Exam 13: The Cost of Capital

When calculating the WACC, it is a standard practice to subtract ________ to compute the net debt outstanding.

The after-tax cost of debt ________ the before-tax cost of debt for a firm that has a positive marginal tax rate.

Assume General Motors has a weighted average cost of capital of 9%. GM is considering investing in a new plant that will save the company $20 million over each of the first two years, and then $10 million each year thereafter. If the investment is $100 million, what is the net present value (NPV) of the project?

A firm has $2 million market value and it sells preferred stock with a par value of $100. If the coupon rate on the preferred stock is 6% and the preferred stock trades at $98, what is the cost of preferred stock capital?

A firm incurs $35,000 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?

Assume Ford Motor Company is discussing new ways to recapitalize the firm and raise additional capital. Its current capital structure has a 30% weight in equity, 15% in preferred stock, and 55% in debt. The cost of equity capital is 16%, the cost of preferred stock is 11%, 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%?

When corporate tax rates decline, the net cost of debt financing ________.

IBM expects to pay a dividend of $2 next year and expects these dividends to grow at 9% a year. The price of IBM is $80 per share. What is IBM's cost of equity capital?

The fact that the interest paid on debt is a tax-deductible expense increases the cost of debt financing.

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

Assume Ford Motors expects a new hybrid-engine project to produce incremental cash flows of $45 million each year, and expects these to grow at 3% each year. The upfront project costs are $380 million and Ford's weighted average cost of capital is 9%. If the issuance costs for external finances are $10 million, what is the net present value (NPV) of the project?

The costs of external financing must be deducted from the net present value (NPV) of a project to evaluate if it is worth undertaking.

To attract capital from outside investors, a firm must offer potential investors an expected return that is commensurate with the level of risk that they can bear.

When we use the WACC to assess a project, we assume that the ________ ratio does not change.

Different divisions with differing lines of business use different costs of capital because their cost of equity is different and also because the ________ could be different.

A firm is considering acquiring a competitor. The firm plans on offering $160 million for the competitor. The firm will need to issue new debt and equity to finance the acquisition. You estimate the issuance costs to be $10 million. The acquisition will generate an incremental free cash flow of $20 million in the first year and this cash flow is expected to grow at an annual rate of 3% forever. If the firm's WACC is 13%, what is the value of this project?

Assume JUP has debt with a book value of $20 million, trading at 120% of par value. The bonds have a yield to maturity of 7%. The firm's book value of equity is $16 million, and it has 2 million shares trading at $19 per share. The firm's cost of equity is 12%. What is JUP's WACC if the firm's marginal tax rate is 35%?

Outstanding debt of Home Depot trades with a yield to maturity of 8%. The tax rate of Home Depot is 30%. What is the effective cost of debt of Home Depot?

Verano Inc. has two business divisions-a software product line and a waste water clean-up product line. The software business has a cost of equity capital of 10% and the waste water clean-up business has a cost of equity capital of 8%. Verano has 50% of its revenue from software and the rest from the waste water business. Verano is considering a purchase of another company in the waste water business using equity financing. What is the appropriate cost of capital to evaluate the business?

Leverage is the amount of ________ on a firm's balance sheet.