Exam 11: Calculating the Cost of Capital

Which of the following is a true statement?

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.

Which of the following statements is true?

Which of the following statements is correct?

Suppose that TW, Inc. has a capital structure of 25 percent equity, 15 percent preferred stock, and 60 percent debt. If the before-tax component costs of equity, preferred stock and debt are 13.5 percent, 9.5 percent and 4 percent, respectively, what is TW's WACC if the firm faces an average tax rate of 30%?

Suppose that Model Nails, Inc.'s capital structure features 60 percent equity, 40 percent debt, and that its before-tax cost of debt is 6 percent, while its cost of equity is 10 percent. If the appropriate weighted average tax rate is 28 percent, what will be Model Nails' WACC?

FarCry Industries, a maker of telecommunications equipment, has 6 million shares of common stock outstanding, 1 million shares of preferred stock outstanding, and 10 thousand bonds. If the common shares are selling for $27 per share, the preferred shares are selling for $15 per share, and the bonds are selling for 119% of par ($1000), what weight should you use for debt in the computation of FarCry's WACC?

When calculating the component cost of equity, what two ways can it be calculated, and which way is better and why?

Marme Inc. has preferred stock selling for 137% of par that pays an 11% annual dividend. What would be Marme's component cost of preferred stock?

For computing a project WAAC, why do we take some component costs from the firm, but compute others that are specific for the project being considered?

Explain why the divisional cost of capital approach may cause problems if new projects are assigned to the wrong division.

A firm uses only debt and equity in its capital structure. The firm's weight of debt is 40%. The firm could issue new bonds at a yield to maturity of 9% and the firm has a tax rate of 30%. If the firm's WACC is 11%, what is the firm's cost of equity?

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 firm has 5,000,000 shares of common stock outstanding, each with a market price of $10.00 per share. It has 55,000 bonds outstanding, each selling for $990 with a $1000 face value. The bonds mature in 15 years, have a coupon rate of 8%, and pay coupons semi-annually. The firm's equity has a beta of 2.0, and the expected market return is 15%. The tax rate is 35% and the WACC is 16%. Calculate the risk-free rate.

Which of the following will impact the cost of equity component in the weighted average cost of capital?

Suppose that Tan Lotion's common shares sell for $18 per share, are expected to set their next annual dividend at $1.00 per share, and that all future dividends are expected to grow by 7 percent per year, indefinitely. If Tan Lotion faces a flotation cost of 12% on new equity issues, what will be the flotation-adjusted cost of equity?

FDR Industries has 50 million shares of stock outstanding selling at $30 per share and an issue of $200 million in 9.5 percent, annual coupon bonds with a maturity of 10 years, selling at 105 percent of par ($1000). If FDR's weighted average tax rate is 28 percent and its cost of equity is 16 percent, what is FDR's WACC?

Rings N Things Industries has 40 million shares of common stock outstanding, 20 million shares of preferred stock outstanding, and 50 thousand bonds. If the common shares are selling for $25 per share, the preferred shares are selling for $15 per share, and the bonds are selling for 100 percent of par ($1000), what would be the weights used in the calculation of Ring's WACC for common stock, preferred stock, and bonds, respectively?

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, 1.2, 1.5 and 1.8, 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 percent, 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?

What is the theoretical minimum for the weighted average cost of capital?