which of the following is a reason why the divisional cost of capital approach may cause problems if new projects are assigned to the wrong division? A. the industry average beta that is used in lieu of the firm's beta because the firm has not existed long enough to have a beta calculated C. If projects are assigned to the wrong division. C. most analysts calculate the weighted average cost of capital on a before-tax basis to facilitate comparisons. A decrease in the firm's marginal corporate tax rate will decrease the weighted average cost of capital. C. The WACC measures the before-tax cost of capital. All of these statements are equally correct.86% B. None of these statements is correct. C. The firm's tax rate is 36%. The firm's share price falls 10%. 10.Chapter 11 . D. C. Flotation costs can decrease the weighted average cost of capital. When comparing two firms within the same industry. D. 9. B. None of these answers is correct. The firm is expected to reduce its dividend. C.91% C. Which of the following statements is correct? A. The firm's corporate tax rate increases. Which of the following is most correct? A. D. Flotation costs can decrease the weighted average cost of capital. B. B. Firms should use historical costs rather than marginal costs of capital. 107. An increase in the risk-free rate will increase the cost of equity. Which of the following will increase the cost of equity? A. 3. The cost of debt is based on the cost of all liabilities. 108. D. Apple's 9% annual coupon bond has 10 years until maturity and the bonds are selling in the market for $890. Which of the following statements is correct? A.95% 11-29 . 109. None of these statements is correct. 106. including accounts payable and accruals.81% D. 6. What is the firm's after-tax cost of debt? A.Calculating the Cost of Capital 105. An increase in the firm's marginal corporate tax rate will decrease the weighted average cost of capital. B. The firm could issue new bonds at a yield to maturity of 10% and the firm has a tax rate of 30%.57% 11-30 .Calculating the Cost of Capital 110. 15.51% B.50% C. A firm uses only debt and equity in its capital structure. what was the firm's tax rate? A.50% D.50% 111.13% C.50% D. The firm could issue new bonds at a yield to maturity of 9% and the firm has a tax rate of 30%. 15. A firm uses only debt and equity in its capital structure.68% 113. 15. The firm's weight of debt is 40%. what is the firm's cost of equity? A. If the firm's after-tax cost of debt is 8%. If the firm's WACC is 12%. 14. 15.09% B.Chapter 11 .74% 112. 36. Apple's 9% annual coupon bond has 10 years until maturity and the bonds are selling in the market for $1190. 34. 44.50% C. 44. 37. 14. Apple's 9% annual coupon bond has 10 years until maturity and the bonds are selling in the market for $790. 15. what is the firm's cost of equity? A. 16. 21. 34.63% C. If the firm's after-tax cost of debt is 5%.11% B.21% D. 23.03% D. If the firm's WACC is 11%. what was the firm's tax rate? A.92% B. The firm's weight of debt is 45%. with average betas for each division of 0. 5. what will the WACCs be for each division? 11-31 . 5. 6. A firm uses only debt and equity in its capital structure.97% D.2. 6.5. The firm currently has 4 divisions.89% B. 6. 7.05% C. The firm's cost of equity is 13% and it has a tax rate of 30%. and if the current cost of equity (based on an average firm beta of 1.Chapter 11 . If the firm's WACC is 13%. 9. A firm uses only debt and equity in its capital structure.38% D. what is the firm's before-tax cost of debt? A. A through D. The firm's weight of equity is 75%. The firm's cost of equity is 16% and it has a tax rate of 30%. 1. 1.17% B. Suppose your firm has decided to use a divisional WACC approach to analyze projects.36% 115.8. respectively. market premium of 10 percent) is 15 percent and the after- tax yield on the company's bonds is 7 percent. what is the firm's before-tax cost of debt? A.28% C. If the firm's WACC is 11%. If all current and future projects will be financed with half debt and half equity. The firm's weight of equity is 70%.Calculating the Cost of Capital 114. 5.0 and a current risk-free rate of 5 percent.71% Essay Questions 116.5 and 1. what two ways can it be calculated. For computing a project WAAC. List and explain all the components of the WACC equation. 118. and which way is better and why? 119. why do we take some component costs from the firm. When calculating the component cost of equity. but compute others that are specific for the project being considered? 11-32 . should project-specific or firmwide debt and preferred stock components be used.Calculating the Cost of Capital 117. When calculating WACC. and why? 120.Chapter 11 . 123. 11-33 . Denote the impact that flotation costs have on capital budgeting decisions.Chapter 11 .Calculating the Cost of Capital 121. Differentiate between the objective and subjective approach to computing a divisional cost of capital. Explain why the divisional cost of capital approach may cause problems if new projects are assigned to the wrong division. 124. Why do we use market-based weights instead of book-value weights when computing the WAAC? 122. Source: NEW Topic: Constant growth model 11-34 .Calculating the Cost of Capital Chapter 11 Calculating the Cost of Capital Answer Key Multiple Choice Questions 1. able to be adjusted for stocks that don't expect constant growth without sizeable errors. D. always going to have assumptions that will hold true. B. weights are based on A. only going to be appropriate for the limited number of stocks that just happen to expect constant growth. only going to be appropriate for the limited number of stocks that just happen to expect nonconstant growth. book values. When calculating the weighted average cost of capital. D. C. B. book weights. Which of these completes this statement to make it true? The constant growth model is A. AACSB: Reflective Thinking Blooms: Remember Difficulty: 2 Intermediate Learning Objective: 11-01 Understand the relationship of cost of capital to the investor's required return. AACSB: Reflective Thinking Blooms: Remember Difficulty: 1 Basic Learning Objective: 11-01 Understand the relationship of cost of capital to the investor's required return. Source: NEW Topic: WACC 2. C.Chapter 11 . market betas. market values. D.Chapter 11 . we use the average rate on the firm's existing debt. we use the coupon rate on the firm's existing debt. One would use the marginal tax rate that the firm paid the prior year. C. Source: NEW Topic: Cost of debt 4.Calculating the Cost of Capital 3. Source: NEW Topic: Marginal tax rate 11-35 . preferred stock. we need to solve for the Yield to Maturity (YTM) on the firm's existing debt. B. One would use the weighted average of the marginal tax rates that would have been paid on the taxable income shielded by the interest deduction. AACSB: Reflective Thinking Blooms: Remember Difficulty: 1 Basic Learning Objective: 11-02 Use the weighted-average cost of capital (WACC) formula to calculate a project's cost of capital. To estimate the before-tax cost of debt. C. AACSB: Reflective Thinking Blooms: Remember Difficulty: 1 Basic Learning Objective: 11-03 Explain how the firm chooses among estimating costs of equity. Which of the following is a true statement regarding the appropriate tax rate to be used in the WACC? A. Which of the following is a true statement? A. To estimate the before-tax cost of debt. One would use the marginal tax rates that would have been paid on the taxable income shielded by the interest deduction. and debt. we need to solve for the Yield to Call (YTC) on the firm's existing debt. D. B. To estimate the before-tax cost of debt. To estimate the before-tax cost of debt. One would use the average tax rate that the firm paid the prior year. Calculating the Cost of Capital 5. preferred stock and debt would be the entire book value of each source of capital. If the new project is riskier than the firm's existing projects. C. If we are calculating WACC for a project. Which of these statements is true regarding calculating weights for WACC? A. preferred stock and debt would be the entire book value of each source of capital. Source: NEW Topic: WACC 6. then equity. preferred stock. B. D. If the new project is riskier than the firm's existing projects. then it should be charged the firm's cost of capital. B. then equity. preferred stock and debt would be the entire market value of each source of capital. then equity. AACSB: Reflective Thinking Blooms: Remember Difficulty: 2 Intermediate Learning Objective: 11-03 Explain how the firm chooses among estimating costs of equity. preferred stock and debt would be the entire market value of each source of capital. Which of the following statements is true? A.Chapter 11 . then it should be charged a higher cost of capital. The new project's risk is not a factor in determining its cost of capital. If we are calculating WACC for the firm. If we are calculating WACC for the firm. If we are calculating WACC for a project. If the new project is riskier than the firm's existing projects. and debt. D. then equity. C. AACSB: Reflective Thinking Blooms: Remember Difficulty: 2 Intermediate Learning Objective: 11-05 Identify which elements of WACC are used to calculate a project-specific WACC. Source: NEW Topic: Project specific WACC 11-36 . then it should be charged a lower cost of capital. Source: NEW Topic: Beta estimate 11-37 . D. pure-play proxies D. weighted average beta AACSB: Reflective Thinking Blooms: Remember Difficulty: 1 Basic Learning Objective: 11-05 Identify which elements of WACC are used to calculate a project-specific WACC.Calculating the Cost of Capital 7. An average of which of the following will give a fairly accurate estimate of what a project's beta will be? A. B. the increased risk will be borne disproportionately by bond holders. flotation beta B.Chapter 11 . the increased risk will be borne disproportionately by common stockholders. the increased risk will be borne equally amongst the bond holders. proxy beta C. A. preferred stockholders. and common stockholders. AACSB: Reflective Thinking Blooms: Remember Difficulty: 2 Intermediate Learning Objective: 11-05 Identify which elements of WACC are used to calculate a project-specific WACC. the increased risk will be borne disproportionately by preferred stockholders. C. Which of the following makes this a true statement? If the new project does significantly increase the firm's overall risk. Source: NEW Topic: Project risk 8. AACSB: Reflective Thinking Blooms: Remember Difficulty: 2 Intermediate Learning Objective: 11-05 Identify which elements of WACC are used to calculate a project-specific WACC. A. C. Source: NEW Topic: Beta estimate 10. or even one. one would like to find at least three or four pure-play proxies. Divisional WACC C. Proxy WACC D.Calculating the Cost of Capital 9. when searching for a beta for a new line of business A. This is an estimated WACC computed using some sort of proxy for the average equity risk of the projects in a particular division. proxies might represent a suitable sample if their line of business resembles the proposed new project closely enough. B. Pure-play WACC AACSB: Reflective Thinking Blooms: Remember Difficulty: 1 Basic Learning Objective: 11-06 Evaluate trade-offs between a firmwide WACC and a divisional cost of capital approach. one could find other firms engaged in the proposed new line of business and use their betas as proxies to estimate the project's risk.Chapter 11 . two. Which of the following makes this a true statement? Ideally. All the answers make this a true statement. Average WACC B. Source: NEW Topic: Divisional cost of capital 11-38 . D. simply considering the project's risk relative to the firm's lines of business and adjusting upward or downward to account for subjective opinions of project risk. and then constructing divisional WACCs. computing the average beta for the firm. B. An objective approach to calculating divisional WACCs would be done by A. Using a divisional WACC vs a WACC for the firm's current operations will result in quite a few incorrect decisions. B. simply averaging out all the WACCs for all the firm's projects. Source: NEW Topic: Divisional cost of capital 12. Using a firmwide WACC to evaluate new projects would have no impact on projects that present less risk than the firm's average beta. D. D. Using a simple firmwide WACC to evaluate new projects would give an unfair advantage to projects that present more risk than the firm's average beta. C. computing the average beta per division. Which of these statements is true regarding divisional WACC? A. AACSB: Reflective Thinking Blooms: Remember Difficulty: 2 Intermediate Learning Objective: 11-06 Evaluate trade-offs between a firmwide WACC and a divisional cost of capital approach.Calculating the Cost of Capital 11. AACSB: Reflective Thinking Blooms: Remember Difficulty: 2 Intermediate Learning Objective: 11-06 Evaluate trade-offs between a firmwide WACC and a divisional cost of capital approach. using these figures for each division in the CAPM formula.Chapter 11 . the firm's CAPM formula. C. Source: NEW Topic: Divisional cost of capital 11-39 . and the firm's WACC. Using a simple firmwide WACC to evaluate new projects would give an unfair advantage to projects that present less risk than the firm's average beta. Chapter 11 .Calculating the Cost of Capital 13. Source: NEW Topic: Flotation costs 14. the firm can increase the project's WACC to incorporate the flotation costs' impact. is not impacted by taxes. the component cost will need to be integrated only for the firm's WACC. uses the pre-tax costs of capital to compute the firm's weighted average cost of debt financing. separation principle D. B. D. generally accepted accounting principle B. C. the component cost will need to be integrated to figure project WACCs. the firm can leave the WACC alone and adjust the project's initial investment upwards. AACSB: Reflective Thinking Blooms: Remember Difficulty: 1 Basic Learning Objective: 11-08 Demonstrate how to adjust the WACC to reflect flotation costs. C. D. uses the after-tax costs of capital to compute the firm's weighted average cost of debt financing. WACC principle AACSB: Reflective Thinking Blooms: Remember Difficulty: 1 Basic Learning Objective: 11-08 Demonstrate how to adjust the WACC to reflect flotation costs. Source: NEW Topic: WACC 11-40 . Which of these makes this a true statement? The WACC formula A. This is a principle of capital budgeting which states that the calculations of cash flows should remain independent of financing. Source: NEW Topic: Flotation costs 15. B. A. financing principle C. AACSB: Reflective Thinking Blooms: Remember Difficulty: 1 Basic Learning Objective: 11-02 Use the weighted-average cost of capital (WACC) formula to calculate a project's cost of capital. Which statement makes this a false statement? When a firm pays commissions to underwriting firms that float the issuance of new stock. A. focuses on operating costs only to keep them separate from financing costs. only the market after-tax cost of equity. interest expense C. the relative sizes of the total market capitalizations for each kind of security that the firm issues. only the market after-tax cost of debt. flotation costs B.Chapter 11 . Source: NEW Topic: Flotation costs 11-41 . AACSB: Reflective Thinking Blooms: Remember Difficulty: 1 Basic Learning Objective: 11-04 Calculate the weights used for WACC projections. D. C.Calculating the Cost of Capital 16. the relative sizes of the total book capitalizations for each kind of security that the firm issues. A. seller financing charges D. Source: NEW Topic: WACC weights 17. B. user fees AACSB: Reflective Thinking Blooms: Remember Difficulty: 1 Basic Learning Objective: 11-08 Demonstrate how to adjust the WACC to reflect flotation costs. it should reflect A. These are fees paid by firms to investment bankers for issuing new securities. Which of these makes this a true statement? When determining the appropriate weights used in calculating a WACC. 2) = 16% AACSB: Analytical Blooms: Analyze Blooms: Apply Difficulty: 1 Basic Learning Objective: 11-03 Explain how the firm chooses among estimating costs of equity. 28. and the expected return on the market is 14 percent. the current risk-free rate is 2.0.7125% AACSB: Analytical Blooms: Analyze Blooms: Apply Difficulty: 1 Basic Learning Objective: 11-03 Explain how the firm chooses among estimating costs of equity.71% B. and debt. and the expected return on the market is 9 percent.45. What is TJ Co's cost of equity? A.Chapter 11 . Source: 11 .45 * (14 .0 * (9 .20% C. 17. 26. What is FlavR Co's cost of equity? A.75.05% D. 21. 13% C.64% 5.1 Topic: Cost of equity 19. 20% 2 + 2. Source: 11 . and debt. FlavR Co stock has a beta of 2.1 Topic: Cost of equity 11-42 . preferred stock. TJ Co stock has a beta of 1.5.Calculating the Cost of Capital 18.75) = 17. 11% B. 16% D.75 + 1. preferred stock. the current risk-free rate is 5. 10% C.16 AACSB: Analytical Blooms: Analyze Blooms: Apply Difficulty: 1 Basic Learning Objective: 11-03 Explain how the firm chooses among estimating costs of equity.32% N = 10 PV = 990 PMT = 90 FV = 1000 CPT I = 9. 9. 17.26% B. 9. and debt.6) = 12.1 Topic: Cost of equity 21. 10-year bond issue selling for 99 percent of par that pays an annual coupon of 9 percent. CJ Co stock has a beta of 0.26% AACSB: Analytical Blooms: Analyze Blooms: Apply Difficulty: 1 Basic Learning Objective: 11-03 Explain how the firm chooses among estimating costs of equity. preferred stock.50% D.6 + 0. 9. 18. WC Inc.9 * (13 . the current risk-free rate is 5.5. and the expected return on the market is 13 percent.16% D. What is CJ Co's cost of equity? A.34% 5.9. 19. 12. and debt. preferred stock. What would be WC's before-tax component cost of debt? A. Source: 11 . 22. has a $10 million (face value).Calculating the Cost of Capital 20.3 Topic: Cost of debt 11-43 .00% B.30% C.6.Chapter 11 . Source: 11 . 14% AACSB: Analytical Blooms: Analyze Blooms: Apply Difficulty: 1 Basic Learning Objective: 11-03 Explain how the firm chooses among estimating costs of equity. Source: 11 .86% B.00% 8/95 = 8. preferred stock.00% C.42% AACSB: Analytical Blooms: Analyze Blooms: Apply Difficulty: 1 Basic Learning Objective: 11-03 Explain how the firm chooses among estimating costs of equity. 7. What would be IVY's component cost of preferred stock? A.7 Topic: Cost of preferred stock 23.7 Topic: Cost of preferred stock 11-44 . IVY has preferred stock selling for 98 percent of par that pays a 7 percent annual coupon. 14. Fern has preferred stock selling for 95 percent of par that pays an 8 percent annual coupon. and debt. 7. Source: 11 . 6. What would be Fern's component cost of preferred stock? A. 8. 8. and debt.42% D.14% D.00% 7/98 = 7.Calculating the Cost of Capital 22.00% C. preferred stock. 7. 9.60% B.Chapter 11 . If the common shares are selling for $25 per share.91% C. the preferred share are selling for $12.000. and debt.59% B.000 * 25 + 5.50 + 1. What would be Rose's component cost of preferred stock? A. 9. 4.49% AACSB: Analytical Blooms: Analyze Blooms: Apply Difficulty: 1 Basic Learning Objective: 11-04 Calculate the weights used for WACC projections.Calculating the Cost of Capital 24.49% C. and 1 million bonds.Chapter 11 .9 Topic: Weight of equity 11-45 .000. Sports Corp has 10 million shares of common stock outstanding.50 per share. 62.55% B.97 * 1000) = 250M/1. 9.000.09% 9/99 = 9.00% D.000 * 12.7 Topic: Cost of preferred stock 25. Rose has preferred stock selling for 99 percent of par that pays a 9 percent annual coupon.000.09% AACSB: Analytical Blooms: Analyze Blooms: Apply Difficulty: 1 Basic Learning Objective: 11-03 Explain how the firm chooses among estimating costs of equity.75% (10.50% D. 5 million shares of preferred stock outstanding. and the bonds are selling for 97 percent of par.000 * .5M = 19. what would be the weight used for equity in the computation of Sports's WACC? A. 18.282. 8. Source: 11 . 19. 79. Source: 11 .000 * 25)/(10. preferred stock. 98 * 1000) = $140M/ $173.000 = 57.50 per share.50 + 20.33% B.900. 57. Carrie D's has 6 million shares of common stock outstanding. Source: 11 . and the bonds are selling for 98 percent of par.000 * 28)/(5.36% C.1M = 80.000.64% D.00% (6.000 * 28 + 10. 2 million shares of preferred stock outstanding.000.Chapter 11 .000 * 15 + 2. and the bonds are selling for 109 percent of par. If the common shares are selling for $15 per share.19% (5.000 * 15)/(6.09 * 1000) = 90.000. 80. Source: 11 . 75.000 * 28 + 1.9 Topic: Weight of equity 11-46 .000/156. what would be the weight used for equity in the computation of JackIT's WACC? A. 91. and 10 thousand bonds.36% AACSB: Analytical Blooms: Analyze Blooms: Apply Difficulty: 1 Basic Learning Objective: 11-04 Calculate the weights used for WACC projections.000 * 13. 33.000.000.000.Calculating the Cost of Capital 26.08% D. If the common shares are selling for $28 per share.9 Topic: Weight of equity 27.000. the preferred shares are selling for $28 per share. and 20 thousand bonds.33% B. 33.88% AACSB: Analytical Blooms: Analyze Blooms: Apply Difficulty: 1 Basic Learning Objective: 11-04 Calculate the weights used for WACC projections. the preferred share are selling for $13. what would be the weight used for equity in the computation of Carrie D's WACC? A. 83.000 * 1. 61.88% C. 1 million shares of preferred stock outstanding.000 * . JackITs has 5 million shares of common stock outstanding. 000 * 32 + 20.000 * 1.35% AACSB: Analytical Blooms: Analyze Blooms: Apply Difficulty: 1 Basic Learning Objective: 11-04 Calculate the weights used for WACC projections. Source: 11 .000 * 30 + 10. and 10 thousand bonds. If the common shares are selling for $13 per share. 33. the preferred shares are selling for $20 per share. 48. what would be the weight used for preferred stock in the computation of TellAll's WACC? A.35% C.Chapter 11 .000.000.42% D. 33.000 * 1.000 * 13 + 4. 66.61% (8. 20 million shares of preferred stock outstanding.45% (20.000.13 Topic: Weight of equity 11-47 . 4 million shares of preferred stock outstanding.06 * 1000) = 400M/826M = 48. 66.000 * 13)/(8.9 Topic: Weight of equity 29. 55.000 * 20)/(10. and the bonds are selling for 106 percent of par. 44.000 * 20 + 100.05 * 1000) = 104M/234.43% C. Solar Shades has 8 million shares of common stock outstanding. and the bonds are selling for 105 percent of par.000. TellAll has 10 million shares of common stock outstanding.33% B.5M = 44.33% B. Source: 11 . and 100 thousand bonds.Calculating the Cost of Capital 28.43% AACSB: Analytical Blooms: Analyze Blooms: Apply Difficulty: 1 Basic Learning Objective: 11-04 Calculate the weights used for WACC projections.000.55% D. the preferred shares are selling for $30 per share. If the common shares are selling for $32 per share. 46. what would be the weight used for equity in the computation of Solar Shades' WACC? A.000. 000. 33. and the bonds are selling for 105 percent of par. 3. what would be the weight used for debt in the computation of Town Crier's WACC? A.000 * 20 + 60. 3.33% (10. and 50 thousand bonds.50 + 10. Town Crier has 10 million shares of common stock outstanding.000. 2 million shares of preferred stock outstanding.7M/320.12% C.000 * 0.02% B. Paper Exchange has 80 million shares of common stock outstanding.000 * 10 + 50.84% (60.05 * 1000) = 600M/2252.2M = 26.000 * 10)/(80. 42.33% D.02% AACSB: Analytical Blooms: Analyze Blooms: Apply Difficulty: 1 Basic Learning Objective: 11-04 Calculate the weights used for WACC projections.97 * 1000) = 9. the preferred shares are selling for $10 per share.97 * 1000)/(10. 60 million shares of preferred stock outstanding.64% AACSB: Analytical Blooms: Analyze Blooms: Apply Difficulty: 1 Basic Learning Objective: 11-04 Calculate the weights used for WACC projections.20% D. Source: 11 .000.000.27% C.000. If the common shares are selling for $20 per share. 3. and the bonds are selling for 97 percent of par.Calculating the Cost of Capital 30. Source: 11 . 3.000 * 0.Chapter 11 . If the common shares are selling for $28 per share.7M = 3.50 per share.000 * 15.000 * 1. 27. and 10 thousand bonds.000 * 28 + 2. 26. the preferred shares are selling for $15.13 Topic: Weight of preferred stock 31. what would be the weight used for preferred stock in the computation of Paper's WACC? A.64% B.11 Topic: Weight of debt 11-48 . and that its before-tax cost of debt is 9 percent.000 * 0.000.000 * 30 + 4.00% . Source: 11 . Bill's Boards has 20 million shares of common stock outstanding.87% D. Inc.96 * 1000)/(20.'s capital structure features 40 percent equity. If the appropriate weighted average tax rate is 34 percent.79% C.79% AACSB: Analytical Blooms: Analyze Blooms: Apply Difficulty: 1 Basic Learning Objective: 11-04 Calculate the weights used for WACC projections. 60 percent debt. 4 million shares of preferred stock outstanding.564% AACSB: Analytical Blooms: Analyze Blooms: Apply Difficulty: 2 Intermediate Learning Objective: 11-02 Use the weighted-average cost of capital (WACC) formula to calculate a project's cost of capital.15 Topic: WACC 11-49 .40% D.2M/687.000 * 17 + 20. 9. and 20 thousand bonds. the preferred shares are selling for $17 per share.Chapter 11 .33% (20. what would be the weight used for debt in the computation of Bill's WACC? A.36% B. 24. Suppose that TipsNToes. while its cost of equity is 15 percent.83% B. Source: 11 . 2. 11.56% C. and the bonds are selling for 96 percent of par.34) = 9. 2. 3. If the common shares are selling for $30 per share.000.40 x 15% + 0 x 0% + .2M = 2. 9.000 * 0.11 Topic: Weight of debt 33.Calculating the Cost of Capital 32.96 * 1000) = 19. 0. what will be TipsNToes' WACC? A..60 x 9% x (1 . what will be Model Nails' WACC? A.60 x 10% + 0 x 0% + . 16.18% B. 6. what will be Hanna Nails' WACC? A.70% C.55 x 5% x (1 . Source: 11 .00% .40) = 5.Chapter 11 . 5. 5.73% B. If the appropriate weighted average tax rate is 28 percent.. 8.40% D.40 x 6% x (1 .80% D. and that its before-tax cost of debt is 5 percent.45 x 9% + 0 x 0% + .728% AACSB: Analytical Blooms: Analyze Blooms: Apply Difficulty: 2 Intermediate Learning Objective: 11-02 Use the weighted-average cost of capital (WACC) formula to calculate a project's cost of capital. 40 percent debt. Source: 11 .Calculating the Cost of Capital 34. and that its before-tax cost of debt is 6 percent.28) = 7.00% C.'s capital structure features 45 percent equity. Inc. 7. Inc. If the appropriate weighted average tax rate is 40 percent. 8.7% AACSB: Analytical Blooms: Analyze Blooms: Apply Difficulty: 2 Intermediate Learning Objective: 11-02 Use the weighted-average cost of capital (WACC) formula to calculate a project's cost of capital.00% . while its cost of equity is 9 percent.. 7. 55 percent debt.15 Topic: WACC 35. Suppose that Hanna Nails.15 Topic: WACC 11-50 . while its cost of equity is 10 percent.'s capital structure features 60 percent equity. Suppose that Model Nails. 000/245. 12.000 = . Source: NEW Topic: WACC 11-51 .00% .000.76% C.000 To calculate WACC: .3878 x 6. and that its before-tax cost of debt is 4 percent.9147% AACSB: Analytical Blooms: Analyze Blooms: Apply Difficulty: 2 Intermediate Learning Objective: 11-02 Use the weighted-average cost of capital (WACC) formula to calculate a project's cost of capital.. If TJ's tax rate is 34%. 4.000 bonds outstanding.92% B.80% D. so 140.5714 Preferred Stock: $10.000. 70 percent debt.Chapter 11 .5714 x 12% + . 5. what will be Glamour Nails' WACC? A. If the appropriate weighted average tax rate is 34 percent.43% To calculate weights: Common Stock: 7.000.000 x $20 = $140. 9.000. 4.3878 Total = $245.15 Topic: WACC 37.0408 x 10% + .000.000..00 per share.95 x 1000 = $95.000.000 = .34) = 8. what is the WACC? A.59% D. TJ Industries has 7 million shares of common stock outstanding with a market price of $20.000/245.85% C.000 and selling at 95% of par value. Source: 11 . 8.000.000. The company also has outstanding preferred stock with a market value of $10 million.000. so 95.34) = 4. and the cost of debt is 6.70 x 4% x (1 .Calculating the Cost of Capital 36.000. The cost of equity is 12%. Inc.000.0408 Bonds: 100.000 x . while its cost of equity is 10 percent.'s capital structure features 30 percent equity.000.000. Suppose that Glamour Nails.45% x (1 . the cost of preferred is 10%.848% AACSB: Analytical Blooms: Analyze Blooms: Apply Difficulty: 2 Intermediate Learning Objective: 11-02 Use the weighted-average cost of capital (WACC) formula to calculate a project's cost of capital.30 x 10% + 0 x 0% + . 7. 13. so 10.45%. and 100.000 = . each with face value $1.78% B.000/245. 000. Source: NEW Topic: WACC 11-52 .000 = .000. PNB Industries has 20 million shares of common stock outstanding with a market price of $18..000.000.000.0559 Bonds: 500. 9. 7.5419 Total = $895.000.0559 x 12% + . and the cost of debt is 8.000 = .00 per share.4022 Preferred Stock: $50.47% AACSB: Analytical Blooms: Analyze Blooms: Apply Difficulty: 2 Intermediate Learning Objective: 11-02 Use the weighted-average cost of capital (WACC) formula to calculate a project's cost of capital.97 x 1000 = $485.31% D. each with face value $1.5419 x 8.83% To calculate weights: Common Stock: 20.50%. 11.000 and selling at 97% of par value. The cost of equity is 15%.000/895.000.47% C.000 x $18 = $360.000.000.000. so 485.000/895.000 To calculate WACC: .5% x (1 . and 500.000. so 360. 11. what is the WACC? A.000 x .Chapter 11 .4) = 9. If PNB's tax rate is 40%.000. so 50.Calculating the Cost of Capital 38.000.05% B.000/895. The company also has outstanding preferred stock with a market value of $50 million.4022 x 15% + .000 = .000.000 bonds outstanding. the cost of preferred is 12%. PAW Industries has 5 million shares of common stock outstanding with a market price of $8.000 To calculate WACC: . so 10.000/146.000.000.000 x . 14. 12.. what is the WACC? A.000.0685 x 15% + .000/146. 10. so 96.38% C.000.000 = .000.13905% AACSB: Analytical Blooms: Analyze Blooms: Apply Difficulty: 2 Intermediate Learning Objective: 11-02 Use the weighted-average cost of capital (WACC) formula to calculate a project's cost of capital.000.00 per share.96 x 1000 = $96. The cost of equity is 19%.33% To calculate weights: Common Stock: 5.Chapter 11 . so 40.000.000 x $8 = $40.000.51% D.000.000/146.2740 x 19% + .6575 Total = $146.6575 x 9% x (1 .000 = . The company also has outstanding preferred stock with a market value of $10 million.000 and selling at 96% of par value.2740 Preferred Stock: $10.000.000. each with face value $1.000 = . Source: NEW Topic: WACC 11-53 . 10. and the cost of debt is 9%. and 100.Calculating the Cost of Capital 39.14% B. the cost of preferred is 15%.0685 Bonds: 100.34) = 10.000. If PAW's tax rate is 34%.000 bonds outstanding.000.000. If the before-tax component costs of equity.. Source: 11 .3 x 6.Calculating the Cost of Capital 40.2% D. 12 percent and 6.104% AACSB: Analytical Blooms: Analyze Blooms: Apply Difficulty: 2 Intermediate Learning Objective: 11-02 Use the weighted-average cost of capital (WACC) formula to calculate a project's cost of capital..28) = 13. 13.5 percent and 4 percent.00% C. and 60 percent debt. 6. Inc. 15 percent preferred stock.5 percent.19% B.17 Topic: WACC 11-54 . Inc.3) = 6.48% C.60 x 4% x (1 . what is PAW's WACC if the firm faces an average tax rate of 28%? A. respectively.5% + . 9.17 Topic: WACC 41. If the before-tax component costs of equity.5 percent. what is TW's WACC if the firm faces an average tax rate of 30%? A. preferred stock and debt are 13.1 x 12% + .5% + . 10. Source: 11 .15 x 9.6 x 17. 9.10% D.Chapter 11 . 6.5 percent. has a capital structure of 25 percent equity. 10 percent preferred stock.25 x 13. preferred stock and debt are 17.71% B. 13. Suppose that PAW. Suppose that TW. has a capital structure of 60 percent equity. respectively.65% To calculate WACC: .48% AACSB: Analytical Blooms: Analyze Blooms: Apply Difficulty: 2 Intermediate Learning Objective: 11-02 Use the weighted-average cost of capital (WACC) formula to calculate a project's cost of capital.5% x (1 .0% To calculate WACC: . 12. and 30 percent debt. 7.5% + . 43 x 15. has a capital structure of 43 percent equity.Chapter 11 .. 9. 11.64% C.Calculating the Cost of Capital 42.4 percent. 23 percent preferred stock.4% + .45% B. what is TNT's WACC if the firm faces an average tax rate of 28%? A. 10.30% To calculate WACC: .23 x 10% + .17 Topic: WACC 11-55 . preferred stock and debt are 15.28) = 10.34 x 7% x (1 . If the before-tax component costs of equity. 10. Source: 11 . 10 percent and 7 percent.6356% AACSB: Analytical Blooms: Analyze Blooms: Apply Difficulty: 2 Intermediate Learning Objective: 11-02 Use the weighted-average cost of capital (WACC) formula to calculate a project's cost of capital.80% D. and 34 percent debt. respectively. Inc. Suppose that TNT. 19% B..000/168.000/168.98% To calculate Rd: FV = 1000.0 x 0% + .200. preferred stock.000.000.200.000 = . 12. and debt.000.7432 Preferred Stock: $0 = 0 Bonds: 40.200. so 43.19 Topic: WACC 11-56 .Chapter 11 . PV = -1080. 12.50% D. 9. PMT = 80. Source: 11 .000 = .34) = 12.12 To calculate weights: Common Stock: 5. what is JAK's WACC? A.36% C. If JAK's weighted average tax rate is 34 percent and its cost of equity is 15 percent.200.2568 x 7.000. I = 7. annual coupon bonds with a maturity of 15 years.000. JAK Industries has 5 million shares of stock outstanding selling at $25 per share and an issue of $40 million in 8 percent.2568 Total = $168.000 x $25 = $125. N = 15.7432 x 15% + . 12.000 x 1.200.000. selling at 108 percent of par ($1000).35475% AACSB: Analytical Blooms: Analyze Blooms: Apply Difficulty: 2 Intermediate Learning Objective: 11-03 Explain how the firm chooses among estimating costs of equity. so 125.08 = $43.Calculating the Cost of Capital 43.12% x (1 .000 To calculate WACC: . 000.05 = $210. preferred stock.000.807% AACSB: Analytical Blooms: Analyze Blooms: Apply Difficulty: 2 Intermediate Learning Objective: 11-03 Explain how the firm chooses among estimating costs of equity.000 = .5 percent. and debt.000.73 To calculate weights: Common Stock: 50.000/1.000.000.000 To calculate WACC: .8772 x 16% + .000/1.11% To calculate Rd: FV = 1000. N = 10.000 x $30 = $1.28) = 14.19 Topic: WACC 11-57 .1228 Total = $1. selling at 105 percent of par ($1000). Source: 11 . 15. PV = -1050.. so 1.73% x (1 .710.500. PMT = 95.000.0 x 0% + . If FDR's weighted average tax rate is 28 percent and its cost of equity is 16 percent.1228 x 8. I = 8.000.000. 12.710. 8772 Preferred Stock: $0 = 0 Bonds: 200.500.000 = . FDR Industries has 50 million shares of stock outstanding selling at $30 per share and an issue of $200 million in 9.000. so 210.81% C. 14.710.Calculating the Cost of Capital 44. what is FDR's WACC? A.000.75% B.000 x 1.000.Chapter 11 . 14. annual coupon bonds with a maturity of 10 years.88% D. 000 x $10 = $100.000.000/130.000. If XYZ's weighted average tax rate is 40 percent and its cost of equity is 15 percent. what is XYZ's WACC? A.600.000.600. PV = -1020.4) = 12. so 30.000 = .06% B.65% AACSB: Analytical Blooms: Analyze Blooms: Apply Difficulty: 2 Intermediate Learning Objective: 11-03 Explain how the firm chooses among estimating costs of equity.000.000.000/130.7657 x 15% + . N = 25.000 To calculate WACC: . selling at 102 percent of par ($1000).Calculating the Cost of Capital 45.Chapter 11 .600. 11.. so 100. I = 8.02 = $30.600. preferred stock.000.19 Topic: WACC 11-58 . 8.65% D.31% x (1 . XYZ Industries has 10 million shares of stock outstanding selling at $10 per share and an issue of $30 million in 8.75% C. annual coupon bonds with a maturity of 25 years. PMT = 85.7657 Preferred Stock: $0 = 0 Bonds: 30.3076 To calculate weights: Common Stock: 10.5 percent.0 x 0% + .600. Source: 11 .43% To calculate Rd: FV = 1000. 13.000 = .2343 x 8.2343 Total = $130. 12. and debt.000 x 1. 9445 Preferred Stock: $0 = 0 Bonds: 30. I = 8. its next dividend is expected to be $2. what is its WACC? A. selling at 98 percent of par ($1000).400.20 Topic: WACC 11-59 .400.79% To calculate Rd: FV = 1000.34) = 11.2293 To calculate Rs: Rs = ($2/$25) + 4% = 8% + 4% = 12% To calculate weights: Common Stock: 20. 10.400. PMT = 80.000 = .9445 x 12% + . so 29.400. so 500. preferred stock. and debt. has 20 million shares of stock outstanding selling at $25 per share and an issue of $30 million in 8 percent.6355% AACSB: Analytical Blooms: Analyze Blooms: Apply Difficulty: 2 Intermediate Learning Objective: 11-03 Explain how the firm chooses among estimating costs of equity. and all future dividends are expected to grow at 4 percent per year. 7..0555 Total = $529. If Cup Cake's weighted average tax rate is 34 percent.94% B. N = 16.000.Chapter 11 .000 To calculate WACC: .0555 x 8. Cup Cake Ltd.64% D.000.000.Calculating the Cost of Capital 46.000.000 = . annual coupon bonds with a maturity of 16 years. PV = -980.0 x 0% + .000 x $25 = $500.23% x (1 .000.000 x 0.000/529. indefinitely. 11.00% C.00 per share. 11.000.400.98 = $29.000/529. Source: 11 . 700.000. N = 25.000 x 0. Source: 11 . annual coupon bonds with a maturity of 25 years.000.Chapter 11 .84% C.000.8855 x 11.52% To calculate Rd: FV = 1000. selling at 97 percent of par ($1000). 11.1145 Total = $84. what is its WACC? A. and all future dividends are expected to grow at 5 percent per year.000/84. indefinitely.16% AACSB: Analytical Blooms: Analyze Blooms: Apply Difficulty: 2 Intermediate Learning Objective: 11-03 Explain how the firm chooses among estimating costs of equity.000 x $15 = $75.16% D. If Crab Cakes' weighted average tax rate is 30 percent.000.000/84. 8.. I = 10. PV = -970.700.42% B.700.700.1145 x 10.3392 To calculate Rs: Rs = ($1/$15) + 5% = 6. 10. so 75.67% + .67% To calculate weights: Common Stock: 5.67% + 5% = 11. has 5 million shares of stock outstanding selling at $15 per share and an issue of $10 million in 10 percent.8855 Preferred Stock: $0 = 0 Bonds: 10.000 = .000 = .000.00 per share. PMT = 100.Calculating the Cost of Capital 47.000 To calculate WACC: .97 = $9. preferred stock. so 9.000.0 x 0% + . and debt.3) = 11.20 Topic: WACC 11-60 .700. Crab Cakes Ltd. 11. its next dividend is expected to be $1.34% x (1 . 3. 54.8597 Preferred Stock: $1.000 x 0. Source: 11 . preferred stock.800.98 x 1000 = $9. 85.000/290.32%. respectively? A.000.93%.64%.33%.800. If the common shares are selling for $50 per share.800.75% Common Stock: 5.1067 Bonds: 10. 10. 33.0338 Total = $290.Calculating the Cost of Capital 48.000 = .000 AACSB: Analytical Blooms: Analyze Blooms: Apply Difficulty: 2 Intermediate Learning Objective: 11-04 Calculate the weights used for WACC projections.000.67%.800.33% B.19%. the preferred shares are selling for $31 per share.21 Topic: WACC weights 11-61 .000 = .000.Chapter 11 .000 x 31 = 31. 17. 33.000 x $50 = $250. and bonds.000.800.000. 16. 27. and the bonds are selling for 98 percent of par ($1000). Pumpkin Pie Industries has 5 million shares of common stock outstanding.000 = . 33.000.000.000/290.800. 83. so 31.17% C. and 10 thousand bonds. what would be the weights used in the calculation of Pumpkin Pie's WACC for common stock.33%. so 250. 1 million shares of preferred stock outstanding.000.000/290.000. so 9. 0.38% D.97%. 000 = .000. and 100 thousand bonds.000.21 Topic: WACC weights 11-62 . what would be the weights used in the calculation of Sea Shell's WACC for common stock.000 = . Sea Shell Industries has 50 million shares of common stock outstanding.000.000.000. so 950. 7.50 per share.Chapter 11 .8392 Preferred Stock: $10.000 AACSB: Analytical Blooms: Analyze Blooms: Apply Difficulty: 2 Intermediate Learning Objective: 11-04 Calculate the weights used for WACC projections.26%.92%.83%.000. 33. so 97.33%.000 x 8. 77.Calculating the Cost of Capital 49.50 = 85.64%.000. and bonds. 0. respectively? A. 33. 83.000 = .132.000/1.132.000.000 x 0.97 x 1000 = $97.000. the preferred shares are selling for $8.57% Common Stock: 50.19%. 8.33%.17% C. 16.000.000/1. preferred stock.000 x $19 = $950.000.000. 15.0751 Bonds: 100. 33. Source: 11 . 82. and the bonds are selling for 97 percent of par ($1000). 6.132.91% D.51%.000.000. so 85.132. 10 million shares of preferred stock outstanding.0857 Total = $1.000/1. If the common shares are selling for $19 per share.000.33% B. 000.350.000.33%.000/1. so 1.000. Source: 11 .07%. 66. 0.000.08% D.000.33% B.000.350.350. and 50 thousand bonds. 33. 74.000. 33.000 x 15 = 300.000.0371 Total = $1. preferred stock.000.22%. and the bonds are selling for 100 percent of par ($1000). so 300.Calculating the Cost of Capital 50.000 = .000 = .43% Common Stock: 40.000.2222 Bonds: 50. 33.61%. 10.Chapter 11 .000 AACSB: Analytical Blooms: Analyze Blooms: Apply Difficulty: 2 Intermediate Learning Objective: 11-04 Calculate the weights used for WACC projections.000.000.000 x $25 = $1.000.000.71%. so 50.31%. Rings N Things Industries has 40 million shares of common stock outstanding. 17.000/1.000/1. what would be the weights used in the calculation of Ring's WACC for common stock. 3.000.21 Topic: WACC weights 11-63 . 71. 20 million shares of preferred stock outstanding.000 = .33%.71% C. If the common shares are selling for $25 per share.000 x 1.350. 7407 Preferred Stock: $20. 22.86%. the preferred shares are selling for $15 per share.000. and bonds.00 x 1000 = $50.000. 33. respectively? A. 000. so 10. If Tan Lines faces a flotation cost of 10% on new equity issues.56% $1/[$20 . 10. and that all future dividends are expected to grow by 5 percent per year. 10.000.26%.000/150.50 = 10.71% Common Stock: 2. 29.12%.000 AACSB: Analytical Blooms: Analyze Blooms: Apply Difficulty: 2 Intermediate Learning Objective: 11-04 Calculate the weights used for WACC projections.000.000.000 x 0.22% D.000/150. 1 million shares of preferred stock outstanding.6379 Total = $150. so 96.2923 Preferred Stock: $1. what will be the flotation-adjusted cost of equity? A.000 x $22 = $44.05 = . preferred stock.000 = . and the bonds are selling for 96 percent of par ($1000).Calculating the Cost of Capital 51.21 Topic: WACC weights 52. 6. respectively? A. 33.000/150.0698 Bonds: 100.05 = ($1/$18) + . 3. Suppose that Tan Lines' common shares sell for $20 per share.500.Chapter 11 . 63.000 x 10.79% C. so 44.56% AACSB: Analytical Blooms: Analyze Blooms: Apply Difficulty: 2 Intermediate Learning Objective: 11-08 Demonstrate how to adjust the WACC to reflect flotation costs. 64. Source: 11 .000 = .000.06% B.52%.96 x 1000 = $96. the preferred shares are selling for $10. 32.33%.50% C. and bonds. 33. 17. are expected to set their next annual dividend at $1.500.500.00 per share.10 x $20)] + .(.000 = . 5.000.23 Topic: Flotation costs 11-64 .500.23%.50 per share.000.17%.98%.33% B. If the common shares are selling for $22 per share. 74. 33.00% D.1055556 = 10.500. 5. and 100 thousand bonds.500. indefinitely.000. Source: 11 .33%.000. what would be the weights used in the calculation of Accessory's WACC for common stock. 8. Accessory Industries has 2 million shares of common stock outstanding. 08 = ($3/$49. indefinitely. are expected to set their next annual dividend at $3.00 per share.73% B.10 = ($2/$29. 15.72% AACSB: Analytical Blooms: Analyze Blooms: Apply Difficulty: 2 Intermediate Learning Objective: 11-08 Demonstrate how to adjust the WACC to reflect flotation costs. 16. Source: 11 . what will be the flotation-adjusted cost of equity? A.Calculating the Cost of Capital 53.45% B.00 per share. 14. are expected to set their next annual dividend at $2.23 Topic: Flotation costs 54. 8.45% D. 5. what will be the flotation-adjusted cost of equity? A. If Beach faces a flotation cost of 10% on new equity issues.10 = .71% D.06% AACSB: Analytical Blooms: Analyze Blooms: Apply Difficulty: 2 Intermediate Learning Objective: 11-08 Demonstrate how to adjust the WACC to reflect flotation costs. If Wave faces a flotation cost of 15% on new equity issues.72% $2/[$35 .50) + .1406 = 14. Source: 11 .Chapter 11 . and that all future dividends are expected to grow by 8 percent per year.75) + .08 = .(. and that all future dividends are expected to grow by 10 percent per year. 6. Suppose that Beach Blanket's common shares sell for $55 per share.1672 = 16. indefinitely.15 x $35)] + .06% $3/[$55 . 13.06% C. 10.23 Topic: Flotation costs 11-65 . Suppose that Wave Runners' common shares sell for $35 per share.10 x $55)] + .07% C.(. 31% $1/[$18 .56% D. 12. what will be the flotation-adjusted cost of equity? A. Source: 11 . 13.06% C.07 = ($1/$15. are expected to set their next annual dividend at $1.Chapter 11 .(.00 per share. and that all future dividends are expected to grow by 7 percent per year. If Tan Lotion faces a flotation cost of 12% on new equity issues.84) + .23 Topic: Flotation costs 11-66 .07 = .1331 = 13.Calculating the Cost of Capital 55.37% B.12 x $18)] + . indefinitely. Suppose that Tan Lotion's common shares sell for $18 per share. 6. 7.31% AACSB: Analytical Blooms: Analyze Blooms: Apply Difficulty: 2 Intermediate Learning Objective: 11-08 Demonstrate how to adjust the WACC to reflect flotation costs. have a coupon rate of 10%. N = (15 x 2) = 30. A firm has 1. I = 5.000. 5.8% B.500. 27. PMT = (100/2) = 50. The tax rate is 35% and the WACC is 16%. 11.60 = Rf + (20 .000/23. each selling for $900 (with a face value of $1.000 bonds outstanding.000.5Rf -2. each with a market price of $10.60% Now calculate risk free: 27.000).500.Rf) 1. PV = -900.500.70. 30. Source: NEW Topic: Risk-free rate in WACC 11-67 .5.4 = -.4 To calculate weights: Common Stock: 1. and pay coupons semi- annually.6% D.0% To calculate Rd: FV = 1000.500.000.70 x 2 = 11.5 Rf Rf = 4.4% C.000 = .1.35) Ie = 27..Chapter 11 .4255 Preferred Stock: 0 Bonds: 15.000/23.000 = .5 27. The firm's equity has a beta of 1.000.5745 x 11.000 x 900 = $13. and the expected market return is 20%. so 10. The bonds mature in 15 years.5745 Total = $23.000 x $10 = $10. What is the risk-free rate? A.8% AACSB: Analytical Blooms: Analyze Blooms: Apply Difficulty: 3 Advanced Learning Objective: 11-02 Use the weighted-average cost of capital (WACC) formula to calculate a project's cost of capital.4255 x Ie + .000 To calculate Rs: 16% = . It has 15.000.00 per share.500.Calculating the Cost of Capital 56.4 x (1 .000. so 13.60 = Rf + 30 . 4.000 shares of common stock outstanding. It has 25. so 24.36 = Rf + 22. I = 4.1.000 x 980 = $24.Calculating the Cost of Capital 57.Chapter 11 . N = (20 x 2) = 40.28% B.30) Ie = 19..500.5 19.000/72.000 bonds outstanding.Rf) 1.22 x (1 .000 x $12 = $48.61.28% AACSB: Analytical Blooms: Analyze Blooms: Apply Difficulty: 3 Advanced Learning Objective: 11-02 Use the weighted-average cost of capital (WACC) formula to calculate a project's cost of capital.000 shares of common stock outstanding.5Rf -3.000.500.3379 x 9. PV = -980.36% To calculate Rd: FV = 1000. each with a market price of $12.00 per share. so 48. 4.500.000 = .500.5.22 To calculate weights: Common Stock: 4. PMT = (90/2) = 45. Source: NEW Topic: Risk-free rate in WACC 11-68 .500. The firm's equity has a beta of 1. and the expected market return is 15%.5 Rf Rf = 6.000 = .6621 Preferred Stock: 0 Bonds: 25. The bonds mature in 20 years. 8. each selling for $980.000 To calculate Rs: 15% = .000.6621 x Ie + .36 = Rf + (15 .000. The tax rate is 30% and the WACC is 15%. and pay coupons semi-annually.000.22% D.36% Now calculate risk free: 19.000.14 = -. What is the risk-free rate? A.00% C.3379 Total = $72.5 .000/72.61 x 2 = 9.000. 6. A firm has 4. have a coupon rate of 9%. 9. 19. which project(s) will be incorrectly rejected? A. accept Project C: 3 + 6 (1. Project D D. accept Project D: 3 + 6 (2. Source: 11 .25 Topic: Firmwide vs.9) = 8.2) = 16. project-specific WACCs 11-69 . accept Project B: 3 + 6 (1.6%.2%. reject AACSB: Analytical Blooms: Analyze Blooms: Apply Difficulty: 3 Advanced Learning Objective: 11-06 Evaluate trade-offs between a firmwide WACC and a divisional cost of capital approach. D Project A: 3 + 6 (0.4%.Calculating the Cost of Capital 58.1) = 9. Projects B and C C. C. Project A B. The T-bill rate is 3 percent and the market risk premium is 6 percent. Project B Using WACC accept B. If the firm uses its current WACC of 12 percent to evaluate these projects.4) = 11.Chapter 11 .4%. An all-equity firm is considering the projects shown below. which project(s) will be incorrectly accepted? A.25 Topic: Firmwide vs. The T-bill rate is 4 percent and the market risk premium is 8 percent. project-specific WACCs 11-70 . reject Project B: 4 + 8 (1.2%. Projects C and D Using WACC accept B. accept Project C: 4 + 8 (1. If the firm uses its current WACC of 13 percent to evaluate these projects. reject Project D: 4 + 8 (1. Project A B.Calculating the Cost of Capital 59. An all-equity firm is considering the projects shown below. Source: 11 .9) = 19. Project C C.6%. reject AACSB: Analytical Blooms: Analyze Blooms: Apply Difficulty: 3 Advanced Learning Objective: 11-06 Evaluate trade-offs between a firmwide WACC and a divisional cost of capital approach.5) = 16%. C. D Project A: 4 + 8 (0.7) = 9.1) = 12. Project D D.8%.Chapter 11 . Project D Using WACC accept B Project A: 4 + 9 (0.30% 5 + 1(15.0. 18. If the firm uses its current WACC of 14 percent to evaluate these projects. The T-bill rate is 4 percent and the market risk premium is 9 percent.20% C. Project A B.5) = 15. accept Project B: 4 + 9 (1.Calculating the Cost of Capital 60. What is Diddy's cost of equity? A. Source: 11 . preferred stock.5%.50 AACSB: Analytical Blooms: Apply Difficulty: 1 Basic Learning Objective: 11-03 Explain how the firm chooses among estimating costs of equity. and the expected return on the market is 15. Source: 11 . An all-equity firm is considering the projects shown below.50% D. reject AACSB: Analytical Blooms: Analyze Blooms: Apply Difficulty: 3 Advanced Learning Objective: 11-06 Evaluate trade-offs between a firmwide WACC and a divisional cost of capital approach. the current risk-free rate is 5%.Chapter 11 . 14.7%. reject Project D: 4 + 9 (2.4%. project-specific WACCs 61. which project(s) will be incorrectly rejected? A. Project B C.25%. Project C D.50% B. 15. Diddy Corp stock has a beta of 1.6) = 18.1) = 22.1 Topic: Cost of equity 11-71 . accept Project C: 4 + 9 (1.3) = 15.5 . and debt.25) = 6.9%.25 Topic: Firmwide vs. 16. Oberon Inc. 13. 15. JaiLai Cos. FV = 1000. the current risk-free rate is 6.2%.36% 6.3 Topic: Cost of debt 11-72 . What is JaiLai's cost of equity? A. has a $20 million ($1000 face value) 10-year bond issue selling for 99% of par that pays an annual coupon of 7.2) = 14.Calculating the Cost of Capital 62. n = 10. 6.7(11 .40% D. 7.50. Source: 11 .81% B.15% PV = -990.41% D. Source: 11 . 7. i = 7. preferred stock. and debt.19% C.6.2 Topic: Cost of equity 63. 8. and the expected return on the market is 11%.7.02% C.12% B. What would be Oberon's before-tax component cost of debt? A.Chapter 11 . preferred stock.25%. PMT = 72.2 + 1. and debt. 13. 14.36 AACSB: Analytical Blooms: Apply Difficulty: 1 Basic Learning Objective: 11-03 Explain how the firm chooses among estimating costs of equity.40% AACSB: Analytical Blooms: Apply Difficulty: 1 Basic Learning Objective: 11-03 Explain how the firm chooses among estimating costs of equity. stock has a beta of 1. 9.67 * 2 = 7. and debt. i = 4. FV = 1000. 9. KatyDid Clothes has a $150 million ($1000 face value) 15-year bond issue selling for 86% of par that carries a coupon rate of 8%. KatyDid Clothes has a $150 million ($1000 face value) 15-year bond issue selling for 106% of par that carries a coupon rate of 8%. What would be KatyDid's before-tax component cost of debt? A.80% D. Source: 11 . 7. paid semi-annually. What would be KatyDid's before-tax component cost of debt? A.67% B.34% C. and debt.09% PV = 1060.13% C.90% B.Calculating the Cost of Capital 64.4 Topic: Cost of debt 65. preferred stock. 8. 3. 7. PMT = 40.4 Topic: Cost of debt 11-73 . 8. 4. FV = 1000.9 * 2 = 9.09% PV = -860.67.12% D. 7.34% AACSB: Analytical Blooms: Apply Difficulty: 1 Basic Learning Objective: 11-03 Explain how the firm chooses among estimating costs of equity. 4. Source: 11 . n = 30. paid semi-annually. PMT = 40. 3.Chapter 11 .80% AACSB: Analytical Blooms: Apply Difficulty: 1 Basic Learning Objective: 11-03 Explain how the firm chooses among estimating costs of equity. i = 3. preferred stock. n = 30. 8 Topic: Cost of preferred stock 67.11 Topic: Weight of debt 11-74 .Chapter 11 . preferred stock. has 6 million shares of common stock outstanding.17% D.81% D. 11. 1 million shares of preferred stock outstanding. and the bonds are selling for 119% of par ($1000). 5. a maker of telecommunications equipment. Source: 11 . Marme Inc.00% B. What would be Marme's component cost of preferred stock? A.Calculating the Cost of Capital 66. FarCry Industries.30% AACSB: Analytical Blooms: Apply Difficulty: 1 Basic Learning Objective: 11-04 Calculate the weights used for WACC projections. 4. Source: 11 . 6.30% 1190 * .07% C. what weight should you use for debt in the computation of FarCry's WACC? A. 8.03% C. and 10 thousand bonds. If the common shares are selling for $27 per share. has preferred stock selling for 137% of par that pays an 11% annual dividend. 5. 8.01 + 6 * 27 + 1 * 15] = 6. 10. and debt.01/[1190 * . the preferred shares are selling for $15 per share.93% B.03% AACSB: Analytical Blooms: Apply Difficulty: 1 Basic Learning Objective: 11-03 Explain how the firm chooses among estimating costs of equity.16% 11/137 = 8. the preferred shares are selling for $10 per share.Calculating the Cost of Capital 68. has 4 million shares of common stock outstanding.50 per share.Chapter 11 . 29. Source: 11 .01] = 26. what weight should you use for preferred stock in the computation of FarCry's WACC? A.86% 1110 * . and 10 thousand bonds.79% D. and the bonds are selling for 111% of par ($1000).5 * 1/[26 * 12 + 114. 28. 3 million shares of preferred stock outstanding.74% B. 32. If the common shares sell for $12 per share. 26. the preferred shares sell for $114. 27.24% AACSB: Analytical Blooms: Apply Difficulty: 1 Basic Learning Objective: 11-04 Calculate the weights used for WACC projections.24% D.05/[1110 * . If the common shares are selling for $21 per share.01% 114. 1 million shares of preferred stock outstanding.74% AACSB: Analytical Blooms: Apply Difficulty: 1 Basic Learning Objective: 11-04 Calculate the weights used for WACC projections. Source: 11 .05 + 3 * 10 + 4 * 21] = 32. has 26 million shares of common stock outstanding.86% C. and the bonds sell for 98% of par ($1000). OMG Inc.5 * 1 + 980 * .13 Topic: Weight of preferred stock 11-75 . FarCry Industries. and 50 thousand bonds. 25.52% B. what weight should you use for debt in the computation of OMG's WACC? A. 25.12 Topic: Weight of debt 69.51% C. a maker of telecommunications equipment. 21. 91% B. 27.5 * 1/[26 * 15 + 114.13 Topic: Weight of preferred stock 71. what weight should you use for preferred stock in the computation of OMG's WACC? A.25% 114. 83. 3 million shares of preferred stock outstanding.58% C. 22. the preferred shares sell for $114. a maker of telecommunications equipment. 31.25% AACSB: Analytical Blooms: Apply Difficulty: 1 Basic Learning Objective: 11-04 Calculate the weights used for WACC projections. If the common shares sell for $17 per share.Calculating the Cost of Capital 70. FarCry Industries. what weight should you use for preferred stock in the computation of FarCry's WACC? A. OMG Inc.Chapter 11 .66% AACSB: Analytical Blooms: Apply Difficulty: 1 Basic Learning Objective: 11-04 Calculate the weights used for WACC projections. and the bonds sell for 117% of par ($1000). 28. 1 million shares of preferred stock outstanding.51% C.01] = 22. and 10 thousand bonds.005 + 4 * 17] = 83. and 5 thousand bonds. If the common shares sell for $15 per share. Source: 11 .50 per share. Source: 11 . the preferred shares sell for $126 per share.66% 126 * 3/[3 * 126 + 1170 * . 28.91% D. and the bonds sell for 101% of par ($1000). 47.24% D.14 Topic: Weight of preferred stock 11-76 .52% B. has 4 million shares of common stock outstanding. 26. has 26 million shares of common stock outstanding.5 * 1 + 1010 * . The cost of equity is 14%.5%. 12. = > i = 6.54 Step 2: 8 * 17/[8 * 17 + 1.37% C.98% C. 12.000.500. 13. If TAFKAP's weighted average tax rate is 34% and its cost of equity is 12. the cost of preferred is 10%.5%. Source: 11 .500.000 * 20]] + .09 * 20]12.500.000.34)[(25000 * 900)/[25000 * 900 + 10.37% AACSB: Analytical Blooms: Apply Difficulty: 2 Intermediate Learning Objective: 11-02 Use the weighted-average cost of capital (WACC) formula to calculate a project's cost of capital.Chapter 11 .000 and selling at 90% of par value.1 * [[10.000]/[25000 * 900 + 10.Calculating the Cost of Capital 72.19 Topic: WAAC 11-77 .000. 13. what is TAFKAP's WACC? A.39% B. 12. 12.. 11.09 * 20] * 6.02% B. PMT = 75.000 * 20]] + .72% .39% AACSB: Analytical Blooms: Apply Difficulty: 2 Intermediate Learning Objective: 11-02 Use the weighted-average cost of capital (WACC) formula to calculate a project's cost of capital.500. FV = 1000.25%.13% D. annual coupon bonds with a maturity of 15 years. TAFKAP Industries has 8 million shares of stock outstanding selling at $17 per share and an issue of $20 million in 7.000 bonds outstanding. n = 15.14 * [(6. selling at 109% of par ($1000).000 * 20]] = 12. Source: NEW Topic: WACC 73. JLP Industries has 6.0625 * (1 .83% Step 1: cost of debt = > PV = -1090.34] = 11.000 + 6.5% + 20 * 1.000 + 6. and the cost of debt is 6. 11.00 per share. If JLP's tax rate is 34%.000 + 6. each with face value $1.. what is the WACC? A.000 * 20)/[25000 * 900 + 10.54% * [1 .5 million shares of common stock outstanding with a market price of $20. and 25.000.16% D. The company also has outstanding preferred stock with a market value of $10 million.09/[8 * 17 + 1. 27% C.935] * .85% = cost of debt.64% B. what is its WACC? A. 2. and pay coupons semi- annually.86(1 . has 10 million shares of stock outstanding selling at $20 per share and an issue of $50 million in 8%.18% = Risk-free rate + 1. If Johnny Cake's weighted average tax rate is 34%. A firm has 5.000 shares of common stock outstanding.935] * .Chapter 11 . 20. FV = 1000.18% C. The bonds mature in 12 years. annual coupon bonds with a maturity of 13 years.34) = 5. PMT = 45.4. each selling for $1100 with a $1000 face value. FV = 1000. Source: 11 .18% D.000 bonds outstanding.05 = 15% = cost of equity. selling at 93. 13. and debt.20 Topic: WACC 75. n = 24.19% Step 1: Cost of debt: PV = -1100.025 * 1100] * (cost of equity) + . The tax rate is 35% and the WACC is 14%.Calculating the Cost of Capital 74.00 per share.. 14. preferred stock.85. and the expected market return is 15%.05% AACSB: Analytical Blooms: Apply Difficulty: 3 Advanced Learning Objective: 11-02 Use the weighted-average cost of capital (WACC) formula to calculate a project's cost of capital. PMT = 80. its next dividend is expected to be $2.0586 = 13.15 + 50 * 935/[10 * 20 + 50 * . Cost of debt = 7.26% D.05% B.025 * 1100/[5 * 8 + . 1. Step 3: WACC = 10 * 20/[10 * 20 + 50 * . 15. n = 13. Step 2: PV = -935.35) = >cost of equity = 20. 12. have a coupon rate of 9%.025 * 1100] * (7. each with a market price of $8. and all future dividends are expected to grow at 5% per year. 13. Source: NEW Topic: Risk-free rate in WACC 11-78 .06% Step 1: 2/20 + . i = 8.4(15%-Risk free rate) = > Risk-free rate = 2.71%)(1 .00 per share..000. indefinitely. Johnny Cake Ltd. Calculate the risk-free rate.5% of par ($1000).26% AACSB: Analytical Blooms: Apply Difficulty: 2 Intermediate Learning Objective: 11-03 Explain how the firm chooses among estimating costs of equity. A. The firm's equity has a beta of 1. i = 3. Step 3: 20.71 Step 2: Use WAAC to solve for cost of equity: 14% = (5 * 8)/[5 * 8 + . It has 25.18%. 27. A firm has 5. The firm's equity has a beta of 2.0(15%-Risk free rate) = > Risk-free rate = 2.0. Calculate the risk-free rate.Calculating the Cost of Capital 76. each with a market price of $10.Chapter 11 .. FV = 1000.06. n = 30.12 Step 2: Use WAAC to solve for cost of equity: 16% = (5 * 10)/[5 * 10 + .000 shares of common stock outstanding. It has 55.32% D. i = 4. 2.12%)(1 . A. The bonds mature in 15 years. Cost of debt = 8.055 * 990] * (cost of equity) + . and pay coupons semi- annually. 2.68% B. and the expected market return is 15%.000 bonds outstanding. Source: NEW Topic: Risk-free rate in WACC 11-79 . 1. Step 3: 27. PMT = 40.055 * 990] * (8.68%.00 per share.79% C. The tax rate is 35% and the WACC is 16%. each selling for $990 with a $1000 face value.000.68% = Risk-free rate + 2. have a coupon rate of 8%.35) = >cost of equity = 27.32% AACSB: Analytical Blooms: Apply Difficulty: 3 Advanced Learning Objective: 11-02 Use the weighted-average cost of capital (WACC) formula to calculate a project's cost of capital.055 * 990/[5 * 10 + .12% Step 1: Cost of debt: PV = -990. Project D: 12%. only Project A would be incorrectly rejected since its required return is only 7.4%. An all-equity firm is considering the projects shown below. Both Projects A and C would be incorrectly rejected. AACSB: Analytical Blooms: Apply Difficulty: 3 Advanced Learning Objective: 11-06 Evaluate trade-offs between a firmwide WACC and a divisional cost of capital approach. project-specific WACCs 11-80 . If the firm uses its current WACC of 12% to evaluate these projects. C.25 Topic: Firmwide vs. Source: 11 .2%. None of the projects would be incorrectly rejected. which project(s). Project A: 7. Only Project A would be incorrectly rejected. if any.8% given its risk and it is expected to return 9%. Projects A. Step 1: Find Project Required Returns using CAPM. Project C: 11. Project B: 10. will be incorrectly rejected? A.Calculating the Cost of Capital 77.8%.Chapter 11 . D. B. B and C would be incorrectly rejected. The T-bill rate is 3% and the market risk premium is 6%. 4%. will be incorrectly accepted or rejected? A. Project A would be incorrectly rejected since its required return is only 8. AACSB: Analytical Blooms: Apply Difficulty: 3 Advanced Learning Objective: 11-06 Evaluate trade-offs between a firmwide WACC and a divisional cost of capital approach.Chapter 11 . If the firm uses its current WACC of 12% to evaluate these projects. if any.5%.2%. An all-equity firm is considering the projects shown below.Calculating the Cost of Capital 78. Project D: 14.8% given its risk. B.8%. The T-bill rate is 4% and the market risk premium is 7%. Project C: 13. which project(s). Project A: 8. Project C would be incorrectly accepted since it should earn 13. None of the projects will be incorrectly accepted or rejected. Both Projects A and C would be incorrectly rejected. C. Project B: 12. Project A would be incorrectly rejected. D. Source: 11 .26 Topic: Firmwide vs. Step 1: Find Project Required Returns using CAPM.2% given its risk and it is expected to return 9%. project-specific WACCs 11-81 . Project A will be incorrectly rejected and Project B would be incorrectly accepted. Chapter 11 - Calculating the Cost of Capital 79. Suppose your firm has decided to use a divisional WACC approach to analyze projects. The firm currently has 4 divisions, A through D, with average betas for each division of 0.5, 1.0, 1.3 and 1.6, respectively. If all current and future projects will be financed with half debt and half equity, and if the current cost of equity (based on an average firm beta of 1.0 and a current risk-free rate of 7%) is 14% and the after-tax yield on the company's bonds is 8%, what are the WACCs for divisions A through D? A. 9.00%; 10.25%; 12.95%; 13.15% B. 9.75%; 12.00%; 12.65%; 13.75% C. 9.25%; 11.00%; 12.05%; 13.10% D. 8.95%; 10.15%; 12.50%; 13.45% Step 1: Find the market risk premium. 14% = 7% + 1.0(MRP); = > MRP = 7%. Step 2: Find the cost of equity for each division using CAPM; A: 7 + .5 * 7 = 10.5%; B: 14%; C: 16.1%; D: 18.2%; Step 3: Find the WAACs for each division; A: .5(10.5%) + .5(8%) = 9.25%; B: 11%; C: 12.05%; D:13.1% AACSB: Analytical Blooms: Understand Difficulty: 3 Advanced Learning Objective: 11-02 Use the weighted-average cost of capital (WACC) formula to calculate a project's cost of capital. Source: 11 - 27 Topic: WACC 11-82 Chapter 11 - Calculating the Cost of Capital 80. Suppose your firm has decided to use a divisional WACC approach to analyze projects. The firm currently has 2 divisions, A and B, with betas for each division of 0.5 and 1.5, respectively. If all current and future projects will be financed with half debt and half equity, and if the current cost of equity (based on an average firm beta of 1.0 and a current risk-free rate of 5%) is 14% and the after-tax yield on the company's bonds is 6%, what are the WACCs for divisions A and B? A. 7.75%; 12.25% B. 8.75%; 12.00% C. 9.25%; 11.00% D. 8.95%; 10.15% Step 1: Find the market risk premium. 14% = 5% + 1.0(MRP); = > MRP = 9%. Step 2: Find the cost of equity for each division using CAPM; A: 5 + .5 * 9 = 9.5%; B: 18.5; Step 3: Find the WAACs for each division; A: .5(9.5%) + .5(6%) = 7.75%; B: 12.25% AACSB: Analytical Blooms: Understand Difficulty: 3 Advanced Learning Objective: 11-02 Use the weighted-average cost of capital (WACC) formula to calculate a project's cost of capital. Source: NEW Topic: WACC 81. Which of the following statements is correct? A. The weighted average cost of capital is calculated on a before-tax basis. B. An increase in the market risk premium is likely to increase the weighted average cost of capital. C. The weights of debt and equity should be based on the balance sheet because this is the most accurate assessment of the valuation. D. All of these statements are correct. AACSB: Analytical Blooms: Understand Difficulty: 1 Basic Learning Objective: 11-02 Use the weighted-average cost of capital (WACC) formula to calculate a project's cost of capital. Source: NEW Topic: WACC 11-83 Chapter 11 - Calculating the Cost of Capital 82. Which of the following statements is correct? A. If the risk-free rate increases, it will have no impact on the weighted average cost of capital. B. Investor returns are reduced when float costs increase, and therefore float costs reduce the weighted average cost of capital. C. The weighted average cost of capital is a historical cost. D. None of these statements is correct. AACSB: Analytical Blooms: Understand Difficulty: 2 Intermediate Learning Objective: 11-02 Use the weighted-average cost of capital (WACC) formula to calculate a project's cost of capital. Source: NEW Topic: WACC 83. Which of the following will impact the cost of equity component in the weighted average cost of capital? A. The risk-free rate B. Beta C. Expected return on the market D. All of these AACSB: Analytical Blooms: Understand Difficulty: 1 Basic Learning Objective: 11-02 Use the weighted-average cost of capital (WACC) formula to calculate a project's cost of capital. Source: NEW Topic: Cost of equity 11-84 40% D.5%. the current risk-free rate is 4%. the expected rate on the market is 11%. 15. 11. and the stock has a beta of 1.89% AACSB: Analytical Blooms: Apply Difficulty: 2 Intermediate Learning Objective: 11-02 Use the weighted-average cost of capital (WACC) formula to calculate a project's cost of capital. Source: NEW Topic: Cost of equity 85.75/60 + . Step 3: Find the average of the two estimates: 11. and the stock has a beta of 1. 14.71% Step 1: Find the cost of equity using constant-growth formula: 1.75 per share. Source: NEW Topic: Cost of equity 11-85 . ADK expects to set their next annual dividend at $1. the current risk-free rate is 4%.38% C.5(11 .Chapter 11 . 12.88% AACSB: Analytical Blooms: Apply Difficulty: 2 Intermediate Learning Objective: 11-02 Use the weighted-average cost of capital (WACC) formula to calculate a project's cost of capital.89% B. 12.Calculating the Cost of Capital 84.2. ADK expects to set their next annual dividend at $3. If ADK expects future dividends to grow at 9% per year. what should be the best estimate of the firm's cost of equity? A.07 = 11. If ADK expects future dividends to grow at 7% per year.4) = 14.2(11 .4%.5. Step 2: Find the cost of equity using CAPM: 4 + 1. the expected rate on the market is 11%. what should be the best estimate of the firm's cost of equity? A. 15.03% Step 1: Find the cost of equity using constant-growth formula: 3.25%.38% Step 2: Find the cost of equity using CAPM: 4 + 1.75 per share. 11.88% D. ADK Industries common shares sell for $60 per share.75/40 + . 14. indefinitely. Step 3: Find the average of the two estimates: 14.09 = 15.25% B.4) = 12.50% C. indefinitely. ADK Industries common shares sell for $40 per share. and debt. Which of the following will directly impact the cost of equity? A. Stock price D. Expected future tax rates C. Capital Structure B. Profit margins AACSB: Analytical Blooms: Remember Blooms: Understand Difficulty: 1 Basic Learning Objective: 11-02 Use the weighted-average cost of capital (WACC) formula to calculate a project's cost of capital. Expected growth rate in sales B.Calculating the Cost of Capital 86. Competition within the industry AACSB: Analytical Blooms: Remember Blooms: Understand Difficulty: 1 Basic Learning Objective: 11-03 Explain how the firm chooses among estimating costs of equity. Source: NEW Topic: Cost of equity 87. Debt Ratio C. Coupon Rate D.Chapter 11 . Source: NEW Topic: Cost of debt 11-86 . preferred stock. Which of the following will directly impact the cost of debt? A. 19%.70% D. Source: NEW Topic: Cost of debt 89.32%.000 15-year 9% annual coupon bonds outstanding. Step 2: 10. preferred stock. ADK has 30. PMT = 45.88% Step 1: PV = -900. i = 7.76% Step 1: PV = -1110. 6. 4.05%.02% C.02% AACSB: Analytical Blooms: Apply Difficulty: 1 Basic Learning Objective: 11-03 Explain how the firm chooses among estimating costs of equity.Calculating the Cost of Capital 88. and debt. If the bonds currently sell for 90% of par and the firm pays an average tax rate of 32%. If the bonds currently sell for 111% of par and the firm pays an average tax rate of 36%. Step 2: 7. 5. preferred stock.95% AACSB: Analytical Blooms: Apply Difficulty: 1 Basic Learning Objective: 11-03 Explain how the firm chooses among estimating costs of equity. FV = 1000. i = 5.15% D. and debt.32%. ADK has 30. what will be the before-tax and after-tax component cost of debt? A.74%(1 .36) = 4.000 15-year 9% semi-annual coupon bonds outstanding.Chapter 11 . 5.61% B. 7. FV = 1000. 10. 9%. 9. 11. 8. 10.32) = 7. what will be the before-tax and after-tax component cost of debt? A.95% B. 7. n = 15.. 5.85%.32%(1 . Source: NEW Topic: Cost of debt 11-87 .. PMT = 90.06% C. 7. 7.12%. n = 30.16 * 2 = 10. 6.74%.16.74%. 5.91%. subjective B.Chapter 11 . Divisional WACC D. Source: NEW Topic: Divisional WAAC 11-88 . Source: NEW Topic: Divisional WACC 91. objective C. Source: NEW Topic: Divisional WACC 92. An estimated WACC computed using some sort of proxy for the average equity risk of the projects in a particular business unit is known as the ____________. The ____________ approach to computing a divisional weighted average cost of capital (WACC) requires only that WACCs for "risky" and "relatively safe" divisions be adjusted. Business unit WACC B.Calculating the Cost of Capital 90. implicit AACSB: Analytical Blooms: Remember Difficulty: 2 Intermediate Learning Objective: 11-07 Distinguish subjective and objective approaches to divisional cost of capital. firmwide D. A. A. Pure play beta C. implicit AACSB: Analytical Blooms: Remember Difficulty: 2 Intermediate Learning Objective: 11-07 Distinguish subjective and objective approaches to divisional cost of capital. A. subjective B. objective C. The ___________ approach to computing a divisional weighted average cost of capital (WACC) uses the average beta of projects in each division to calculate the WACC. Component cost AACSB: Analytical Blooms: Remember Difficulty: 1 Basic Learning Objective: 11-06 Evaluate trade-offs between a firmwide WACC and a divisional cost of capital approach. firmwide D. None of these statements is correct. The after-tax cost of debt B. AACSB: Analytical Blooms: Remember Difficulty: 2 Intermediate Learning Objective: 11-08 Demonstrate how to adjust the WACC to reflect flotation costs.Calculating the Cost of Capital 93. The cost of equity AACSB: Reflective Thinking Blooms: Evaluate Blooms: Understand Difficulty: 2 Intermediate Learning Objective: 11-02 Use the weighted-average cost of capital (WACC) formula to calculate a project's cost of capital. The cost of preferred stock C. D. Source: NEW Topic: Flotation costs 95. Which of the following statements is correct? A. Source: NEW Topic: WACC 11-89 .Chapter 11 . A. B. C. What is the theoretical minimum for the weighted average cost of capital? A. The flotation-adjusted cost of equity may be more than or less than the cost of equity that has not been adjusted for flotation costs. Flotation costs are _______________. commissions to the underwriting firm that floats the issue D. insignificant and can be assumed away B. Source: NEW Topic: Flotation costs 94. the difference between the bid-ask spread on the sale of the security C. The flotation-adjusted cost of equity will always be more than the cost of equity that has not been adjusted for flotation costs. None of these answers are correct. The flotation-adjusted cost of equity will always be less than the cost of equity that has not been adjusted for flotation costs. CAPM D. AACSB: Analytical Blooms: Remember Difficulty: 1 Basic Learning Objective: 11-08 Demonstrate how to adjust the WACC to reflect flotation costs. D. and debt. Source: NEW Topic: Cost of equity 98. and debt. and debt. When the firm has multiple divisions. because we can only estimate the marginal tax rate of the preferred stockholders D. AACSB: Analytical Blooms: Remember Blooms: Understand Difficulty: 2 Intermediate Learning Objective: 11-03 Explain how the firm chooses among estimating costs of equity. C. When you are able to estimate the market risk premium with certainty. preferred stock. None of these answers is correct. AACSB: Analytical Blooms: Remember Blooms: Understand Difficulty: 2 Intermediate Learning Objective: 11-03 Explain how the firm chooses among estimating costs of equity. When you are able to estimate the firm's beta with certainty. Which of following is a situation in which you would want to use the CAPM approach for estimating the component cost of equity? A. B.Calculating the Cost of Capital 96. because preferred dividends are paid out of before-tax income B. The reason that we do not use an after-tax cost of preferred stock is __________. because most of the investors in preferred stock do not pay tax on the dividends C. A. When the firm has a low beta. preferred stock. When the firm's stock is expected to experience constant dividend growth. Source: NEW Topic: Cost of equity 97. D. When the firm has a high level of financial leverage. Source: NEW Topic: Cost of preferred stock 11-90 .Chapter 11 . Which of the following is a situation in which you would want to use the constant growth model approach for estimating the component cost of equity? A. AACSB: Analytical Blooms: Remember Blooms: Understand Difficulty: 1 Basic Learning Objective: 11-03 Explain how the firm chooses among estimating costs of equity. C. preferred stock. B. When you are able to estimate the risk-free rate with certainty. When the firm pays a constant dividend. Because often-times firms "window-dress" their financial statements. B. Use the industry average flotation cost for common stock. AACSB: Analytical Blooms: Remember Blooms: Understand Difficulty: 2 Intermediate Learning Objective: 11-04 Calculate the weights used for WACC projections.Calculating the Cost of Capital 99. C. None of these answers is correct. preferred and common stock. D. Source: NEW Topic: Flotation costs 11-91 . Use an average of the flotation costs for debt. B.Chapter 11 . Because we are interested in determining what the cost of financing the firm's assets would be given today's market situation and the component costs the firm currently faces. Source: NEW Topic: WAAC Weights 100. AACSB: Analytical Blooms: Remember Blooms: Understand Difficulty: 2 Intermediate Learning Objective: 11-08 Demonstrate how to adjust the WACC to reflect flotation costs. Why do we use market-value weights instead of book-value weights? A. Suppose a new project was going to be financed partially with retained earnings. What flotation costs should you use for retained earnings? A. Because it is required in the Sarbanes-Oxley regulations. Use the same flotation cost that would be used to issue new common stock. not what the historical prices would have been. Zero. C. D. D.Chapter 11 . If projects are assigned to the wrong division. then it should be expect to be "charged" a higher cost of capital than the firm's overall WACC. Source: NEW Topic: Firm WAAC vs. None of these answers is correct. Managers in different divisions may use different methods to calculate the WACC. AACSB: Analytical Blooms: Remember Blooms: Understand Difficulty: 2 Intermediate Learning Objective: 11-05 Identify which elements of WACC are used to calculate a project-specific WACC. then it should be expect to be "charged" a lower cost of capital than the firm's overall WACC. Source: NEW Topic: Divisional WAACs 102. AACSB: Analytical Blooms: Remember Blooms: Understand Difficulty: 2 Intermediate Learning Objective: 11-06 Evaluate trade-offs between a firmwide WACC and a divisional cost of capital approach. If a new project is riskier than the firm's existing projects. Which of the following statements is correct? A. None of these answers is correct.Calculating the Cost of Capital 101. The project's risk and the cost of capital to which it is compared are independent. Project WAAC 11-92 . B. C. Which of the following is a reason why the divisional cost of capital approach may cause problems if new projects are assigned to the wrong division? A. implying that the project will be evaluated with a divisional cost of capital that is much different from what a project-specific cost of capital would be. If a new project is riskier than the firm's existing projects. C. the risk of that division may be significantly different than the risk of the project. D. B. The expected return of the new project may be incorrect. AACSB: Analytical Blooms: Remember Blooms: Understand Difficulty: 2 Intermediate Learning Objective: 11-02 Use the weighted-average cost of capital (WACC) formula to calculate a project's cost of capital. B. Source: NEW Topic: Firm WAAC vs. D. D. Source: NEW Topic: WACC 105.Chapter 11 . None of these answers is correct. None of these statements is correct. Flotation costs can decrease the weighted average cost of capital. Source: NEW Topic: WACC 11-93 . B. An increase in the firm's marginal corporate tax rate will decrease the weighted average cost of capital. the average beta of firms that are only engaged in the proposed new line of business B. and debt. AACSB: Analytical Blooms: Remember Blooms: Understand Difficulty: 1 Basic Learning Objective: 11-03 Explain how the firm chooses among estimating costs of equity. It is common that the after-tax cost of debt exceeds the cost of equity. C. A. Project WAAC 104. The WACC measures the before-tax cost of capital. Which of the following statements is correct? A. Which of the following statements is correct? A. C. preferred stock. None of these statements is correct. The WACC is a measure of the before-tax cost of capital. the beta used when the firm has a great deal of business risk D. the industry average beta that is used in lieu of the firm's beta because the firm has not existed long enough to have a beta calculated C.Calculating the Cost of Capital 103. A proxy beta is _________________. AACSB: Analytical Blooms: Remember Difficulty: 2 Intermediate Learning Objective: 11-05 Identify which elements of WACC are used to calculate a project-specific WACC. The WACC measures the marginal cost of capital. A decrease in the firm's marginal corporate tax rate will decrease the weighted average cost of capital. Source: NEW Topic: WACC 107.Calculating the Cost of Capital 106. Firms should use historical costs rather than marginal costs of capital. B. When comparing two firms within the same industry. B. Which of the following will increase the cost of equity? A. An increase in the risk-free rate will increase the cost of equity.Chapter 11 . The firm's corporate tax rate increases. None of these answers is correct. including accounts payable and accruals. Source: NEW Topic: WACC and Cost of Equity 11-94 . AACSB: Analytical Blooms: Remember Blooms: Understand Difficulty: 3 Advanced Learning Objective: 11-02 Use the weighted-average cost of capital (WACC) formula to calculate a project's cost of capital. Which of the following statements is correct? A. C. AACSB: Analytical Blooms: Remember Blooms: Understand Difficulty: 2 Intermediate Learning Objective: 11-02 Use the weighted-average cost of capital (WACC) formula to calculate a project's cost of capital. C. The cost of debt is based on the cost of all liabilities. None of these statements is correct. D. Source: NEW Topic: Cost of equity 108. All of these statements are equally correct. B. The firm's share price falls 10%. The firm is expected to reduce its dividend. AACSB: Reflective Thinking Blooms: Evaluate Difficulty: 2 Intermediate Learning Objective: 11-03 Explain how the firm chooses among estimating costs of equity. D. Flotation costs can decrease the weighted average cost of capital. Learning Objective: 11-03 Explain how the firm chooses among estimating costs of equity. preferred stock. preferred stock. D. Which of the following is most correct? A. C. most analysts calculate the weighted average cost of capital on a before-tax basis to facilitate comparisons. and debt. and debt. Apple's 9% annual coupon bond has 10 years until maturity and the bonds are selling in the market for $1190. = > T = 21. 10. Source: NEW Topic: Cost of debt 110. 21. PMT = 90. 9. The firm's tax rate is 36%.50% C. 3. i = 6.95% Step 1: PV = -890. = > i = 10. Step 2: 5% = 6.81% D. FV = 1000.86%.86% B. 6. n = 10.51% B.91% C.36) = 6.50% Step 1: PV = -1190. what was the firm's tax rate? A. What is the firm's after-tax cost of debt? A. Source: NEW Topic: Cost of debt 11-95 . N = 10. If the firm's after-tax cost of debt is 5%. PMT = 90.Calculating the Cost of Capital 109.37.95% AACSB: Analytical Blooms: Apply Difficulty: 1 Basic Learning Objective: 11-02 Use the weighted-average cost of capital (WACC) formula to calculate a project's cost of capital.50% D.. 44.Chapter 11 .51% AACSB: Analytical Blooms: Apply Difficulty: 2 Intermediate Learning Objective: 11-02 Use the weighted-average cost of capital (WACC) formula to calculate a project's cost of capital.86%(1 . 36.37%(1-T). Apple's 9% annual coupon bond has 10 years until maturity and the bonds are selling in the market for $890. 34. Step 2: 10. FV = 1000. i = 12. 15. 37.68% 11% = . 34. Step 2: 8% = 12. Apple's 9% annual coupon bond has 10 years until maturity and the bonds are selling in the market for $790. PMT = 90.50% C.. = > T = 37.50% D.74% AACSB: Analytical Blooms: Apply Difficulty: 2 Intermediate Learning Objective: 11-02 Use the weighted-average cost of capital (WACC) formula to calculate a project's cost of capital.Calculating the Cost of Capital 111.4)(cost of equity)..92% B. 15. what is the firm's cost of equity? A.3) + (1 .85.74% Step 1: PV = -790. Source: NEW Topic: Cost of debt 112. Source: NEW Topic: WACC 11-96 . what was the firm's tax rate? A. cost of equity = 14. A firm uses only debt and equity in its capital structure.11% B. 23. If the firm's after-tax cost of debt is 8%. FV = 1000.85%(1-T). n = 10. 44.13% AACSB: Analytical Blooms: Apply Difficulty: 3 Advanced Learning Objective: 11-02 Use the weighted-average cost of capital (WACC) formula to calculate a project's cost of capital. If the firm's WACC is 11%.03% D. 14. The firm could issue new bonds at a yield to maturity of 9% and the firm has a tax rate of 30%.Chapter 11 . The firm's weight of debt is 40%.4(9%)(1 . 15.13% C. 3) + (1 .45(10%)(1 . cost of debt = 6. 15. The firm's cost of equity is 13% and it has a tax rate of 30%.05% C.38% D. A firm uses only debt and equity in its capital structure. Source: NEW Topic: WACC 11-97 . The firm's weight of debt is 45%.57% 12% = .Calculating the Cost of Capital 113.79% AACSB: Analytical Blooms: Apply Difficulty: 3 Advanced Learning Objective: 11-02 Use the weighted-average cost of capital (WACC) formula to calculate a project's cost of capital.21% D.7(13%) + (1 . The firm could issue new bonds at a yield to maturity of 10% and the firm has a tax rate of 30%.63% C.05% 11% = . If the firm's WACC is 11%.3).09% B... A firm uses only debt and equity in its capital structure.7)(cost of debt)(1 .. 7. what is the firm's cost of equity? A... 9. If the firm's WACC is 12%. 6. cost of equity = 16. what is the firm's before-tax cost of debt? A.3).09% AACSB: Analytical Blooms: Apply Difficulty: 3 Advanced Learning Objective: 11-02 Use the weighted-average cost of capital (WACC) formula to calculate a project's cost of capital. Source: NEW Topic: WACC 114.6)(cost of debt)(1 . 16.45)(cost of equity)..36% 11% = .17% B.Chapter 11 . 14. cost of debt = 9.7(13%) + (1 . 5. 15. The firm's weight of equity is 70%. 71% AACSB: Analytical Blooms: Apply Difficulty: 3 Advanced Learning Objective: 11-02 Use the weighted-average cost of capital (WACC) formula to calculate a project's cost of capital.71% 13% = ..28% C.Chapter 11 . The firm's weight of equity is 75%.. 6.75(16%) + (1 . 5.Calculating the Cost of Capital 115. Source: NEW Topic: WACC Essay Questions 11-98 . 6.75)(cost of debt)(1 . cost of debt = 5. If the firm's WACC is 13%.97% D. 5. what is the firm's before-tax cost of debt? A. The firm's cost of equity is 16% and it has a tax rate of 30%. A firm uses only debt and equity in its capital structure.3).89% B. 5 x 10% = 8.5 x 7% + .2.5 x 20% = 13. market premium of 10 percent) is 15 percent and the after- tax yield on the company's bonds is 7 percent. what will the WACCs be for each division? Cost of Equity: Division A: 5 + 10(. with average betas for each division of 0. and if the current cost of equity (based on an average firm beta of 1. 1. 1.0 and a current risk-free rate of 5 percent.5) = 10% Division B: 5 + 10(1.5 x 23% = 15% AACSB: Analytical Blooms: Analyze Blooms: Apply Difficulty: 3 Advanced Learning Objective: 11-07 Distinguish subjective and objective approaches to divisional cost of capital.5% Division D: .5 x 7% + .5) = 20% Division D: 5 + 10(1.Calculating the Cost of Capital 116.8) = 23% WACC: Division A: . Source: NEW Topic: Divisional WACCs 11-99 .5 x 17% = 12% Division C: .5 x 7% + . The firm currently has 4 divisions.5.5 x 7% + .2) = 17% Division C: 5 + 10(1.5 and 1.8.5% Division B: . respectively. If all current and future projects will be financed with half debt and half equity. A through D.Chapter 11 . Suppose your firm has decided to use a divisional WACC approach to analyze projects. Source: NEW Topic: Cost of equity calculation methods 11-100 . P = market value of preferred stock. and Tc = the appropriate corporate tax rate. what two ways can it be calculated. When calculating the component cost of equity.Chapter 11 . Source: NEW Topic: WACC equation components 118. iE = the after-tax cost of equity. E = market value of pure equity used in financing the relevant project or firm.Calculating the Cost of Capital 117. D = market value of debt used. iP = the after-tax cost of preferred stock. AACSB: Reflective Thinking Blooms: Remember Difficulty: 2 Intermediate Learning Objective: 11-02 Use the weighted-average cost of capital (WACC) formula to calculate a project's cost of capital. AACSB: Reflective Thinking Blooms: Remember Difficulty: 2 Intermediate Learning Objective: 11-02 Use the weighted-average cost of capital (WACC) formula to calculate a project's cost of capital. List and explain all the components of the WACC equation. one should expect the CAPM approach will apply more accurately in most cases as not many stocks will have constant growth rate(s). iD = the after-tax cost of debt. and which way is better and why? Capital Asset Pricing Model and Constant-Growth Model Overall. Source: NEW Topic: WACC weights 11-101 . any debt and preferred stock components of capital should use firmwide. not project-specific ones. When calculating WACC.Calculating the Cost of Capital 119. For computing a project WAAC.Chapter 11 . because the debt holders and owners of preferred shares can legally expect to be paid back out of the firm's revenues even if the specific project being funded isn't successful. Source: NEW Topic: Project WAAC 121. not what the historical prices would have been. AACSB: Analytical Blooms: Create Blooms: Understand Difficulty: 3 Advanced Learning Objective: 11-05 Identify which elements of WACC are used to calculate a project-specific WACC. and why? Any debt and preferred stock that a firm issues are rightfully obligations of the entire firm. Why do we use market-based weights instead of book-value weights when computing the WAAC? Because we're interested in determining what the cost of financing the firm's assets would be given today's market situation and the component costs the firm currently faces. AACSB: Reflective Thinking Blooms: Remember Difficulty: 2 Intermediate Learning Objective: 11-05 Identify which elements of WACC are used to calculate a project-specific WACC. Thus. but compute others that are specific for the project being considered? The costs of debt and preferred stock are firmwide obligations. Source: NEW Topic: Debt and preferred stock in relation to project specific WACCs 120. AACSB: Analytical Blooms: Understand Difficulty: 1 Basic Learning Objective: 11-04 Calculate the weights used for WACC projections. WACC figures. why do we take some component costs from the firm. should project-specific or firmwide debt and preferred stock components be used. not project- specific. Differentiate between the objective and subjective approach to computing a divisional cost of capital.Calculating the Cost of Capital 122. Source: NEW Topic: Flotation costs 124. implying that the project will be evaluated with a divisional cost of capital that is much different from what a project-specific cost of capital would be. If projects are assigned to the wrong division. subjective approaches adjust downward divisional WACCs for relatively safe divisions. which in turn. Similarly. AACSB: Analytical Blooms: Remember Blooms: Understand Difficulty: 1 Basic Learning Objective: 11-08 Demonstrate how to adjust the WACC to reflect flotation costs. Denote the impact that flotation costs have on capital budgeting decisions. the risk of that division may be significantly different than the risk of the project. Source: NEW Topic: Divisional WACC 123. Flotation costs increase the component costs of capital. AACSB: Analytical Blooms: Understand Difficulty: 2 Intermediate Learning Objective: 11-06 Evaluate trade-offs between a firmwide WACC and a divisional cost of capital approach. Explain why the divisional cost of capital approach may cause problems if new projects are assigned to the wrong division. increase the WACC. AACSB: Analytical Blooms: Remember Blooms: Understand Difficulty: 3 Advanced Learning Objective: 11-07 Distinguish subjective and objective approaches to divisional cost of capital.Chapter 11 . An objective approach to computing a divisional WACC uses the average beta of projects in each division to calculate the WACC. Source: NEW Topic: Divisional WACC 11-102 . The subjective approach requires only that WACCs for "risky" divisions be adjusted.