Deck 15: Selection of a Minimum Attractive Rate of Return

Question 1

Case Study 15.1
A Publically traded company has issued $50M worth of stocks. The stock holders expect a rate of return of 12%. The company has a bank loan at an interest rate of 10% worth $12M. The company has sold bonds worth $20M at a rate of 6% compounded yearly.

-Determine the before tax cost of capital for the company.

A) 10.63%
B) 9.32%
C) 10.24%
D) None of these

Answer 1

10.24%

Question 2

Case Study 15.1
A Publically traded company has issued $50M worth of stocks. The stock holders expect a rate of return of 12%. The company has a bank loan at an interest rate of 10% worth $12M. The company has sold bonds worth $20M at a rate of 6% compounded yearly.

-What is the after tax cost of capital if the company is in the 34% income tax bracket.

A) 9.25%
B) 6.2%
C) 7.02%
D) None of these

Answer 2

9.25%

Question 3

Case Study 15.2
A distributing company has financed an expansion requiring $50 million as shown in table below even though historically the company has financed any capital requirement with 20% debt at 12% interest and 80% equity with a 8% rate of return.
$$\begin{array} { | l | l | l | } \hline \text { Source of capital } & \text { Amuunt } & \text { Interest Rate/ Dividend } \\\hline \text { Stocks } & \$ 16 \mathrm { M } & 8 \% \\\hline \text { Retaired eariirgs } & \$ 25 \mathrm { M } & 10 \% \\\hline \text { Bonds } & \$ 9 \mathrm { M } & 6 \% \\\hline\end{array}$$

-What is the weighted average cost of capital based on historical method?

A) 5.8%
B) 7.9%
C) 8.2%
D) 8.80%

Answer 3

8.80%

Question 4

Case Study 15.2
A distributing company has financed an expansion requiring $50 million as shown in table below even though historically the company has financed any capital requirement with 20% debt at 12% interest and 80% equity with a 8% rate of return.
$$\begin{array} { | l | l | l | } \hline \text { Source of capital } & \text { Amuunt } & \text { Interest Rate/ Dividend } \\\hline \text { Stocks } & \$ 16 \mathrm { M } & 8 \% \\\hline \text { Retaired eariirgs } & \$ 25 \mathrm { M } & 10 \% \\\hline \text { Bonds } & \$ 9 \mathrm { M } & 6 \% \\\hline\end{array}$$

-What is the weighted average cost of capital based on current financing?

A) 6.4%
B) 8.2%
C) 8.64%
D) 9.3%

Question 5

A medium size manufacturing company has a budget of $200,000 to invest on five different capital projects. Each has a six year life. Additional financial data for the five project opportunities are given below.
$$\begin{array} { | l | l | l | l | l | l | } \hline & \mathbf { A } & \mathbf { B } & \mathrm { C } & \mathrm { D } & \mathrm { E } \\\hline \text { Initial Cost } & \$ 50 \mathrm {~K} & \$ 80 K & \$ 30 K & \$ 40 \mathrm {~K} & \$ 60 \mathrm {~K} \\\hline \text { EUAB } & 12,160 & 18,368 & 7,932 & \mathbf { 8 } 652 & 13,374 \\\hline\end{array}$$ Determine which projects should be funded.

A) A
B) B
C) C
D) D
E) E

Question 6

The after-tax cost of capital for borrowed amount at a 10% interest rate is 7.5% if the corporate income-tax rate is 25%

Question 7

The cost of capital is average interest rate from all sources of funds generated by a company.

Question 8

Treasury stocks are stocks sold by U.S Department of Treasury.

Question 9

The opportunity cost is the rate of return on the best rejected project.