Question 1

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

1,190 × 0.01/[1190 × 0.01 + 6 × 27 + 1 × 15] = 6.30 percent

Question 2

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

Using WACC accept B, C, D
Project A: 3 + 6 (0.9) = 8.4 percent,
accept Project B: 3 + 6 (1.1) = 9.6 percent,
accept Project C: 3 + 6 (1.4) = 11.4 percent,
accept Project D: 3 + 6 (2.2) = 16.2% percent, reject

Question 3

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 stock 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

0.0625 × (1 − 0.34)[(25,000 × 900)/[25,000 × 900 + 10,000,000 + 6,500,000 × 20]] + 0.14 × [(6,500,000 × 20)/[25,000 × 900 + 10,000,000 + 6,500,000 × 20]] + 0.1 × [[10,000,000]/[25,000 × 900 + 10,000,000 + 6,500,000 × 20]] = 12.39%

Question 4

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

1,110 × 0.05/[1,110 × 0.05 + 3 × 10 + 4 × 21] = 32.74 percent

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

Using WACC accept B, C, D
Project A: 4 + 8 (0.7) = 9.6 percent,
reject Project B: 4 + 8 (1.1) = 12.8 percent,
accept Project C: 4 + 8 (1.5) = 16 percent,
reject Project D: 4 + 8 (1.9) = 19.2 percent, reject

Question 6

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

PV = 1060; FV = 1000; N = 30; PMT = 40; I = 3.67; 3.67 × 2 = 7.34 percent

Question 7

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

Step 1: 2/20 + 0.05 = 15% = cost of equity
Step 2: PV = −935; PMT = 80; N = 13; FV = 1000; I = 8.86(1 - 0.34) = 5.85% = cost of debt
Step 3: WACC = 10 × 20/[10 × 20 + 50 × 0.935] × 0.15 + 50 × 935/[10 × 20 + 50 × 0.935] × 0.0586 = 13.26%

Question 8

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.

Accepted Answer

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.

Question 9

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

5 + 1(15.5 − 5) = 15.50

Question 10

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

114.5 × 1/[26 × 15 + 114.5 × 1 + 1,010 × 0.01] = 22.25 percent

Question 11

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

11/137 = 8.03 percent

Question 12

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

126 × 3/[3 × 126 + 1,170 × 0.005 + 4 × 17] = 83.66 percent

Question 13

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

Step 1: Cost of debt: PV = −1100; PMT = 45; N = 24; FV = 1000; I = 3.85; Cost of debt = 7.71;
Step 2: Use WACC to solve for cost of equity: 14% = (5 × 8)/[5 × 8 + 0.025 × 1,100] × (cost of equity) + 0.025 × 1,100/[5 × 8 + 0.025 × 1,100] × (7.71%)(1 - 0.35) => cost of equity = 20.18%;
Step 3: 20.18% = Risk-free rate + 1.4(15% -Risk free rate) => Risk-free rate = 2.05%

Question 14

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

PV = −990; FV = 1000; PMT = 72.50; N = 10; I = 7.40 percent

Question 15

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

114.5 × 1/[26 × 12 + 114.5 × 1 + 980 × 0.01] = 26.24 percent

Question 16

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 percent 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: cost of debt => PV = −1090; PMT = 75; FV = 1000; N = 15; => I = 6.54
Step 2: 8 × 17/[8 × 17 + 1.09 × 20]12.5%+ 20 × 1.09/[8 × 17 + 1.09 × 20] × 6.54% × [1 − 0.34] = 11.37%

Question 17

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

PV= −860; FV = 1000; N = 30; PMT= 40; I = 4.9; 4.9 × 2 = 9.80 percent

Question 18

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

6.2 + 1.7(11 − 6.2) = 14.36

Question 19

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

Using WACC accept B
Project A: 4 + 9 (0.25) = 6.25 percent,
accept Project B: 4 + 9 (1.3) = 15.7 percent,
accept Project C: 4 + 9 (1.6) = 18.4 percent,
reject Project D: 4 + 9 (2.1) = 22.9 percent, reject

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

Step 1: Cost of debt: PV = −990; PMT = 40; N = 30; FV = 1000; I = 4.06; Cost of debt = 8.12;
Step 2: Use WACC to solve for cost of equity: 16% = (5 × 10)/[5 × 10 + 0.055 × 990] × (cost of equity) + 0.055 × 990/[5 × 10 + 0.055 × 990] × (8.12%)(1 - 0.35) => cost of equity = 27.68%;
Step 3: 27.68% = Risk-free rate + 2.0(15% -Risk free rate) => Risk-free rate = 2.32%

Quiz 11: Calculating the Cost of Capital

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 8 percent.If the firm uses its current WACC of 13 percent to evaluate these projects,which project(s) will be incorrectly accepted?

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?

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?

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?

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 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?

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?

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?