Finance-3120 Exam 3 TB-Chapter 9
D) risk-free rate.
All the following variables are used in computing the cost of debt EXCEPT A) maturity value of the debt. B) market price of the debt. C) number of years to maturity. D) risk-free rate.
A) -$9,306
CrochetCo is considering an investment in a project which would require an initial outlay of $350,000 and produce expected cash flows in years 1-5 of $95,450 per year. You have determined that the current after-tax cost of the firm's capital (required rate of return) for each source of financing is as follows: Cost of Long-Term Debt 7% Cost of Preferred Stock 11% Cost of CommonStock 15% Long-term debt currently makes up 25% of the capital structure, preferred stock 15%, and common stock 60%. What is the net present value of this project? A) -$9,306 B) $2,149 C) $5,983 D) $11,568
C) 9.97%
Donner, Inc. will finance a proposed investment by issuing new securities while maintaining its optimal capital structure of 60% debt and 40% equity. The firm can issue bonds at a price of $950.00 before $15 flotation costs. The 10-year bonds will have an annual coupon rate of 8% and a face value of $1,000. The company can issue new equity at a before-tax cost of 16% and its marginal tax rate is 34%. What is the appropriate cost of capital to use in analyzing this project? A) 3.63% B) 8.77% C) 9.97% D) 11.81%
B) cause the cost of capital to increase.
Due to changes in regulatory requirements, the transactions costs associated with selling corporate securities increased by $1 per share. This change will A) cause the cost of capital to decrease. B) cause the cost of capital to increase. C) have no effect on the cost of capital because transactions costs are expensed immediately. D) cause the cost of capital to decrease only if investors may be billed for part of the increase in transactions costs.
D) 60% debt, 15% preferred stock, 25% common equity
For a typical corporation, which of the following capital structures will result in the lowest weighted average cost of capital? A) 40% debt, 20% preferred stock, 40% common equity B) 50% debt, 10% preferred stock, 40% common equity C) 60% debt, 10% preferred stock, 30% common equity D) 60% debt, 15% preferred stock, 25% common equity
D) 11.79%
Keystone Corporation will issue new common stock to finance an expansion. The existing common stock just paid a $1.50 dividend, and dividends are expected to grow at a constant rate 8% indefinitely. The stock sells for $45, and flotation expenses of 5% of the selling price will be incurred on new shares. What is the cost of new common stock be for Keystone Corp.? A) 11.33% B) 11.51% C) 11.60% D) 11.79% E) 12.53%
B) flotation costs are incurred when new stock is issued.
The cost of retained earnings is less than the cost of new common stock because A) marginal tax brackets increase. B) flotation costs are incurred when new stock is issued. C) dividends are not tax deductible. D) accounting rules allow a deduction when using retained earnings.
D) 20.1%
The risk-free rate of return is 2.5% and the market risk premium is 8%. Rogue Transport has a beta of 2.2 and a standard deviation of returns of 28%. Rogue Transport's marginal tax rate is 35%. Analysts expect Rogue Transport's dividends to grow by 6% per year for the foreseeable future. Using the capital asset pricing model, what is Rogue Transport's cost of retained earnings? A) 16.4% B) 17.7% C) 19.6% D) 20.1%
B) less than 12%.
WineCellars Inc. currently has a weighted average cost of capital of 12%. WineCellars has been growing rapidly over the past several years, selling common stock in each year to finance its growth. However, due to difficult economic times this year, WineCellars decides to cut its dividend and increase its retained earnings so that the common equity portion of its capital structure will include only retained earnings and no new common stock will be sold. WineCellars' weighted average cost of capital this year should be A) zero, since no new stock will be sold. B) less than 12%. C) equal to 12%. D) greater than 12%.
C) 4.70%
XRT, Inc. is issuing a $1,000 par value bond that pays 8.5% interest annually. Investors are expected to pay $1,100 for the 12-year bond. The firm will pay $50 per bond in flotation costs. What is the after-tax cost of new debt if the firm is in the 35% tax bracket? A) 8.23% B) 4.55% C) 4.70% D) 7.45%
B) 17.72%.
A company has preferred stock that can be sold for $21 per share. The preferred stock pays an annual dividend of 3.5% based on a par value of $100. Flotation costs associated with the sale of preferred stock equal $1.25 per share. The company's marginal tax rate is 35%. Therefore, the cost of preferred stock is A) 18.87%. B) 17.72%. C) 14.26%. D) 12.94%
B) 24.24%.
A company has preferred stock with a current market price of $18 per share. The preferred stock pays an annual dividend of 4% based on a par value of $100. Flotation costs associated with the sale of preferred stock equal $1.50 per share. The company's marginal tax rate is 40%. Therefore, the cost of preferred stock is A) 28.80%. B) 24.24%. C) 22.22%. D) 14.55%
A) 3.74%
A corporate bond has a face value of $1,000 and a coupon rate of 5%. The bond matures in 15 years and has a current market price of $925. If the corporation sells more bonds, it will incur flotation costs of $25 per bond. If the corporate tax rate is 35%, what is the after-tax cost of debt capital? A) 3.74% B) 4.45% C) 5.29% D) 6.78%
B) 6.56%
A corporate bond has a face value of $1,000 and a coupon rate of 9%. The bond matures in 14 years and has a current market price of $946. If the corporation sells more bonds, it will incur flotation costs of $26 per bond. If the corporate tax rate is 35%, what is the after-tax cost of debt capital? A) 5.57% B) 6.56% C) 8.18% D) 7.31%
C) capital structure.
A firm's cost of capital is influenced by A) the current ratio. B) par value of common stock. C) capital structure. D) net income.
D) the probability distribution of expected returns
A firm's weighted average cost of capital is determined using all of the following inputs EXCEPT A) the firm's capital structure. B) the amount of capital necessary to make the investment. C) the firm's after-tax cost of debt. D) the probability distribution of expected returns.
B) 18.89%
Adventure Outfitter Corp. can sell common stock for $27 per share and its investors require a 17% return. However, the administrative or flotation costs associated with selling the stock amount to $2.70 per share. What is the cost of capital for Adventure Outfitter if the corporation raises money by selling common stock? A) 27.00% B) 18.89% C) 18.33% D) 17.00%
D) an increase in the cost of common equity, whether or not the funds come from retained earnings or newly issued common stock.
All else equal, an increase in beta results in A) an increase in the cost of retained earnings. B) an increase in the cost of newly issued common stock. C) an increase in the after-tax cost of debt. D) an increase in the cost of common equity, whether or not the funds come from retained earnings or newly issued common stock
B) 12.00%
Baxter Inc. has a target capital structure of 30% debt, 15% preferred stock, and 55% common equity. The company's after-tax cost of debt is 7%, its cost of preferred stock is 11%, its cost of retained earnings is 15%, and its cost of new common stock is 16%. The company stock has a beta of 1.5 and the company's marginal tax rate is 35%. What is the company's weighted average cost of capital if retained earnings are used to fund the common equity portion? A) 11.20% B) 12.00% C) 13.80% D) 14.45%
C) 11.12 percent
Beauty Inc. plans to maintain its optimal capital structure of 40 percent debt, 10 percent preferred stock, and 50 percent common equity indefinitely. The required return on each component source of capital is as follows: debt—8 percent; preferred stock—12 percent; common equity—16 percent. Assuming a 40 percent marginal tax rate, what after-tax rate of return must the firm earn on its investments if the value of the firm is to remain unchanged? A) 12.40 percent B) 12.00 percent C) 11.12 percent D) 10.64 percent
B) 18.13%
Blammo, Inc. has a target capital structure of 30% debt and 70% equity. The firm is planning to invest in a project that will necessitate raising new capital. New debt will be issued at a before-tax yield of 14%, with a coupon rate of 10%. The equity will be provided by internally generated funds so no new outside equity will be issued. If the required rate of return on the firm's stock is 22% and its marginal tax rate is 35%, compute the firm's cost of capital. A) 18.00% B) 18.13% C) 19.68% D) 15.55%
C) the rate of return that must be earned on additional investment if firm value is to remain unchanged.
Cost of capital is A) the coupon rate of debt. B) a hurdle rate set by the board of directors. C) the rate of return that must be earned on additional investment if firm value is to remain unchanged. D) the average cost of the firm's assets.
C) the internal rate of return for new investments.
Cost of capital is commonly used interchangeably with all of the following terms EXCEPT A) the firm's required rate of return. B) the hurdle rate for new investments. C) the internal rate of return for new investments. D) the firm's opportunity cost of funds.
C) favor projects in the research and development division because the higher risk projects look more favorable if a lower cost of capital is used to evaluate them.
Coyote Inc. operates three divisions. One division involves significant research and development, and thus has a high-risk cost of capital of 15%. The second division operates in business segments related to Coyote's core business, and this division has a cost of capital of 10% based upon its risk. Coyote's core business is the least risky segment, with a cost of capital of 8%. The firm's overall weighted average cost of capital of 11% has been used to evaluate capital budgeting projects for all three divisions. This approach will A) favor projects in the core business division because that division is the least risky. B) favor projects in the related businesses division because the cost of capital for this division is the closest to the firm's weighted average cost of capital. C) favor projects in the research and development division because the higher risk projects look more favorable if a lower cost of capital is used to evaluate them. D) not favor any division over the other because they all use the same company-wide weighted average cost of capital.
A) 8.76%
Crandal Dockworks is undergoing a major expansion. The expansion will be financed by issuing new 15-year, $1,000 par, 9% annual coupon bonds. The market price of the bonds is $1,070 each. Crandal's flotation expense on the new bonds will be $50 per bond. Crandal's marginal tax rate is 35%. What is the pre-tax cost of debt for the newly-issued bonds? A) 8.76% B) 8.12% C) 7.49% D) 10.25%
C) 8.17%
Crandal Dockworks is undergoing a major expansion. The expansion will be financed by issuing new 15-year, $1,000 par, 9% annual coupon bonds. The market price of the bonds is $1,070 each. Five Rivers flotation expense on the new bonds will be $50 per bond. Crandal's marginal tax rate is 35%. What is the yield to maturity on the newly-issued bonds? A) 6.95% B) 7.99% C) 8.17% D) 9.82%
C) 13.75%
GHJ Inc. is investing in a major capital budgeting project that will require the expenditure of $16 million. The money will be raised by issuing $2 million of bonds, $4 million of preferred stock, and $10 million of new common stock. The company estimates is after-tax cost of debt to be 7%, its cost of preferred stock to be 9%, the cost of retained earnings to be 14%, and the cost of new common stock to be 17%. What is the weighted average cost of capital for this project? A) 12.20% B) 13.12% C) 13.75% D) 14.23%
C) 18.9%
GPS Inc. wishes to estimate its cost of retained earnings. The firm's beta is 1.3. The rate on 6-month T-bills is 2%, and the return on the S&P 500 index is 15%. What is the appropriate cost for retained earnings in determining the firm's cost of capital? A) 17.0% B) 19.5% C) 18.9% D) 22.1%
C) 11.60%
Grandview Inc. will issue new common stock to finance an expansion. The existing common stock just paid a $1.50 dividend, and dividends are expected to grow at a constant rate 8% indefinitely. The stock sells for $45, and flotation expenses of 5% of the selling price will be incurred on new shares. What is the cost of retained earnings for Grandview? A) 11.33% B) 11.51% C) 11.60% D) 11.79% E) 12.53%
D) 12.09%
Haroldson Inc. common stock is selling for $22 per share. The last dividend was $1.20, and dividends are expected to grow at a 6% annual rate. Flotation costs on new stock sales are 5% of the selling price. What is the cost of Haroldson Inc.'s new common stock? A) 5.73% B) 11.45% C) 11.78% D) 12.09%
C) 11.78%
Haroldson Inc. common stock is selling for $22 per share. The last dividend was $1.20, and dividends are expected to grow at a 6% annual rate. Flotation costs on new stock sales are 5% of the selling price. What is the cost of Haroldson's retained earnings? A) 5.73% B) 11.45% C) 11.78% D) 12.09%
C) higher cost of retained earnings.
Higher flotation costs will result in all of the following EXCEPT A) higher after-tax cost of debt. B) higher weighted average cost of capital. C) higher cost of retained earnings. D) higher cost of common equity when new common shares are sold.
D) component cost of internal equity
In capital budgeting analysis, when computing the weighted average cost of capital, the CAPM approach is typically used to find which of the following? A) market value weight of equity B) pretax component cost of debt C) after-tax component cost of debt D) component cost of internal equity
A) debt.
In general, the least expensive source of capital is A) debt. B) new common stock. C) preferred stock D) retained earnings.
C) cost of new common stock, cost of retained earnings, cost of preferred stock, cost of debt
In general, which of the following rankings, from highest to lowest cost, is most accurate? A) cost of new common stock, cost of preferred stock, cost of debt, cost of retained earnings B) cost of debt, cost of preferred stock, cost of new common stock, cost of retained earnings C) cost of new common stock, cost of retained earnings, cost of preferred stock, cost of debt D) cost of preferred stock, cost of new common stock, cost of retained earnings, cost of deb
C) $15.5 million
JPR Company is financed 75 percent by equity and 25 percent by debt. If the firm expects to earn $30 million in net income next year and retain 40% of it, how large can the capital budget be before common stock must be sold? A) $7.5 million B) $12.0 million C) $15.5 million D) $16.0 million
C) 8.00%
JPR Company's preferred stock is currently selling for $28.00, and pays a perpetual annual dividend of $2.00 per share. Underwriters of a new issue of preferred stock would charge $3 per share in flotation costs. The firm's tax rate is 40%. Compute the cost of new preferred stock for JPR. A) 4.80% B) 7.14% C) 8.00% D) 9.15%
A) 13 percent
Jiffy Co. expects to pay a dividend of $3.00 per share in one year. The current price of Jiffy common stock is $60 per share. Flotation costs are $3.00 per share when Jiffy issues new stock. What is the cost of internal common equity (retained earnings) if the long-term growth in dividends is projected to be 8 percent indefinitely? A) 13 percent B) 14 percent C) 15 percent D) 16 percent
B) 20.09%.
Johnson Production Company paid a dividend yesterday of $3.50 per share. The dividend is expected to grow at a constant rate of 10% per year. The price of KayCee's common stock today is $40 per share. If KayCee decides to issue new common stock, flotation costs will equal $4.00 per share. KayCee's marginal tax rate is 35%. Based on the above information, the cost of new common stock is A) 26.41%. B) 20.09%. C) 19.63%. D) 17.55%.
C) 19.63%.
Johnson Production Company paid a dividend yesterday of $3.50 per share. The dividend is expected to grow at a constant rate of 10% per year. The price of KayCee's common stock today is $40 per share. If KayCee decides to issue new common stock, flotation costs will equal $4.00 per share. KayCee's marginal tax rate is 35%. Based on the above information, the cost of retained earnings is A) 26.41%. B) 20.09%. C) 19.63%. D) 17.55%
B) 10.80%
Kokapeli, Inc. has a target capital structure of 40% debt and 60% common equity, and has a 40% marginal tax rate. If the firm's yield to maturity on bonds is 7.5% and investors require a 15% return on the firm's common stock, what is the firm's weighted average cost of capital? A) 7.20% B) 10.80% C) 12.00% D) 12.25%
B) 5.69%
Mountain Retreat and Resort is undergoing a major expansion. The expansion will be financed by issuing new 15-year, $1,000 par, 9% annual coupon bonds. The market price of the bonds is $1,070 each. The firm's flotation expense on the new bonds will be $50 per bond. The firm's marginal tax rate is 35%. What is the relevant cost of the new bonds for capital budgeting purposes? A) 5.14% B) 5.69% C) 8.45% D) 4.82%
C) 21.00%, 23.29%
Phillips Enterprises Inc. is expected to pay a dividend of $2.60 next year. Dividends are expected to grow at a constant rate of 8% per year, and the stock price is currently $20.00. New stock can be sold at this price subject to flotation costs of 15%. The company's marginal tax rate is 35%. Compute the cost of internal equity (retained earnings) and the cost of external equity (new common stock), respectively. A) 0, 21.00% B) 8.00%, 23.29% C) 21.00%, 23.29% D) 23.00%, 25.48%
C) 10.18%
PrimaCare has a capital structure that consists of $7 million of debt, $2 million of preferred stock, and $11 million of common equity, based upon current market values. The firm's yield to maturity on its bonds is 7.4%, and investors require an 8% return on the firm's preferred and a 14% return on PrimaCare's common stock. If the tax rate is 35%, what is PrimaCare's WACC? A) 7.21% B) 8.12% C) 10.18% D) 12.25%
B) 4.87%
QRM, Inc.'s marginal tax rate is 35%. It can issue 10-year bonds with an annual coupon rate of 7% and a par value of $1,000. After $12 per bond flotation costs, new bonds will net the company $966 in proceeds. Determine the appropriate after-tax cost of new debt for the firm to use in a capital budgeting analysis. A) 2.62% B) 4.87% C) 7.50% D) 7.8%
A) 28.38%.
Sentry Manufacturing paid a dividend yesterday of $5 per share (D0 = $5). The dividend is expected to grow at a constant rate of 8% per year. The price of Sentry Manufacturing's stock today is $29 per share. If Sentry Manufacturing decides to issue new common stock, flotation costs will equal $2.50 per share. Sentry Manufacturing's marginal tax rate is 35%. Based on the above information, the cost of new common stock is A) 28.38%. B) 24.12%. C) 26.62%. D) 31.40%.
C) 26.62%.
Sentry Manufacturing paid a dividend yesterday of $5 per share (D0 = $5). The dividend is expected to grow at a constant rate of 8% per year. The price of Sentry Manufacturing's stock today is $29 per share. If Sentry Manufacturing decides to issue new common stock, flotation costs will equal $2.50 per share. Sentry Manufacturing's marginal tax rate is 35%. Based on the above information, the cost of retained earnings is A) 28.38%. B) 24.12%. C) 26.62%. D) 31.40%.
B) 8.75 percent
TC, Inc. has $15 million of outstanding bonds with a coupon rate of 10 percent. The yield to maturity on these bonds is 12.5 percent. If the firm's tax rate is 30 percent, what is relevant cost of debt financing to TC, Inc.? A) 13.75 percent B) 8.75 percent C) 7.00 percent D) 3.75 percent
D) 10.53%
Tempo Corp. will issue preferred stock to finance a new artillery line. The firm's existing preferred stock pays a dividend of $4.00 per share and is selling for $40 per share. Investment bankers have advised Tempo that flotation costs on the new preferred issue would be 5% of the selling price. Tempo's marginal tax rate is 30%. What is the relevant cost of new preferred stock? A) 7.00% B) 7.37% C) 10.00% D) 10.53% E) 15.00%
D) 10.74%
The DEF Company is planning a $64 million expansion. The expansion is to be financed by selling $25.6 million in new debt and $38.4 million in new common stock. The before-tax required rate of return on debt is 9 percent and the required rate of return on equity is 14 percent. If the company is in the 35 percent tax bracket, what is the firm's cost of capital? A) 8.92% B) 9.89% C) 11.50% D) 10.74%
B) the marginal cost of capital.
The average cost associated with each additional dollar of financing for investment projects is A) the incremental return. B) the marginal cost of capital. C) CAPM required return. D) the component cost of capital.
A) flotation costs on new equity.
The cost of external equity capital is greater than the cost of retained earnings because of A) flotation costs on new equity. B) increasing marginal tax rates. C) higher dividends. D) greater risk for shareholders.
D) preferred stock dividend divided by the net selling price of preferred.
The cost of new preferred stock is equal to A) the preferred stock dividend divided by the market price. B) the preferred stock dividend divided by its par value. C) (1 - tax rate) times the preferred stock dividend divided by net price. D) preferred stock dividend divided by the net selling price of preferred.
D) 25.0%
The risk-free rate of return is 3% and the expected return on the market portfolio is 14%. Oklahoma Oilco has a beta of 2.0 and a standard deviation of returns of 26%. Oilco's marginal tax rate is 35%. Analysts expect Oilco's net income to grow by 12% per year for the next 5 years. Using the capital asset pricing model, what is Oklahoma Oilco's cost of retained earnings? A) 18.6% B) 21.2% C) 22.8% D) 25.0%
A) corporate taxes and flotation costs
Two considerations that cause a corporation's cost of capital to be different than its investors' required returns are A) corporate taxes and flotation costs. B) individual taxes and corporate taxes. C) individual taxes and dividends. D) corporate taxes and the earned income tax credit.
D) A and B above
Using the weighted average cost of capital as the required rate of return for every project will A) cause a firm to reject projects that should have been accepted. B) cause a firm to accept projects that were too risky. C) result in maximization of shareholder wealth. D) A and B above
B) the incurrence of flotation costs when new securities are issued
Which of the following causes a firm's cost of capital (WACC) to differ from an investor's required rate of return on the company's common stock? A) the fact that the risk-free rate of interest has increased B) the incurrence of flotation costs when new securities are issued C) The market risk premium exceeds 12%. D) None of the above — the WACC and required return are the same.
C) the flotation costs incurred when issuing new securities
Which of the following differentiates the cost of retained earnings from the cost of newly-issued common stock? A) the cost of the pre-emptive rights held by existing shareholders B) the greater marginal tax rate faced by the now-larger firm C) the flotation costs incurred when issuing new securities D) the larger dividends paid to the new common stockholders
B) after-tax cost of accounts payable
Which of the following should NOT be considered when calculating a firm's WACC? A) after-tax YTM on a firm's bonds B) after-tax cost of accounts payable C) cost of newly issued preferred stock D) cost of newly issued common stock
D) cost of carrying inventory
Which of the following should NOT be considered when calculating a firm's WACC? A) cost of preferred stock B) after-tax cost of bonds C) cost of common stock D) cost of carrying inventory
D) The cost of a particular source of capital is equal to the investor's required rate of return after adjusting for the effects of both flotation costs and corporate taxes.
Which of the following statements is MOST correct? A) Because the cost of debt is lower than the cost of equity, value-maximizing firms maintain debt ratios of close to 100%. B) Corporations that are 100% equity financed will have a much lower weighted average cost of capital because the lack of debt lowers their risk of bankruptcy. C) The source of capital with the lowest after-tax cost is preferred stock, because it is a hybrid security, part debt and part equity. D) The cost of a particular source of capital is equal to the investor's required rate of return after adjusting for the effects of both flotation costs and corporate taxes.
C) Not all lines of business have equal risk and it is likely that the firm will accept projects whose returns are unacceptably low in relation to the risk involved.
Why should firms that own and operate multiple businesses that have different risk characteristics use business-specific, or divisional costs of capital? A) Not all divisions have equal risk and the firm might accept projects whose returns are higher than are deemed appropriate. B) Not all business divisions have equal risk and the firm will likely become less risky in the future. C) Not all lines of business have equal risk and it is likely that the firm will accept projects whose returns are unacceptably low in relation to the risk involved. D) Use of the same weighted average cost of capital for all divisions may result in too much money being allocated to the least risky division.
