Exam 14: The Cost of Capital

Liverpool International Corporation's marginal tax rate is 35%. It can issue three-year bonds with a coupon rate of 4.5%. The bonds can be sold now at their par value of $1,000. Determine the appropriate after-tax cost of debt for Dublin International to use in a capital budgeting analysis.

The cost of common equity is already on an after-tax basis since dividends paid to common stockholders are not tax-deductible.

Most large firms use individual costs of capital to evaluate all projects.

The WACC should be computed using

A firm's capital structure consists of which of the following?

Alpha's beta is 1.06, the present T-bond rate is 6%, and the return on the S & P 500 is 15.25%. What is Alpha's cost of common equity using the CAPM approach?

The cost of preferred stock is equal to

The cost of capital is

In most instances, as the amount of debt rises, the common stockholders will decrease their required rate of return.

Metals Corp. has $2,575,000 of debt, $550,000 of preferred stock, and $18,125,000 of common equity. Metals Corp.'s after-tax cost of debt is 5.25%, preferred stock has a cost of 6.35%, and newly issued common stock has a cost of 14.05%. What is Metals Corp.'s weighted average cost of capital?

When calculating the cost of common equity, it is important to consider the common stock and retained earnings accounts separately.

The market values of Spencer's long-term capital sources differ from the book values because

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?

A bond with a Moody's rating of Aaa and and S&P rating of AAA will have a higher required return than a bond with a Moody's rating of Aa1 and an S&P rating of AA+.

The after-tax cost of this debt issue is

The "pure play" approach to estimating a divisions WACC involves

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?

The weighted average cost of capital is the minimum required return that must be earned on additional investment if firm value is to remain unchanged.

Discuss the primary advantages of the CAPM approach in determining the cost of common equity.

If the before-tax cost of debt is 9% and the firm has a 34% marginal tax rate, the after-tax cost of debt is 5.94%.