Exam 14: Cost of Capital

A firm's overall cost of equity is:

Miller Sisters has an overall beta of 0.79 and a cost of equity of 11.2 percent for the firm overall.The firm is 100 percent financed with common stock.Division A within the firm has an estimated beta of 1.08 and is the riskiest of all of the firm's operations.What is an appropriate cost of capital for division A if the market risk premium is 9.5 percent?

The weighted average cost of capital for a firm may be dependent upon the firm's: I.rate of growth. II.debt-equity ratio. III.preferred dividend payment. IV.retention ratio.

Mullineaux Corporation has a target capital structure of 41 percent common stock,4 percent preferred stock,and 55 percent debt.Its cost of equity is 18 percent,the cost of preferred stock is 6.5 percent,and the pre-tax cost of debt is 8.5 percent.What is the firm's WACC given a tax rate of 39 percent?

The Corner Bakery has a bond issue outstanding that matures in 7 years.The bonds pay interest semi-annually.Currently,the bonds are quoted at 101.4 percent of face value and carry a 9 percent coupon.What is the firm's aftertax cost of debt if the tax rate is 30 percent?

Yesteryear Productions is considering a project with an initial start up cost of $960,000.The firm maintains a debt-equity ratio of 0.50 and has a flotation cost of debt of 6.8 percent and a flotation cost of equity of 11.4 percent.The firm has sufficient internally generated equity to cover the equity cost of this project.What is the initial cost of the project including the flotation costs?

Explain how the use of internal equity rather than external equity affects the analysis of a project.

Electronics Galore has 950,000 shares of common stock outstanding at a market price of $38 a share.The company also has 40,000 bonds outstanding that are quoted at 106 percent of face value.What weight should be given to the debt when the firm computes its weighted average cost of capital?

Wilderness Adventures specializes in back-country tours and resort management.Travel Excitement specializes in making travel reservations and promoting vacation travel.Wilderness Adventures has an aftertax cost of capital of 13 percent and Travel Excitement has an aftertax cost of capital of 11 percent.Both firms are considering building wilderness campgrounds complete with man-made lakes and hiking trails.The estimated net present value of such a project is estimated at $87,000 at a discount rate of 11 percent and -$12,500 at a 13 percent discount rate.Which firm or firms,if either,should accept this project?

Give an example of a situation where a firm should adopt the pure play approach for determining the cost of capital for a project. A. The example should explain why the WACC of Firm B, which is engaged in the type of operations Firm A is considering, should be used as the basis for setting the discount rate for the proposed project.

National Home Rentals has a beta of 1.24,a stock price of $22,and recently paid an annual dividend of $0.94 a share.The dividend growth rate is 4.5 percent.The market has a 10.6 percent rate of return and a risk premium of 7.5 percent.What is the firm's cost of equity?

Cookie Dough Manufacturing has a target debt-equity ratio of 0.5.Its cost of equity is 15 percent,and its cost of debt is 11 percent.What is the firm's WACC given a tax rate of 31 percent?

Suppose your company needs $14 million to build a new assembly line.Your target debt-equity ratio is 0.84.The flotation cost for new equity is 9.5 percent,but the floatation cost for debt is only 2.5 percent.What is the true cost of building the new assembly line after taking flotation costs into account?

Central Systems,Inc.desires a weighted average cost of capital of 8 percent.The firm has an aftertax cost of debt of 5.4 percent and a cost of equity of 15.2 percent.What debt-equity ratio is needed for the firm to achieve its targeted weighted average cost of capital?

When a manager develops a cost of capital for a specific project based on the cost of capital for another firm which has a similar line of business as the project,the manager is utilizing the _____ approach.

The Daily Brew has a debt-equity ratio of 0.64.The firm is analyzing a new project which requires an initial cash outlay of $420,000 for equipment.The flotation cost is 9.6 percent for equity and 5.4 percent for debt.What is the initial cost of the project including the flotation costs?

Which of the following statements are correct? I.The SML approach is dependent upon a reliable measure of a firm's unsystematic risk. II.The SML approach can be applied to firms that retain all of their earnings. III.The SML approach assumes a firm's future risks are similar to its past risks. IV.The SML approach assumes the reward-to-risk ratio is constant.

Which one of the following statements related to the SML approach to equity valuation is correct? Assume the firm uses debt in its capital structure.

Western Wear is considering a project that requires an initial investment of $274,000.The firm maintains a debt-equity ratio of 0.40 and has a flotation cost of debt of 8 percent and a flotation cost of equity of 10.5 percent.The firm has sufficient internally generated equity to cover the equity portion of this project.What is the initial cost of the project including the flotation costs?

Titan Mining Corporation has 14 million shares of common stock outstanding,900,000 shares of 9 percent preferred stock outstanding and 220,000 ten percent semiannual bonds outstanding,par value $1,000 each.The common stock currently sells for $42 per share and has a beta of 1.15,the preferred stock currently sells for $80 per share,and the bonds have 17 years to maturity and sell for 91 percent of par.The market risk premium is 11.5 percent,T-bills are yielding 7.5 percent,and the firm's tax rate is 32 percent.What discount rate should the firm apply to a new project's cash flows if the project has the same risk as the firm's typical project?