mgt 181 - ch 14

The average of a firm's cost of equity and aftertax cost of debt that is weighted based on the firm's capital structure is called the

weighted average cost of capital

A firm's cost of capital:

depends upon how the funds raised are going to be spent

The weighted average cost of capital for a wholesaler:

is the return investors require on the total assets of the firm

All else constant, which one of the following will increase a firm's cost of equity if the firm computes that cost using the security market line approach? Assume the firm currently pays an annual dividend of $1 a share and has a beta of 1.2.

a reduction in the risk-free rate

A firm's overall cost of equity is:

highly dependent upon the growth rate and risk level of the firm

The cost of equity for a firm:

ignores the firm's risks when that cost is based on the dividend growth model

The dividend growth model:

is only as reliable as the estimated rate of growth

Which one of the following statements related to the SML approach to equity valuation is correct? Assume the firm uses debt in its capital structure.

The model is dependent upon a reliable estimate of the market risk premium.

The cost of preferred stock is computed the same as the:

return on a perpetuity

The cost of preferred stock:

is equal to the dividend yield

The capital structure weights used in computing the weighted average cost of capital:

are based on the market value of the firm's debt and equity securities

Which one of the following statements is correct for a firm that uses debt in its capital
structure?

The WACC should decrease as the firm's debt-equity ratio increases

Morris Industries has a capital structure of 55 percent common stock, 10 percent preferred stock, and 45 percent debt. The firm has a 60 percent dividend payout ratio, a beta of 0.89, and a tax rate of 38 percent. Given this, which one of the following statements is correct?

The firm's cost of equity is unaffected by a change in the firm's tax rate

The aftertax cost of debt

has a greater effect on a firm's cost of capital when the debt-equity ratio increases

The weighted average cost of capital for a firm is the:

rate of return a firm must earn on its existing assets to maintain the current value of its
stock

Wilderness Adventures specializes in back-country tours and resort management. Travel Excitement specializes in making travel reservations and promoting vacation travel. Wilderness Adventures has an aftertax cost of capital of 13 percent and Travel Excitement has an aftertax cost of capital of 11 percent. Both firms are considering building wilderness campgrounds complete with man-made lakes and hiking trails. The estimated net present value of such a project is estimated at $87,000 at a discount rate of 11 percent and -$12,500 at a 13 percent discount rate. Which firm or firms, if either, should accept this project?

neither Wilderness Adventures nor Travel Excitement

The Shoe Outlet has paid annual dividends of $0.65, $0.70, $0.72, and $0.75 per share over the last four years, respectively. The stock is currently selling for $26 a share. What is this firm's cost of equity?

7.93%

Sweet Treats common stock is currently priced at $18.53 a share. The company just paid $1.25 per share as its annual dividend. The dividends have been increasing by 2.5 percent annually and are expected to continue doing the same. What is this firm's cost of equity?

9.41%

Southern Home Cookin' just paid its annual dividend of $0.65 a share. The stock has a
market price of $13 and a beta of 1.12. The return on the U.S. Treasury bill is 2.5 percent and the market risk premium is 6.8 percent. What is the cost of equity?

10.12%

Tidewater Fishing has a current beta of 1.21. The market risk premium is 8.9 percent and the risk-free rate of return is 3.2 percent. By how much will the cost of equity increase if the company expands its operations such that the company beta rises to 1.50?

1.88%

Wind Power Systems has 20-year, semi-annual bonds outstanding with a 5 percent coupon. The face amount of each bond is $1,000. These bonds are currently selling for 114 percent of face value. What is the company's pre-tax cost of debt?

4.71%

Boulder Furniture has bonds outstanding that mature in 15 years, have a 6 percent coupon, and pay interest annually. These bonds have a face value of $1,000 and a current market price of $1,075. What is the company's aftertax cost of debt if its tax rate is 32 percent?

3.58%

Henessey Markets has a growth rate of 4.8 percent and is equally as risky as the market. The stock is currently selling for $17 a share. The overall stock market has a 10.6 percent rate of return and a risk premium of 8.7 percent. What is the expected rate of return on this stock?

10.6%

Dog Gone Good Engines has a bond issue outstanding with 17 years to maturity. These bonds have a $1,000 face value, a 9 percent coupon, and pay interest semi-annually. The bonds are currently quoted at 82 percent of face value. What is the company's pre-tax cost of debt if the tax rate is 38 percent?

11.42%

Samuelson Plastics has 7.5 percent preferred stock outstanding. Currently, this stock has a market value per share of $52 and a book value per share of $38. What is the cost of preferred stock?

14.42%

New York Deli has 7 percent preferred stock outstanding that sells for $34 a share. This stock was originally issued at $45 per share. What is the cost of preferred stock?

20.59%

Nelson's Landscaping has 1,200 bonds outstanding that are selling for $990 each. The
company also has 2,500 shares of preferred stock at a market price of $28 a share. The common stock is priced at $37 a share and there are 28,000 shares outstanding. What is the weight of the common stock as it relates to the firm's weighted average cost of capital?

45.16%

Mangrove Fruit Farms has a $250,000 bond issue outstanding that is selling at 92 percent of face value. The firm also has 1,500 shares of preferred stock and 15,000 shares of common stock outstanding. The preferred stock has a market price of $35 a share compared to a price of $24 a share for the common stock. What is the weight of the preferred stock as it relates to the firm's weighted average cost of capital?

8.17%

Wayco Industrial Supply has a pre-tax cost of debt of 7.6 percent, a cost of equity of 14.3 percent, and a cost of preferred stock of 8.5 percent. The firm has 220,000 shares of common stock outstanding at a market price of $27 a share. There are 25,000 shares of preferred stock outstanding at a market price of $41 a share. The bond issue has a face value of $550,000 and a market quote of 101.2. The company's tax rate is 37 percent. What is the firm's weighted average cost of capital?

10.18%

Central Systems, Inc. desires a weighted average cost of capital of 8 percent. The firm has an aftertax cost of debt of 5.4 percent and a cost of equity of 15.2 percent. What debt-equity ratio is needed for the firm to achieve its targeted weighted average cost of capital?

3.63

R.S. Green has 250,000 shares of common stock outstanding at a market price of $28 a share. Next year's annual dividend is expected to be $1.55 a share. The dividend growth rate is 2 percent. The firm also has 7,500 bonds outstanding with a face value of $1,000 per bond. The bonds carry a 7 percent coupon, pay interest semiannually, and mature in 7.5 years. The bonds are selling at 98 percent of face value. The company's tax rate is 34 percent. What is the firm's weighted average cost of capital?

8.5%

Granite Works maintains a debt-equity ratio of 0.65 and has a tax rate of 32 percent. The firm does not issue preferred stock. The pre-tax cost of debt is 9.8 percent. There are 25,000 shares of stock outstanding with a beta of 1.2 and a market price of $19 a share. The current market risk premium is 8.5 percent and the current risk-free rate is 3.6 percent. This year, the firm paid an annual dividend of $1.10 a share and expects to increase that amount by 2 percent each year. Using an average expected cost of equity, what is the weighted average cost of capital?

8.78%

Delta Lighting has 30,000 shares of common stock outstanding at a market price of $15.00 a share. This stock was originally issued at $31 per share. The firm also has a bond issue outstanding with a total face value of $280,000 which is selling for 86 percent of par. The cost of equity is 13 percent while the aftertax cost of debt is 6.9 percent. The firm has a beta of 1.48 and a tax rate of 30 percent. What is the weighted average cost of capital?

10.87%

Electronics Galore has 950,000 shares of common stock outstanding at a market price of $38 a share. The company also has 40,000 bonds outstanding that are quoted at 106 percent of face value. What weight should be given to the debt when the firm computes its weighted average cost of capital?

54%