big test chp 11

31. Town Crier has 10 million shares of common stock outstanding, 2 million shares of preferred stock outstanding, and 10 thousand bonds. If the common shares are selling for $28 per share, the preferred shares are selling for $15.50 per share, and the bonds are selling for 97 percent of par, what would be the weight used for debt in the computation of Town Crier's WACC?

(10,000 * 0.97 * 1000)/(10,000,000 * 28 + 2,000,000 * 15.50 + 10,000 * 0.97 * 1000) = 9.7M/320.7M = 3.02%

25. Sports Corp has 10 million shares of common stock outstanding, 5 million shares of preferred stock outstanding, and 1 million bonds. If the common shares are selling for $25 per share, the preferred share are selling for $12.50 per share, and the bonds are selling for 97 percent of par, what would be the weight used for equity in the computation of Sports's WACC?

(10,000,000 * 25)/(10,000,000 * 25 + 5,000,000 * 12.50 + 1,000,000 * .97 * 1000) = 250M/1,282.5M = 19.49%

32. Bill's Boards has 20 million shares of common stock outstanding, 4 million shares of preferred stock outstanding, and 20 thousand bonds. If the common shares are selling for $30 per share, the preferred shares are selling for $17 per share, and the bonds are selling for 96 percent of par, what would be the weight used for debt in the computation of Bill's WACC?

(20,000 * 0.96 * 1000)/(20,000,000 * 30 + 4,000,000 * 17 + 20,000 * 0.96 * 1000) = 19.2M/687.2M = 2.79%

29. TellAll has 10 million shares of common stock outstanding, 20 million shares of preferred stock outstanding, and 100 thousand bonds. If the common shares are selling for $32 per share, the preferred shares are selling for $20 per share, and the bonds are selling for 106 percent of par, what would be the weight used for preferred stock in the computation of TellAll's WACC?

(20,000,000 * 20)/(10,000,000 * 32 + 20,000,000 * 20 + 100,000 * 1.06 * 1000) = 400M/826M = 48.43%

26. JackITs has 5 million shares of common stock outstanding, 1 million shares of preferred stock outstanding, and 20 thousand bonds. If the common shares are selling for $28 per share, the preferred share are selling for $13.50 per share, and the bonds are selling for 98 percent of par, what would be the weight used for equity in the computation of JackIT's WACC?

(5,000,000 * 28)/(5,000,000 * 28 + 1,000,000 * 13.50 + 20,000 * .98 * 1000) = $140M/$173.1M = 80.88%

27. Carrie D's has 6 million shares of common stock outstanding, 2 million shares of preferred stock outstanding, and 10 thousand bonds. If the common shares are selling for $15 per share, the preferred shares are selling for $28 per share, and the bonds are selling for 109 percent of par, what would be the weight used for equity in the computation of Carrie D's WACC?

(6,000,000 * 15)/(6,000,000 * 15 + 2,000,000 * 28 + 10,000 * 1.09 * 1000) = 90,000,000/156,900,000 = 57.36%

30. Paper Exchange has 80 million shares of common stock outstanding, 60 million shares of preferred stock outstanding, and 50 thousand bonds. If the common shares are selling for $20 per share, the preferred shares are selling for $10 per share, and the bonds are selling for 105 percent of par, what would be the weight used for preferred stock in the computation of Paper's WACC?

(60,000,000 * 10)/(80,000,000 * 20 + 60,000,000 * 10 + 50,000 * 1.05 * 1000) = 600M/2252.2M = 26.64%

28. Solar Shades has 8 million shares of common stock outstanding, 4 million shares of preferred stock outstanding, and 10 thousand bonds. If the common shares are selling for $13 per share, the preferred shares are selling for $30 per share, and the bonds are selling for 105 percent of par, what would be the weight used for equity in the computation of Solar Shades' WACC?

(8,000,000 * 13)/(8,000,000 * 13 + 4,000,000 * 30 + 10,000 * 1.05 * 1000) = 104M/234.5M = 44.35%

40. Suppose that TW, Inc. has a capital structure of 25 percent equity, 15 percent preferred stock, and 60 percent debt. If the before-tax component costs of equity, preferred stock and debt are 13.5 percent, 9.5 percent and 4 percent, respectively, what is TW's WACC if the firm faces an average tax rate of 30%?

.25 x 13.5% + .15 x 9.5% + .60 x 4% x (1 - .3) = 6.48%

36. Suppose that Glamour Nails, Inc.'s capital structure features 30 percent equity, 70 percent debt, and that its before-tax cost of debt is 4 percent, while its cost of equity is 10 percent. If the appropriate weighted average tax rate is 34 percent, what will be Glamour Nails' WACC?

.30 x 10% + 0 x 0% + .70 x 4% x (1 - .34) = 4.848%

33. Suppose that TipsNToes, Inc.'s capital structure features 40 percent equity, 60 percent debt, and that its before-tax cost of debt is 9 percent, while its cost of equity is 15 percent. If the appropriate weighted average tax rate is 34 percent, what will be TipsNToes' WACC?

.40 x 15% + 0 x 0% + .60 x 9% x (1 - .34) = 9.564%

42. Suppose that TNT, Inc. has a capital structure of 43 percent equity, 23 percent preferred stock, and 34 percent debt. If the before-tax component costs of equity, preferred stock and debt are 15.4 percent, 10 percent and 7 percent, respectively, what is TNT's WACC if the firm faces an average tax rate of 28%?

.43 x 15.4% + .23 x 10% + .34 x 7% x (1 - .28) = 10.6356%

35. Suppose that Hanna Nails, Inc.'s capital structure features 45 percent equity, 55 percent debt, and that its before-tax cost of debt is 5 percent, while its cost of equity is 9 percent. If the appropriate weighted average tax rate is 40 percent, what will be Hanna Nails' WACC?

.45 x 9% + 0 x 0% + .55 x 5% x (1 - .40) = 5.7%

41. Suppose that PAW, Inc. has a capital structure of 60 percent equity, 10 percent preferred stock, and 30 percent debt. If the before-tax component costs of equity, preferred stock and debt are 17.5 percent, 12 percent and 6.5 percent, respectively, what is PAW's WACC if the firm faces an average tax rate of 28%?

.6 x 17.5% + .1 x 12% + .3 x 6.5% x (1 - .28) = 13.104%

34. Suppose that Model Nails, Inc.'s capital structure features 60 percent equity, 40 percent debt, and that its before-tax cost of debt is 6 percent, while its cost of equity is 10 percent. If the appropriate weighted average tax rate is 28 percent, what will be Model Nails' WACC?

.60 x 10% + 0 x 0% + .40 x 6% x (1 - .28) = 7.728%

112. A firm uses only debt and equity in its capital structure. The firm's weight of debt is 40%. The firm could issue new bonds at a yield to maturity of 9% and the firm has a tax rate of 30%. If the firm's WACC is 11%, what is the firm's cost of equity?

11% = .4(9%)(1 - .3) + (1 - .4)(cost of equity); cost of equity = 14.13%

114. A firm uses only debt and equity in its capital structure. The firm's weight of equity is 70%. The firm's cost of equity is 13% and it has a tax rate of 30%. If the firm's WACC is 11%, what is the firm's before-tax cost of debt?

11% = .7(13%) + (1 - .7)(cost of debt)(1 - .3); cost of debt = 9.05%

113. A firm uses only debt and equity in its capital structure. The firm's weight of debt is 45%. The firm could issue new bonds at a yield to maturity of 10% and the firm has a tax rate of 30%. If the firm's WACC is 12%, what is the firm's cost of equity?

12% = .45(10%)(1 - .3) + (1 - .45)(cost of equity); cost of equity = 16.09%

115. A firm uses only debt and equity in its capital structure. The firm's weight of equity is 75%. The firm's cost of equity is 16% and it has a tax rate of 30%. If the firm's WACC is 13%, what is the firm's before-tax cost of debt?

13% = .75(16%) + (1 - .75)(cost of debt)(1 - .3); cost of debt = 5.71%

18. FlavR Co stock has a beta of 2.0, the current risk-free rate is 2, and the expected return on the market is 9 percent. What is FlavR Co's cost of equity?

2 + 2.0 * (9 - 2) = 16%

20. CJ Co stock has a beta of 0.9, the current risk-free rate is 5.6, and the expected return on the market is 13 percent. What is CJ Co's cost of equity?

5.6 + 0.9 * (13 - 5.6) = 12.26%

19. TJ Co stock has a beta of 1.45, the current risk-free rate is 5.75, and the expected return on the market is 14 percent. What is TJ Co's cost of equity?

5.75 + 1.45 * (14 - 5.75) = 17.7125%

22. IVY has preferred stock selling for 98 percent of par that pays a 7 percent annual coupon. What would be IVY's component cost of preferred stock?

7/98 = 7.14%

23. Fern has preferred stock selling for 95 percent of par that pays an 8 percent annual coupon. What would be Fern's component cost of preferred stock?

8/95 = 8.42%

24. Rose has preferred stock selling for 99 percent of par that pays a 9 percent annual coupon. What would be Rose's component cost of preferred stock?

9/99 = 9.09%

106. Which of the following statements is correct?

A. A decrease in the firm's marginal corporate tax rate will decrease the weighted average cost of capital. B. Flotation costs can decrease the weighted average cost of capital. C. The cost of debt is based on the cost of all liabilities, including accounts payable and accruals. D. None of these statements is correct.**

82. Which of the following statements is correct?

A. If the risk-free rate increases, it will have no impact on the weighted average cost of capital. B. Investor returns are reduced when float costs increase, and therefore float costs reduce the weighted average cost of capital. C. The weighted average cost of capital is a historical cost. D. None of these statements is correct.**

83. Which of the following will impact the cost of equity component in the weighted average cost of capital?

A. The risk-free rate B. Beta C. Expected return on the market D. all**

98. The reason that we do not use an after-tax cost of preferred stock is __________.

A. because preferred dividends are paid out of before-tax income B. because most of the investors in preferred stock do not pay tax on the dividends C. because we can only estimate the marginal tax rate of the preferred stockholders D. None of these answers is correct. **

9. Which of the following makes this a true statement? Ideally, when searching for a beta for a new line of business

All the answers make this a true statement.

An _______ in the firm's marginal corporate tax rate will decrease the weighted average cost of capital.

An increase in the firm's marginal corporate tax rate will decrease the weighted average cost of capital.

81. Which of the following statements is correct?

An increase in the market risk premium is likely to increase the weighted average cost of capital

An increase in the ________ rate will increase the cost of equity.

An increase in the risk-free rate will increase the cost of equity.

99. Why do we use market-value weights instead of book-value weights?

Because we are interested in determining what the cost of financing the firm's assets would be given today's market situation and the component costs the firm currently faces, not what the historical prices would have been.

38. PNB Industries has 20 million shares of common stock outstanding with a market price of $18.00 per share. The company also has outstanding preferred stock with a market value of $50 million, and 500,000 bonds outstanding, each with face value $1,000 and selling at 97% of par value. The cost of equity is 15%, the cost of preferred is 12%, and the cost of debt is 8.50%. If PNB's tax rate is 40%, what is the WACC?

Common Stock: 20,000,000 x $18 = $360,000,000, so 360,000,000/895,000,000 = .4022

39. PAW Industries has 5 million shares of common stock outstanding with a market price of $8.00 per share. The company also has outstanding preferred stock with a market value of $10 million, and 100,000 bonds outstanding, each with face value $1,000 and selling at 96% of par value. The cost of equity is 19%, the cost of preferred is 15%, and the cost of debt is 9%. If PAW's tax rate is 34%, what is the WACC?

Common Stock: 5,000,000 x $8 = $40,000,000, so 40,000,000/146,000,000 = .2740

37. TJ Industries has 7 million shares of common stock outstanding with a market price of $20.00 per share. The company also has outstanding preferred stock with a market value of $10 million, and 100,000 bonds outstanding, each with face value $1,000 and selling at 95% of par value. The cost of equity is 12%, the cost of preferred is 10%, and the cost of debt is 6.45%. If TJ's tax rate is 34%, what is the WACC?

Common Stock: 7,000,000 x $20 = $140,000,000, so 140,000,000/245,000,000 = .5714 Preferred Stock: $10,000,000, so 10,000,000/245,000,000 = .0408 Bonds: 100,000 x .95 x 1000 = $95,000,000, so 95,000,000/245,000,000 = .3878 Total = $245,000,000 To calculate WACC: .5714 x 12% + .0408 x 10% + .3878 x 6.45% x (1 - .34) = 8.9147%

87. Which of the following will directly impact the cost of debt?

Coupon Rate

10. This is an estimated WACC computed using some sort of proxy for the average equity risk of the projects in a particular division.

Divisional WACC

90. An estimated WACC computed using some sort of proxy for the average equity risk of the projects in a particular business unit is known as the ____________.

Divisional WACC

102. Which of the following statements is correct?

If a new project is riskier than the firm's existing projects, then it should be expect to be "charged" a higher cost of capital than the firm's overall WACC.

101. Which of the following is a reason why the divisional cost of capital approach may cause problems if new projects are assigned to the wrong division?

If projects are assigned to the wrong division, the risk of that division may be significantly different than the risk of the project, implying that the project will be evaluated with a divisional cost of capital that is much different from what a project-specific cost of capital would be.

6. Which of the following statements is true?

If the new project is riskier than the firm's existing projects, then it should be charged a higher cost of capital.

5. Which of these statements is true regarding calculating weights for WACC?

If we are calculating WACC for the firm, then equity, preferred stock and debt would be the entire market value of each source of capital.

21. WC Inc. has a $10 million (face value), 10-year bond issue selling for 99 percent of par that pays an annual coupon of 9 percent. What would be WC's before-tax component cost of debt?

N = 10 PV = 990 PMT = 90 FV = 1000 CPT I = 9.16

4. Which of the following is a true statement regarding the appropriate tax rate to be used in the WACC?

One would use the weighted average of the marginal tax rates that would have been paid on the taxable income shielded by the interest deduction.

84. ADK Industries common shares sell for $40 per share. ADK expects to set their next annual dividend at $1.75 per share. If ADK expects future dividends to grow at 7% per year, indefinitely, the current risk-free rate is 4%, the expected rate on the market is 11%, and the stock has a beta of 1.2, what should be the best estimate of the firm's cost of equity?

Step 1: Find the cost of equity using constant-growth formula: 1.75/40 + .07 = 11.38% Step 2: Find the cost of equity using CAPM: 4 + 1.2(11 - 4) = 12.4%; Step 3: Find the average of the two estimates: 11.89%

85. ADK Industries common shares sell for $60 per share. ADK expects to set their next annual dividend at $3.75 per share. If ADK expects future dividends to grow at 9% per year, indefinitely, the current risk-free rate is 4%, the expected rate on the market is 11%, and the stock has a beta of 1.5, what should be the best estimate of the firm's cost of equity?

Step 1: Find the cost of equity using constant-growth formula: 3.75/60 + .09 = 15.25%; Step 2: Find the cost of equity using CAPM: 4 + 1.5(11 - 4) = 14.5%; Step 3: Find the average of the two estimates: 14.88%

110. Apple's 9% annual coupon bond has 10 years until maturity and the bonds are selling in the market for $1190. If the firm's after-tax cost of debt is 5%, what was the firm's tax rate?

Step 1: PV = -1190; PMT = 90; FV = 1000; n = 10; i = 6.37; Step 2: 5% = 6.37%(1-T); = > T = 21.51%

111. Apple's 9% annual coupon bond has 10 years until maturity and the bonds are selling in the market for $790. If the firm's after-tax cost of debt is 8%, what was the firm's tax rate?

Step 1: PV = -790; PMT = 90; FV = 1000; n = 10; i = 12.85; Step 2: 8% = 12.85%(1-T); = > T = 37.74%

109. Apple's 9% annual coupon bond has 10 years until maturity and the bonds are selling in the market for $890. The firm's tax rate is 36%. What is the firm's after-tax cost of debt?

Step 1: PV = -890; PMT = 90; FV = 1000; N = 10; = > i = 10.86%; Step 2: 10.86%(1 - .36) = 6.95%

86. Which of the following will directly impact the cost of equity?

Stock price

The _______ measures the marginal cost of capital.

The WACC measures the marginal cost of capital.

95. What is the theoretical minimum for the weighted average cost of capital?

The after-tax cost of debt

107. Which of the following will increase the cost of equity?

The firm's share price falls 10%

94. Which of the following statements is correct?

The flotation-adjusted cost of equity will always be more than the cost of equity that has not been adjusted for flotation costs.

43. JAK Industries has 5 million shares of stock outstanding selling at $25 per share and an issue of $40 million in 8 percent, annual coupon bonds with a maturity of 15 years, selling at 108 percent of par ($1000). If JAK's weighted average tax rate is 34 percent and its cost of equity is 15 percent, what is JAK's WACC?

To calculate Rd:

44. FDR Industries has 50 million shares of stock outstanding selling at $30 per share and an issue of $200 million in 9.5 percent, annual coupon bonds with a maturity of 10 years, selling at 105 percent of par ($1000). If FDR's weighted average tax rate is 28 percent and its cost of equity is 16 percent, what is FDR's WACC?

To calculate Rd:

To estimate the before-tax cost of debt, we need to solve for the ___________ on the firm's existing debt.

To estimate the before-tax cost of debt, we need to solve for the Yield to Maturity (YTM) on the firm's existing debt.

11. Which of these statements is true regarding divisional WACC?

Using a simple firmwide WACC to evaluate new projects would give an unfair advantage to projects that present more risk than the firm's average beta.

97. Which of the following is a situation in which you would want to use the constant growth model approach for estimating the component cost of equity?

When the firm's stock is expected to experience constant dividend growth.

96. Which of following is a situation in which you would want to use the CAPM approach for estimating the component cost of equity?

When you are able to estimate the firm's beta with certainty.

100. Suppose a new project was going to be financed partially with retained earnings. What flotation costs should you use for retained earnings?

Zero.

93. Flotation costs are _______________.

commissions to the underwriting firm that floats the issue

12. An objective approach to calculating divisional WACCs would be done by

computing the average beta per division, using these figures for each division in the CAPM formula, and then constructing divisional WACCs.

17. These are fees paid by firms to investment bankers for issuing new securities.

flotation costs

1. When calculating the weighted average cost of capital, weights are based on

market values.

91. The ___________ approach to computing a divisional weighted average cost of capital (WACC) uses the average beta of projects in each division to calculate the WACC.

objective

2. Which of these completes this statement to make it true? The constant growth model is

only going to be appropriate for the limited number of stocks that just happen to expect constant growth.

8. An average of which of the following will give a fairly accurate estimate of what a project's beta will be?

proxy beta

14. This is a principle of capital budgeting which states that the calculations of cash flows should remain independent of financing.

separation principle

92. The ____________ approach to computing a divisional weighted average cost of capital (WACC) requires only that WACCs for "risky" and "relatively safe" divisions be adjusted.

subjective

103. A proxy beta is _________________.

the average beta of firms that are only engaged in the proposed new line of business

13. Which statement makes this a false statement? When a firm pays commissions to underwriting firms that float the issuance of new stock,

the component cost will need to be integrated to figure project WACCs.

7. Which of the following makes this a true statement? If the new project does significantly increase the firm's overall risk,

the increased risk will be borne disproportionately by common stockholders.

16. Which of these makes this a true statement? When determining the appropriate weights used in calculating a WACC, it should reflect

the relative sizes of the total market capitalizations for each kind of security that the firm issues.

15. Which of these makes this a true statement? The WACC formula

uses the after-tax costs of capital to compute the firm's weighted average cost of debt financing.