Exam 12: Determining the Cost of Capital

Ford Motor Company is discussing new ways to recapitalize the firm and raise additional capital.Its current capital structure has a 20% weight in equity,10% in preferred stock,and 70% in debt.The cost of equity capital is 14%,the cost of preferred stock is 10%,and the pretax cost of debt is 9%.What is the weighted average cost of capital for Ford if its marginal tax rate is 30%?

Holding everything else constant,an increase in cash ________ the firm's net debt.

When we compute the cost of equity capital for a project we assume that the ________ of the project is equivalent to the average risk of the firm's investments.

Bombardier Inc has common stock trading at a price of $15,and a market capitalization of $8 billion.The firm also has preferred stock worth a total of $2 billion,currently trading at $23 per share and paying a dividend of $2.75 per share.The firm's beta is 0.93,the risk-free rate is 3.2%,and the market risk premium is 7%.The firm has $12 billion of debt with a yield to maturity of 5%.If the firm's tax rate is 20%,what is Bombardier's WACC?

Preferred stock of Ford Motors pays a dividend of $4 each year and trades at a price of $30.What is the cost of preferred stock capital for Ford?

The ________ of a firm's debt can be used as the firm's current cost of debt.

Firms that have many divisions with different lines of business do not use a company-wide WACC to evaluate projects.

Divisional costs of capital are more appropriate when evaluating a project for a line of business when the types of business in a firm are

When a firm is evaluating the purchase of a business that is unrelated to its current business,it is appropriate to use the current WACC of the firm that is purchasing the business.

Your estimate of the market risk premium is 7%.The risk-free rate of return is 4% and General Motors has a beta of 1.5.What is General Motors' cost of equity capital?

SAP Inc.received a $1 million grant under its Small Business Innovation program.SAP invested the grant money and developed a system to remove metal contaminants from storm water in shipyards.The firm estimates that each shipyard spends $500,000 a year on storm water clean-up efforts.If SAP is able to sign up and retain four shipyards from the first year onwards,what is the present value (PV)of the project (net of investment)if the cost of capital for SAP is 18% per year? Assume a cost of operations and other costs for SAP equal 50% of revenue.

The outstanding debt of Berstin Corp.has eight years to maturity,a current yield of 8%,and a price of $95.Assume the debt has a face value of $100.What is the pretax cost of debt if the tax rate is 30%?

The fact that the after-tax cost of debt is lower than the pretax cost of debt implicitly assumes that interest expense can be

An all-equity firm produced a dividend flow of $20,000 last year.The market value of the firm is $650,000 and the dividend is expected to increase at 4% each year.What is the cost of equity capital for this firm?

Why do we use leverage if it increases the risk of a firm?

SAP Inc.received a $1.5 million grant under its Small Business Innovation program.SAP invested the grant money and developed a system to remove metal contaminants from storm water in shipyards.The firm estimates that each shipyard spends $400,000 a year on storm water clean-up efforts.If SAP is able to sign up and retain four shipyards in the first year onwards,what is the present value (PV)of the project (net of investment)if the cost of capital for SAP is 16% per year? Assume a cost of operations and other costs for SAP equal 60% of revenue.

Epiphany is an all-equity firm with an estimated market value of $500,000.The firm sells $200,000 of debt and uses the proceeds to purchase outstanding equity.Compute the weight in equity and the weight in debt after the proposed financing and repurchase of equity.

Timbuktu Corp has a market value of debt of $2.5 billion,and a market value of equity of $1.5 billion. What weights should Timbuktu use for debt and equity in calculating its WACC?

Lululemon Athletica has a current share price of $52.50,and a market capitalization of $7 billion.The company is expected to pay a dividend of $0.20 per share,with a dividend growth rate of 3% per year.The firm has $4 billion of debt with a yield to maturity of 7%.If the firm's tax rate is 25%,what is Lululemon's WACC?

A firm has outstanding debt with a coupon rate of 7%,seven years maturity,and a price of $1000 per $1000 face value.What is the after-tax cost of debt if the marginal tax rate of the firm is 30%?