Question 1

You have been hired as a consultant by Feludi Inc.'s CFO, who wants you to help her estimate the cost of capital.You have been provided with the following data: rRF = 4.10%; RPM = 5.25%; and b = 1.30.Based on the CAPM approach, what is the cost of common from reinvested earnings?

Accepted Answer

A)   9.67%
B)   9.97%
C)   10.28%
D)   10.60%
E)   10.93%F) A) and B)
G) None of the above

Question 2

Collins Group
The Collins Group, a leading producer of custom automobile accessories, has hired you to estimate the firm's weighted average cost of capital. The balance sheet and some other information are provided below.
 Assets‾Current assetsNet plant, property, and equipment Total assetsLiabilities and Equity‾Accounts payableAccrualsCurrent liabilitiesLong-term debt (40,000 bonds, $ 1,000 par value)  Total liabilitiesCommon stock (10,000,000 shares) Retained earningsTotal shareholders’ equityTotal liabilities and shareholders’ equity$38,000,000101,000,000‾$139,000.000‾$10,000,0009,000,000‾$19,000,00040,000,000‾$59,000,000‾30,000,00050,000,000‾80,000,000‾$139,000,000‾\begin{array}{c}\begin{array}{lll}\underline{\text {Assets}}\ \text {Current assets}\ \text {Net plant, property, and equipment }\ \text {Total assets}\\\underline{\text {Liabilities and Equity}}\ \text {Accounts payable}\ \text {Accruals}\ \text {Current liabilities}\ \text {Long-term debt (40,000 bonds,  \$ 1,000  par value) }\ \text { Total liabilities}\ \text {Common stock $ (10,000,000 $  shares) }\ \text {Retained earnings}\ \text {Total shareholders&#x27; equity}\ \text {Total liabilities and shareholders&#x27; equity} \end{array}\begin{array}{r}\\$ 38,000,000 \\underline{101,000,000 }\\underline{ \$ 139,000.000} \\\\$ 10,000,000 \\underline{9,000,000} \\$ 19,000,000 \\underline{40,000,000 }\\underline{ \$ 59,000,000 }\ 30,000,000 \\underline{50,000,000 }\\underline{80,000,000} \\underline{\$ 139,000,000} \ \end{array}\end{array}Assets​Current assetsNet plant, property, and equipment Total assetsLiabilities and Equity​Accounts payableAccrualsCurrent liabilitiesLong-term debt (40,000 bonds, $ 1,000 par value)  Total liabilitiesCommon stock (10,000,000 shares) Retained earningsTotal shareholders’ equityTotal liabilities and shareholders’ equity​$38,000,000101,000,000​$139,000.000​$10,000,0009,000,000​$19,000,00040,000,000​$59,000,000​30,000,00050,000,000​80,000,000​$139,000,000​​​

The stock is currently selling for $15.25 per share, and its noncallable $1,000 par value, 20-year, 7.25% bonds with semiannual payments are selling for $875.00. The beta is 1.25, the yield on a 6-month Treasury bill is 3.50%, and the yield on a 20-year Treasury bond is 5.50%. The required return on the stock market is 11.50%, but the market has had an average annual return of 14.50% during the past 5 years. The firm's tax rate is 25%.

-Refer to the data for the Collins Group.Which of the following is the best estimate for the weight of debt for use in calculating the firm's WACC?

Accepted Answer

A)   18.67%
B)   19.60%
C)   20.58%
D)   21.61%
E)   22.69% F) B) and E)
G) A) and D)

Question 3

The president and CFO of Spellman Transportation are having a disagreement about whether to use market value or book value weights in calculating the WACC.Spellman's balance sheet shows a total of noncallable $45 million long-term debt with a coupon rate of 7.00% and a yield to maturity of 6.00%.This debt currently has a market value of $50 million.The company has 10 million shares of common stock, and the book value of the common equity (common stock plus retained earnings)  is $65 million.The current stock price is $22.50 per share; stockholders' required return, rs, is 14.00%; and the firm's tax rate is 25%.The CFO thinks the WACC should be based on market value weights, but the president thinks book weights are more appropriate.What is the difference between these two WACCs?

Accepted Answer

A)   1.42%
B)   1.57%
C)   1.75%
D)   1.94%
E)   2.16%F) A) and D)
G) A) and E)

Question 4

Adams Inc.has the following data: rRF = 5.00%; RPM = 6.00%; and b = 1.05.What is the firm's cost of common from reinvested earnings based on the CAPM?

Accepted Answer

A)   11.30%
B)   11.64%
C)   11.99%
D)   12.35%
E)   12.72%F) A) and D)
G) D) and E)

Question 5

The Lincoln Company sold a $1,000 par value, noncallable bond several years ago that now has 20 years to maturity and a 7.00% annual coupon that is paid semiannually.The bond currently sells for $925 and the company's tax rate is 25%.What is the component cost of debt for use in the WACC calculation?

Accepted Answer

A)   5.35%
B)   5.58%
C)   5.81%
D)   6.04%
E)   6.28%F) D) and E)
G) B) and D)

Question 6

You were recently hired by Garrett Design, Inc.to estimate its cost of common equity.You obtained the following data: D1 = $1.75; P0 = $42.50; gL = 7.00% (constant) ; and F = 5.00%.What is the cost of equity raised by selling new common stock?

Accepted Answer

A)   10.77%
B)   11.33%
C)   11.90%
D)   12.50%
E)   13.12%F) None of the above
G) B) and D)

Question 7

To estimate the company's WACC, Marshall Inc.recently hired you as a consultant.You have obtained the following information.(1)  The firm's noncallable bonds mature in 20 years, have an 8.00% annual coupon, a par value of $1,000, and a market price of $1,050.00.(2)  The company's tax rate is 25%.(3)  The risk-free rate is 4.50%, the market risk premium is 5.50%, and the stock's beta is 1.20.(4)  The target capital structure consists of 35% debt and the balance is common equity.The firm uses the CAPM to estimate the cost of common stock, and it does not expect to issue any new shares.What is its WACC?

Accepted Answer

A)   7.48%
B)   7.88%
C)   8.29%
D)   8.73%
E)   9.19%F) C) and D)
G) D) and E)

Question 8

Collins Group
The Collins Group, a leading producer of custom automobile accessories, has hired you to estimate the firm's weighted average cost of capital. The balance sheet and some other information are provided below.
 Assets‾Current assetsNet plant, property, and equipment Total assetsLiabilities and Equity‾Accounts payableAccrualsCurrent liabilitiesLong-term debt (40,000 bonds, $ 1,000 par value)  Total liabilitiesCommon stock (10,000,000 shares) Retained earningsTotal shareholders’ equityTotal liabilities and shareholders’ equity$38,000,000101,000,000‾$139,000.000‾$10,000,0009,000,000‾$19,000,00040,000,000‾$59,000,000‾30,000,00050,000,000‾80,000,000‾$139,000,000‾\begin{array}{c}\begin{array}{lll}\underline{\text {Assets}}\ \text {Current assets}\ \text {Net plant, property, and equipment }\ \text {Total assets}\\\underline{\text {Liabilities and Equity}}\ \text {Accounts payable}\ \text {Accruals}\ \text {Current liabilities}\ \text {Long-term debt (40,000 bonds,  \$ 1,000  par value) }\ \text { Total liabilities}\ \text {Common stock $ (10,000,000 $  shares) }\ \text {Retained earnings}\ \text {Total shareholders&#x27; equity}\ \text {Total liabilities and shareholders&#x27; equity} \end{array}\begin{array}{r}\\$ 38,000,000 \\underline{101,000,000 }\\underline{ \$ 139,000.000} \\\\$ 10,000,000 \\underline{9,000,000} \\$ 19,000,000 \\underline{40,000,000 }\\underline{ \$ 59,000,000 }\ 30,000,000 \\underline{50,000,000 }\\underline{80,000,000} \\underline{\$ 139,000,000} \ \end{array}\end{array}Assets​Current assetsNet plant, property, and equipment Total assetsLiabilities and Equity​Accounts payableAccrualsCurrent liabilitiesLong-term debt (40,000 bonds, $ 1,000 par value)  Total liabilitiesCommon stock (10,000,000 shares) Retained earningsTotal shareholders’ equityTotal liabilities and shareholders’ equity​$38,000,000101,000,000​$139,000.000​$10,000,0009,000,000​$19,000,00040,000,000​$59,000,000​30,000,00050,000,000​80,000,000​$139,000,000​​​

The stock is currently selling for $15.25 per share, and its noncallable $1,000 par value, 20-year, 7.25% bonds with semiannual payments are selling for $875.00. The beta is 1.25, the yield on a 6-month Treasury bill is 3.50%, and the yield on a 20-year Treasury bond is 5.50%. The required return on the stock market is 11.50%, but the market has had an average annual return of 14.50% during the past 5 years. The firm's tax rate is 25%.
-Refer to the data for the Collins Group.What is the best estimate of the firm's WACC?

Accepted Answer

A)   11.08%
B)   11.42%
C)   11.77%
D)   12.13%
E)   12.49% F) C) and E)
G) A) and E)

Question 9

The cost of debt is equal to one minus the marginal tax rate multiplied by the average coupon rate on all outstanding debt.

Accepted Answer

A) True 
 B)False

Question 10

Which of the following statements is CORRECT?

Accepted Answer

A)   WACC calculations should be based on the before-tax costs of all the individual capital components.
B)   Flotation costs associated with issuing new common stock normally reduce the WACC.
C)   If a company's tax rate increases, then, all else equal, its weighted average cost of capital will decline.
D)   An increase in the risk-free rate will normally lower the marginal costs of both debt and equity financing.
E)   A change in a company's target capital structure cannot affect its WACC.F) B) and D)
G) A) and E)

Question 11

Which of the following statements is CORRECT?

Accepted Answer

A)   The dividend growth model is generally preferred by academics and financial executives over other models for estimating the cost of equity.This is because of the dividend growth model's logical appeal and also because accurate estimates for its key inputs, the dividend yield and the growth rate, are easy to obtain.
B)   The bond-yield-plus-risk-premium approach to estimating the cost of equity may not always be accurate, but it has the advantage that its two key inputs, the firm's own cost of debt and its risk premium, can be found by using standardized and objective procedures.
C)   Surveys indicate that the CAPM is the most widely used method for estimating the cost of equity.However, other methods are also used because CAPM estimates may be subject to error, and people like to use different methods as checks on one another.If all of the methods produce similar results, this increases the decision maker's confidence in the estimated cost of equity.
D)   The dividend growth model model is preferred by academics and finance practitioners over other cost of capital models because it correctly recognizes that the expected return on a stock consists of a dividend yield plus an expected capital gains yield.
E)   Although some methods used to estimate the cost of equity are subject to severe limitations, the CAPM is a simple, straightforward, and reliable model that consistently produces accurate cost of equity estimates.In particular, academics and corporate finance people generally agree that its key inputs⎯beta, the risk-free rate, and the market risk premium⎯can be estimated with little error.F) A) and D)
G) B) and D)

Question 12

To help estimate its cost of common equity, Maxwell and Associates recently hired you.You have obtained the following data: D0 = $0.90; P0 = $27.50; and gL = 7.00% (constant) .Based on the dividend growth model, what is the cost of common from reinvested earnings?

Accepted Answer

A)   9.29%
B)   9.68%
C)   10.08%
D)   10.50%
E)   10.92%F) B) and E)
G) None of the above

Question 13

If the expected dividend growth rate is zero, then the cost of external equity capital raised by issuing new common stock (re) is equal to the cost of equity capital from retaining earnings (rs) divided by one minus the percentage flotation cost required to sell the new stock, (1 − F).If the expected growth rate is not zero, then the cost of external equity must be found using a different formula.

Accepted Answer

A) True 
 B)False

Question 14

If a firm's marginal tax rate is increased, this would, other things held constant, lower the cost of debt used to calculate its WACC.

Accepted Answer

A) True 
 B)False

Question 15

Collins Group
The Collins Group, a leading producer of custom automobile accessories, has hired you to estimate the firm's weighted average cost of capital. The balance sheet and some other information are provided below.
 Assets‾Current assetsNet plant, property, and equipment Total assetsLiabilities and Equity‾Accounts payableAccrualsCurrent liabilitiesLong-term debt (40,000 bonds, $ 1,000 par value)  Total liabilitiesCommon stock (10,000,000 shares) Retained earningsTotal shareholders’ equityTotal liabilities and shareholders’ equity$38,000,000101,000,000‾$139,000.000‾$10,000,0009,000,000‾$19,000,00040,000,000‾$59,000,000‾30,000,00050,000,000‾80,000,000‾$139,000,000‾\begin{array}{c}\begin{array}{lll}\underline{\text {Assets}}\ \text {Current assets}\ \text {Net plant, property, and equipment }\ \text {Total assets}\\\underline{\text {Liabilities and Equity}}\ \text {Accounts payable}\ \text {Accruals}\ \text {Current liabilities}\ \text {Long-term debt (40,000 bonds,  \$ 1,000  par value) }\ \text { Total liabilities}\ \text {Common stock $ (10,000,000 $  shares) }\ \text {Retained earnings}\ \text {Total shareholders&#x27; equity}\ \text {Total liabilities and shareholders&#x27; equity} \end{array}\begin{array}{r}\\$ 38,000,000 \\underline{101,000,000 }\\underline{ \$ 139,000.000} \\\\$ 10,000,000 \\underline{9,000,000} \\$ 19,000,000 \\underline{40,000,000 }\\underline{ \$ 59,000,000 }\ 30,000,000 \\underline{50,000,000 }\\underline{80,000,000} \\underline{\$ 139,000,000} \ \end{array}\end{array}Assets​Current assetsNet plant, property, and equipment Total assetsLiabilities and Equity​Accounts payableAccrualsCurrent liabilitiesLong-term debt (40,000 bonds, $ 1,000 par value)  Total liabilitiesCommon stock (10,000,000 shares) Retained earningsTotal shareholders’ equityTotal liabilities and shareholders’ equity​$38,000,000101,000,000​$139,000.000​$10,000,0009,000,000​$19,000,00040,000,000​$59,000,000​30,000,00050,000,000​80,000,000​$139,000,000​​​

The stock is currently selling for $15.25 per share, and its noncallable $1,000 par value, 20-year, 7.25% bonds with semiannual payments are selling for $875.00. The beta is 1.25, the yield on a 6-month Treasury bill is 3.50%, and the yield on a 20-year Treasury bond is 5.50%. The required return on the stock market is 11.50%, but the market has had an average annual return of 14.50% during the past 5 years. The firm's tax rate is 25%.
-Refer to the data for the Collins Group.Based on the CAPM, what is the firm's cost of common stock?

Accepted Answer

A)   11.15%
B)   11.73%
C)   12.35%
D)   13.00%
E)   13.65% F) A) and B)
G) C) and D)

Question 16

For a typical firm, which of the following sequences is CORRECT? All rates are after taxes, and assume that the firm operates at its target capital structure.

Accepted Answer

A)   re > rs > WACC > rd.
B)   WACC > re > rs > rd.
C)   rd > re > rs > WACC.
D)   WACC > rd > rs > re.
E)   rs > re > rd > WACC.F) D) and E)
G) C) and D)

Question 17

When estimating the cost of equity by use of the dividend growth method, the single biggest potential problem is to determine the growth rate that investors use when they estimate a stock's expected future rate of return.This problem leaves us unsure of the true value of rs.

Accepted Answer

A) True 
 B)False

Question 18

Bloom and Co.has no debt or preferred stock⎯it uses only equity capital, and has two equally-sized divisions.Division X's cost of capital is 10.0%, Division Y's cost is 14.0%, and the corporate (composite)  WACC is 12.0%.All of Division X's projects are equally risky, as are all of Division Y's projects.However, the projects of Division X are less risky than those of Division Y.Which of the following projects should the firm accept?

Accepted Answer

A)   A Division Y project with a 12% return.
B)   A Division X project with an 11% return.
C)   A Division X project with a 9% return.
D)   A Division Y project with an 11% return.
E)   A Division Y project with a 13% return.F) C) and D)
G) B) and E)

Question 19

If expectations for long-term inflation rose, but the slope of the SML remained constant, this would have a greater impact on the required rate of return on equity, rs, than on the interest rate on long-term debt, rd, for most firms.Therefore, the percentage point increase in the cost of equity would be greater than the increase in the interest rate on long-term debt.

Accepted Answer

A) True 
 B)False

Question 20

You are a finance intern at Chambers and Sons and they have asked you to help estimate the company's cost of common equity.You obtained the following data: D1 = $1.25; P0 = $27.50; gL = 5.00% (constant) ; and F = 6.00%.What is the cost of equity raised by selling new common stock?

Accepted Answer

A)   9.06%
B)   9.44%
C)   9.84%
D)   10.23%
E)   10.64%F) B) and E)
G) C) and D)

Exam 9: The Cost of Capital

Which of the following statements is CORRECT?

Correct Answer
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Adams Inc.has the following data: r_RF = 5.00%; RP_M = 6.00%; and b = 1.05.What is the firm's cost of common from reinvested earnings based on the CAPM?

Correct Answer
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You are a finance intern at Chambers and Sons and they have asked you to help estimate the company's cost of common equity.You obtained the following data: D₁ = $1.25; P₀ = $27.50; g_L = 5.00% (constant) ; and F = 6.00%.What is the cost of equity raised by selling new common stock?

Correct Answer
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When estimating the cost of equity by use of the dividend growth method, the single biggest potential problem is to determine the growth rate that investors use when they estimate a stock's expected future rate of return.This problem leaves us unsure of the true value of r_s.

Correct Answer
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Correct Answer
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Which of the following statements is CORRECT?

Correct Answer
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Correct Answer
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Correct Answer
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For a typical firm, which of the following sequences is CORRECT? All rates are after taxes, and assume that the firm operates at its target capital structure.

Correct Answer
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The cost of debt is equal to one minus the marginal tax rate multiplied by the average coupon rate on all outstanding debt.

Correct Answer
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Correct Answer
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Correct Answer
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To help estimate its cost of common equity, Maxwell and Associates recently hired you.You have obtained the following data: D₀ = $0.90; P₀ = $27.50; and g_L = 7.00% (constant) .Based on the dividend growth model, what is the cost of common from reinvested earnings?

Correct Answer
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You have been hired as a consultant by Feludi Inc.'s CFO, who wants you to help her estimate the cost of capital.You have been provided with the following data: r_RF = 4.10%; RP_M = 5.25%; and b = 1.30.Based on the CAPM approach, what is the cost of common from reinvested earnings?

Correct Answer
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Correct Answer
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If a firm's marginal tax rate is increased, this would, other things held constant, lower the cost of debt used to calculate its WACC.

Correct Answer
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Correct Answer
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Correct Answer
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Correct Answer
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You were recently hired by Garrett Design, Inc.to estimate its cost of common equity.You obtained the following data: D₁ = $1.75; P₀ = $42.50; g_L = 7.00% (constant) ; and F = 5.00%.What is the cost of equity raised by selling new common stock?

Correct Answer
verified

Exam 9: The Cost of Capital

Which of the following statements is CORRECT?

Correct AnswerverifiedShow Answer

Adams Inc.has the following data: rRF = 5.00%; RPM = 6.00%; and b = 1.05.What is the firm's cost of common from reinvested earnings based on the CAPM?

Correct AnswerverifiedShow Answer

You are a finance intern at Chambers and Sons and they have asked you to help estimate the company's cost of common equity.You obtained the following data: D1 = $1.25; P0 = $27.50; gL = 5.00% (constant) ; and F = 6.00%.What is the cost of equity raised by selling new common stock?

Correct AnswerverifiedShow Answer

When estimating the cost of equity by use of the dividend growth method, the single biggest potential problem is to determine the growth rate that investors use when they estimate a stock's expected future rate of return.This problem leaves us unsure of the true value of rs.

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Which of the following statements is CORRECT?

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

For a typical firm, which of the following sequences is CORRECT? All rates are after taxes, and assume that the firm operates at its target capital structure.

Correct AnswerverifiedShow Answer

The cost of debt is equal to one minus the marginal tax rate multiplied by the average coupon rate on all outstanding debt.

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

To help estimate its cost of common equity, Maxwell and Associates recently hired you.You have obtained the following data: D0 = $0.90; P0 = $27.50; and gL = 7.00% (constant) .Based on the dividend growth model, what is the cost of common from reinvested earnings?

Correct AnswerverifiedShow Answer

You have been hired as a consultant by Feludi Inc.'s CFO, who wants you to help her estimate the cost of capital.You have been provided with the following data: rRF = 4.10%; RPM = 5.25%; and b = 1.30.Based on the CAPM approach, what is the cost of common from reinvested earnings?

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

If a firm's marginal tax rate is increased, this would, other things held constant, lower the cost of debt used to calculate its WACC.

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

You were recently hired by Garrett Design, Inc.to estimate its cost of common equity.You obtained the following data: D1 = $1.75; P0 = $42.50; gL = 7.00% (constant) ; and F = 5.00%.What is the cost of equity raised by selling new common stock?

Correct AnswerverifiedShow Answer

Correct Answer
verified

Adams Inc.has the following data: r_RF = 5.00%; RP_M = 6.00%; and b = 1.05.What is the firm's cost of common from reinvested earnings based on the CAPM?

Correct Answer
verified

You are a finance intern at Chambers and Sons and they have asked you to help estimate the company's cost of common equity.You obtained the following data: D₁ = $1.25; P₀ = $27.50; g_L = 5.00% (constant) ; and F = 6.00%.What is the cost of equity raised by selling new common stock?

Correct Answer
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When estimating the cost of equity by use of the dividend growth method, the single biggest potential problem is to determine the growth rate that investors use when they estimate a stock's expected future rate of return.This problem leaves us unsure of the true value of r_s.

Correct Answer
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Correct Answer
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Correct Answer
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Correct Answer
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Correct Answer
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To help estimate its cost of common equity, Maxwell and Associates recently hired you.You have obtained the following data: D₀ = $0.90; P₀ = $27.50; and g_L = 7.00% (constant) .Based on the dividend growth model, what is the cost of common from reinvested earnings?

Correct Answer
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You have been hired as a consultant by Feludi Inc.'s CFO, who wants you to help her estimate the cost of capital.You have been provided with the following data: r_RF = 4.10%; RP_M = 5.25%; and b = 1.30.Based on the CAPM approach, what is the cost of common from reinvested earnings?

Correct Answer
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Correct Answer
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Correct Answer
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Correct Answer
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Correct Answer
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Correct Answer
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You were recently hired by Garrett Design, Inc.to estimate its cost of common equity.You obtained the following data: D₁ = $1.75; P₀ = $42.50; g_L = 7.00% (constant) ; and F = 5.00%.What is the cost of equity raised by selling new common stock?

Correct Answer
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