Question 1

The cost of equity for a company with a debt-equity ratio of .41:

Accepted Answer

A)  tends to remain static even as the company's level of risk increases. 
B)  increases as the unsystematic risk of the company's stock increases. 
C)  is affected by either a change in the company's beta or its projected rate of growth. 
D)  equals the risk-free rate plus the market risk premium. 
E)  equals the company's pretax weighted average cost of capital.

Question 2

Suppose ALK Co. needs $13.8 million to build a new assembly line. The target debt-equity ratio is .48. The flotation cost for new equity is 9.6 percent, but the floatation cost for debt is only 5.1 percent. What is the true cost of building the new assembly line after taking flotation costs into account?

Accepted Answer

A)  $17,306,191 
B)  $15,022,949 
C)  $16,318,414 
D)  $15,719,310 
E)  $16,666,667

Question 3

The outstanding bonds of Tech Express are priced at $1,023 and mature in 13 years. These bonds have a face value of $1,000, a coupon rate of 6.5 percent, and pay interest semiannually. The tax rate is 21 percent. What is the aftertax cost of debt?

Accepted Answer

A)  4.28 percent 
B)  4.22 percent 
C)  4.35 percent 
D)  4.93 percent 
E)  4.41 percent

Question 4

The common stock of Metal Molds has a negative growth rate of 1.63 percent and a required return of 18.21 percent. The current stock price is $9.82. What was the amount of the last dividend paid?

Accepted Answer

A)  $1.07 
B)  $2.11 
C)  $1.64 
D)  $1.73 
E)  $1.98

Question 5

Textile Mills borrows money at a rate of 8.7 percent. This interest rate is referred to as the:

Accepted Answer

A)  compound rate. 
B)  current yield. 
C)  cost of debt. 
D)  capital gains yield. 
E)  cost of capital.

Question 6

Western Wear is considering a project that requires an initial investment of $602,000. The firm maintains a debt-equity ratio of .55 and has a flotation cost of debt of 4.9 percent and a flotation cost of equity of 10.2 percent. The firm has sufficient internally generated equity to cover the equity portion of this project. What is the initial cost of the project including the flotation costs?

Accepted Answer

A)  $612,652 
B)  $618,406 
C)  $686,005 
D)  $697,747 
E)  $656,636

Question 7

If a company uses its WACC as the discount rate for all of the projects it undertakes then the company will tend to:

Accepted Answer

A)  accept all positive net present value projects. 
B)  increase the average risk level of the company over time. 
C)  reject all high-risk projects. 
D)  reject all negative net present value projects. 
E)  favor low-risk projects over high-risk projects.

Question 8

Miller Stores has an overall beta of 1.38 and a cost of equity of 12.7 percent for the company overall. The firm is all-equity financed. Division A within the firm has an estimated beta of 1.52 and is the riskiest of all of the company's operations. What is an appropriate cost of capital for Division A if the market risk premium is 7.4 percent?

Accepted Answer

A)  13.12 percent 
B)  13.74 percent 
C)  12.63 percent 
D)  12.77 percent 
E)  13.01 percent

Question 9

The Bakery is considering a new project it considers to be a little riskier than its current operations. Thus, management has decided to add an additional 1.2 percent to the company's overall cost of capital when evaluating this project. The project has an initial cash outlay of $63,000 and projected cash inflows of $19,000 in Year 1, $34,000 in Year 2, and $28,000 in Year 3. The firm uses 33 percent debt and 67 percent common stock as its capital structure. The company's cost of equity is 13.8 percent while the aftertax cost of debt for the firm is 5.7 percent. What is the projected net present value of the new project?

Accepted Answer

A)  −$409 
B)  $618 
C)  −$308 
D)  $427 
E)  $573

Question 10

Yesteryear Productions is considering a project with an initial costs of $318,000. The firm maintains a debt-equity ratio of .60 and has a flotation cost of debt of 5.2 percent and a flotation cost of equity of 11.1 percent. The firm has sufficient internally generated equity to cover the equity cost of this project. What is the initial cost of the project including the flotation costs?

Accepted Answer

A)  $349,019 
B)  $324,324 
C)  $312,386 
D)  $318,513 
E)  $324,706

Question 11

Bleakly Enterprises has a capital structure of 56 percent common stock, 4 percent preferred stock, and 40 percent debt. The flotation costs are 3.7 percent for debt, 4.8 percent for preferred stock, and 5.2 percent for common stock. The corporate tax rate is 21 percent. What is the weighted average flotation cost?

Accepted Answer

A)  5.83 percent 
B)  5.20 percent 
C)  4.42 percent 
D)  5.67 percent 
E)  4.58 percent

Question 12

Which one of the following statements is correct?

Accepted Answer

A)  The subjective approach assigns a discount rate to each project based on other companies in the same category as the project. 
B)  Overall, a company makes better decisions when it uses the subjective approach than when it uses its WACC as the discount rate for all projects. 
C)  Companies will correctly accept or reject every project if they adopt the subjective approach. 
D)  Mandatory projects should only be accepted if they produce a positive NPV when the overall company WACC is used as the discount rate. 
E)  The pure play approach should only be used with low-risk projects.

Question 13

Street Corporation's common stock has a beta of 1.33. The risk-free rate is 3.4 percent and the expected return on the market is 10.97 percent. What is the cost of equity?

Accepted Answer

A)  12.49 percent 
B)  12.84 percent 
C)  13.47 percent 
D)  14.07 percent 
E)  13.33 percent

Question 14

Kelso's has a debt-equity ratio of .62 and a tax rate of 21 percent. The firm does not issue preferred stock. The cost of equity is 16.3 percent and the aftertax cost of debt is 5.21 percent. What is the weighted average cost of capital?

Accepted Answer

A)  10.96 percent 
B)  11.67 percent 
C)  12.06 percent 
D)  11.38 percent 
E)  11.57 percent

Question 15

Highway Express has paid annual dividends of $1.32, $1.33, $1.38, $1.40, and $1.42 over the past five years, respectively. What is the average dividend growth rate?

Accepted Answer

A)  1.85 percent 
B)  2.16 percent 
C)  1.98 percent 
D)  2.47 percent 
E)  2.39 percent

Question 16

When a manager develops a cost of capital for a specific project based on the cost of capital for another firm that has a similar line of business as the project, the manager is utilizing the ________ approach.

Accepted Answer

A)  subjective risk 
B)  pure play 
C)  divisional cost of capital 
D)  capital adjustment 
E)  security market line

Question 17

The Shoe Outlet has paid annual dividends of $.58, $.66, $.72, and $.75 per share over the last four years, respectively. The stock is currently selling for $10.08 a share. What is the cost of equity?

Accepted Answer

A)  18.74 percent 
B)  17.13 percent 
C)  10.38 percent 
D)  19.53 percent 
E)  11.79 percent

Question 18

The weighted average cost of capital for a firm with debt is the:

Accepted Answer

A)  discount rate that the firm should apply to all of the projects it undertakes. 
B)  rate of return a company must earn on its existing assets to maintain the current value of its stock. 
C)  coupon rate the firm should expect to pay on its next bond issue. 
D)  minimum discount rate the firm should require on any new project. 
E)  rate of return debtholders should expect to earn on their investment in this firm.

Question 19

Panelli's is analyzing a project with an initial cost of $139,000 and cash inflows of $74,000 in Year 1 and $86,000 in Year 2. This project is an extension of current operations and thus is equally as risky as the current company. The company uses only debt and common stock to finance its operations and maintains a debt-equity ratio of .39 The aftertax cost of debt is 5.1 percent, the cost of equity is 13.2 percent, and the tax rate is 21 percent. What is the projected net present value of this project?

Accepted Answer

A)  $411 
B)  $1,109 
C)  −$1,807 
D)  $938 
E)  −$2,399

Exam 14: Cost of Capital