FNAN 522 CH 14 FINAL EXAM

You are evaluating a project that requires $324,000 in external financing. The flotation cost of equity is 8.4 percent and the flotation cost of debt is 5.1 percent. What is the initial cost of the project including the flotation costs if you maintain a debt-equity ratio of .35? $352,842 $349,021 $350,439 $355,551 $346,646

$350,439

The Well Derrick has 6.3 percent preferred stock outstanding that sells for $57 a share. This stock was originally issued at $45 per share and has a stated value of $100 per share. What is the cost of preferred stock if the relevant combined tax rate is 23 percent? 11.22 percent 10.94 percent 10.45 percent 11.05 percent 11.37 percent

11.05 percent

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? 10.96 percent 11.67 percent 12.06 percent 11.38 percent 11.57 percent

12.06 percent

Decker's is an all-equity financed chain of retail furniture stores. Furniture Fashions produces furniture and is the primary supplier to Decker's. Decker's has a beta of 1.62 as compared to Furniture Fashions' beta of 1.43. The risk-free rate of return is 3.1 percent and the market risk premium is 7.6 percent. What discount rate should Decker's use if it considers a project that involves the manufacturing of furniture? 13.97 percent 12.92 percent 13.50 percent 14.08 percent 14.54 percent

13.97 percent

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? 5.83 percent 5.20 percent 4.42 percent 5.67 percent 4.58 percent

4.58 percent

Western Wear is considering a project that requires an initial investment of $274,000. The firm maintains a debt-equity ratio of 0.40 and has a flotation cost of debt of 8 percent and a flotation cost of equity of 10.5 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? A. $280,409 B. $281,406 C. $288,005 D. $297,747 E. $302,762

A. $280,409

Which one of the following statements is correct for a firm that uses debt in its capital structure? A. The WACC should decrease as the firm's debt-equity ratio increases. B. When computing the WACC, the weight assigned to the preferred stock is based on the coupon rate multiplied by the par value of the preferred. C. The firm's WACC will decrease as the corporate tax rate decreases. D. The weight of the common stock used in the computation of the WACC is based on the number of shares outstanding multiplied by the book value per share. E. The WACC will remain constant unless a firm retires some of its debt.

A. The WACC should decrease as the firm's debt-equity ratio increases.

Kelso's has a debt-equity ratio of 0.6 and a tax rate of 35 percent. The firm does not issue preferred stock. The cost of equity is 14.5 percent and the aftertax cost of debt is 4.8 percent. What is the weighted average cost of capital? A. 10.46 percent B. 10.67 percent C. 10.86 percent D. 11.38 percent E. 11.57 percent

C. 10.86 percent

The subjective approach to project analysis: A. is used only when a firm has an all-equity capital structure. B. uses the WACC of firm X as the basis for the discount rate for a project under consideration by firm Y. C. assigns discount rates to projects based on the discretion of the senior managers of a firm. D. allows managers to randomly adjust the discount rate assigned to a project once the project's beta has been determined. E. applies a lower discount rate to projects that are financed totally with equity as compared to those that are partially financed with debt.

C. assigns discount rates to projects based on the discretion of the senior managers of a firm.

Chelsea Fashions is expected to pay an annual dividend of $0.80 a share next year. The market price of the stock is $19.60 and the growth rate is 5 percent. What is the firm's cost of equity? A. 7.58 percent B. 7.91 percent C. 8.24 percent D. 9.08 percent E. 10.00 percent

D. 9.08 percent R = (.80/19.60) + .05 = 9.08 percent

Sweet Treats common stock is currently priced at $18.53 a share. The company just paid $1.25 per share as its annual dividend. The dividends have been increasing by 2.5 percent annually and are expected to continue doing the same. What is this firm's cost of equity? A. 6.03 percent B. 6.18 percent C. 8.47 percent D. 9.41 percent E. 9.82 percent

D. 9.41 percent e = [($1.25 × 1.025)/$18.53] + 0.025 = 9.41 percent

Grill Works and More has 7 percent preferred stock outstanding that is currently selling for $49 a share. The market rate of return is 14 percent and the firm's tax rate is 37 percent. What is the firm's cost of preferred stock? A. 13.77 percent B. 13.29 percent C. 13.67 percent D. 14.29 percent E. 14.54 percent

D. 14.29 percent

Electronics Galore has 950,000 shares of common stock outstanding at a market price of $38 a share. The company also has 40,000 bonds outstanding that are quoted at 106 percent of face value. What weight should be given to the debt when the firm computes its weighted average cost of capital? A. 42 percent B. 46 percent C. 50 percent D. 54 percent E. 58 percent

D. 54 percent

Justice, Inc. has a capital structure which is based on 30 percent debt, 5 percent preferred stock, and 65 percent common stock. The flotation costs are 11 percent for common stock, 10 percent for preferred stock, and 7 percent for debt. The corporate tax rate is 37 percent. What is the weighted average flotation cost? A. 8.97 percent B. 9.48 percent C. 9.62 percent D. 9.75 percent E. 10.00 percent

D. 9.75 percent

The dividend growth model can be used to compute the cost of equity for a firm in which of the following situations? I. firms that have a 100 percent retention ratio II. firms that pay a constant dividend III. firms that pay an increasing dividend IV. firms that pay a decreasing dividend A. I and II only B. I and III only C. II and III only D. I, II, and III only E. II, III, and IV only

E. II, III, and IV only

Which of the following statements are correct? I. The SML approach is dependent upon a reliable measure of a firm's unsystematic risk. II. The SML approach can be applied to firms that retain all of their earnings. III. The SML approach assumes a firm's future risks are similar to its past risks. IV. The SML approach assumes the reward-to-risk ratio is constant. A. I and III only B. II and IV only C. III and IV only D. I, II, and III only E. II, III, and IV only

E. II, III, and IV only

If a firm uses its WACC as the discount rate for all of the projects it undertakes then the firm will tend to: I. reject some positive net present value projects. II. accept some negative net present value projects. III. favor high risk projects over low risk projects. IV. increase its overall level of risk over time. A. I and III only B. III and IV only C. I, II, and III only D. I, II, and IV only E. I, II, III, and IV

E. I, II, III, and IV

All else constant, which one of the following will increase a firm's cost of equity if the firm computes that cost using the security market line approach? Assume the firm currently pays an annual dividend of $1 a share and has a beta of 1.2. A. a reduction in the dividend amount B. an increase in the dividend amount C. a reduction in the market rate of return D. a reduction in the firm's beta E. a reduction in the risk-free rate

E. a reduction in the risk-free rate

The aftertax cost of debt: A. varies inversely to changes in market interest rates. B. will generally exceed the cost of equity if the relevant tax rate is zero. C. will generally equal the cost of preferred if the tax rate is zero. D. is unaffected by changes in the market rate of interest. E. has a greater effect on a firm's cost of capital when the debt-equity ratio increases.

E. has a greater effect on a firm's cost of capital when the debt-equity ratio increases.

Which one of the following statements is correct? The subjective approach assigns a discount rate to each project based on other companies in the same category as the project. 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. Companies will correctly accept or reject every project if they adopt the subjective approach. Mandatory projects should only be accepted if they produce a positive NPV when the overall company WACC is used as the discount rate. The pure play approach should only be used with low-risk projects.

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.

Black River Tours has a capital structure of 60 percent common stock, 5 percent preferred stock, and 35 percent debt. The dividend payout ratio is 30 percent, the company's beta is 1.21, and the tax rate is 21 percent. Given this, which one of the following statements is correct? The aftertax cost of debt will be greater than the current yield-to-maturity on the company's outstanding bonds. The company's cost of preferred is most likely less than the company's actual cost of debt. The cost of equity is unaffected by a change in the company's tax rate. The cost of equity can only be estimated using the capital asset pricing model. The weighted average cost of capital will remain constant as long as the company's capital structure remains constant.

The cost of equity is unaffected by a change in the company's tax rate.

Jenner's is a multi-division firm that uses its overall WACC as the discount rate for all proposed projects. Each division is in a separate line of business and each presents risks unique to those lines. Given this, a division within the firm will tend to: receive less project funding if its line of business is riskier than that of the other divisions. avoid risky projects so it can receive more project funding. become less risky over time based on the projects that are accepted. have an equal probability with all the other divisions of receiving funding. prefer higher risk projects over lower risk projects.

prefer higher risk projects over lower risk projects.

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. subjective risk pure play divisional cost of capital capital adjustment security market line

pure play

The weighted average cost of capital for a company is least dependent upon the: company's beta. coupon rate of the company's outstanding bonds. growth rate of the company's dividends. company's marginal tax rate. standard deviation of the company's common stock.

standard deviation of the company's common stock.