FiltersDone

Question type

Essay

Multiple Choice

Short Answer

True False

Matching

Exam 10: Cost of Capital

Show Answer

Share

---

All types

Filters

Study FlashcardsPractice ExamLearn

Question 1

Multiple Choice

Review LaterAdd Note

Review Later

the assistant to the CFO of Johnstone Inc., you must estimate its cost of common equity You have been provided with the following data: D0 = $0.80; P0 = $22.50; and g = 8.00% (constant) Based on the DCF approach, what is the cost of common from retained earnings?

A) 10.69%
B) 11.25%
C) 11.84%
D) 12.43%
E) 13.05%

F) A) and E)
G) A) and D)

Correct Answer

verified

Show Answer

Question 2

True/False

Review LaterAdd Note

Review Later

Firms raise capital at the total corporate level by retaining earnings and by obtaining funds in the capital markets They then provide funds to their different divisions for investment in capital projects The divisions may vary in risk, and the projects within the divisions may also vary in risk Therefore, it is conceptually correct to use different risk-adjusted costs of capital for different capital budgeting projects.

A) True
B) False

Correct Answer

verified

Show Answer

Question 3

Multiple Choice

Review LaterAdd Note

Trahern Baking Cocommon stock sells for $32.50 per shareIt expects to earn $3.50 per share during the current year, its expected dividend payout ratio is 65%, and its expected constant dividend growth rate is 6.0% New stock can be sold to the public at the current price, but a flotation cost of 5% would be incurred What would be the cost of equity from new common stock?

the winner of a contest, you are now CFO for the day for Maguire Incand your day's job involves raising capital for expansionMaguire's common stock currently sells for $45.00 per share, the company expects to earn $2.75 per share during the current year, its expected payout ratio is 70%, and its expected constant growth rate is 6.00% New stock can be sold to the public at the current price, but a flotation cost of 8% would be incurred By how much would the cost of new stock exceed the cost of common from retained earnings?

before-tax cost of debt, which is lower than the after-tax cost, is used as the component cost of debt for purposes of developing the firm's WACC.

capital budgeting and cost of capital purposes, the firm should always consider retained earnings as the first source of capital--i.e., use these funds first--because retained earnings have no cost to the firm.

estimating the cost of equity by use of the bond-yield-plus-risk-premium method, we can generally get a good idea of the interest rate on new long-term debt, but we cannot be sure that the risk premium we add is appropriate This problem leaves us unsure of the true value of rs.

Funds acquired by the firm through retaining earnings have no cost because there are no dividend or interest payments associated with them, and no flotation costs are required to raise them, but capital raised by selling new stock or bonds does have a cost.

Which of the following is NOT a capital component when calculating the weighted average cost of capital (WACC) for use in capital budgeting?

Anderson Company has equal amounts of low-risk, average-risk, and high-risk projects The firm's overall WACC is 12% The CFO believes that this is the correct WACC for the company's average-risk projects, but that a lower rate should be used for lower-risk projects and a higher rate for higher-risk projects The CEO disagrees, on the grounds that even though projects have different risks, the WACC used to evaluate each project should be the same because the company obtains capital for all projects from the same sources If the CEO's position is accepted, what is likely to happen over time?

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.

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 retained earnings?

president and CFO of Spellman Transportation are having a disagreement about whether to use market value or book value weights in calculating the WACCSpellman'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 millionThe current stock price is $22.50 per share; stockholders' required return, rs, is 14.00%; and the firm's tax rate is 40% 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?

Kenny Electric Company's noncallable bonds were issued several years ago and now have 20 years to maturity These bonds have a 9.25% annual coupon, paid semiannually, sells at a price of $1,075, and has a par value of $1,000 If the firm's tax rate is 40%, what is the component cost of debt for use in the WACC calculation?

cost of capital used in capital budgeting should reflect the average cost of the various sources of long-term funds a firm uses to acquire assets.

Suppose the debt ratio (D/TA) is 50%, the interest rate on new debt is 8%, the current cost of equity is 16%, and the tax rate is 40% An increase in the debt ratio to 60% would decrease the weighted average cost of capital (WACC).

cost of perpetual preferred stock is found as the preferred's annual dividend divided by the market price of the preferred stock No adjustment is needed for taxes because preferred dividends, unlike interest on debt, is not deductible by the issuing firm.

CEO of Harding Media Incas asked you to help estimate its cost of common equity You have obtained the following data: D0 = $0.85; P0 = $22.00; and g = 6.00% (constant) The CEO thinks, however, that the stock price is temporarily depressed, and that it will soon rise to $40.00 Based on the DCF approach, by how much would the cost of common from retained earnings change if the stock price changes as the CEO expects?

estimating the cost of equity by use of the DCF 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.

Quinlan Enterprises stock trades for $52.50 per shareIt is expected to pay a $2.50 dividend at year end (D1 = $2.50) , and the dividend is expected to grow at a constant rate of 5.50% a year The before-tax cost of debt is 7.50%, and the tax rate is 40% The target capital structure consists of 45% debt and 55% common equity What is the company's WACC if all the equity used is from retained earnings?