45) The cost of equity for RJ Corporation is 8.4 percent and the debt-equity ratio is .6. The
expected return on the market is 10.4 percent and the risk-free rate is 3.8 percent. Using the
common assumption for the debt beta, what is the asset beta?
A) .70
B) .44
C) .62
D) .67
E) .59
46) Barges has an asset beta of .57, the risk-free rate is 4.3 percent, and the market risk premium
is 7.7 percent. What is the equity beta if the firm has a debt-equity ratio of .56?
A) .46
B) .89
C) .74
D) .37
E) .32
47) HNT is an all-equity firm with a beta of .88. What will the firm’s equity beta be if the firm
switches to a debt-equity ratio of .35?
A) .88
B) 1.23
C) .97
D) 1.19
E) 1.06
48) A firm has an equity beta of 1.2, the risk-free rate is 3.4 percent, the market return is 15.7
percent, and the pretax cost of debt is 9.4 percent. The debt-equity ratio is .47. If you apply the
common beta assumptions, what is the firm’s asset beta?
A) .82
B) .61
C) .67
D) .58
E) .73
49) BG’s cost of equity is 9.4 percent, the expected return on the market is 13.6 percent, and the
risk-free rate is 3.8 percent. What is the firm’s debt-equity ratio if its asset beta is .36? Assume
there is no preferred stock.
A) .52
B) .59
C) .82
D) .77
E) .63
50) LR Engines stock is selling for $42.39 a share, has an ROE of 14.3 percent, and a dividend
payout ratio of 35 percent. The next expected dividend is $1.62 a share. What is the cost of
equity for this firm?
A) 12.86 percent
B) 13.12 percent
C) 13.47 percent
D) 12.52 percent
E) 13.70 percent
51) Clancy’s just paid its annual dividend of $1.48 per share. Analysts expect the stock price to
increase by 2.1 percent annually and value the stock at $14.65 per share currently. What is the
cost of equity for this firm?
A) 12.41 percent
B) 13.32 percent
C) 12.20 percent
D) 13.87 percent
E) 14.06 percent
52) Southern Imports is an all-equity firm with a beta of 1.32. The firm is considering a new
project that entails less risk than its current operations and thus management feels that the firm’s
beta should be lowered by .18 when assigning a discount rate to this project. The market rate of
return is 9.4 percent and the risk-free rate is 2.8 percent. What discount rate should be assigned
to this project?
A) 11.46 percent
B) 11.21 percent
C) 10.87 percent
D) 6.49 percent
E) 10.32 percent
53) APL has an overall cost of capital of 11.6 percent and a beta of 1.31. The firm is
contemplating a new project that is unrelated to the firm’s current operations. SKL is a firm that
operates similarly to the new project and SKL has a cost of capital of 10.7 percent. APL knows
that it will be less efficient than SKL and thus feels that an adjustment of +1 percent should be
added to the project’s discount rate to allow for this inefficiency. What discount rate should be
assigned to the new project?
A) 10.7 percent
B) 11.3 percent
C) 11.7 percent
D) 11.6 percent
E) 12.6 percent
54) The Shoe Box pays an annual dividend of $3.80 on its preferred stock. What is the cost of
preferred if the stock currently sells for $42.70 a share and the tax rate is 21 percent?
A) 7.94 percent
B) 11.87 percent
C) 6.68 percent
D) 9.39 percent
E) 8.90 percent
55) Ladder Works has debt outstanding with a coupon rate of 6 percent and a yield to maturity of
6.8 percent. What is the aftertax cost of debt if the tax rate is 21 percent? Assume all interest is
tax deductible.
A) 5.37 percent
B) 4.86 percent
C) 4.74 percent
D) 5.29 percent
E) 5.13 percent
56) High Road Tours has an aftertax cost of debt of 5.1 percent at its current tax rate of 34
percent. What will its aftertax cost of debt be if the tax rate drops to 21 percent? Assume all
interest is tax deductible.
A) 6.10 percent
B) 5.92 percent
C) 6.17 percent
D) 4.03 percent
E) 4.47 percent
57) Jack’s Construction Co. has 80 bonds outstanding that are selling at their par value of $1,000
each. Bonds with similar characteristics are yielding a pretax 8.6 percent. The firm also has
4,000 shares of common stock outstanding. The stock has a beta of 1.1 and sells for $40 a share.
The U.S. T-bill is yielding 4 percent, the market risk premium is 8 percent, and the firm’s tax rate
is 21 percent. What is the firm’s weighted average cost of capital assuming its earnings are
sufficient to classify all interest as a tax-deductible expense?
A) 10.10 percent
B) 11.39 percent
C) 10.80 percent
D) 10.65 percent
E) 11.40 percent
58) Peter’s Audio has a yield to maturity on its debt of 7.8 percent, a cost of equity of 12.4
percent, and a cost of preferred stock of 8 percent. The firm has 105 shares of common stock
outstanding at a market price of $22 a share. There are 25 shares of preferred stock outstanding
at a market price of $45 a share. The bond issue has a total face value of $1,500 and sells at 98
percent of face value. If the tax rate is 21 percent, what is the weighted average cost of capital
assuming all interest is tax deductible?
A) 9.68 percent
B) 8.54 percent
C) 8.69 percent
D) 9.52 percent
E) 9.45 percent
59) Phil’s Carvings wants to have a weighted average cost of capital of 9.5 percent. The firm has
an aftertax cost of debt of 6.5 percent and a cost of equity of 12.75 percent. What debt-equity
ratio is needed for the firm to achieve its targeted weighted average cost of capital?
A) .84
B) .92
C) 1.08
D) .76
E) .67
60) Sound Systems has 200 shares of common stock outstanding at a market price of $37 a share.
The firm recently paid an annual dividend in the amount of $1.20 per share and has a dividend
growth rate of 4 percent. The firm also has 5 bonds outstanding with a face value of $1,000 per
bond that are selling at 99 percent of par. The bonds have a coupon rate of 6 percent and a yield
to maturity of 6.7 percent. All interest is tax deductible. If the tax rate is 21 percent, what is the
weighted average cost of capital?
A) 5.93 percent
B) 6.87 percent
C) 6.37 percent
D) 6.54 percent
E) 7.08 percent
61) Suppose Simmons’ common stock has a beta of 1.37, the risk-free rate is 3.4 percent, and the
market risk premium is 8.2 percent. The yield to maturity on the firm’s bonds is 7.6 percent and
the debt-equity ratio is .45. What is the WACC if the tax rate is 23 percent and all interest is tax
deductible?
A) 14.07 percent
B) 10.94 percent
C) 12.60 percent
D) 10.59 percent
E) 11.91 percent
62) Tin Roof’s net cash flows for the next three years are projected at $72,000, $78,000, and
$84,000, respectively. After that, the cash flows are expected to increase by 3.2 percent annually.
The aftertax cost of debt is 6.2 percent and the cost of equity is 11.4 percent. What is the value of
the firm if it is financed with 40 percent debt and 60 percent equity?
A) $1,215,650
B) $1,328,141
C) $1,461,439
D) $1,575,941
E) $1,279,623
63) The expected net cash flows of Advantage Leasing for the next three years are $42,000,
$49,000, and $64,000, respectively. After three years, the growth rate of these cash flows will be
a constant 2 percent annually. The WACC is 8 percent. What is the present value of the terminal
value?
A) $881,822
B) $863,689
C) $959,259
D) $910,444
E) $828,406
64) Norris Co. has developed an improved version of its most popular product. To get this
improvement to the market will cost $48 million but the project will return an additional $13.5
million for 5 years in net cash flows. The firm’s debt-equity ratio is .25, the cost of equity is 13
percent, the pretax cost of debt is 9 percent, and the tax rate is 21 percent. All interest is tax
deductible. What is the net present value of this proposed project?
A) $906,411
B) $902,459
C) $879,838
D) $884,318
E) $889,760
65) Hu’s has 25,000 shares of common stock outstanding with a beta of 1.4, a market price of
$32 a share, and a dividend yield of 5.7 percent. Dividends increase by 4.2 percent annually. The
firm also has $450,000 of debt outstanding that is selling at 102 percent of par that has a yield to
maturity of 6.8 percent. The tax rate is 21 percent and all interest is tax deductible. The firm is
considering a project that has the same risk level as the firm’s current operations, an initial cost
of $328,000 and cash inflows of $52,500, $155,000, and $225,000 for Years 1 to 3, respectively.
What is the NPV of the project?
A) $28,515
B) $31,492
C) $36,511
D) $27,006
E) $30,157
66) ABC is considering acquiring XYZ and has compiled this information on XYZ:
Year
1
2
3
EBIT
$
318,000
$
364,000
$
392,000
Capital spending
46,500
28,000
36,200
Increases in net working capital
5,500
6,500
1,200
Depreciation
34,000
32,100
28,700
The applicable tax rate is 21 percent and the terminal value of XYZ as of Year 3 is $2.5 million.
What is the NPV of this acquisition if the discount rate is 7.1 percent and the acquisition cost is
$2.25 million?
A) $538,316
B) $509,482
C) $499,003
D) $506,048
E) $496,399
67) The Upper Tier has a current debt-equity ratio of .52 and a target debt-equity ratio of .45.
The cost of floating equity is 9.5 percent and the flotation cost of debt is 6.6 percent. What
should the firm use as their weighted average flotation cost?
A) 8.01 percent
B) 8.51 percent
C) 8.33 percent
D) 7.76 percent
E) 8.60 percent
68) Downtown Stores can issue equity at a flotation cost of 8.76 percent and debt at 5.93 percent.
The firm currently has a debt-equity ratio of .37 but prefers a ratio of .35. What should this firm
use as their weighted average flotation cost?
A) 8.26 percent
B) 8.03 percent
C) 8.34 percent
D) 8.37 percent
E) 8.00 percent
69) Explain a) the factors that determine a security’s beta and b) how asset beta relates to equity
beta.
70) The Neptune Company offers network communications systems to computer users. The
company is planning a major investment expansion but is unsure of the cost of equity capital as it
has no publicly-traded equity. Your assignment is to determine an appropriate equity cost. List
and explain the steps you will need to take to complete this assignment.
71) World Corporation has traditionally employed a firm-wide discount rate for capital
budgeting purposes. However, its two divisions, publishing and entertainment, have different
degrees of risk given by βP = 1.1, βE = 1.8, while the beta for the overall firm is 1.3. The
publishing division has proposed three projects with these internal rates of return: P1 = 13.2
percent; P2 = 12.4 percent; and P3 = 9.8 percent. The entertainment division has presented their
three projects: E1 = 16.4 percent; E2 = 17.8 percent; and E3 = 14.7 percent. The risk-free rate is
4 percent and the market risk premium is 8 percent. Identify which projects will be accepted if
the firm applies its overall beta to all projects. Then identify which projects will be accepted if
the division betas are properly applied.
72) On-line Text Co. has four new text publishing products that it is considering. The projects
are of equal risk with a beta of 1.6. The risk-free rate is 4.2 percent and the market rate is
expected to be 12.3 percent. The projects and their expected internal rates of return are: W = 14.4
percent; X = 18 percent, Y = 16.4 percent; and Z = 17.2 percent. Which projects should be
accepted? Justify your acceptance decision.