Exam 9: The Cost of Capital

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

Bloom and Co.has no debt or preferred stock⎯it uses only equity capital, and has two equally-sized divisions.Division X's cost of capital is 10.0%, Division Y's cost is 14.0%, and the corporate (composite) WACC is 12.0%.All of Division X's projects are equally risky, as are all of Division Y's projects.However, the projects of Division X are less risky than those of Division Y.Which of the following projects should the firm accept?

Which of the following statements is CORRECT?

In general, firms should use their weighted average cost of capital (WACC) to evaluate capital budgeting projects because most projects are funded with general corporate funds, which come from a variety of sources.However, if the firm plans to use only debt or only equity to fund a particular project, it should use the after-tax cost of that specific type of capital to evaluate that project.

To estimate the company's WACC, Marshall Inc.recently hired you as a consultant.You have obtained the following information.(1) The firm's noncallable bonds mature in 20 years, have an 8.00% annual coupon, a par value of $1,000, and a market price of $1,050.00.(2) The company's tax rate is 25%.(3) The risk-free rate is 4.50%, the market risk premium is 5.50%, and the stock's beta is 1.20.(4) The target capital structure consists of 35% debt and the balance is common equity.The firm uses the CAPM to estimate the cost of common stock, and it does not expect to issue any new shares.What is its WACC?

Suppose you are the president of a small, publicly-traded corporation.Since you believe that your firm's stock price is temporarily depressed, all additional capital funds required during the current year will be raised using debt.In this case, the appropriate marginal cost of capital for use in capital budgeting during the current year is the after-tax cost of debt.

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

Suppose Acme Industries correctly estimates its WACC at a given point in time and then uses that same cost of capital to evaluate all projects for the next 10 years, then the firm will most likely

Which of the following statements is CORRECT?

The president and CFO of Spellman Transportation are having a disagreement about whether to use market value or book value weights in calculating the WACC.Spellman's balance sheet shows a total of noncallable $45 million long-term debt with a coupon rate of 7.00% and a yield to maturity of 6.00%.This debt currently has a market value of $50 million.The company has 10 million shares of common stock, and the book value of the common equity (common stock plus retained earnings) is $65 million.The current stock price is $22.50 per share; stockholders' required return, r_s, is 14.00%; and the firm's tax rate is 25%.The CFO thinks the WACC should be based on market value weights, but the president thinks book weights are more appropriate.What is the difference between these two WACCs?

Collins Group The Collins Group, a leading producer of custom automobile accessories, has hired you to estimate the firm's weighted average cost of capital.The balance sheet and some other information are provided below. Assets Current assets \ 38,000,000 Net plant, property, and equipment 101,000,000 Total assets \ 139,000,000 Liabilities and Equity Accounts payable \ 10,000,000 Accruals 9,000,000 Current liabilities \ 19,000,000 Long-term debt ( 40,000 bonds, \ 1,000 par value) 40,000,000 Total liabilities \ 59,000,000 Common stock (10,000,000 shares) 30,000,000 Retained earnings 50,000,000 Total shareholders' equity \ 0,000,000 Total liabilities and shareholders' equity \ 139,000,000 The stock is currently selling for $15.25 per share, and its noncallable $1,000 par value, 20-year, 7.25% bonds with semiannual payments are selling for $875.00.The beta is 1.25, the yield on a 6-month Treasury bill is 3.50%, and the yield on a 20-year Treasury bond is 5.50%.The required return on the stock market is 11.50%, but the market has had an average annual return of 14.50% during the past 5 years.The firm's tax rate is 25%. -Refer to the data for the Collins Group.What is the best estimate of the firm's WACC?

With its current financial policies, Flagstaff Inc.will have to issue new common stock to fund its capital budget.Since new stock has a higher cost than reinvested earnings, Flagstaff would like to avoid issuing new stock.Which of the following actions would REDUCE its need to issue new common stock?

Which of the following is NOT a capital component when calculating the weighted average cost of capital (WACC) for use in capital budgeting?

Which of the following statements is CORRECT?

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

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

Which of the following statements is CORRECT? Assume a company's target capital structure is 50% debt and 50% common equity.

Which of the following statements is CORRECT?

Which of the following statements is CORRECT?

The cost of perpetual preferred stock is found as the preferred's annual dividend divided by the market price of the preferred stock.No adjustment is needed for taxes because preferred dividends, unlike interest on debt, is not deductible by the issuing firm.