Exam 14: The Cost of Capital

National Gridlock's capital structure consisted of $125 million of debt and $250 million of equity before it issued bonds to borrow an additional $125 million.The new funds will be used to finance infrastructure improvements and expansion.The company believes that the project will generate enough cash to retire 1/5 of the bonds each year.How do the borrowing and the repayment plan affect the discount rate(s)that should be used to evaluate this project?

Which of the following is the preferred method in estimating a firm's cost of capital?

Tantasqua Paper Products is composed of 3 divisions: industrial paper products,commercial paper products,and a forestry division which grows trees for wood pulp used in the paper-making process.Each of these divisions takes on a large number of projects with differing risk characteristics.Tantasqua now uses a single discount rate based on the company's WACC to evaluate all capital budgeting proposals.Discuss the advantages and disadvantages of this approach.

When investors increase their required rate of return,the cost of capital increases simultaneously.

Plimoth Plantation's overall WACC is 11%.It has an opportunity to accept a project that involves nearly riskless cash flows,but will earn only 7%.This project will require a significant portion of the firm's capital.If Plimoth accepts this project

Which of the following is NOT used to calculate the cost of debt?

Toto and Associates' preferred stock is selling for $18.40.The stock pays an annual dividend of $2.21 per share.What is the cost of preferred stock to the company?

Why are market values preferred to book (balance sheet)values when computing a firm's weighted average cost of capital.

Sprite Communications will erect 20 new transmission towers at a total cost of $15,000,000.The expansion will increase after-tax operating cash flows by $2.3 million dollars per year for the next 20 years.Sprite's WACC is 12%.To raise the $15,000,000,Sprite will need to issue new securities at a weighted average flotation cost of 12%.What is the NPV of the expansion?

When calculating the weighted average cost of capital,which of the following has to be adjusted for taxes?

Sonderson Corporation is undertaking a capital budgeting analysis.The firm's beta is 1.5.The rate on six-month T-bills is 5%,and the return on the S&P 500 index is 12%.What is the appropriate cost of common equity in determining the firm's cost of capital?

Which of the following statements is true?

In theory using the same discount rate to evaluate all projects can lead to

Verigreen Lawn Care products just paid a dividend of $1.85.This dividend is expected to grow at a constant rate of 3% per year,so the next expected dividend is $1.90.The stock price is currently $12.50.New stock can be sold at this price subject to flotation costs of 15%.The company's marginal tax rate is 40%.Compute the cost of common equity.

Reliable Metals plans to issue bonds that will mature in 20 years,will have a semi-annual coupon rate of 7%,and will have a Moody's rating of Aa2.Bonds of other metals companies with similar maturities and ratings currently yield an average of 6.3%.

Dublin International Corporation's marginal tax rate is 40%.It can issue three-year bonds with a coupon rate of 8.5% and par value of $1,000.The bonds can be sold now at a price of $938.90 each.Determine the appropriate after-tax cost of debt for Dublin International to use in a capital budgeting analysis.

MTD Inc.has a new bond issue that will net the firm $1,603,500.The bonds have a $1,500,000 par value,pay interest annually at a 6% coupon rate,and mature in 10 years.The firm has a marginal tax rate of 34%.The after-tax cost of the debt issue is

When computing a firm's cost of capital,book values should be used be used because they are more objective.

The firm's weighted average cost of capital is

Estimating a divisional cost of capital by comparing the division to a similar free-standing company is known as