Question 1

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?

Accepted Answer

A)  5.88% 
B)  8% 
C)  6.44% 
D)  5.60% 
A)  5.88% 
B)  8% 
C)  6.44% 
D)  5.60%

Question 2

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

Accepted Answer

A)  increasing the fraction of its equity 
B)  decreasing the fraction of its debt 
C)  decreasing its leverage 
D)  increasing its leverage 
A)  increasing the fraction of its equity 
B)  decreasing the fraction of its debt 
C)  decreasing its leverage 
D)  increasing its leverage

Question 3

Assume Time Warner shares have a market capitalization of $40 billion. The company is expected to pay a dividend of $0.25 per share and each share trades for $40. The growth rate in dividends is expected to be 7% per year. Also, Time Warner has $20 billion of debt that trades with a yield to maturity of 9%. If the firm's tax rate is 40%, what is the WACC?

Accepted Answer

A)  5.85% 
B)  6.54% 
C)  6.88% 
D)  7.57% 
A)  5.85% 
B)  6.54% 
C)  6.88% 
D)  7.57%

Question 4

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.

Accepted Answer

A)  0.15, 0.85 
B)  0.18, 0.82 
C)  0.30, 0.70 
D)  0.70, 0.30 
A)  0.15, 0.85 
B)  0.18, 0.82 
C)  0.30, 0.70 
D)  0.70, 0.30

Question 5

A firm has a capital structure with $75 million in equity and $75 million of debt. The cost of equity capital is 10% and the pretax cost of debt is 7%. If the marginal tax rate of the firm is 35%, compute the weighted average cost of capital of the firm.

Accepted Answer

A)  7.3% 
B)  7.6% 
C)  8.0% 
D)  8.4% 
A)  7.3% 
B)  7.6% 
C)  8.0% 
D)  8.4%

Question 6

Epiphany is an all-equity firm with an estimated market value of $300,000. The firm sells $250,000 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.

Accepted Answer

A)  0.42, 0.58 
B)  0.50, 0.50 
C)  0.17, 0.83 
D)  0.58, 0.42 
A)  0.42, 0.58 
B)  0.50, 0.50 
C)  0.17, 0.83 
D)  0.58, 0.42

Question 7

IBM expects to pay a dividend of $5 next year and expects these dividends to grow at 7% a year. The price of IBM is $90 per share. What is IBM's cost of equity capital?

Accepted Answer

A)  3.77% 
B)  5.02% 
C)  7% 
D)  12.56% 
A)  3.77% 
B)  5.02% 
C)  7% 
D)  12.56%

Question 8

Why do we use market values rather than book values in calculation of WACC?

Accepted Answer

We use market values rather th

Question 9

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%?

Accepted Answer

A)  6.61% 
B)  6.96% 
C)  7.31% 
D)  7.66% 
A)  6.61% 
B)  6.96% 
C)  7.31% 
D)  7.66%

Question 10

Assume the market value of Fords' equity, preferred stock, and debt are$6 billion, $2 billion, and $13 billion, respectively. Ford has a beta of 1.7, the market risk premium is 8%, and the risk-free rate of interest is 3%. Ford's preferred stock pays a dividend of $4 each year and trades at a price of $30 per share. Ford's debt trades with a yield to maturity of 8.0%. What is Ford's weighted average cost of capital if its tax rate is 30%?

Accepted Answer

A)  9.95% 
B)  9.48% 
C)  10.43% 
D)  11.38% 
A)  9.95% 
B)  9.48% 
C)  10.43% 
D)  11.38%

Question 11

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?

Accepted Answer

A)  $324 million 
B)  $378 million 
C)  $360 million 
D)  $396 million 
A)  $324 million 
B)  $378 million 
C)  $360 million 
D)  $396 million

Question 12

Divisional costs of capital are more appropriate when evaluating a project for a line of business when the types of business in a firm are ________.

Accepted Answer

A)  mature businesses 
B)  similar 
C)  new businesses 
D)  different 
A)  mature businesses 
B)  similar 
C)  new businesses 
D)  different

Question 13

Assume the market value of Fords' equity, preferred stock and debt are $6 billion, $3 billion, and $13 billion, respectively. Ford has a beta of 1.7, the market risk premium is 8%, and the risk-free rate of interest is 3%. Ford's preferred stock pays a dividend of $2.50 each year and trades at a price of $30 per share. Ford's debt trades with a yield to maturity of 9.5%. What is Ford's weighted average cost of capital if its tax rate is 35%?

Accepted Answer

A)  9.78% 
B)  10.24% 
C)  9.31% 
D)  11.18% 
A)  9.78% 
B)  10.24% 
C)  9.31% 
D)  11.18%

Question 14

When we compute the cost of equity capital for a project we assume that the ________ of the project is equivalent to the average market risk of the firm's investments.

Accepted Answer

A)  diversifiable risk 
B)  market risk 
C)  unsystematic risk 
D)  volatility 
A)  diversifiable risk 
B)  market risk 
C)  unsystematic risk 
D)  volatility

Question 15

Is it incorrect to use the coupon rate of debt toward cost of debt?

Accepted Answer

Yes, it is inaccurate to use t

Question 16

A firm raised all its capital via equity rather than debt. Such a firm is also referred to as a(n) ________ firm.

Accepted Answer

A)  levered 
B)  margined 
C)  risk less 
D)  unlevered 
A)  levered 
B)  margined 
C)  risk less 
D)  unlevered

Question 17

Among the two models Constant Dividend Growth Model (CDGM) and Capital Asset Pricing Model (CAPM), which is a better method for computation of the cost of equity?

Accepted Answer

The Capital Asset Pricing Model (CAPM) i

Question 18

Assume Lavender Corporation has a market value of $4 billion of equity and a market value of $19.8 billion of debt. What are the weights in equity and debt that are used for calculating the WACC?

Accepted Answer

A)  0.10, 0.90 
B)  0.832, 0.168 
C)  0.168, 0.832 
D)  0.90, 0.10 
A)  0.10, 0.90 
B)  0.832, 0.168 
C)  0.168, 0.832 
D)  0.90, 0.10

Question 19

SIROM Scientific Solutions has $12 million of outstanding equity and $4 million of bank debt. The bank debt costs 4% per year. The estimated equity beta is 1. If the market risk premium is 8% and the risk-free rate is 4%, compute the weighted average cost of capital if the firm's tax rate is 30%.

Accepted Answer

A)  8.73% 
B)  9.22% 
C)  9.70% 
D)  10.67% 
A)  8.73% 
B)  9.22% 
C)  9.70% 
D)  10.67%

Question 20

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?

Accepted Answer

A)  3.86% 
B)  8% 
C)  12.22% 
D)  12.86% 
A)  3.86% 
B)  8% 
C)  12.22% 
D)  12.86%

Exam 13: The Cost of Capital

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?

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

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.

A firm has a capital structure with $75 million in equity and $75 million of debt. The cost of equity capital is 10% and the pretax cost of debt is 7%. If the marginal tax rate of the firm is 35%, compute the weighted average cost of capital of the firm.

Epiphany is an all-equity firm with an estimated market value of $300,000. The firm sells $250,000 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.

IBM expects to pay a dividend of $5 next year and expects these dividends to grow at 7% a year. The price of IBM is $90 per share. What is IBM's cost of equity capital?

Why do we use market values rather than book values in calculation of WACC?

Divisional costs of capital are more appropriate when evaluating a project for a line of business when the types of business in a firm are ________.

When we compute the cost of equity capital for a project we assume that the ________ of the project is equivalent to the average market risk of the firm's investments.

Is it incorrect to use the coupon rate of debt toward cost of debt?

A firm raised all its capital via equity rather than debt. Such a firm is also referred to as a(n) ________ firm.

Among the two models Constant Dividend Growth Model (CDGM) and Capital Asset Pricing Model (CAPM), which is a better method for computation of the cost of equity?

Assume Lavender Corporation has a market value of $4 billion of equity and a market value of $19.8 billion of debt. What are the weights in equity and debt that are used for calculating the WACC?

SIROM Scientific Solutions has $12 million of outstanding equity and $4 million of bank debt. The bank debt costs 4% per year. The estimated equity beta is 1. If the market risk premium is 8% and the risk-free rate is 4%, compute the weighted average cost of capital if the firm's tax rate is 30%.

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?

Corporate Finance and the Financial Manager

Introduction to Financial Statement Analysis

Time Value of Money: an Introduction

Time Value of Money: Valuing Cash Flow Streams

Interest Rates

Bonds

Stock Valuation

Investment Decision Rules

Fundamentals of Capital Budgeting

Stock Valuation: a Second Look

Risk and Return in Capital Markets

Systematic Risk and the Equity Risk Premium

Raising Equity Capital

Debt Financing

Capital Structure

Payout Policy

Financial Modeling and Pro Forma Analysis

Working Capital Management

Short-Term Financial Planning

Option Applications and Corporate Finance

Mergers and Acquisitions

International Corporate Finance

Leasing

Insurance and Risk Management

Corporate Governance

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