3) Rogue Rotors has debt with a market value of $350,000, preferred stock with a market value
of $100,000, and common stock with a market value of $650,000. If debt has a cost of 7%,
preferred stock a cost of 9%, common stock a cost of 13%, and the firm has a tax rate of 30%,
what is the WACC?
A) 8.64%
B) 9.12%
C) 10.06%
D) 10.88%
4) The following information comes from the balance sheet of Roamer Enterprises. The value of
common stock is $60,000, retained earnings equal $40,000, total common equity equals
$100,000, preferred stock has a value of $10,000 and long-term debt totals $120,000. For
purposes of estimating the firm’s WACC, what are the weights of long-term debt, preferred
stock, and equity?
A) D/V = 52.17%, PS/V = 43.48%, and E/V = 4.35%
B) D/V = 52.17%, PS/V = 4.35%, and E/V = 43.48%
C) D/V = $120,000, PS/V = $10,000, and E/V =$100,000
D) There is not enough information to answer this question.
5) The following information comes from the Galaxy Construction balance sheet. The value of
common stock is $10,000, retained earnings equals $7,000, total common equity equals $17,000,
preferred stock has a value of $3,000, and long-term debt totals $15,000. If the cost of debt is
8.00%, preferred stock has a cost of 10.00%, common stock has a cost of 12.00%, and the firm
has a corporate tax rate of 30%, calculate the firm’s WACC adjusted for taxes.
A) 10.11%
B) 10.00%
C) 9.09%
D) There is not enough information to answer this question.
6) The following market information was gathered for the ACME corporation. The common
stock is selling for $40.00 per share and there are 100,000 shares outstanding. Retained earnings
equal $400,000, preferred stock has 1,000 shares outstanding selling at $120.00 per share, and
500 outstanding long-term bonds are selling for $1,035.00 each. For purposes of estimating the
firm’s WACC, what are the market value weights of long-term debt, preferred stock, and equity?
A) D/V = 11.16%, PS/V = 2.59%, and E/V = 86.25%
B) D/V = 10.27%, PS/V = 2.38%, and E/V = 87.34%
C) D/V = 10.78%, PS/V = 3.08%, and E/V = 86.14%
D) D/V = 33.33%, PS/V = 33.33%, and E/V = 33.33%
7) The following market information was gathered for the Rogue Corporation. The firm has
5,000 bonds outstanding, each selling for $1,050.00 with a required rate of return of 7.00%.
Rogue has 3,000 shares of preferred stock outstanding, selling for $60.00 per share and 80,000
shares of common stock outstanding, selling for $24.00 per share. If the preferred stock has a
required rate of return of 9.00% and the common stock requires a 11.00% return, and the firm
has a corporate tax rate of 20%, calculate the firm’s WACC adjusted for taxes.
A) 6.77%
B) 9.23%
C) 9.53%
D) There is not enough information to answer this question because there is no information
provided about the amount of retained earnings held by the firm.
8) Market values require multiplying the ________ of each component source of capital by the
________.
A) price; quantity
B) book value; quantity
C) price; book value
D) None of the above
9) Investors ________ for estimating the WACC.
A) are indifferent between using market and book value
B) prefer book value to market value
C) prefer market value to book value
D) prefer a mix of book and market value
10) Generally speaking, when the information is available, investors prefer to use ________
rather than ________ when evaluating a firm.
A) past data; current data
B) market values; book values
C) current data; market values
D) book values; market values
12) To estimate the market value of a publicly traded bond that has a broad market with frequent
trading, it is usually best to multiply the number of bonds outstanding by the bond par value.
13) When possible, investors and analysts prefer to use book value to market value for estimating
the WACC.
14) Equity is an attractive form of financing for a firm because it has additional tax advantages
for the firm compared to debt.
15) When estimating a weighted average cost of capital, a firm can use either book values or
market values for estimating the value of the component sources of capital. Where would you
find book values, and what value do they represent? How would you calculate market values? In
general, would you prefer to use market or book values for estimating the WACC? Under what
circumstances would you use book values?
26
Copyright © 2019 Pearson Education, Inc.
11.4 Using the Weighted Average Cost of Capital in a Budgeting Decision
1) Your firm has an average-risk project under consideration. You choose to fund the project in
the same manner as the firm’s existing capital structure. If the cost of debt is 8.00%, the cost of
preferred stock is 11.00%, the cost of common stock is 14.00%, and the WACC adjusted for
taxes is 13.00%, what is the NPV of the project, given the expected cash flows listed here?
Category
T0
T1
T2
T3
Investment
-$2,000,000
NWC
-$250,000
$250,000
Operating Cash Flow
$850,000
$850,000
$850,000
Salvage
$50,000
Total Incremental Cash Flow
-$2,250,000
$850,000
$850,000
$1,150,000
A) -$74,121
B) $-35,105
C) $2,214,895
D) $2,479,604
2) Your firm has an average-risk project under consideration. You choose to fund the project in
the same manner as the firm’s existing capital structure. If the cost of debt is 8.00%, the cost of
preferred stock is 11.00%, the cost of common stock is 14.00%, and the WACC adjusted for
taxes is 13.00%, what is the IRR of the project given the expected cash flows listed here? Use a
financial calculator to determine your answer.
Category
T0
T1
T2
T3
Investment
-$2,000,000
NWC
-$250,000
$250,000
Operating Cash Flow
$850,000
$850,000
$850,000
Salvage
$50,000
Total Incremental Cash Flow
-$2,250,000
$850,000
$850,000
$1,150,000
A) About 12.13%
B) About 13.00%
C) About 24.95%
D) There is not enough information to answer this question.
3) Your firm has an average-risk project under consideration. You choose to fund the project in
the same manner as the firm’s existing capital structure. If the cost of debt is 8.50%, the cost of
preferred stock is 9.00%, the cost of common stock is 11.50%, and the WACC adjusted for taxes
is 10.50%, what is the NPV of the project, given the expected cash flows listed here?
Category
T0
T1
T2
T3
Investment
-$800,000
NWC
-$50,000
$50,000
Operating Cash Flow
$350,000
$350,000
$350,000
Salvage
$20,000
Total Incremental Cash Flow
-$850,000
$350,000
$350,000
$420,000
A) $914,675
B) $98,415
C) $64,675
D) $48,415
4) Your firm has an average-risk project under consideration. You choose to fund the project in
the same manner as the firm’s existing capital structure. If the cost of debt is 8.50%, the cost of
preferred stock is 9.00%, the cost of common stock is 11.50%, and the WACC adjusted for taxes
is 10.50%, what is the IRR of the project, given the expected cash flows listed here? Use a
financial calculator to determine your answer.
Category
T0
T1
T2
T3
Investment
-$800,000
NWC
-$50,000
$50,000
Operating Cash Flow
$350,000
$350,000
$350,000
Salvage
$20,000
Total Incremental Cash Flow
-$850,000
$350,000
$350,000
$420,000
A) About 11.50%
B) About 12.30%
C) About 14.67%
D) There is not enough information to answer this question.
5) Your firm has an average-risk project under consideration. You choose to fund the project in
the same manner as the firm’s existing capital structure. If the cost of debt is 10.00%, the cost of
preferred stock is 13.00%, the cost of common stock is 16.00%, and the WACC adjusted for
taxes is 13.00%, what is the NPV of the project, given the expected cash flows listed here?
Category
T0
T1
T2
T3
Investment
-$3,000,000
NWC
-$350,000
$350,000
Operating Cash Flow
$950,000
$950,000
$950,000
Salvage
$50,000
Total Incremental Cash Flow
-$3,350,000
$950,000
$950,000
$1,350,000
A) -$917,930
B) -$829,685
C) $0
D) $2,520,315
6) Your firm has an average-risk project under consideration. You choose to fund the project in
the same manner as the firm’s existing capital structure. If the cost of debt is 11.00%, the cost of
preferred stock is 12.00%, the cost of common stock is 17.00%, and the WACC adjusted for
taxes is 15.00%, what is the IRR of the project, given the expected cash flows listed here? Use a
financial calculator to determine your answer.
Category
T0
T1
T2
T3
Investment
-$2,000,000
NWC
-$350,000
$350,000
Operating Cash Flow
$950,000
$950,000
$950,000
Salvage
$50,000
Total Incremental Cash Flow
-$2,350,000
$950,000
$950,000
$1,350,000
A) About 16.97%
B) About 12.02%
C) About 11.16%
D) About 8.94%
7) If all projects are assigned the same discount rate for purposes of evaluation, which of the
following could occur?
A) Low-risk projects could be rejected when in fact they are good investment choices.
B) High-risk projects could be accepted when in fact they are poor investment choices.
C) High-risk projects could be accepted when in fact they are good investment choices.
D) All of the choices could occur when using a single discount rate for all projects.
8) It is necessary to assign the appropriate cost of capital for each individual project that reflects
that project’s ________ when doing capital budgeting.
A) life
B) cash flows
C) riskiness
D) managers