Table 9.1
A firm has determined its optimal capital structure which is composed of the following sources
and target market value proportions.
Debt: The firm can sell a 12-year, $1,000 par value, 7 percent bond for $960. A flotation cost of
2 percent of the face value would be required in addition to the discount of $40.
Preferred Stock: The firm has determined it can issue preferred stock at $75 per share par
value. The stock will pay a $10 annual dividend. The cost of issuing and selling the stock is $3
per share.
Common Stock: A firm’s common stock is currently selling for $18 per share. The dividend
expected to be paid at the end of the coming year is $1.74. Its dividend payments have been
growing at a constant rate for the last four years. Four years ago, the dividend was $1.50. It is
expected that to sell, a new common stock issue must be underpriced $1 per share in floatation
costs. Additionally, the firm’s marginal tax rate is 40 percent.
13) The firm’s before-tax cost of debt is ________. (See Table 9.1)
A) 7.8 percent
B) 10.6 percent
C) 11.2 percent
D) 12.7 percent
14) The firm’s after-tax cost of debt is ________. (See Table 9.1)
A) 3.25 percent
B) 4.67 percent
C) 8 percent
D) 8.13 percent
15) The firm’s cost of preferred stock is ________. (See Table 9.1)
A) 7.2 percent
B) 8.3 percent
C) 13.3 percent
D) 13.9 percent
16) The firm’s cost of a new issue of common stock is ________. (See Table 9.1)
A) 7 percent
B) 9.08 percent
C) 14.2 percent
D) 13.4 percent
17) The firm’s cost of retained earnings is ________. (See Table 9.1)
A) 10.2 percent
B) 13.9 percent
C) 12.7 percent
D) 13.6 percent
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18) The weighted average cost of capital up to the point when retained earnings are exhausted is
________. (See Table 9.1)
A) 7.5 percent
B) 8.65 percent
C) 10.4 percent
D) 11.9 percent
Answer: D
Diff: 2
Topic: Calculating Weighted Average Cost of Capital (WACC)
Learning Obj.: LG 6
Learning Outcome: F-13
AACSB: Analytical Thinking
19) If the target market proportion of long-term debt is reduced to 15 percent — increasing the
proportion of common stock equity to 75 percent, what will be the revised weighted average cost
of capital? (See Table 9.1)
A) 13.6 percent
B) 11.0 percent
C) 12.34 percent
D) 10.4 percent
Answer: C
Diff: 2
Topic: Calculating Weighted Average Cost of Capital (WACC)
Learning Obj.: LG 6
Learning Outcome: F-13
AACSB: Analytical Thinking
35
Copyright © 2019 Pearson Education, Inc.
Table 9.2
A firm has determined its optimal structure which is composed of the following sources and
target market value proportions.
Debt: The firm can sell a 15-year, $1,000 par value, 8 percent bond for $1,050. A flotation cost
of 2 percent of the face value would be required in addition to the premium of $50.
Common Stock: A firm’s common stock is currently selling for $75 per share. The dividend
expected to be paid at the end of the coming year is $5. Its dividend payments have been
growing at a constant rate for the last five years. Five years ago, the dividend was $3.10. It is
expected that to sell, a new common stock issue must be underpriced $2 per share and the firm
must pay $1 per share in flotation costs. Additionally, the firm has a marginal tax rate of 40
percent.
20) The firm’s before-tax cost of debt is ________. (See Table 9.2)
A) 7.7 percent
B) 10.6 percent
C) 11.2 percent
D) 12.7 percent
Answer: A
Diff: 1
Topic: Calculating Weighted Average Cost of Capital (WACC)
Learning Obj.: LG 6
Learning Outcome: F-13
AACSB: Analytical Thinking
21) The firm’s after-tax cost of debt is ________. (See Table 9.2)
A) 4.6 percent
B) 6 percent
C) 7 percent
D) 7.7 percent
Answer: A
Diff: 1
Topic: Calculating Weighted Average Cost of Capital (WACC)
Learning Obj.: LG 6
Learning Outcome: F-13
AACSB: Analytical Thinking
22) The firm’s cost of a new issue of common stock is ________. (See Table 9.2)
A) 10.2 percent
B) 14.3 percent
C) 16.7 percent
D) 15.2 percent
23) The firm’s cost of retained earnings is ________. (See Table 9.2)
A) 10.2 percent
B) 14.3 percent
C) 18.9 percent
D) 15.0 percent
24) The weighted average cost of capital up to the point when retained earnings are exhausted is
________. (See Table 9.2)
A) 6.8 percent
B) 7.7 percent
C) 8.7 percent
D) 11.29 percent
37
25) Assuming the firm plans to pay out all of its earnings as dividends, the weighted average cost
of capital is ________. (See Table 9.2)
A) 10.44 percent
B) 8.9 percent
C) 11.6 percent
D) 12.1 percent
Answer: B
Table 9.3
Balance Sheet
General Talc Mines
December 31, 2019
26)
Given this after-tax cost of each source of capital, the weighted average cost of capital using
book weights for General Talc Mines is ________. (See Table 9.3)
A) 11.6 percent
B) 15.5 percent
C) 16.6 percent
D) 17.5 percent
27) General Talc Mines has compiled the following data regarding the market value and cost of
the specific sources of capital.
Market price per share of common stock $50
Market value of long-term debt $980 per bond
The weighted average cost of capital using market value weights is ________. (See Table 9.3)
A) 11.7 percent
B) 13.5 percent
C) 15.8 percent
D) 17.5 percent
28) A firm has determined its optimal capital structure, which is composed of the following
sources and target market value proportions:
Debt: The firm can sell a 20-year, $1,000 par value, 9 percent bond for $980. A flotation cost of
2 percent of the face value would be required in addition to the discount of $20.
Preferred Stock: The firm has determined it can issue preferred stock at $65 per share par
value. The stock will pay an $8.00 annual dividend. The cost of issuing and selling the stock is
$3 per share.
Common Stock: The firm’s common stock is currently selling for $40 per share. The dividend
expected to be paid at the end of the coming year is $5.07. Its dividend payments have been
growing at a constant rate for the last five years. Five years ago, the dividend was $3.45. It is
expected that to sell, a new common stock issue must be underpriced at $1 per share and the firm
must pay $1 per share in flotation costs. Additionally, the firm’s marginal tax rate is 40 percent.
Calculate the firm’s weighted average cost of capital assuming the firm has exhausted all retained
earnings.
29) Promo Pak has compiled the following financial data:
(a) Calculate the weighted average cost of capital using book value weights.
(b) Calculate the weighted average cost of capital using market value weights.
30) A certain firm originally had capital structure weights of 50% debt and 50% common equity.
Since establishing those weights, the firm’s stock price has risen dramatically. The firm has done
no additional borrowing. Assume that nothing else in the economy has changed (e.g., interest
rates, tax rates, and other macroeconomic factors remain constant). Because the firm’s stock price
has increased a great deal, ________.
A) the firm’s cost of equity has increased
B) the firm’s cost of debt has increased
C) the firm’s WACC has decreased
D) the firm’s cost of equity has decreased
31) If a firm’s stock price increases and everything else remains constant, the proportion of debt
in the firm’s capital structure will fall.
32) Debt is nearly always a less costly source of financing than equity. Does it follow then that
most firms could decrease their WACC if they simply used more debt and less equity in their
capital structure?