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Exam 12: Cost of Capital

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Question 31

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The cost of capital for a project depends primarily on which one of the following?

A) Source of funds used for the project
B) Division within the firm that undertakes the project
C) Project's modified internal rate of return
D) How the project uses its funds
E) Project's fixed costs

F) C) and D)
G) B) and E)

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Question 32

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Appalachian Mountain Goods has paid increasing dividends of $.0.12,$0.18,$0.20,and $0.25 a share over the past four years,respectively.The firm estimates that future increases in its dividends will be equal to the arithmetic average growth rate over these past four years.The stock is currently selling for $12.60 a share.The risk-free rate is 3.2 percent and the market risk premium is 9.1 percent.What is the cost of equity for this firm if its beta is 1.26?

A) 14.34 percent
B) 16.91 percent
C) 19.78 percent
D) 22.96 percent
E) 24.03 percent

F) A) and E)
G) C) and D)

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Question 33

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The Five and Dime Store has a cost of equity of 15.8 percent,a pretax cost of debt of 7.7 percent,and a tax rate of 35 percent.What is the firm's weighted average cost of capital if the debt-equity ratio is 0.40?

Musical Charts just paid an annual dividend of $2.45 per share.This dividend is expected to increase by 3.3 percent annually.Currently,the firm has a beta of 1.09 and a stock price of $36 a share.The risk-free rate is 4.2 percent and the market rate of return is 12.6 percent.What is the cost of equity capital for this firm?

The 7.5 percent preferred stock of Home Town Brewers is selling for $45 a share.What is the firm's cost of preferred stock if the tax rate is 35 percent and the par value per share is $100?

The Color Box uses a combination of common stock,preferred stock,and debt financing.The company wants preferred stock to represent 8 percent of the total financing.It also wants to structure the firm in a manner that will produce a weighted average cost of capital of 10.25 percent.The aftertax cost of debt is 5.1 percent,the cost of preferred is 9.3 percent,and the cost of common stock is 15.6 percent.What percentage of the firm's capital funding should be debt financing?

All else constant,the weighted average cost of capital for a risky,levered firm will decrease if:

Stock in ABC Enterprises has a beta of 1.06.The market risk premium is 6.8 percent,and T-bills are currently yielding 3.2 percent.ABC's most recent dividend was $1.56 per share,and dividends are expected to grow at a 4 percent annual rate indefinitely.If the stock sells for $43 a share,what is your best estimate of ABC's cost of equity?

You need to use the pure play approach to assign a cost of capital to a proposed investment.Which one of the following characteristics should you most concentrate on as you search for an appropriate pure play firm?

Which one of the following is the primary determinant of an investment's cost of capital?

Alpha Industries is considering a project with an initial cost of $7.4 million.The project will produce cash inflows of $1.54 million a year for seven years.The firm uses the subjective approach to assign discount rates to projects.For this project,the subjective adjustment is +1.5 percent.The firm has a pretax cost of debt of 8.6 percent and a cost of equity of 13.7 percent.The debt-equity ratio is 0.0.65 and the tax rate is 35 percent.What is the net present value of the project?

Kelly's uses the firm's WACC as the required return for some of its projects.For other projects,the firms uses a rate equal to WACC plus 1 percent,while another set of projects is assigned rates equal to WACC minus some amount.Which one of the following factors should be the key factor the firm uses to determine the amount of the adjustment it will make when assigning the project a discount rate?

Country Kitchen's cost of equity is 15.3 percent and its aftertax cost of debt is 6.9 percent.What is the firm's weighted average cost of capital if its debt-equity ratio is 0.58 and the tax rate is 30 percent?

Madison Square Stores has a $20 million bond issue outstanding that currently has a market value of $18.6 million.The bonds mature in 6.5 years and pay semiannual interest payments of $35 each.What is the firm's pretax cost of debt?

Birds of a Feather has 10-year bonds outstanding that carry an annual coupon of 8 percent.The bonds mature in 7 years and are currently priced at 110 percent of face value.What is the firm's pretax cost of debt?

Rockingham Motors issued a 20-year,8 percent semiannual bond 3 years ago.The bond currently sells for 98.6 percent of its face value.The company's tax rate is 35 percent.What is the aftertax cost of debt?

Smith and Weston has 55,000 shares of common stock outstanding at a price of $31 a share.It also has 3,000 shares of preferred stock outstanding at a price of $62 a share.The firm has 8 percent,12-year bonds outstanding with a total face value of $400,000.The bonds are currently quoted at 101.2 percent of face and pay interest semiannually.What is the capital structure weight of the firm's preferred stock if the tax rate is 35 percent?

Which one of the following is the pretax cost of debt?

Which of the following will increase the cost of equity for a firm with a beta of 1.1? I.Decrease in the security's beta II.Decrease in the market risk premium III.Decrease in the risk-free rate IV.Increase in the risk-free rate

Kate is the CFO of a major firm and has the job of assigning discount rates to each project that is under consideration.Kate's method of doing this is to assign an incrementally higher rate as the risk level of the project increases over that of the current firm.Likewise,she assigns lower rates as the risk level declines.Which one of the following approaches is Kate using to assign the discount rates?