FRL 301 part 1 and 2

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 7 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. $279,592 B. $281,406 C. $288,005 D. $297,747 E. $302, 762

A. $279,592 Average flotation cost = (1/1.40)(0) + (.40)(1.40)(0.07) = 0.02 Initial cost = $274,000/(1 - 0.02) = $279,592

Highway Express has just paid annual dividends of $1.16, $1.20, $1.25, $1.10, and $0.95 over the past 5 years respectively. What is the average dividend growth rate? A. -4.51 percent B. -3.60 percent C. 2.28 percent D. 2.47 percent E. 4.39 percent

A. -4.51 percent ($1.20 - $1.16)/$1.16 =0.034483 ($1.25 - $1.20)/$1.20 = 0.041667 ($1.10 - $1.25)/$1.25 = -0.12 ($0.95 - $1.10)/$1.10= -.0136364 g = (0.034483 + 0.041667 + -0.12 + -.0136364)/4 = -4.51

Decker's is a chain of furniture retail stores. Furniture Fashions is a furniture maker and a supplier to Decker's. Decker's has a beta of 1.38 as compared to Furniture Fashion's beta of 1.12. The risk-free rate of return is 3.5 percent and the market risk premium is 8 percent. What discount rate should Decker's use if it considers a project that involves manufacturing of furniture? A. 12.46 percent B. 12.92 percent C. 13.50 percent D. 14.08 percent E. 14.54 percent

A. 12.46 percent Re = 0.035 + 1.12(0.08) = 12.46 percent

Cookie Dough Manufacturing has a target debt-equity ratio of 0.5. Its cost of equity is 15 percent, and its cost of debt is 11 percent. What is the firm's WACC given a tax rate of 31 percent? A. 12.53 percent B. 12.78 percent C. 13.11 percent D. 13.48 percent E. 13.67 percent

A. 12.53 percent WACC = (1/1.5)(0.15) + (0.5/1.5)(0.11)(1 - 0.31) = 12.53 percent

Stock in Country Road industries has a beta of .97 percent. The market risk premium is 10 percent while T-bills are currently yielding at 5.5 percent. Country Road's most recent dividend was $1.70 per share, and dividends are expected to grow at 7 percent annual rate indefinitely. The stock sells for $32 a share. What is the estimated cost of equity using the average of the CAPM approach and the dividend discount approach? A. 13.94 percent B. 14.06 percent C. 14.21 percent D. 14.38 percent E. 14.50 percent

A. 13.94 percent Re = 0.055 + 0.97(0.10) = 0.152 Re = [($1.70 x 1.07)/$32] + .07 = 0.12684375 Re Average = (0.152 + 0.12684375)/2 = 13.94 percent

Wind Power Systems has 20 year, semi annual bonds outstanding with a 5 percent coupon. The face amount of each bond is $1000. These bonds are currently selling for 114 percent of the face value. What is the company's pre-tax cost of debt? A. 3.98 percent B. 4.42 percent C. 4.71 percent D. 5.36 percent E. 5.55 percent

A. 3.98 percent N= 20 x 2 = 40 PV = 1.14 x 1000 = -1140 PMT = 50/2 = 25 FV = 1000 I/Y = /2 = 3.98

Decline, Inc. is trying to determine its cost of debt. The firm has a debt issue outstanding with 15 years to maturity that is quoted at 107 percent of face value. The issue makes semiannual payments and has an embedded cost of 11 percent annually. What is the aftertax cost of debt if the tax rate is 33 percent. A. 6.76 percent B. 6.90 percent C. 7.17 percent D. 7.37 percent E. 7.42 percent

A. 6.76 percent Enter: N = 15 x 2 = 30 PV = -1,070 FV = 1000 PMT = 11% of 1000 = 110 that is divided by 2 because of semi annual payments = 55 Solve: I/Y= 5.042435 x 2 = 10.085 Rd = 10.085(1 - .33) =6.76 percent

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.

The pre-tax cost of debt: A. is based on the current yield to maturity of the firm's outstanding bonds. B. is equal to the coupon rate on the latest bonds issued by a firm. C. is equivalent to the average current yield on all of a firm's outstanding bonds. D. is based on the original yield to maturity on the latest bonds issued by a firm. E. has to be estimated as it cannot be directly observed in the market.

A. is based on the current yield to maturity of the firm's outstanding bonds.

The cost of preferred stock: A. is equal to the dividend yield. B. is equal to the yield to maturity. C. is highly dependent on the dividend growth rate D. is independent of the stock's price. E. decreases when tax rates increase.

A. is equal to the dividend yield.

The dividend growth model: A. is only as reliable as the estimated rate of growth B. can only be used if historical dividend information is available. C. considers the risk that future dividends may vary from their estimated values. D. applies only when a firm is currently paying dividends. E. uses beta to measure the systematic risk of a firm.

A. is only as reliable as the estimated rate of growth.

Assigning discount rates to individual projects based on the risk level of each project: A. may cause the firm's overall weighted average cost of capital to either increase or decreased over time. B. will prevent the firm's overall cost of capital from changing over time. C. will cause the firm's overall cost of capital to decrease over time. D. decreases the value of the firm over time. E. negates the firm's goal of creating the most value for the shareholders.

A. may cause the firm's overall weighted average cost of capital to either increase or decrease over time.

Carson Electronics uses 70 percent common stock and 30 percent debt to finance its operations. The aftertax cost of debt is 5.4 percent and cost of equity is 15.4 percent. Management is considering a project that will produce a cash inflow of $36,000 in the first year. The cash inflows will then grow at 3 percent per year forever. What is the maximum amount the firm can initially invest in this project to avoid a negative net present value for the project? A. $299,032 B. $382,979 C. $411,406 D. $434,086 E. $441,414

B. $382,979 WACC = 0.70(0.154) + 0.30(0.054) = 0.124 PV = $36,000/(0.124 = 0.03) = $382,979

Yesteryear Productions is considering a project with an initial start up cost of $960,000. The firm maintains a debt-equity ratio of 0.50 and has a flotation cost of debt of 6.8 percent and a flotation cost of equity of 11.4 percent. The firm has sufficient internally generated equity to cover the cost of this project. What is the initial cost of the project including the flotation costs? A. $979,417 B. $982,265 C. $992,386 D. $1,038,513 E. $1,065,089

B. $982,265 Average flotation costs = (1/1.5)(0) + (0.5/1.5)(0.068) = 0.0226667 Initial cost = $960,000/(1 - 0.0226667) = $982,265

The Bakery is considering a new project it considers to be a little riskier than its current operations. Thus, management has decide to add an additional 1.5 percent to the company's overall cost of capital when evaluating this project. The project has an initial cash outlay of $62,000 and projected cash inflows of $17,000 in year one, $28,000 in year two, and $30,000 in year three. The firm uses 25 percent debt and 75 percent common stock as its capital structure. The company's cost of equity is 15.5 percent while the aftertax cost of debt for the firm is 6.1 percent. What is the projected net present value of the new project? A. -$6,208 B. -$5,964 C. -$2,308 D. $1,427 E. $1, 573

B. -$5,964 WACC firm = (0.75 x 0.155) + (0.25 x 0.061) = 0.1315 WACC project = 0.1315 + 0.015 = 0.1465 NPV = -$62,000 + ($17,000/1.1465) + ($28,000/1.1465^2) + ($30,000/1.1465^3) = -$5,964

Delta Lighting has 30,000 shares of common stock outstanding at a market price of $17.50 a share. This stock was originally issued at $31 per share. The firm also has a bond issue outstanding with a total face value of $280,000 which is selling for 86 percent of par. The cost of equity is 16 percent while the aftertax cost of debt is 6.9 percent. The firm has a beta of 1.48 and a tax rate of 30 percent. What is the weighted average cost of capital? A. 11.07 percent B. 13.14 percent C. 14.36 percent D. 15.29 percent E. 15.47 percent

B. 13.14 percent Common: 30,000 x $17.50 = $525,000 Debt: $280,000 x 0.86 = $240,800 Total: $765,800

Suppose your company needs $14 million to build a new assembly line. Your target debt-equity ratio is .84. The flotation cost for new equity is 9.5 percent, but the flotation cost for debt is only 2.5 percent. What is the true cost of building the new assembly line after taking flotation costs into account? A. 14.82 m B. 14.94 m C. 15.07 m D. 15.12 m E. 15.23 m

B. 14.94 m fA = (1/1.84)(0.095) + (0.84/1.84)(0.025) = 0.063043 Amount raised = $14m/(1 - 0.063043) = 14.94 milion

Miller Sisters has an overall beta of 0.64 and a cost of equity of 11.2 percent for the firm overall. The firm is 100 percent finances with common stock. Division A within the firm has an estimated beta of 1.08 and is the riskiest of all the firm's operations. What is an appropriate cost of capital for division A if the market risk premium is 9.5 percent? A. 15.12 percent B. 15.38 percent C. 15.63 percent D. 15.77 percent E. 16.01 percent

B. 15.38 percent 0.112 = rf + 0.64(0.095); rf = 0.0512 ReDivision = 0.0512 + 1.08(0.095) = 15.38 percent

Jiminy's Cricket Farm issued a 30 year, 8 percent, semiannual bond 6 years ago. The bond currently sells for 114 percent of its face value. What is the aftertax cost of debt if the company's tax rate is 31 percent. A. 4.63 percent B. 4.70 percent C. 4.75 percent D. 4.82 percent E. 4.86 percent

B. 4.70 percent Enter: N = 24 x 2 = 48 PV = -1,140 PMT = 80/2 = 40 FV = 1000 Solve: I/Y = 3.404 = 6.81 0.0681(1 - 0.31) = 4.70 percent

Nelson's Landscaping has 1,200 bonds outstanding that are selling for $990 each. The company also has 2,500 shares of preferred stock at a market price of $28 a share. The common stock is priced at $37 a share and there are 28,000 shares outstanding. What is the weight of the common stock as it relates to the firm's weighted average cost of capital? A. 43.08 percent B. 45.16 percent C. 47.11 percent D. 54.00 percent E. 55.45 percent

B. 45.16 percent Debt: 1200 x $990 = $1,1880,000 Preferred: 2,500 x $28 = $70,000 Common: 28,000 x $37 = $1,036,000 Total = $2,294,000 Weight of Common Stock = 1,036,000/2,249,000 = 45.16

R.S. Green has 250,000 shares of common stock outstanding at a market price of $28 a share. Next year's annual dividend is expected to be $1.55 a share. The dividend growth rate is 2 percent. The firm also has 7,500 bonds outstanding with a face value of $1000 per bond. The bonds carry a 7 percent coupon, pay interest semi-annually, and mature in 7.5 years. The bonds are selling at 98 percent of face value. The company's tax rate is 34 percent. What is the firm's weighted average cost of capital? A. 5.4 percent B. 6.2 percent C. 7.5 percent D. 8.5 percent E. 9.6 percent

B. 6.2 percent Debt: 7,500 x $1,000 x 0.98 = $7.35m Common: 250,000 x $28 = $7.00m Total: $14.35m Re = ($1.55/$28) + 0.02 = 0.075357 Enter: N = 7.5 x 2 = 15 PV = -980 PMT = 70/2 = 35 FV = 1,000 Solve: I/Y: 3.675829 x 7.35166 WACC = ($7m/$14.35m)(0.075357) + ($7.35m/$14.35m)(0.0735166)(1 - 0.34) = 6.2 percent

The Shoe Outlet has paid annual dividends of $0.65, $0.70, $0.72, and $0.75 per share over the last four years, respectively. The stock is currently selling for $26 a share. What is the firm's cost of equity? A. 7.56 percent B. 7.93 percent C. 10.38 percent D. 10.53 percent E. 11.79

B. 7.93 percent ($0.70 - $0.65)/$0.65 = 0.076923 ($0.72-$0.70)/$0.70=0.028571 ($0.75 - $0.72)/$0.72= 0.041667 g= (0.076923 + 0.028571 + 0.041667)/3 = .049054 Re= [($0.75 x 1.049054)/$26] + .049054 = 7.93 percent

A group of individuals got together and purchased all of the outstanding shares of common stock of DL Smith, Inc. What is the return that these individuals require on this investment? A. Dividend Yield B. Cost of Equity C. Capital Gains Yield D. Cost of Capital E. Income Return

B. Cost of Equity

The after-tax cost of debt generally increases when: I. a firm's bond rating increases. II. the market of the interest increases. III. tax rates decrease. IV. bond prices rise. A. I and III only B. II and III only C. I, II, and III only D. II, III, and IV only E. I, II, III, and IV

B. II and III only

Which one of the following statements is correct? A. The subjective approach assesses the risks of each project and assigns an adjustment factor that is unique just for that project. B. Overall, a firm makes better decisions when it uses the subjective approach than when it uses its WACC as the discount rate for all projects. C. Firms will correctly accept or reject every project if they adopt the subjective approach. D. Mandatory projects should only be accepted if they produce a positive NPV when the firm's WACC is used as the discount rate. E. The pure play approach should only be used with low-risk projects.

B. Overall, a firm makes better decisions when it uses the subjective approach than when it uses its WACC as the discount rate for all projects.

When a manager develops a cost of capital for a specific project based on the cost of capital for another firm which has a similar line of business as the project, the manager is utilizing the _______ approach. A. subjective risk B. pure play C. divisional cost of capital D. capital adjustment E. security market line

B. Pure play

The flotation cost for a firm is computed as: A. The arithmetic average of the flotation costs of both debt and equity. B. The weighted average of the flotation costs associated with each form of financing. C. The geometric average of the flotation costs associated with each form of financing. D. one-half of the flotation costs of debt plus one half of the flotation cost of equity. E. a weighted average based on the book values of the firm's debt and equity.

B. The weighted average of the flotation costs associated with each form of financing.

The capital structure weights used in computing the weighted average cost of capital: A. are based on the book values of total debt and total equity. B. are based on the market value of the firm's debt and equity securities. C. are computed using the book value of the long-term debt and the book value of equity. D. remain constant over time unless the firm issues new securities. E. are restricted to the firm's debt and common stock.

B. are based on the market value of the firm's debt and equity securities.

The weighted average cost of capital for a firm is the: A. discount rate which the firm should apply to all of the projects it undertakes. B. rate of return a firm must earn on its existing assets to maintain the current value of its stock. C. coupon rate the firm should expect to pay on its next bond issue. D. minimum discount rate the firm should require on any new project. E. rate of return on shareholders should expect to earn on their investment in this firm.

B. rate of return a firm must earn on its existing assets to maintain the current value of its stock.

You are evaluation a project which required $230,000 in external financing. The flotation cost of equity is 11.6 percent and the flotation cost of debt is 5.4 percent. What is the initial cost of the project including the flotation costs if you maintain a debt-equity ratio of 0.45? A. $248,494 B. $249,021 C. $254,638 D. $255,551 E. $255,646

C. $254,638 Average flotation cost = (1/1.45)(.116) + (.45/1.45)(.054) = 0.0967586 Initial cost = $230,000/(1 - 0.0967586) = $254,638

The Daily Brew has a debt-equity ratio of 0.72. The firm is analyzing a new project which required an initial cash outlay of $420,000 for equipment. The flotation cost is 9.6 percent for equity and 5.4 percent for debt. What is the initial cost of the project including the flotation costs? A. $302,400 B. $368,924 C. $455,738 D. $456,400 E. $583,333

C. $455,738 Average flotation cost = (1/1.72)(0.096) + (0.72/1.72)(0.054) = 0.0784186 Initial cost = $420,000/(1-0.0784186) = $455,738

Southern Home Cookin' just paid its annual dividend of $0.65 a share. The stock has a market price of $13 and a beta of 1.12. The return on the U.S. Treasury bill is 2.5 percent and the market risk premium is 6.8 percent. What is the cost of equity? A. 9.98 percent B. 10.03 percent C. 10.12 percent D. 10.37 percent E. 10.45 percent

C. 10.12 percent Re= 0.025 + (1.12 x 0.068) = 10.12

Muliineaux Corporation has a target capital structure of 41 percent common stock, 4 percent preferred stock, and 55 percent debt. Its cost of equity is 19 percent, the cost of preferred stock is 6.5 percent, and the pre-tax cost of debt is 7.5 percent. What is the firm's WACC given a tax rate of 34 percent? A. 9.87 percent B. 10.43 percent C. 10.77 percent D. 13.38 percent E. 15.17 percent

C. 10.77 percent WACC = 0.41(0.19) + (0.04)(0.65) + (0.55)(.075)(1 - 0.34) = 10.77 percent

The Market Outlet has a beta of 1.38 and a cost of equity of 14.945 percent. The risk-free rate of return is 4.25 percent. What discount rate should the firm assign to a new project that has a beta of 1.25? A. 13.54 percent B. 13.72 percent C. 13.94 percent D. 14.14 percent E. 14.36 percent

C. 13.94 percent Re = 0.14945 = 0.0425 + (1.38 x mrp); mrp = 0.0775 Rproject=0.0425 + (1.25 x 0.0775) = 13.94 percent

The City Street Corporation's common stock has a beta of 1.2. The risk-free rate is 3.5 percent and the expected return on the market is 13 percent. What is the firm's cost of equity? A. 11.4 percent B. 12.8 percent C. 14.9 percent D. 17.6 percent E. 19.1 percent

C. 14.9 percent Re = 0.035 + 1.2(0.13 - 0.035) = 14.9 percent

Boulder Furniture has bonds outstanding that mature in 13 years, have a 6 percent coupon, and pay interest annually. These bonds have a face value of $1,000 and a current market price of $1,040. What is the company's aftertax cost of debt if its tax rate is 32 percent? A. 2.97 percent B. 3.32 percent C. 3.78 percent D. 5.21 percent E. 5.53 percent

C. 3.78 percent Enter: N= 13 PV = -1,040 PMT = 60 FV = 1,000 Solve for: I/Y = 5.5597 Aftertax Rd = 0.055597 x (1 - 0.32) = 3.78 percent

Boulder Furniture has bonds outstanding that mature in 13 years, have a 6 percent coupon, and pay interest annually. These bonds have a face value of $1,000 and a current market price of $1,040. What is the company's aftertax cost of debt if its tax rate is 32 percent? A. 2.97 percent B. 3.24 percent C. 3.78 percent D. 5.21 percent E. 5.53 percent

C. 3.78 percent N= 13 PV= -1,040 PMT = 60 FV = 1,000 I/Y = 5.5597 Solve for after tax Rd = 0.055597 x (1 - 0.32) = 3.78 percent

Handy Man, Inc. has zero coupon bonds outstanding that mature in 8 years. The bonds have a face value of $1,000 and a current market price of $640. What is the company's pre-tax cost of debt? A. 2.55 percent B. 5.09 percent C. 5.66 percent D. 7.31 percent E. 7.48 percent

C. 5.66 percent Enter: N = 8 x 2 = 16 (zero coupon bonds are semi-annual) PV = -640 FV = 1000 Solve for: I/Y = 2.82 x 2 = 5.66

Simple Foods has a zero coupon bound issue outstanding that matures in 9 years. The bonds are selling at 42 percent of par value. What is the company's after tax cost of debt if the tax rate is 38 percent? A. 5.48 percent B. 5.73 percent C. 6.12 percent D. 7.73 percent E. 9.88 percent

C. 6.12 percent Enter: N = 9 x 2 = 18 PV = -420 FV = 1000 Solve: I/Y = 4.937471 x 2 = 9.874843 Aftertax Rd = 9.874943 x (1 - 0.38) = 6.12 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. 9.38 percent C. 9.62 percent D. 9.75 percent E. 10 percent

C. 9.62 percent D. 9.75 percent Average flotation cost = (.65 x .11) + (.05 x .10) + (.30 x .07) = 9.75 percent

Which one of the following statements is correct? A. Firms should accept low risk projects prior to funding high risk projects. B. Making subjective adjustments to firm's WACC when determining project discount rates unfairly punished low-risk divisions within a firm. C. A project that is unacceptable today might be acceptable tomorrow given a change in market returns. D. The pure play method is most frequently used for projects involving the expansion of a firm's current operations. E. Firms that elect to use the pure play method for determining a discount rate for a project cannot subjectively adjust the pure play rate.

C. A project that is unacceptable today might be acceptable tomorrow given a change in market returns

Textile Mills borrows money at a rate of 13.5%. This interest rate is referred to as.. A. compound rate B. current yield C. cost of debt D. capital gains yield E. cost of capital

C. Cost of Debt

Morris Industries has a capital structure of 55% common stock, 10 percent preferred stock, and 45% debt. The firm has a 60 percent dividend payout ratio, a beta of 0.89, and a tax rate of 38%. Given this, which one of the following statements is correct? A. The after-tax cost of debt will be greater than the current yield-to-maturity on the firm's bonds. B. The firm's cost of equity is unaffected by a change in the firm's tax rate. C. The firm's cost of equity is unaffected by a change in the firm's tax rate. D. The cost of equity can only be estimated using the SML approach. E. The firm's weighted average cost of capital will remain constant as long as the capital structure remains constant.

C. The firm's cost of equity in unaffected by a change in the firm's tax rate.

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 their 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.

Phil's is a sit-down restaurant that specializes in specialty soups and sandwiches. Both firms are currently considering expanding their operations during the summer months by offering pre-wrapped donuts, sandwiches, and wraps at a local beach. Phil's currently has a WACC of 14% while Theresa's WACC is 10%. The expansion project has a projected net present value of $12,600 at a 10% discount rate and a net present value of -$2,080 at a 14% discount rate. Which firm or firms should expand and offer food at the local beach during the summer months. A. Phil's only. B. Theresa's only. C. both Phil's and Theresa's. D. neither Phil's or Theresa's E. cannot be determined from the information provided.

C. both Phil's and Theresa's.

A firm's overall cost of equity is: A. is generally less than the firm's WACC given a leveraged firm. B. unaffected by changes in the market risk premium. C. highly dependent upon the growth rate and risk level of the firm. D. generally less than the firm's after-tax cost of debt. E. inversely related to changes in the firm's tax rate.

C. highly dependent upon the growth rate and risk level of the firm.

The cost of equity for a firm: A. tends to remain static for firms with increasing levels of risk. B. increases as the unsystematic risk of the firm increases. C. ignores the firm's risks when the cost is based on the dividend growth model. D. equals the risk-free rate plus the market risk premium. E. equals the firm's pretax weighted average cost of capital.

C. ignores the firm's risks when that cost is based on the dividend growth model.

The weighted average cost of capital for a wholesaler: A. is equivalent to the after-tax cost of the firm's liabilities. B. should be used as the required return when analyzing a potential acquisition of a retail outlet. C. is the return investors require on the total assets of the firm. D. remains constant when the debt-equity ratio changes. E. is unaffected by changes in corporate tax rates.

C. is the return investors require on the total assets of the firm.

Which one of the following statements related to the SML approach to equity valuation is correct. Assume the firm uses debt in its capital structure. A. the model considers a firm's rate of growth. B. The model applies only to non-dividend paying firms. C. the model is dependent upon a reliable estimate of the market risk premium. D. the model generally produces the same cost of equity as the dividend growth model. E. this approach generally produces a cost of equity that equals the firm's overall cost of capital.

C. the model is dependent upon a reliable estimate of the market risk premium.

Central Systems, Inc. desires a weighted average cost of capital of 8 percent. The firm has an aftertax cost of debt of 4.8 percent and a cost of equity of 15.2 percent. What debt-equity ratio is needed for the firm to achieve its targeted weighted average cost of capital? A. 0.38 B. 0.44 C. 1.02 D. 2.25 E. 2.63

D. 2.25 WACC = 0.08 = [We x 0.152] +[(1 - We) x 0.048)] We = 0.3077; Wd = 1 - We = 0.6923 Debt-equity ratio = 0.6923/0.3077 = 2.25

The outstanding bonds of Tech Express are priced at $989 and mature in 8 years. These bonds have a 6 percent coupon and pay interest annually. The firm's tax rate is 39%. What is the firm's aftertax cost of debt? A. 3.01 percent B. 3.22 percent C. 3.35 percent D. 3.77 percent E. 4.41 percent

D. 3.77 percent Enter: N= 8 PV= -989 PMT= 60 FV = 1000 Solve: I/Y = 6.1784 Aftertax Rd = 0.061784 x (1-0.39) = 3.77 percent

Holdup Bank has an issue of preferred stock with a $5 stated dividend that just sold for $92 a share. What is the bank's cost of preferred? A. 4.60 percent B. 4.64 percent C. 5.39 percent D. 5.43 percent E. 5.54 percent

D. 5.43 percent Rp = $5/$92 = 5.43

Electronic 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 Debt: 40,000 x $1000 x 1.06 = $42.4m Common: 950,000 x $38 = $36.1m Total: 78.5m Weight of Debt = $42.4m/$78.5m = 54 percent.

The Corner Bakery has a bond issue outstanding that matures in 7 years. The bonds pay interest semi-annually. Currently, the bonds are quotes at 101.4 percent of face value and carry a 9 percent coupon. What is the firm's aftertax cost of debt if the tax rate is 30 percent? A. 4.88 percent B. 5.36 percent C. 5.45 percent D. 6.11 percent E. 8.74 percent

D. 6.11 percent Enter: N = 7 x 2 = 14 PV = -1,014 PMT = 90/2 = 45 FV = 1,000 I/Y = 4.364257 x 2 = 8.728513 Aftertax Rd = 0.087285 x (1 - 0.30) = 6.11 percent

Chelsea Fashions is expected to pay an annual dividend of $0.80 a share next year. The market price of the stock is $22.40 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. 8.57 percent E. 9.00 percent

D. 8.57 percent Re = ($0.80/$22.40) + .05 = 8.57%

Sweet Treats common stock is currently priced at $19.06 a share. The company just paid $1.15 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 the firm's cost of equity? A. 6.03 percent B. 6.18 percent C. 8.47 percent D. 8.68 percent E. 8.82 percent

D. 8.68 percent e = [($1.15 x 1.025)/$19.06] + 0.025 = 8.68

Wilderness Adventures specialized in back-country tours and resort management. Travel Excitement specializes in making travel reservations and promoting vacation travel. Wilderness Adventures has an aftertax cost of capital of 13 percent and Travel Excitement has an aftertax cost of capital of 11 percent. Both firms are considering building wilderness campgrounds complete with man-made lakes and hiking trails. The estimated net present value of such a project is estimates at $87,000 at a discount rate of 11 percent and -$12,500 at a 13 percent discount rate. Which firm or firms, if either, should accept this project? A. Wilderness Adventures only. B. Travel Excitement only. C. Both Wilderness Adventures and Travel Excitement. D. Neither Wilderness nor Travel. E. Cannot be determined without further information.

D. Neither Wilderness nor Travel.

Peterson industries has two separate divisions. Each division is in a separate line of business. Division A is the largest division and represents 70% of the firm's overall sales. Division A is also riskier of the two divisions. Division B is the smaller and least risky of the two. When management is deciding which of the various divisional projects should be accepted, the managers should: A. allocate more funds to Division A since it is the largest of the two divisions. B. fund all of Division B's projects first since they tend to be less risky and then allocate the remaining funds to Division A projects that have the highest net present values. C. allocate the company's funds to the projects with the highest net present values based on the firm's weighted average cost of capital. D. assign appropriate, but differing, discount rates to each project and then select the projects with the highest net present values. E. fund the highest net present value projects from each division based on an allocation of &0% of the funds to Division A and 30% of the funds to Division B.

D. assign appropriate, but differing, discount rates to each project and then select the projects with the highest net present values.

Flotation costs for a levered firm should: A. be ignored when analyzing a project because they are not an actual project cost. B. be spread over the life of a project thereby reducing the cash flows for each year of the project. C. only be considered when two projects are mutually exclusive. D. be weighted and included in the initial cash flow. E. be totally ignored when internal equity funding is utilized.

D. be weighted and included in the initial cash flow.

Scholastic Toys is considering developing and distributing a new board game for children. The project is similar in risk to the firm's current operations. The firm maintains a debt-equity ratio of .40 and retains all profits to fund the firm's rapid growth. How should the firm determine its cost of equity? A. by adding the market risk premium to the after-tax cost of debt. B. by multiplying the market risk premium by (1-0.40) C. by using the dividend growth model. D. by using the capital asset pricing model. E. by averaging the costs based on the dividend growth model and the capital asset pricing model.

D. by using the capital asset pricing model.

Incorporating flotation costs into the analysis of a project will: A. cause the project to be improperly evaluated. B. increase the net present value of the project. C. increase the project's rate of return. D. increase the initial cash outflow of the project. E. have no effect on the present value of the project.

D. increase the initial cash outflow of the project.

Deep Mining and Precious Metals are separate firms that are both considering a silver exploration project. Deep Mining is in the actual mining business and has an aftertax cost of capital of 12.8 percent. Precious Metals is in the precious gem retail business and has an aftertax cost of capital of 10.6 percent. The project under consideration has initial costs of $575,000 and anticipated annual cash inflows of $102,000 a year for 10 years. Which firm(s), if either, should accept this project? A. Company A only B. Company B only C. both Company A and Company B D. neither Company A or B E. Cannot be determined without further information.

D. neither Company A or B NPV = -$575,000 + $102,000 x {(1-[(1/(1 + 0.128)]^10}/0.128] = $-17,071 Compute using calculator: Co = -525,000 Cf1 -10 = 102,000 I = 12.8% CPT NPV = -17,071 Neither company should accept this project as the applicable discount rate for both firms is 12.8 percent and the NPV is negative at this discount rate.

The cost of preferred stock is computed the same as the: A. pre-tax cost of debt B. return on annuity C. aftertax cost of a debt D. return on a perpetuity E. cost of an irregular growth common stock

D. return on a perpetuity

Panelli's is analyzing a project with initial cost of $102,000 and cash inflows of $65,000 in year one and $74,000 in year two. This project is an extension of the firm's current operations and thus is equally risky as the current firm. The firm uses only debt and common stock to finance its operations and maintains a debt-equity ratio of 0.45. The aftertax cost of debt is 4.8 percent, the cost of equity is 12.7 percent, and the tax rate is 35 percent. What is the projected net present value of this project? A. $15,411 B. $15,809 C. $16,333 D. $16,938 E. $17,840

E. $17,840 WACC = (1/1.45)(0.127) + (0.45/1.45)(0.048) = Cfo= -$102,000 C01 = $65,000 Co2 = $74,000 I = 10.2483% NPV = 17,840

The common stock of Metal Molds has a negative growth rate of 1.5 percent and a required return of 18 percent. The current stock price is $11.40. What was the amount of the last dividend paid? A. $2.07 B. $2.11 C. $2.19 D. $2.22 E. $2.26

E. $2.26 D1= [(0.18 - (-0.015)) x $11.40] = $2.223 D0= $2.223/(1 - 0.015) = $2.26

Fama's Llamas has a weighted average cost of capital of 10.5 percent. The company's cost of equity is 15.5 percent, and its pretax cost of debt is 8.5 percent. The tax rate is 34 percent. What is the company's target debt-equity ratio? A. 0.89 B. 0.92 C. 0.98 D. 1.01 E. 1.02

E. 1.02 WACC = 0.105 = 0.155(E/V) + (0.085)(D/V)(1 - 0.34) 0.105(V/E) = 0.155 + (0.085(0.66)(D/E) = 0.155 + 0.0561(D/E) D/E = 1.02

Dog Gone Good Engines has a bond issue outstanding with 17 years to maturity. These bonds have a $1000 face value, a 9 percent coupon, and pay interest semi-annually. The bonds are currently quotes at 87 percent of face value. What is the company's pre-tax cost of debt if the tax rate is 38 percent? A. 4.10 percent B. 4.42 percent C. 6.61 percent D. 8.90 percent E. 10.67 percent

E. 10.67 percent Enter: N = 17 x 2 = 34 PV = -870 PMT = 90/2 = 45 FV = 1000 Solve: I/Y = 5.336585 x 2 = 10.67

National Home Rentals has a beta of 1.38, a stock price of $19, and recently paid an annual dividend of $0.94 a share. The dividend growth rate is 4.5 percent. The market has a 10.6 percent rate of return and a risk premium of 7.5 percent. What is the firm's cost of equity? A. 7.05 percent B. 8.67 percent C. 9.13 percent D. 10.30 percent E. 11.56

E. 11.56 Re = (0.106 - 0.075) + (1.38 x 0.075) = 0.1345 Re = [($0.94 x 1.045)/$19] + 0.045 = 0.0967 Re Average = (0.1345 + 0.0967)/2 = 11.56 percent

The Oil Derrick has an overall cost of equity of 13.6 percent and a beta of 1.28. The firm is financed solely with common stock. The risk-free rate of return is 3.4 percent. What is an appropriate cost of capital for a division within the firm that has an estimated beta of 1.18? A. 12.37 percent B. 12.41 percent C. 12.54 percent D. 12.67 percent E. 12.80 percent

E. 12.80 percent 0.136 = 0.034 + 128mrp; mrp= 0.0796875 ReDivision = 0.034 + 1.18)0.0796875) = 12.80 percent

Wayco Industrial Supply has a pre-tax cost of debt of 7.6 percent, a cost of equity of 14.3 percent, and a cost of preferred stock of 8.5 percent. The firm has 220,000 shares of common stock outstanding at a market price of $27 a share. There are 25,000 shares of preferred stock outstanding at a market price of $41 a share. The bond issue has a face value of $550,000 and a market quote of 101.2. The company's tax rate is 37 percent. What is the firm's weighted average cost of capital? A. 10.18 percent B. 10.84 percent C. 11.32 percent D. 12.60 percent E. 12.81 percent

E. 12.81 percent Debt: $550,000 x 1.102 = $556,600 Preferred: 25,000 x $41 = $1,025,00 Common: 220,000 x 27 = $5,940,000 Total: $7,521,600 WACC = ($5,940,000/$721,600)(0.143) + ($1,025,000/$7,521,000)(0.085) + ($556,600/$7,521,600)(0.76)(1-0.37) = 12.81 percent

Jungle, Inc. has a target debt-equity ratio of 0.72. Its WACC is 11.5 percent and the tax rate is 34 percent. What is the cost of equity if the aftertax cost of debt is 5.5 percent? A. 13.75 percent B. 13.84 percent C. 14.41 percent D. 14.79 percent E. 15.82 percent

E. 15.82 percent WACC = 0.115 = (1/1.72)Re + (0.72/1.72)(0.055); Re = 15.82 %

Titan Mining Corporation has 14 million shares of common stock outstanding, 900,000 shares of 9 percent preferred stock outstanding and 210,000 ten percent semiannual bonds outstanding, par value $1,000 each. The common stock currently sells for $34 per share and has a beta of 1.15, the preferred stock currently sells for $80 per share, and the bonds have 17 years to maturity and sell for 91 percent of par. The market risk premium is 11.5 percent, T-bills are yielding 7.5 percent, and the firm's tax rate is 32 percent. What discount rate should the firm apply to a new project's cash flows if the project has the same risk as the firm's typical project? A. 14.59 percent B. 14.72 percent C. 15.17 percent D. 15.54 percent E. 16.41 percent

E. 16.41 percent MVd = 210,000 ($1000) (0.91) = $191,100,000 MVe = 14,000,000 ($34) = $476,000,000 MVp = 900,000 ($80) = $72,000,000 = $739,100,000 V = $191,100,000 + 476,000,000 + 72,000,000 = $739,100,000 D/V =191.1m/739.1m =0.258558 E/V = $476m/739.1m = 0.644027 P/V = $72m/739.1m = 0.097416 Re = 0.075 + 1.15(0.115) = 0.20725 Rp = $9/$80 = 0.1125 Enter: N = 17 x 2 = 34 PV = -910 PMT = 100/2 = 50 FV = 1,000 Solve: I/Y: 5.597571 x2 =11.195143 Rd Aftertax = 0.11195143 (1 - 0.32) = 0.076127 WACC = 0.644027(0.20725) + 0.097416(0.1125) + 0.258558(0.076127) = 16.41 percent

Bleakly Enterprises has a capital structure of 55 percent common stock, 10 percent preferred stock, and 35 percent debt. The flotation costs are 4.5 percent for debt, 7 percent for preferred stock, and 9.5 percent for common stock. The corporate tax is 34 percent. What is the weighted average flotation cost? A. 5.8 percent B. 6.2 percent C. 6.7 percent D. 7.0 percent E. 7.5 percent

E. 7.5 percent Average flotation cost = (0.55 x 0.095) + (0.10 x 0.07) + (0.35 x 0.045) = 7.5 percent

Travis & Sons has a capital structure which is based on 40 percent debt, 5 percent preferred stock, and 55 percent common stock. The pre-tax cost of debt is 7.5 percent, the cost of preferred is 9 percent, and the cost of common stock is 13 percent. The company's tax rate is 39 percent. The company is considering a project that is equally as risky as the overall firm. This project has initial costs of $325,000 and annual cash inflows of $87,000, $279,00, and $116,000 over the next three years, respectively. What is the projected net present value of this project? A. 68,211.04 B. 68,879.97 C. 69,361.08 D. 74,208.18 E. 76,011.23

E. 76,011.23 WACC = (0.55 x 0.13) + (0.05 x 0.09) + [0.40 x 0.075 x (1 - 0.39)] = 0.0943 NPV = -325,000 + ($87,000/1.0943) + ($279,000/1.0943^2) + ($116,000/1.0943^3) = $76,011.23

Mangrove Fruit Farms has $200,000 bond issue outstanding that is selling at 92 percent of face value. The firm also has 1,500 shares of preferred stock and 15,000 shares of common stock outstanding. The preferred stock has a market price of $35 a share compared to a price of $24 share for the common stock. What is the weight of preferred stock as it related to the firm's weighted average cost of capital? A. 6.75 percent B. 7.20 percent C. 7.75 percent D. 8.30 percent E. 8.80 percent

E. 8.80 percent Debt: $200,000 x 0.92 = $184,000 Preferred: 1500 x $35 = $52,500 Common: 15,000 x $24 =360,000 Total = 596,500 Weight of Preferred Stock = $52,500/$596,500 = 8.80 percent

Granite Works maintains a debt-equity ratio of 0.65 and has a tax rate of 32 percent. The firm does not issue preferred stock. The pre-tax cost of debt is 9.8 perfect. There are 25,000 shares of stock outstanding with a beta of 1.2 and a market price of $19 a share. The current market risk premium, is 8.5 percent and the current risk-free rate is 3.6 percent. This year, the firm pain an annual dividend of $1.40 a share and expects to increase that amount by 2 percent each year. Using an average expected cost of equity, what is the weighted average cost of capital? A. 8.44 percent B. 8.78 percent C. 8.96 percent D. 9.13 percent E. 9.20 percent

E. 9.20 percent Re= 0.036 +1.2(0.085) = 0.138 Re= [($1.10 x 1.02)$19] +.02 = 0.0790526 ReAverage = (0.138 + 0.0790526)/2 = 0.108526 WACC = (1/1.65)(0.108526) + (0.65/1.65)(0.098)(1-0.32) = 9.20 percent

If a firm uses its WACC as the discount rate for all 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.

The weighted average cost of capital for a firm may be dependent upon the firm's: I. rate of growth II. debt-equity ratio III. preferred dividend payment. IV. retention ratio. A. I and III only. B. II and IV only. C. I, II, and IV only. D. I, III, and IV only. E. I, II, III, and IV.

E. I, II, III, and IV.

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% 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 follow 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 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.

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.

A firm's cost of capital: A. will decrease as the risk level of the firm increases. B. for a specific project is primarily dependent upon the source of the funds used for the project. C. is independent of the firm's capital structure. D. should be applied as the discount rate for any project considered by the firm. E. depends upon how the funds raised are going to be spent.

E. depends upon how the funds raised are going to be spent.

The after-tax 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.

When a firm has flotation costs equal to 7 percent of the funding need, project and analysts should: A. increase the project's discount rate to offset these expenses by multiplying the firm's WACC by 1.07. B. increase the project's discount rate to offset these expenses by dividing the firm's WACC by (1-0.07). C. add 7 perept to the firm's WACC to get the discount rate for the project. D. increase the initial project cost by multiplying that cost by 1.07 E. increase the initial project cost by dividing that cost by (1-0.07).

E. increase the initial project cost by dividing that cost by (1-0.07).

Markley and Stearns is a multi-divisional firm that used its 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: A. receive less funding if its line of business is riskier than that of the other divisions. B. avoid risky projects so it can receive more project funding. C. become less risky over time based on the projects that are accepted. D. have equal probability of receiving funding as compared to the other divisions. E. prefer higher risk projects over lower risk projects.

E. prefer higher risk projects over lower risk projects.

The discount rate assigned to an individual project should be based on: A. the firm's weighted average cost of capital. B. the actual sources of funding used for the project. C. an average of the firm's overall cost of capital for the past five years. D. the current risk level of the overall firm. E. the risks associated with the use of the funds required by the project.

E. the risks associated with the use of the funds required by the project.

Which one of the following is the primary determinant of a firm's cost of capital? A. debt-equity ratio B. applicable tax rate C. cost of equity D. cost of debt E. use of the funds

E. use of the funds.

The average of a firm's cost of equity and aftertax cost of debt that is weighted based on the firm's capital structure is called the: A. reward to risk ratio B. weighted capital gains rate C. structured cost of capital D. subjective cost of capital E. weighted average cost of capital

E. weighted average cost of capital

Tidewater Fishing has a current beta of 1.48. The market risk premium is 8.9 percent and the risk-free rate of return is 3.2 percent. By how much will the cost of equity increase if the company expands its operations such that the company beta rises to 1.60? A. 0.88 percent B. 1.07 percent C. 1.50 percent D. 2.10 percent E. 2.26 percent

Increase in cost of equity = (1.60 - 1.48) x 0.089 = 1.07 percent

Sister Pools sells outdoor swimming pools and currently has an aftertax cost of capital of 11.6 percent. Al's Construction builds and sells water features and fountains and has an aftertax cost of capital of 10.8 percent. Sister Pools is considering building and selling its own water features and fountains. The sales manager of Sister Pools estimates that the water features and fountains would produce 20 percent of the firm's future total sales. The initial cash outlay for this project would be $85,000. The expected net cash inflows are $16,000 a year for 7 years. What is the net present value of the Sister Pools Project? A. -$11,044 B. -$9,115 C. -$7,262 D. -$4,508 E. $1,219

NPV = -$85,000 + $16,000 x {[1-(1 + 0.108)^7]/0.108} = -$9,115 Or Cf0= -85,000 Cf1 - 7 = 16,000 I = 10.8 CPT NPV = -9,115

Phillps Equipment has 80,000 bonds outstanding that are selling at par. Bonds with similar characteristics are yielding at 6.75 percent. The company also has 7500,000 shares of 7 percent preferred stock and 2.5 million shares of common stock outstanding. The preferred stock selling for $53 a share. The common stock has a beta of 1.34 and sells for $42 a share. The U.S. Treasury bill is yielding 2.8 percent and the return on the market is 11.2 percent. The corporate tax rate is 38 percent. What is the firm's weighted average cost of capital? A. 10.39 percent B. 10.64 percent C. 11.18 percent D. 11.30 percent E. 11.56 percent

Re = 0.028 + 1.34(0.112 - 0.028) = 0.14056 Rp= (0.07 x $100)/$53 = 0.13208 Debt: 80,000 x $1,000 = $80m Preferred: 750,000 x $53 = $39.75m Common: 2.5m x $42 = $105m Total: $224.75m WACC = ($105m/$224.75m)(0.14056) + ($39.75m/$224.75m)(0.13208) + ($80m/224.75m)(0.0675)(1 - 0.38) = 10.39 percent

Silo Mills has a beta of 0.87 and a cost of equity of 11.9 percent. The risk-free rate of return is 2.8 percent. The firm is currently considering a project that has a beta of 1.03 and a project life of 6 years. What discount rate should be assigned to this project? A. 13.33 percent B. 13.57 percent C. 13.62 percent D. 13.84 percent E. 14.09 percent

Re = 0.119 = 0.028 + (0.87 x mrp); mrp = 0.1046 Rproject= 0.028 + (1.03 x 0.1046) = 13.57 percent

Henessy Markets has a growth rate of 4.8 percent and is equally as risky as the market. The stock is currently selling for $17 a share. The overall stock market has a 10.6 percent rate of return and risk premium of 8.7 percent. What is the expected rate of return on this stock? A. 8.7 percent B. 9.2 percent C. 10.6 percent D. 11.3 percent E. 11.7 percent

Re= (0.106 - 0.087) + (1.00 x 0.087) = 10.6 percent

Samuelson Plastics has 7.5 percent preferred stock outstanding. Currently, this stock has a market value per share of $52 and a book value per share of $38. What is cost of preferred stock?

Rp = (.075 x 100)/$52 = 14.42 percent

Grill Works are More has 8 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. 14.77 percent B. 15.29 percent C. 15.67 percent D. 16.33 percent E. 16.54 percent

Rp = (0.08 x $100)/$49 = 16.33 percent

New York Deli's has 7 percent preferred stock outstanding that sells for $36 a share. This stock was originally issues at $50 per share. What is the cost of preferred stock?

Rp =(.07 x 100)/$36 = 19.44 percent

Kelso's had a debt-equity ratio of 0.55 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. 11.06 percent D. 11.38 percent E. 11.57 percent

WACC = (1/1.55)(0.145) + (0.55/1.55)(0.048) = 11.06 percent