Q&A Hero

Q: All things equal, as the tax rate increases, the incentive to use more debt financing increases.

Q: In most instances, as the amount of debt rises, the common stockholders will decrease their required rate of return.

Q: The weighted cost of capital assumes that the company maintains a constant debt to equity ratio.

Q: The cost of capital for a firm which uses 45% debt at an after-tax cost of 10% and 55% common stock at a 15% cost is: A) 12.25%. B) 12.50%. C) 12.75%. D) 13.00%. E) 13.25%.

Q: Assume the following facts about a firm's financing in the next year, and calculate the component cost of debt. Weighted average cost of capital = 11.3% Proportion debt financing = 45% Proportion internal equity financing = 55% Cost of internal equity = 14.0% Cost of after-tax debt = ????? A) 7% B) 8% C) 9% D) 10%

Q: A company has a capital structure that consists of 50% debt and 50% equity. Which of the following is generally true? A) The weighted average cost of capital is less than the cost of equity financing. B) The cost of equity financing is greater than the cost of debt financing. C) The weighted average cost of capital is calculated on a before-tax basis. D) Both A and B.

Q: Which of the following statements regarding calculating a firm's cost of capital is correct? A) The after-tax cost of debt is generally more expensive than the after-tax cost of preferred stock. B) Since retained earnings are readily available, the cost of retained earnings is generally lower than the cost of debt. C) If a company's beta increases, this will increase the cost of capital. D) The level of general economic conditions will determine whether a firm should utilize an arithmetic average cost of capital or a weighted average cost of capital.

Q: The opportunity cost of securities issued by a firm is determined by: A) the rate of return investors could earn on riskless securities. B) the rate of return on the firm's next best investment opportunity. C) the rate of return investors could obtain on similar securities. D) the weighted average rate of return on all securities issued by the firm.

Q: The WACC should be computed using: A) balance sheet weights and target yields. B) weights based on the firm's ideal capital structure and target yields on debt and equity. C) market weights and opportunity costs to the firm. D) market weights and opportunity costs to investors.

Q: The stock of Autumn Leaves Inc.'s closest competitors is priced to yield between 11% and 13%. Autumn Leaves stock pays a $1.00 dividend which is expected to grow at about 4% for the foreseeable future. We would expect Autumn Leaves stock to sell for approximately: A) $8.33. B) $25.00. C) $11.00. D) $13.00.

Q: How frequently do most firms update their cost of capital? A) Rarely, if ever B) At least once a year C) Daily D) Only when there are major changes in the firm's capital structure.

Q: Metals Corp. has $2,575,000 of debt, $550,000 of preferred stock, and $18,125,000 of common equity. Metals Corp.'s after-tax cost of debt is 5.25%, preferred stock has a cost of 6.35%, and newly issued common stock has a cost of 14.05%. What is Metals Corp.'s weighted average cost of capital? A) 12.78% B) 10.84% C) 8.32% D) 6.56%

Q: Tropical Fruit Drinks issued $10,000,000 in bonds to expand its production facilities. After issuing the bonds, the company was 60% debt financed and 40% common equity financed. Tropical intends to retire 20% of the bonds each year for the next 5 years and not to issue any new debt. A) All things equal, we would expect Tropical Fruit Drinks cost of capital to decrease gradually over the next 5 years. B) All things equal, we would expect Tropical Fruit Drinks cost of capital to increase gradually over the next 5 years. C) All things equal, we would expect Tropical Fruit Drinks cost of capital to stay the same for the next 5 years, then decrease rapidly. D) All things equal, we would expect Tropical Fruit Drinks cost of capital to stay the same for the next five years, then increase rapidly.

Q: Reliable Metals plans to issue bonds that will mature in 20 years, will have a semi-annual coupon rate of 7%., and a Moody's rating of Aa2. Bonds of other metals companies with similar maturities and ratings currently yield an average of 6.3%. A) Reliable's bonds will sell at a price to yield about 6.3% because that is the investors' opportunity cost. B) Reliable's bonds should be priced to yield a rate close to the coupon rate. C) Reliable's bonds should yield more than 6.3% because they are new. D) Reliable's bonds should yield less than 6.3% because they are new.

Q: Capital budgeting analyses typically assume a constant cost of capital, even though the analysts know it will change. One reason for this practice is that: A) the changes are too small to affect the decision. B) a constant cost of capital is the most conservative assumption. C) the changes are unpredictable. D) NPV calculations do not allow more than one discount rate.

Q: Which of the following is the preferred method in estimating a firm's cost of capital? A) Consider the cost of a specific source of financing that will be used for a firm's new projects; i.e., the marginal cost of capital. B) Calculate the weighted average cost of new capital to be utilized in financing a firm's projects. C) Calculate the firm's weighted average CAPM to be utilized in financing a firm's projects. D) All of the above are equally acceptable.

Q: Based on current market values, Shawhan Supply 's capital structure is 30% debt, 20% preferred stock, and 50% common stock. When using book values, capital structure is 25% debt, 10% preferred stock, and 65% common stock. The required return on each component is: debt10%; preferred stock11%; and common stock18%. The marginal tax rate is 40%. What rate of return must Shawhan Supply earn on its investments if the value of the firm is to remain unchanged? A) 18.0% B) 13.0% C) 10.0% D) 14.3%

Q: Caribe's common stock sells for $41, and dividends paid last year were $1.18. The dividends and earnings per share are predicted to have a 5% growth rate. What is the cost of common equity for Caribe?

Q: The preferred stock of Wells Co. sells for $15.30 and pays a $1.75 dividend. What is the cost of capital for preferred stock?

Q: Gibson Industries is issuing a $1,000 par value bond with an 8% semi-annual interest coupon rate and that matures in 11 years. Investors are willing to pay $972 for these bonds. Gibson is in the 34% tax bracket. What will be the after-tax cost of debt of the bond?

Q: Sutter Corporation's common stock is selling for $16.80 a share. Last year, Sutter paid a dividend of $.80. Investors are expecting Sutter's dividends to grow at a rate of 5% per year. What is the cost of common equity?

Q: Toto and Associates' preferred stock is selling for $18.40. The stock pays an annual dividend of $2.21 per share. What is the cost of preferred stock to the company?

Q: Hoak Company's common stock is currently selling for $50. Last year's dividend was $1.83 per share. Investors expect dividends to grow at an annual rate of 9% into the future. a. What is Hoak's cost of common equity? b. Selling new common stock is expected to decrease the price of the stock by $5.00. What is the cost of new common stock? Dividends will remain the same.

Q: Moore Financing Corporation has preferred stock in its capital structure paying a dividend of $3.75 and selling for $25.00. If the marginal tax rate for Moore is 34%, what is the after-tax cost of preferred financing?

Q: Vipsu Corporation plans to issue 10-year bonds with a par value of $1,000 that will pay $55 every six months. The net amount of capital to the firm from the sale of each bond is $840.68. If Vipsu is in the 25% tax bracket, what is the after-tax cost of debt?

Q: Discuss the primary advantages of the CAPM approach in determining the cost of common equity.

Q: Explain why the investor's required return on debt is not equal to the corporation's cost of debt, and explain why the investor's required return on equity is not equal to the corporation's cost of equity.

Q: The cost of common equity is usually higher than the firm's WACC.

Q: The cost of common equity is already on an after-tax basis since dividends paid to common stockholders are not tax-deductible.

Q: Assuming an after-tax cost of preferred stock of 12% and a corporate tax rate of 40%, a firm must earn at least $20 before tax on every $100 invested.

Q: The cost of debt is equal to one minus the marginal tax rate times the coupon rate of interest on the firm's outstanding debt.

Q: Only a small minority of bonds issued by large corporations are rated by Moody's or S&P.

Q: No adjustment is made in the cost of preferred stock for taxes since preferred stock dividends are not tax-deductible.

Q: If the before-tax cost of debt is 9% and the firm has a 34% marginal tax rate, the after-tax cost of debt is 5.94%.

Q: A bond with a Moody's rating of Aaa and and S&P rating of AAA will have a higher required return than a bond with an unstable price a Moody's rating of Aa1 and and S&P rating of AA+.

Q: The firm financed completely with equity capital has a cost of capital equal to the required return on common stock.

Q: The firm's weighted average cost of capital is: A) 10.47%. B) 9.29%. C) 8.63%. D) 7.71%.

Q: The after-tax cost of common stock is: A) 14.67%. B) 13.23%. C) 12.41%. D) 11.65%.

Q: Use the following information to answer the following question(s). A firm currently has the following capital structure which it intends to maintain. Debt: $3,000,000 par value of 9% bonds outstanding with an annual before-tax yield to maturity of 7.67% on a new issue. The bonds currently sell for $115 per $100 par value. Common stock: 46,000 shares outstanding currently selling for $50 per share. The firm expects to pay a $5.50 dividend per share one year from now and is experiencing a 3.67% growth rate in dividends, which it expects to continue indefinitely. The firm's marginal tax rate is 40%. The company has no plans to issue new securities. The after-tax cost of debt is: A) 6.20%. B) 5.40%. C) 4.60%. D) 3.80%.

Q: Use the following information to answer the following question(s). A firm currently has the following capital structure which it intends to maintain. Debt: $3,000,000 par value of 9% bonds outstanding with an annual before-tax yield to maturity of 7.67% on a new issue. The bonds currently sell for $115 per $100 par value. Common stock: 46,000 shares outstanding currently selling for $50 per share. The firm expects to pay a $5.50 dividend per share one year from now and is experiencing a 3.67% growth rate in dividends, which it expects to continue indefinitely. The firm's marginal tax rate is 40%. The company has no plans to issue new securities. The proportion of debt in this firm's capital structure is: A) 40%. B) 50%. C) 60%. D) 70%.

Q: Use the following information to answer the following question(s). A firm currently has the following capital structure which it intends to maintain. Debt: $3,000,000 par value of 9% bonds outstanding with an annual before-tax yield to maturity of 7.67% on a new issue. The bonds currently sell for $115 per $100 par value. Common stock: 46,000 shares outstanding currently selling for $50 per share. The firm expects to pay a $5.50 dividend per share one year from now and is experiencing a 3.67% growth rate in dividends, which it expects to continue indefinitely. The firm's marginal tax rate is 40%. The company has no plans to issue new securities. The current total value of the firm is: A) $6,450,000. B) $5,750,000. C) $4,950,000. D) $3,250,000.

Q: The George Company, Inc., has two issues of debt. Issue A has a maturity value of 8 million dollars, a coupon rate of 8%, paid annually, and is selling at par. Issue B was issued as a 15 year bond 5 years ago. Its coupon rate is 9%, paid annually. Investors demand a pre-tax return of 9.3% on this bond. The maturity value of Issue B is 6 million dollars. The George company has a marginal tax rate of 35%. What is the company's after tax cost of debt? A) 4.73% B) 5.56% C) 7.36% D) 8.47%

Q: Paramount, Inc. just paid a dividend of $2.05 per share, and the firm is expected to experience constant growth of 12.50% over the foreseeable future. The common stock is currently selling for $65.90 per share. What is Paramount's cost of retained earnings using the Dividend Growth Model approach? A) 12.50% B) 17.90% C) 16.00% D) 14.55%

Q: Alpha's beta is 1.06, the present T-bond rate is 6%, and the return on the S & P 500 is 15.25%. What is Alpha's cost of common equity using the CAPM approach? A) 21.25% B) 15.81% C) 9.25% D) 6.32%

Q: Given the following information, determine the risk-free rate. Cost of equity = 12% Beta = 1.50 Market risk premium = 3% A) 8.0% B) 7.5% C) 7.0% D) 6.5%

Q: The CAPM approach is used to determine the cost of: A) debt. B) preferred stock. C) common equity. D) long term funds.

Q: A firm has an issue of preferred stock that pays an annual dividend of $2.00 per share and currently is selling for $18.50 per share. Finally, the firm's marginal tax rate is 34%. This firm's cost of financing with new preferred stock is: A) 10%. B) 7.13%. C) 10.81%. D) 6.6%.

Q: In calculating the cost of capital for an average firm, which of the following statements is true? A) The cost of a firm's bonds is greater than the cost of its common stock. B) The cost of a firm's preferred stock is greater than the cost of its common stock. C) The cost of a firm's retained earnings is less than the cost of its bonds. D) The cost of a firm's common stock is greater than the cost of its bonds.

Q: Many corporate finance professionals favor the CAPM for determining the cost of equity. Which of the following is a reason for this preference? A) The data is less expensive. B) The variables in the model that apply to public corporations are readily available from public sources. C) Because the CAPM gives better treatment to flotation costs. D) The CAPM uses data from the firm's financial statements.

Q: Use the following information to answer the following question(s). Berlioz Inc. is trying to estimate its cost of common equity, and it has the following information. The firm has a beta of 0.90, the before-tax cost of the firm's debt is 7.75%, and the firm estimates that the risk-free rate is 4% while the current market return is 12%. Berlioz stock currently sells for $35.00 per share. The firm pays dividends annually and expects dividends to grow at a constant rate of 5% indefinitely. The most recent dividend per share, paid yesterday, is $2.00. Finally, the firm has a marginal tax rate of 34%. XYZ Corporation is trying to determine the appropriate cost of preferred stock to use in determining the firm's cost of capital. This firm's preferred stock is currently selling for $29.89 and pays a perpetual annual dividend of $2.60 per share. Compute the cost of preferred stock for XYZ. A) 7.2% B) 6.2% C) 8.7% D) 16.7%

Q: Use the following information to answer the following question(s). Berlioz Inc. is trying to estimate its cost of common equity, and it has the following information. The firm has a beta of 0.90, the before-tax cost of the firm's debt is 7.75%, and the firm estimates that the risk-free rate is 4% while the current market return is 12%. Berlioz stock currently sells for $35.00 per share. The firm pays dividends annually and expects dividends to grow at a constant rate of 5% indefinitely. The most recent dividend per share, paid yesterday, is $2.00. Finally, the firm has a marginal tax rate of 34%. The best estimate of the cost of new common equity is: A) 11.00%. B) between 11.0%. and 11.2% C) 11.50%. D) between 10%. and 12%

Q: Use the following information to answer the following question(s). Berlioz Inc. is trying to estimate its cost of common equity, and it has the following information. The firm has a beta of 0.90, the before-tax cost of the firm's debt is 7.75%, and the firm estimates that the risk-free rate is 4% while the current market return is 12%. Berlioz stock currently sells for $35.00 per share. The firm pays dividends annually and expects dividends to grow at a constant rate of 5% indefinitely. The most recent dividend per share, paid yesterday, is $2.00. Finally, the firm has a marginal tax rate of 34%. The cost of common equity using the CAPM is: A) 11.00%. B) 11.20%. C) 11.50%. D) 11.72%.

Q: Use the following information to answer the following question(s). Berlioz Inc. is trying to estimate its cost of common equity, and it has the following information. The firm has a beta of 0.90, the before-tax cost of the firm's debt is 7.75%, and the firm estimates that the risk-free rate is 4% while the current market return is 12%. Berlioz stock currently sells for $35.00 per share. The firm pays dividends annually and expects dividends to grow at a constant rate of 5% indefinitely. The most recent dividend per share, paid yesterday, is $2.00. Finally, the firm has a marginal tax rate of 34%. The cost of common equity using the dividend-growth model is: A) 11.00%. B) 11.32%. C) 11.50%. D) 11.72%.

Q: The last paid dividend is $2 for a share of common stock that is currently selling for $20. What is the cost of common equity if the long-term growth rate in dividends for the firm is expected to be 8%? A) 10.8% B) 12.8% C) 14.8% D) 16.8% E) 18.8%

Q: Pony Corporation is undertaking a capital budgeting analysis. The firm's beta is 1.5. The rate on 10-year U.S. Treasury bonds is 5%, and the return on the S & P 500 index is 12%. What is the cost of Pony's common equity? A) 13.3% B) 15.5% C) 17.7% D) 19.9%

Q: Sola Cola Corporation is undertaking a capital budgeting analysis. The rate on 10-year U.S. Treasury bonds is 3.60%, and the return on the S & P 500 index is 11.6%. If the cost of Sola Cola's common equity is 19.6%, calculate their beta. A) 1.69 B) 5.4 C) 2.0 D) 1.38

Q: Verigreen Lawn Care products just paid a dividend of $1.85. This dividend is expected to grow at a constant rate of 3% per year, so the next expected dividend is $1.90. The stock price is currently $12.50. New stock can be sold at this price subject to flotation costs of 15%. The company's marginal tax rate is 40%. Compute the cost of common equity. A) 18.0% B) 17.8% C) 18.2% D) 15.2%

Q: Hill Town Motels has $5 million of debt outstanding with a coupon rate of 12%. Currently, the yield to maturity on these bonds is 14%. If the firm's tax rate is 40%, what is the after-tax cost of debt to Hill Town Motels? A) 5.43% B) 11.2% C) 8.4% D) 5.6%

Q: Dublin International Corporation's marginal tax rate is 40%. It can issue three-year bonds with a coupon rate of 8.5% and par value of $1,000. The bonds can be sold now at a price of $938.90 each. Determine the appropriate after-tax cost of debt for Dublin International to use in a capital budgeting analysis. A) 11.0% B) 5.2% C) 6.6% D) 7.2%

Q: Walker & Son is issuing a 10-year, $1,000 par value bond that pays 9% interest annually. The bond is expected to sell for $885. What is Walker & Son's after-tax cost of debt if the firm is in the 34% tax bracket? A) 7.23% B) 8.01% C) 9.15% D) 10.35%

Q: Use the following information to answer the following question(s). The current market price of an existing debt issue is $1,125. The bonds have a $1,000 par value, pay interest annually at a 12% coupon rate, and mature in 10 years. The firm has a marginal tax rate of 34%. The after-tax cost of this debt issue is: A) 7.92%. B) 6.58%. C) 12%. D) 3.39%.

Q: Use the following information to answer the following question(s). The current market price of an existing debt issue is $1,125. The bonds have a $1,000 par value, pay interest annually at a 12% coupon rate, and mature in 10 years. The firm has a marginal tax rate of 34%. The before-tax cost of this debt issue is: A) 12%. B) 7.92%. C) 9.97%. D) 13%.

Q: Alpha has an outstanding bond issue that has a 7.75% semiannual coupon, a current maturity of 20 years, and sells for $967.97. The firm's income tax rate is 40%. What should Alpha use as an after-tax cost of debt for cost of capital purposes? A) 2.42% B) 4.04% C) 4.85% D) 8.08%

Q: Busing Manufacturing has a new bond issue that will net the firm $1,069,000. The bonds have a $1,000,000 par value, pay interest annually at a 12% coupon rate, and mature in 10 years. The firm has a marginal tax rate of 34%. The after-tax cost of the debt issue is: A) 7.15%. B) 3.68%. C) 7.92%. D) 6.58%.

Q: Bender and Co. is issuing a $1,000 par value bond that pays 9% interest annually. Investors are expected to pay $918 for the 10-year bond. What is the after-tax cost of debt if the firm is in the 34% tax bracket? A) 6.83% B) 9.00% C) 10.35% D) 15.68%

Q: An increase in ________ will increase the cost of common equity. A) the expected growth rate of dividends B) the risk-free rate C) a drop in the stock price D) both A and B

Q: Which of the following is a valid issue in implementing the dividend growth model? The model: A) is too complex to be used to estimate value. B) does not require an accurate estimate of the rate of growth in future dividends. C) is based upon the assumption that dividends are expected to grow at a constant rate forever. D) both A and C.

Q: Which of the following is NOT used to calculate the cost of debt? A) Face value of the debt B) Market price of the debt C) Number of years to maturity D) Risk-free rate

Q: When calculating the weighted average cost of capital, which of the following has to be adjusted for taxes? A) Common stock B) Retained earnings C) Debt D) Preferred stock

Q: The most expensive source of capital is usually: A) preferred stock. B) new common stock. C) debt. D) retained earnings.

Q: The cost of preferred stock is equal to: A) the preferred stock dividend divided by market price. B) the preferred stock dividend divided by its par value. C) (1 - tax rate) times the preferred stock dividend divided by net price. D) the preferred stock dividend divided by the net market price.

Q: Most firms use Treasury securities with maturities of ________ to determine the appropriate risk-free rate to use in the CAPM. A) 90 days B) 180 days C) 10 years D) 30 years

Q: Sonderson Corporation is undertaking a capital budgeting analysis. The firm's beta is 1.5. The rate on six-month T-bills is 5%, and the return on the S&P 500 index is 12%. What is the appropriate cost of common equity in determining the firm's cost of capital? A) 13.1% B) 15.5% C) 17.7% D) 19.9%

Q: The expected dividend is $2.50 for a share of stock priced at $25. What is the cost of common equity if the long-term growth in dividends is projected to be 8%? A) 10% B) 8% C) 25% D) 18%

Q: J & B, Inc. has $5 million of debt outstanding with a coupon rate of 12%. Currently, the yield to maturity on these bonds is 14%. If the firm's tax rate is 40%, what is the after-tax cost of debt to J & B? A) 12.0% B) 14.0% C) 8.4% D) 5.6%

Q: Why are market values preferred to book (balance sheet) values when computing a firm's weighted average cost of capital.

Q: Capital structure represents the mix of long-term sources of funds used by a firm.

Q: A firm's weighted marginal cost of capital increases when internal equity financing is exhausted but is unaffected by an increase in the cost of other financing sources.

Q: Which of the following statements is true? A) The level of general economic conditions will determine whether a firm should utilize an arithmetic average cost of capital or a weighted average cost of capital. B) A firm should utilize a weighted average cost of capital for evaluating investment decisions rather than an arithmetic average cost of capital. C) For an average firm that is capitalized with 65% equity, usage of an arithmetic average cost of capital will usually overstate the true cost of capital. D) All of the above are true. E) None of the above are true.

Q: Use the following information to answer the following question(s). The following data concerning Grafton Computer Peripherals' capital structure is available. $ millions Book Values Market Values Accounts Payable & Accruals $100 Short-term notes 50 50 Long-term debt 150 200 Preferred Stock 25 50 Common Stock 200 500 Total $525 $800 The total capital that should be used in computing the weights for Grafton's WACC is: A) $800. B) $525. C) $750. D) $425.