Chapter 11: Cost of Capital

You have been hired as a consultant by Baldone Inc.'s CFO, who wants you to help her estimate the cost of capital. You have been provided with the following data: risk-free rate = 4%; expected return on the market = 8.25%; and beta = 1.60. Based on the CAPM approach, what is the cost of common from retained earnings? 1) 10.80% 2) 10.93% 3) 10.28% 4) 9.95% 5) 9.67%

1) 10.80%

Trahern Baking Co. common stock sells for $32.50 per share. It expects to earn $3.50 per share during the current year, its expected dividend payout ratio is 65%, and its expected constant dividend growth rate is 5.0%. New stock can be sold to the public at the current price, but a flotation cost of 6% would be incurred. What would be the cost of equity from new common stock? 1) 14.04% 2) 12.45% 3) 13.37% 4) 15.48% 5) 14.74%

2) 12.45%

Emmanuel Goldstein, Inc. can issue 15-year debt with an annual coupon rate of 9% (semiannual payments) at par. The flotation costs will be 4% of the value of the issue and the company's tax rate is 28%. What is the after-tax cost of debt for purposes of computing WACC? 1) 5.10% 2) 6.84% 3) 5.30% 4) 5.70% 5) 9.40%

2) 6.84% De Minimus Threshold = 0.0025*15*1000 = 37.5 Discount = 40 Discount above De Minimus => do not adjust payments PV = -960; N = 30; PMT = 45; FV = 1000; CPT I/Y = 4.7529% * 2 => rd = 9.51% rd(1-T) = 9.51%(1-.28) = 6.84%

The Montgomery Company sold a $1,000 par value, noncallable bond several years ago that now has 10 years to maturity and a 5.00% annual coupon that is paid semiannually. The bond currently sells for $1025 and the company's tax rate is 25%. What is the after-tax component cost of debt for use in the WACC calculation? 1) 4.83% 2) 2.28% 3) 3.51% 4) 2.81% 5) 5.03%

3) 3.51%

A company's perpetual preferred stock currently sells for $92.50 per share, and it pays an $7.00 annual dividend. If the company were to sell a new preferred issue, it would incur a flotation cost of 5.00% of the issue price. What is the firm's cost of preferred stock? 1) 9.10% 2) 8.22% 3) 8.65% 4) 7.97% 5) 9.56%

4) 7.97%

With its current financial policies, Flagstaff Inc. will have to issue new common stock to fund its capital budget. Since new stock has a higher cost than retained earnings, Flagstaff would like to avoid issuing new stock. Which of the following actions would REDUCE its need to issue new common stock? 1) Increase the proposed capital budget 2) Reduce the amount of short-term bank debt in order to increase the current ratio. 3) Increase the dividend payout ratio for the upcoming year 4) Increase the % of debt in the target capital structure 5) Reduce the % of debt in the target capital structure

4) Increase the % of debt in the target capital structure

Taylor Inc. estimates that its average risk projects have a WACC of 11%, its below-average risk projects have a WACC of 9%, and its above-average risk projects have a WACC of 13%. Which of the following projects (A, B, and C) should the company accept? 1) Project A, which is of average risk and has a return of 9%. 2) All of the projects should be accepted. 3) Project C, which is of above-average risk and has a return of 14%. 4) Project B, which is of below-average risk and has a return of 8.5%. 5) None of the projects should be accepted

4) Project B, which is of below-average risk and has a return of 8.5%.

The CEO of Harding Media Inc. as asked you to help estimate its cost of common equity. You have obtained the following data: D0 = $0.85; P0 = $32.00; and g = 6.00% (constant). The CEO thinks, however, that the stock price is temporarily depressed, and that it will soon rise to $45.00. Based on the DCF approach, by how much would the cost of common from retained earnings change if the stock price changes as the CEO expects? 1) -1.85% 2) -1.66% 3) -1.49% 4) -2.03% 5) -0.82%

5) -0.82%

To help them estimate the company's cost of capital, Smithco has hired you as a consultant. You have been provided with the following data: D0 = $1.45; P0 = $22.50; and g = 6.50% (constant). Based on the DCF approach, what is the cost of common from retained earnings? 1) 11.68% 2) 12.94% 3) 11.10% 4) 12.30% 5) 13.36%

5) 13.36%

Assume that you are an intern with the Brayton Company, and you have collected the following data: The yield on the company's outstanding bonds is 8.75%; its tax rate is 25%; the next expected dividend is $0.65 a share; the dividend is expected to grow at a constant rate of 6.00% a year; the price of the stock is $15.00 per share; the flotation cost for selling new shares is F = 10%; and the target capital structure is 55% debt and 45% common equity. What is the firm's WACC, assuming it must issue new stock to finance its capital budget? 1) 6.89% 2) 7.26% 3) 8.04% 4) 7.64% 5) 8.47%

5) 8.47%