60) SIROM Scientific Solutions has $10 million of outstanding equity and $10 million of bank debt. The bank
debt costs 7% per year. The estimated equity beta is 2. If the market risk premium is 6% and the risk–free
rate is 5%, compute the weighted average cost of capital if the firm’s tax rate is 30%.
A) 9.56%
B) 10.21%
C) 10.95%
D) 11.45%
61) SIROM Scientific Solutions has $4 million of outstanding equity and $12 million of bank debt. The bank
debt costs 5% per year. The estimated equity beta is 1. If the market risk premium is 7% and the risk–free
rate is 4%, compute the weighted average cost of capital if the firm’s tax rate is 30%.
A) 4.65%
B) 5.01%
C) 5.38%
D) 5.98%
62) A firm has a capital structure with $50 million in equity and $100 million of debt. The cost of equity capital
is 12% and the pretax cost of debt is 7%. If the marginal tax rate of the firm is 40%, compute the weighted
average cost of capital of the firm.
A) 5.6%
B) 6.3%
C) 6.8%
D) 7.7%
63) A firm has a capital structure with $30 million in equity and $90 million of debt. The cost of equity capital is
10% and the pretax cost of debt is 6%. If the marginal tax rate of the firm is 40%, compute the weighted
average cost of capital of the firm.
A) 4.6%
B) 4.9%
C) 5.2%
D) 5.8%
64) A firm has a capital structure with $100 million in equity and $100 million of debt. The cost of equity capital
is 14% and the pretax cost of debt is 8%. If the marginal tax rate of the firm is 30%, compute the weighted
average cost of capital of the firm.
A) 9.8%
B) 10.3%
C) 11.1%
D) 11.7%
65) A firm has a pre–tax cost of debt of 8.5%. If the firm has a marginal tax rate of 40%, what is its effective cost
of debt?
A) 5.1%
B) 3.4%
C) 8.5%
D) 8.1%
66) The after–tax cost of debt ________ the before–tax cost of debt for a firm that has a positive marginal tax rate.
A) is always greater than
B) is always equal to
C) is always less than
D) may be greater than or less than
TRUE/FALSE. Write ‘T’ if the statement is true and ‘F’ if the statement is false.
67) The WACC does not depend on the risk of a company’s line of business.
MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.
68) Time Warner shares have a market capitalization of $50 billion. The company is expected to pay a dividend
of $0.30 per share and each share trades for $30. The growth rate in dividends is expected to be 7% per year.
Also, Time Warner has $15 billion of debt that trades with a yield to maturity of 8%. If the firm’s tax rate is
30%, what is the WACC?
A) 6.55%
B) 7.24%
C) 7.45%
D) 7.91%
69) Time Warner shares have a market capitalization of $60 billion. The company is expected to pay a dividend
of $0.35 per share and each share trades for $30. The growth rate in dividends is expected to be 8% per year.
Also, Time Warner has $15 billion of debt that trades with a yield to maturity of 7%. If the firm’s tax rate is
30%, compute the WACC?
A) 7.45%
B) 7.91%
C) 8.11%
D) 8.31%
70) Time Warner shares have a market capitalization of $55 billion. The company just paid a dividend of $0.35
per share and each share trades for $35. The growth rate in dividends is expected to be 6.5% per year.
Also, Time Warner has $20 billion of debt that trades with a yield to maturity of 7%. If the firm’s tax rate is
30%, compute the WACC?
A) 6.81%
B) 6.85%
C) 7.45%
D) 7.93%
71) The market value of Fords’ equity, preferred stock, and debt are $6 billion, $2 billion, and $15 billion,
respectively. Ford has a beta of 1.5, the market risk premium is 7%, and the risk–free rate of interest is 4%.
Ford’s preferred stock pays a dividend of $3 each year and trades at a price of $27 per share. Ford’s debt
trades with a yield to maturity of 8.5%. What is Ford’s weighted average cost of capital if its tax rate is 30%?
A) 8.87%
B) 8.63%
C) 9.56%
D) 10.13%
72) The market value of Fords’ equity, preferred stock and debt are $7 billion, $3 billion, and $10 billion,
respectively. Ford has a beta of 1.8, the market risk premium is 7%, and the risk–free rate of interest is 4%.
Ford’s preferred stock pays a dividend of $3.5 each year and trades at a price of $27 per share. Ford’s debt
trades with a yield to maturity of 9.5%. What is Ford’s weighted average cost of capital if its tax rate is 30%?
A) 10.12%
B) 10.34%
C) 11.08%
D) 11.47%
73) The market value of Fords’ equity, preferred stock and debt are $8 billion, $4 billion and $12 billion
respectively. Ford has a beta of 1.3, the market risk premium is 7% and the risk–free rate of interest is 4%.
Ford’s preferred stock pays a dividend of $4 each year and trades at a price of $30 per share. Ford’s debt
trades with a yield to maturity of 8.5%. What is Ford’s weighted average cost of capital if its tax rate is 30%?
A) 8.01%
B) 8.34%
C) 9.46%
D) 9.56%
74) When calculating the WACC, it is standard practice to subtract ________ to compute the net debt
outstanding.
A) equity
B) dividends
C) cash and risk–free securities
D) coupons
75) Many financial managers use market risk premiums that are closer to 5%, which is lower than historical
averages, because investors require a ________ risk premium for holding risky securities than in the past.
A) lower
B) higher
C) similar
D) none of the above
76) When corporate tax rates decline, the net cost of debt financing
A) decreases.
B) is unchanged.
C) increases.
D) none of the above
SHORT ANSWER. Write the word or phrase that best completes each statement or answers the question.
77) What type of adjustment to net debt are prevalent in practice?
MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.
78) Ford Motor Company is discussing new ways to recapitalize the firm and raise additional capital. Its
current capital structure has a 20% weight in equity, 10% in preferred stock, and 70% in debt. The cost of
equity capital is 14%, the cost of preferred stock is 10%, and the pretax cost of debt is 9%. What is the
weighted average cost of capital for Ford if its marginal tax rate is 30%?
A) 7.87%
B) 8.21%
C) 8.89%
D) 9.21%
79) Ford Motor Company is discussing new ways to recapitalize the firm and raise additional capital. Its
current capital structure has a 30% weight in equity, 10% in preferred stock, and 60% in debt. The cost of
equity capital is 17%, the cost of preferred stock is 11%, and the pretax cost of debt is 8%. What is the
weighted average cost of capital for Ford if its marginal tax rate is 30%?
A) 9.56%
B) 9.96%
C) 10.25%
D) 10.73%
80) Ford Motor Company is discussing new ways to recapitalize the firm and raise additional capital. Its
current capital structure has a 10% weight in equity, 20% in preferred stock, and 70% in debt. The cost of
equity capital is 15%, the cost of preferred stock is 10%, and the pretax cost of debt is 8%. What is the
weighted average cost of capital for Ford if its marginal tax rate is 30%?
A) 7.01%
B) 7.42%
C) 7.98%
D) 8.01%
81) Assume JUP has debt with a book value of $20 million, trading at 120% of par value. The bonds have a
yield to maturity of 6%. The firm has book equity of $20 million, and 2 million shares trading at $18 per
share. The firm’s cost of equity is 12%. What is JUP’s WACC if the firm’s marginal tax rate is 35%?
A) 9.60%
B) 8.76%
C) 9.00%
D) 6.24%
82) Holding everything else constant, an increase in cash ________ the firm’s net debt.
A) will decrease
B) will have no impact on
C) will increase
D) may increase or decrease
TRUE/FALSE. Write ‘T’ if the statement is true and ‘F’ if the statement is false.
83) When a firm is evaluating the purchase of a business that is unrelated to its current business, it is appropriate
to use the current WACC of the firm that is purchasing the business.
MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.
84) General Motors has a weighted average cost of capital of 9%. GM is considering investing in a new plant
that will save the company $25 million over each of the first two years, and then $10 million each year
thereafter. If the investment is $100 million, what is the net present value (NPV) of the project?
A) $34.2 million
B) $39.7 million
C) $37.5 million
D) $36.5 million
85) General Motors has a weighted average cost of capital of 10%. GM is considering investing in a new plant
that will save the company $20 million over each of the first two years, and then $15 million each year
thereafter. If the investment is $150 million, what is the net present value (NPV) of the project?
A) $6.6 million
B) $7.3 million
C) $7.9 million
D) $8.7 million
86) General Motors has a weighted average cost of capital of 11%. GM is considering investing in a new plant
that will save the company $30 million over each of the first two years, and then $25 million each year
thereafter. If the investment is $150 million, what is the net present value (NPV) of the project?
A) $45 million
B) –$51 million
C) $–41 million
D) $86 million
87) When we use the WACC to assess a project, we assume that the ________ ratio does not change.
A) reward to systematic risk
B) risk to reward
C) debt to equity
D) volatility to systematic risk
88) When we compute the cost of equity capital for a project we assume that the ________ of the project is
equivalent to the average risk of the firm’s investments.
A) diversifiable risk
B) market risk
C) non–systematic risk
D) volatility
SHORT ANSWER. Write the word or phrase that best completes each statement or answers the question.
89) What is the assumption about risk when using WACC to evaluate a project?
90) What is the assumption about leverage when using WACC to evaluate a project?
MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.
91) SAP Inc. received a $1 million grant under its Small Business Innovation program. SAP invested the grant
money and developed a system to remove metal contaminants from storm water in shipyards. The firm
estimates that each shipyard spends $500,000 a year on storm water clean–up efforts. If SAP is able to sign
up and retain four shipyards from the first year onwards, what is the present value (PV) of the project (net of
investment) if the cost of capital for SAP is 18% per year? Assume a cost of operations and other costs for
SAP equal 50% of revenue.
A) $4.56 million
B) $4.98 million
C) $5.32 million
D) $5.87 million
92) SAP Inc. received a $2 million grant under its Small Business Innovation program. SAP invested the grant
money and developed a system to remove metal contaminants from storm water in shipyards. The firm
estimates that each shipyard spends $600,000 a year on storm water clean–up efforts. If SAP is able to sign
up and retain four shipyards from the first year onwards, what is the present value (PV) of the project (net of
investment) if the cost of capital for SAP is 15% per year? Assume a cost of operations and other costs for
SAP equal 40% of revenue.
A) $6.3 million
B) $6.7 million
C) $7.6 million
D) $7.9 million