Exam 11: Calculating the Cost of Capital

This is a principle of capital budgeting which states that the calculations of cash flows should remain independent of financing.

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 ____________.

OMG Inc. has 4 million shares of common stock outstanding, 3 million shares of preferred stock outstanding, and 50 thousand bonds. If the common shares are selling for $21 per share, the preferred shares are selling for $10 per share, and the bonds are selling for 111% of par ($1000), what weight should you use for debt in the computation of OMG's WACC?

Town Crier has 10 million shares of common stock outstanding, 2 million shares of preferred stock outstanding, and 10 thousand bonds. If the common shares are selling for $28 per share, the preferred shares are selling for $15.50 per share, and the bonds are selling for 97 percent of par, what would be the weight used for debt in the computation of Town Crier's WACC?

Differentiate between the objective and subjective approach to computing a divisional cost of capital.

FarCry Industries, a maker of telecommunications equipment, has 26 million shares of common stock outstanding, 1 million shares of preferred stock outstanding, and 10 thousand bonds. If the common shares sell for $12 per share, the preferred shares sell for $114.50 per share, and the bonds sell for 98% of par ($1000), what weight should you use for preferred stock in the computation of FarCry's WACC?

Suppose that Wave Runners' common shares sell for $35 per share, are expected to set their next annual dividend at $2.00 per share, and that all future dividends are expected to grow by 10 percent per year, indefinitely. If Wave faces a flotation cost of 15% on new equity issues, what will be the flotation-adjusted cost of equity?

A firm uses only debt and equity in its capital structure. The firm's weight of equity is 75%. The firm's cost of equity is 16% and it has a tax rate of 30%. If the firm's WACC is 13%, what is the firm's before-tax cost of debt?

The ____________ approach to computing a divisional weighted average cost of capital (WACC) requires only that WACCs for "risky" and "relatively safe" divisions be adjusted.

Sea Shell Industries has 50 million shares of common stock outstanding, 10 million shares of preferred stock outstanding, and 100 thousand bonds. If the common shares are selling for $19 per share, the preferred shares are selling for $8.50 per share, and the bonds are selling for 97 percent of par ($1000), what would be the weights used in the calculation of Sea Shell's WACC for common stock, preferred stock, and bonds, respectively?

When calculating WACC, should project-specific or firmwide debt and preferred stock components be used, and why?

An all-equity firm is considering the projects shown below. The T-bill rate is 3 percent and the market risk premium is 6 percent. If the firm uses its current WACC of 12 percent to evaluate these projects, which project(s) will be incorrectly rejected?

Suppose that Glamour Nails, Inc.'s capital structure features 30 percent equity, 70 percent debt, and that its before-tax cost of debt is 4 percent, while its cost of equity is 10 percent. If the appropriate weighted average tax rate is 34 percent, what will be Glamour Nails' WACC?

JAK Industries has 5 million shares of stock outstanding selling at $25 per share and an issue of $40 million in 8 percent, annual coupon bonds with a maturity of 15 years, selling at 108 percent of par ($1000). If JAK's weighted average tax rate is 34 percent and its cost of equity is 15 percent, what is JAK's WACC?

Oberon Inc. has a $20 million ($1000 face value) 10-year bond issue selling for 99% of par that pays an annual coupon of 7.25%. What would be Oberon's before-tax component cost of debt?

Apple's 9% annual coupon bond has 10 years until maturity and the bonds are selling in the market for $790. If the firm's after-tax cost of debt is 8%, what was the firm's tax rate?

ADK Industries common shares sell for $40 per share. ADK expects to set their next annual dividend at $1.75 per share. If ADK expects future dividends to grow at 7% per year, indefinitely, the current risk-free rate is 4%, the expected rate on the market is 11%, and the stock has a beta of 1.2, what should be the best estimate of the firm's cost of equity?

Which of the following statements is correct?

Suppose a new project was going to be financed partially with retained earnings. What flotation costs should you use for retained earnings?

ADK Industries common shares sell for $60 per share. ADK expects to set their next annual dividend at $3.75 per share. If ADK expects future dividends to grow at 9% per year, indefinitely, the current risk-free rate is 4%, the expected rate on the market is 11%, and the stock has a beta of 1.5, what should be the best estimate of the firm's cost of equity?