Exam 13: The Cost of Capital

Assume Ford Motor Company is discussing new ways to recapitalize the firm and raise additional capital. Its current capital structure has a 25% weight in equity, 10% in preferred stock, and 65% in debt. The cost of equity capital is 13%, the cost of preferred stock is 9%, and the pretax cost of debt is 8%. What is the weighted average cost of capital for Ford if its marginal tax rate is 40%?

Assume Time Warner shares have a market capitalization of $65 billion. The company just paid a dividend of $0.40 per share and each share trades for $25. The growth rate in dividends is expected to be 7.00% per year. Also, Time Warner has $10 billion of debt that trades with a yield to maturity of 7%. If the firm's tax rate is 40%, compute the WACC?

Assume Ford Motor Company is discussing new ways to recapitalize the firm and raise additional capital. Its current capital structure has a 10% weight in equity, 20% in preferred stock, and 70% in debt. The cost of equity capital is 16%, the cost of preferred stock is 10%, and the pretax cost of debt is 8%. What is the weighted average cost of capital for Ford if its marginal tax rate is 40%?

Assume preferred stock of Ford Motors pays a dividend of $3.50 each year and trades at a price of $30. What is the cost of preferred stock capital for Ford?

A firm has outstanding debt with a coupon rate of 8%, nine years maturity, and a price of $1,000. What is the after-tax cost of debt if the marginal tax rate of the firm is 40%?

Which of the three costs-debt, preferred stock and common equity-is most difficult to estimate?

Assume Ford Motors expects a new hybrid-engine project to produce incremental cash flows of $50 million each year, and expects these to grow at 4% each year. The upfront project costs are $420 million and Ford's weighted average cost of capital is 9%. If the issuance costs for external finances are $20 million, what is the net present value (NPV) of the project?

As a firm increases its level of debt relative to its level of equity, the firm is ________.

Assume JUP has debt with a book value of $24 million, trading at 120% of par value. The firm has book equity of $28 million, and 2 million shares trading at $20 per share. What weights should JUP use in calculating its WACC?

A firm has a pre-tax cost of debt of 9.0%. If the firm has a marginal tax rate of 35%, what is its effective cost of debt?

Epiphany is an all-equity firm with an estimated market value of $500,000. The firm sells $150,000 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.

Assume 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 20% per year? Assume a cost of operations and other costs for SAP equal 60% of revenue.

Many financial managers use market risk premiums that are closer to 5%, which is lower than historical averages, because ________.

The outstanding debt of Berstin Corp. has ten years to maturity, a current yield of 7%, and a price of $95. What is the pretax cost of debt if the tax rate is 30%.

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.

A firm's cost of debt is the rate of interest it would have to pay to refinance its existing debt.

Assume General Motors has a weighted average cost of capital of 10%. GM is considering investing in a new plant that will save the company $30 million over each of the first two years, and then $15 million each year thereafter. If the investment is $150 million, what is the net present value (NPV) of the project?

Assume IBM just paid a dividend of $4.50 and expects these dividends to grow at 8% a year. The price of IBM is $100 per share. What is IBM's cost of equity capital?

What is the assumption about leverage when using WACC to evaluate a project?

A firm incurs $70,000 in interest expenses each year. If the tax rate of the firm is 30%, what is the effective after-tax interest rate expense for the firm?