Exam 14: The Cost of Capital

Which of the following is a correct formula for calculating the weighted average 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 switching to an approach based on separate discount rates for each division or even the risk level of each project.

The average cost of capital is the appropriate rate to use when evaluating new investments, even though the new investments might be in a higher risk class.

Using a firm's overall cost of capital to evaluate individual projects creates an incentive for managers to avoid high risk projects with potentially high returns.

Hoak Company's common stock is currently selling for $50. Last year's dividend was $1.83 per share. Investors expect dividends to grow at an annual rate of 9% into the future. a. What is Hoak's cost of common equity? b. Selling new common stock is expected to decrease the price of the stock by $5.00. What is the cost of new common stock? Dividends will remain the same.

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 statements regarding calculating a firm's cost of capital is correct?

The percentage of debt in Spencer's weighted average cost of capital is

Explain why the investor's required return on debt is not equal to the corporation's cost of debt, and explain why the investor's required return on equity is not equal to the corporation's cost of equity.

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

Green Valley Motels has $5 million of debt outstanding with a coupon rate of 8.2%. Currently, the yield to maturity on these bonds is 7.3%. If the firm's tax rate is 34%, what is the after-tax cost of debt to Hill Town Motels?

Jen and Barry's Ice Cream needs $20 million in new capital to expand its production facilities. It will use 40% debt and 60% equity. The company's after-tax cost of debt is 5% and the cost of equity is 12.5%. Flotation costs will be 3% for debt and 9% for equity. What is the total amount of capital that will need to be raised to finance the expansion project?

The best estimate of the cost of new common equity is

The after-tax cost of debt is

Caribe's common stock sells for $41, and dividends paid last year were $1.18. The dividends and earnings per share are predicted to have a 5% growth rate. What is the cost of common equity for Caribe?

It is not possible for a firm's after-tax cost of common equity to be lower than its after-tax cost of debt.

Toujours 29 has the following record of paying dividends: What are the arithmetic and geometric average growth rates of DIY's dividend payments?

Vipsu Corporation plans to issue 10-year bonds with a par value of $1,000 that will pay $55 every six months. The net amount of capital to the firm from the sale of each bond is $840.68. If Vipsu is in the 25% tax bracket, what is the after-tax cost of debt?

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

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