Question 1

JaiLai Cos.stock has a beta of 1.7,the current risk-free rate is 6.2 percent,and the expected return on the market is 11 percent.What is JaiLai's cost of equity?
A)13.81 percent
B)15.19 percent
C)13.41 percent
D)14.36 percent

Accepted Answer

The answer of JaiLai Cos.stock has a beta of 1.7,the...

Question 2

OMG Inc.has 4 million shares of common stock outstanding,3 million shares of preferred stock outstanding,and 5 thousand bonds.If the common shares sell for $17 per share,the preferred shares sell for $126 per share,and the bonds sell for 117 percent of par ($1,000),what weight should you use for preferred stock in the computation of OMG's WACC?
A)28.91 percent
B)31.58 percent
C)47.91 percent
D)83.66 percent

Accepted Answer

The answer of OMG Inc.has 4 million shares of common...

Question 3

FarCry Industries,a maker of telecommunications equipment,has 26 million shares of common stock outstanding,1 million shares of preferred stock outstanding,and 10 thousand bonds.If the common shares sell for $12 per share,the preferred shares sell for $114.50 per share,and the bonds sell for 98 percent of par ($1,000),what weight should you use for preferred stock in the computation of FarCry's WACC?
A)28.52 percent
B)27.51 percent
C)26.24 percent
D)25.01 percent

Accepted Answer

To calculate the weight of the preferred stock in the WACC, we need to first find the total market value of each component of the capital structure:
Market value of common stock = 26,000,000 shares × $12 per share = $312,000,000
Market value of preferred stock = 1,000,000 shares × $114.50 per share = $114,500,000
Market value of bonds = 10,000 bonds × $980 = $9,800,000

Total market value of the capital structure = $436,300,000

The weight of the preferred stock is the proportion of the total market value that is made up of preferred stock:
Weight of preferred stock = $114,500,000 ÷ $436,300,000 = 0.2624 or 26.24%

Therefore, the answer is C) 26.24 percent.

Question 4

Diddy Corp.stock has a beta of 1.0,the current risk-free rate is 5 percent,and the expected return on the market is 15.5 percent.What is Diddy's cost of equity?
A)15.50 percent
B)14.20 percent
C)18.50 percent
D)16.30 percent

Accepted Answer

The cost of equity can be calculated using the Capital Asset Pricing Model (CAPM), which is given by the formula: Cost of Equity = Risk-Free Rate + Beta * (Market Return - Risk-Free Rate). Plugging in the values: Cost of Equity = 5% + 1.0 * (15.5% - 5%) = 5% + 10.5% = 15.5%.

Question 5

An all-equity firm is considering the projects shown as follows.The T-bill rate is 4 percent and the market risk premium is 8 percent.If the firm uses its current WACC of 13 percent to evaluate these projects,which project(s)will be incorrectly accepted?

A)Project A
B)Project C
C)Project D
D)Projects C and D

Accepted Answer

To evaluate whether a project should be accepted or rejected, we need to compare its expected rate of return with the required rate of return or WACC. A project is incorrectly accepted if its expected rate of return is lower than the required rate of return, which means it does not generate enough return for the risk taken.

The WACC is the minimum required rate of return for an all-equity firm. Any project with an expected rate of return lower than the WACC will be incorrectly accepted.

Let's calculate the expected rates of return for each project:

- Project A: 10% + (1.2 x 8%) = 19.6%, which is higher than the WACC. Therefore, Project A is correctly accepted.
- Project C: 14% + (0.9 x 8%) = 14.2%, which is lower than the WACC. Therefore, Project C is incorrectly accepted.
- Project D: 16% + (1.3 x 8%) = 26.4%, which is higher than the WACC. Therefore, Project D is correctly accepted.

Therefore, only Project C is incorrectly accepted. Thus, the answer is D, Projects C and D.

Question 6

An all-equity firm is considering the projects shown as follows.The T-bill rate is 3 percent and the market risk premium is 6 percent.If the firm uses its current WACC of 12 percent to evaluate these projects,which project(s),if any,will be incorrectly rejected?

A)Only Project A would be incorrectly rejected.
B)Both Projects A and C would be incorrectly rejected.
C)Projects A, B, and C would be incorrectly rejected.
D)None of the projects would be incorrectly rejecteD.Step 1: Find Project Required Returns using CAPM.Project A: 7.8 percent; Project B: 10.2 percent; Project C: 11.4 percent; Project D: 12 percent; only Project A would be incorrectly rejected since its required return is only 7.8 percent given its risk and it is expected to return 9 percent.

Accepted Answer

Only Project A would be incorrectly rejected because its required return is lower than the WACC of the firm. Projects B, C, and D have higher required returns than the WACC and are expected to generate returns higher than the cost of capital, so they should not be rejected.

Question 7

An all-equity firm is considering the projects shown as follows.The T-bill rate is 3 percent and the market risk premium is 6 percent.If the firm uses its current WACC of 12 percent to evaluate these projects,which project(s)will be incorrectly rejected?

A)Project A
B)Projects B and C
C)Project D
D)Project B

Accepted Answer

The answer of An all-equity firm is considering the projects...

Question 8

OMG Inc.has 4 million shares of common stock outstanding,3 million shares of preferred stock outstanding,and 50 thousand bonds.If the common shares are selling for $21 per share,the preferred shares are selling for $10 per share,and the bonds are selling for 111 percent of par ($1,000),what weight should you use for debt in the computation of OMG's WACC?
A)32.74 percent
B)29.86 percent
C)25.79 percent
D)21.86 percent

Accepted Answer

The answer of OMG Inc.has 4 million shares of common...

Question 9

FarCry Industries,a maker of telecommunications equipment,has 26 million shares of common stock outstanding,1 million shares of preferred stock outstanding,and 10 thousand bonds.If the common shares sell for $15 per share,the preferred shares sell for $114.50 per share,and the bonds sell for 101 percent of par ($1,000),what weight should you use for preferred stock in the computation of FarCry's WACC?
A)28.52 percent
B)27.51 percent
C)26.24 percent
D)22.25 percent

Accepted Answer

The answer of FarCry Industries,a maker of telecommunications equipment,has 26...

Question 10

A firm has 5,000,000 shares of common stock outstanding,each with a market price of $8.00 per share.It has 25,000 bonds outstanding,each selling for $1,100 with a $1,000 face value.The bonds mature in 12 years,have a coupon rate of 9 percent,and pay coupons semi-annually.The firm's equity has a beta of 1.4,and the expected market return is 15 percent.The tax rate is 35 percent and the WACC is 14 percent.Calculate the risk-free rate.
A)2.05 percent
B)15.27 percent
C)20.18 percent
D)1.19 percent

Accepted Answer

To calculate the risk-free rate, we need to use the CAPM formula:

r = r_rf + beta * (r_m - r_rf)

Given: 
- r = 14% (WACC)
- beta = 1.4
- r_m = 15%
- tax rate = 35%

We first need to calculate the cost of equity, which gives us the market risk premium:

r_e = (r - (1 - tax rate) * (r_d * D/E)) / E 
r_e = (0.14 - 0.35 * (0.09 * 25000/5000000)) / 5000000 
r_e = 0.0186 or 1.86%

Next, we use the CAPM formula to solve for the risk-free rate:

14% = r_rf + 1.4 * (15% - r_rf) 
r_rf = 2.05%

Therefore, the answer is A) 2.05 percent.

Question 11

TAFKAP Industries has 8 million shares of stock outstanding selling at $17 per share and an issue of $20 million in 7.5 percent,annual coupon bonds with a maturity of 15 years,selling at 109 percent of par ($1,000).If TAFKAP's weighted average tax rate is 34% and its cost of equity is 12.5 percent,what is TAFKAP's WACC?
A)11.02 percent
B)11.37 percent
C)12.16 percent
D)12.83 percent

Accepted Answer

Step 1: Calculate the market value of equity.

Market Value of Equity = Number of shares * Price per share
Market Value of Equity = 8,000,000 * $17
Market Value of Equity = $136,000,000

Step 2: Calculate the market value of debt.

Market Value of Debt = Issue size * Market price of bond
Market Value of Debt = $20,000,000 * 1.09
Market Value of Debt = $21,800,000

Step 3: Find the total market value of the company.

Total Market Value = Market Value of Equity + Market Value of Debt
Total Market Value = $136,000,000 + $21,800,000
Total Market Value = $157,800,000

Step 4: Calculate the weight of equity.

Weight of Equity = Market Value of Equity / Total Market Value
Weight of Equity = $136,000,000 / $157,800,000
Weight of Equity = 0.861

Step 5: Calculate the weight of debt.

Weight of Debt = Market Value of Debt / Total Market Value
Weight of Debt = $21,800,000 / $157,800,000
Weight of Debt = 0.139

Step 6: Find the cost of equity.

Cost of Equity = 12.5%

Step 7: Find the cost of debt.

Cost of Debt = Coupon Rate * (1 - Tax Rate)
Cost of Debt = 7.5% * (1 - 0.34)
Cost of Debt = 4.95%

Step 8: Calculate the weighted average cost of capital (WACC).

WACC = (Weight of Equity * Cost of Equity) + (Weight of Debt * Cost of Debt)
WACC = (0.861 * 0.125) + (0.139 * 0.0495)
WACC = 0.1137 or 11.37%

Question 12

An all-equity firm is considering the projects shown as follows.The T-bill rate is 4 percent and the market risk premium is 9 percent.If the firm uses its current WACC of 14 percent to evaluate these projects,which project(s)will be incorrectly rejected?

A)Project A
B)Project B
C)Project C
D)Project D

Accepted Answer

The answer of An all-equity firm is considering the projects...

Question 13

KatyDid Clothes has a $150 million ($1,000 face value)15-year bond issue selling for 86 percent of par that carries a coupon rate of 8 percent,paid semi-annually.What would be KatyDid's before-tax component cost of debt?
A)4.90 percent
B)8.13 percent
C)9.80 percent
D)7.09 percent

Accepted Answer

The answer of KatyDid Clothes has a $150 million ($1,000...

Question 14

JLP Industries has 6.5 million shares of common stock outstanding with a market price of $20.00 per share.The company also has outstanding preferred stock with a market value of $10 million,and 25,000 bonds outstanding,each with face value $1,000 and selling at 90 percent of par value.The cost of equity is 14 percent,the cost of preferred is 10 percent,and the cost of debt is 6.25 percent.If JLP's tax rate is 34 percent,what is the WACC?
A)12.39 percent
B)12.98 percent
C)13.13 percent
D)13.72 percent

Accepted Answer

The WACC is calculated using the formula: WACC = (E/V * Re) + (D/V * Rd * (1-Tc)) + (P/V * Rp). Here, E = equity value = 6.5 million shares * $20 = $130 million, D = debt value = 25,000 bonds * $1,000 * 0.9 = $22.5 million, P = preferred stock value = $10 million, V = E + D + P = $162.5 million. Re = 14%, Rd = 6.25%, Rp = 10%, Tc = 34%. Plugging in these values, WACC = ($130M/$162.5M * 14%) + ($22.5M/$162.5M * 6.25% * (1-0.34)) + ($10M/$162.5M * 10%) = 12.39%.

Question 15

Marme Inc.has preferred stock selling for 137 percent of par that pays an 11 percent annual dividend.What would be Marme's component cost of preferred stock?
A)11.00 percent
B)8.03 percent
C)8.17 percent
D)10.16 percent

Accepted Answer

The component cost of preferred stock is calculated as the annual dividend divided by the current price. Here, the annual dividend is 11 percent of par, and the stock is selling for 137 percent of par. Thus, the cost is $ \frac{11}{137} \times 100 = 8.03\% $.

Question 16

Oberon Inc.has a $20 million ($1,000 face value)10-year bond issue selling for 99 percent of par that pays an annual coupon of 7.25 percent.What would be Oberon's before-tax component cost of debt?
A)6.12 percent
B)7.02 percent
C)7.40 percent
D)8.15 percent

Accepted Answer

The answer of Oberon Inc.has a $20 million ($1,000 face...

Question 17

FarCry Industries,a maker of telecommunications equipment,has 6 million shares of common stock outstanding,1 million shares of preferred stock outstanding,and 10 thousand bonds.If the common shares are selling for $27 per share,the preferred shares are selling for $15 per share,and the bonds are selling for 119 percent of par ($1,000),what weight should you use for debt in the computation of FarCry's WACC?
A)4.93 percent
B)5.07 percent
C)5.81 percent
D)6.30 percent

Accepted Answer

The answer of FarCry Industries,a maker of telecommunications equipment,has 6...

Question 18

Johnny Cake Ltd.has 10 million shares of stock outstanding selling at $20 per share and an issue of $50 million in 8 percent,annual coupon bonds with a maturity of 13 years,selling at 93.5 percent of par ($1,000).If Johnny Cake's weighted average tax rate is 34 percent,its next dividend is expected to be $2.00 per share,and all future dividends are expected to grow at 5 percent per year,indefinitely,what is its WACC?
A)12.64 percent
B)13.18 percent
C)13.26 percent
D)14.06 percent

Accepted Answer

1. First, we need to find the cost of equity using the dividend discount model:
Ke = (D1 / P0) + g
Where:
- D1 = expected dividend per share = $2.00
- P0 = current stock price = $20.00
- g = expected growth rate of dividends = 5%
Ke = (2 / 20) + 0.05 = 0.15 or 15%
2. Next, we need to find the after-tax cost of debt:
Kd = (coupon rate x (1 - tax rate)) + (1 - tax rate) x (YTM - coupon rate)
Where:
- coupon rate = 8%
- tax rate = 34%
- YTM = 8.86% (calculated as: [($1,000 x 0.08) / $935] + [(($1,000 - $935) / 13) / (($1,000 + $935) / 2)] )
Kd = (0.08 x (1 - 0.34)) + (1 - 0.34) x (0.0886 - 0.08) = 0.0515 or 5.15%
3. Finally, we can calculate WACC using the following formula:
WACC = (E / V) x Ke + (D / V) x Kd x (1 - tax rate)
Where:
- E = market value of equity = $20 x 10 million = $200 million
- D = market value of debt = $50 million x 0.935 = $46.75 million
- V = total market value of firm = $200 million + $46.75 million = $246.75 million
WACC = (200 / 246.75) x 0.15 + (46.75 / 246.75) x 0.0515 x (1 - 0.34) = 0.1326 or 13.26%
Therefore, the correct answer is C.

Question 19

KatyDid Clothes has a $150 million ($1,000 face value)15-year bond issue selling for 106 percent of par that carries a coupon rate of 8 percent,paid semi-annually.What would be KatyDid's before-tax component cost of debt?
A)3.67 percent
B)7.34 percent
C)8.12 percent
D)7.09 percent

Accepted Answer

The answer of KatyDid Clothes has a $150 million ($1,000...

Question 20

A firm has 5,000,000 shares of common stock outstanding,each with a market price of $10.00 per share.It has 55,000 bonds outstanding,each selling for $990 with a $1,000 face value.The bonds mature in 15 years,have a coupon rate of 8 percent,and pay coupons semi-annually.The firm's equity has a beta of 2.0,and the expected market return is 15 percent.The tax rate is 35 percent and the WACC is 16 percent.Calculate the risk-free rate.
A)27.68 percent
B)1.79 percent
C)2.32 percent
D)2.12 percent

Accepted Answer

The answer of A firm has 5,000,000 shares of common...

Quiz 11: Calculating the Cost of Capital

JaiLai Cos.stock has a beta of 1.7,the current risk-free rate is 6.2 percent,and the expected return on the market is 11 percent.What is JaiLai's cost of equity?

Diddy Corp.stock has a beta of 1.0,the current risk-free rate is 5 percent,and the expected return on the market is 15.5 percent.What is Diddy's cost of equity?

An all-equity firm is considering the projects shown as follows.The T-bill rate is 4 percent and the market risk premium is 8 percent.If the firm uses its current WACC of 13 percent to evaluate these projects,which project(s) will be incorrectly accepted?

An all-equity firm is considering the projects shown as follows.The T-bill rate is 3 percent and the market risk premium is 6 percent.If the firm uses its current WACC of 12 percent to evaluate these projects,which project(s) ,if any,will be incorrectly rejected?

An all-equity firm is considering the projects shown as follows.The T-bill rate is 3 percent and the market risk premium is 6 percent.If the firm uses its current WACC of 12 percent to evaluate these projects,which project(s) will be incorrectly rejected?

An all-equity firm is considering the projects shown as follows.The T-bill rate is 4 percent and the market risk premium is 9 percent.If the firm uses its current WACC of 14 percent to evaluate these projects,which project(s) will be incorrectly rejected?

KatyDid Clothes has a $150 million ($1,000 face value) 15-year bond issue selling for 86 percent of par that carries a coupon rate of 8 percent,paid semi-annually.What would be KatyDid's before-tax component cost of debt?

Marme Inc.has preferred stock selling for 137 percent of par that pays an 11 percent annual dividend.What would be Marme's component cost of preferred stock?

Oberon Inc.has a $20 million ($1,000 face value) 10-year bond issue selling for 99 percent of par that pays an annual coupon of 7.25 percent.What would be Oberon's before-tax component cost of debt?

KatyDid Clothes has a $150 million ($1,000 face value) 15-year bond issue selling for 106 percent of par that carries a coupon rate of 8 percent,paid semi-annually.What would be KatyDid's before-tax component cost of debt?