CHAPTER 10—THE COST OF CAPITAL
77. Trahan Lumber Company hired you to help estimate its cost of capital. You obtained the following data: D1 = $1.25;
P0 = $27.50; g = 5.00% (constant); and F = 6.00%. What is the cost of equity raised by selling new common stock?
a.
9.06%
b.
9.44%
c.
9.84%
d.
10.23%
e.
10.64%
c
MODERATE
10-6 Cost of New Common Stock, re
78. You were recently hired by Scheuer Media Inc. to estimate its cost of capital. You obtained the following data: D1 =
$1.75; P0 = $42.50; g = 7.00% (constant); and F = 5.00%. What is the cost of equity raised by selling new common stock?
a.
10.77%
b.
11.33%
c.
11.90%
d.
12.50%
e.
13.12%
MODERATE
CHAPTER 10—THE COST OF CAPITAL
c
79. Weaver Chocolate Co. expects to earn $3.50 per share during the current year, its expected dividend payout ratio is
65%, its expected constant dividend growth rate is 6.0%, and its common stock currently sells for $32.50 per share. New
stock can be sold to the public at the current price, but a flotation cost of 5% would be incurred. What would be the cost of
equity from new common stock?
a.
12.70%
b.
13.37%
c.
14.04%
d.
14.74%
e.
15.48%
MODERATE
10-6 Cost of New Common Stock, re
80. Sorensen Systems Inc. is expected to pay a $2.50 dividend at year end (D1 = $2.50), the dividend is expected to grow
at a constant rate of 5.50% a year, and the common stock currently sells for $52.50 a share. The before-tax cost of debt is
7.50%, and the tax rate is 40%. The target capital structure consists of 45% debt and 55% common equity. What is the
company’s WACC if all the equity used is from retained earnings?
a.
7.07%
b.
7.36%
c.
7.67%
d.
7.98%
e.
8.29%
CHAPTER 10—THE COST OF CAPITAL
81. You were hired as a consultant to Quigley Company, whose target capital structure is 35% debt, 10% preferred, and
55% common equity. The interest rate on new debt is 6.50%, the yield on the preferred is 6.00%, the cost of retained
earnings is 11.25%, and the tax rate is 40%. The firm will not be issuing any new stock. What is Quigley’s WACC?
a.
8.15%
b.
8.48%
c.
8.82%
d.
9.17%
e.
9.54%
a
MODERATE
10-7 Composite, or Weighted Average, Cost of Capital, WACC
82. Keys Printing plans to issue a $1,000 par value, 20-year noncallable bond with a 7.00% annual coupon, paid
semiannually. The company’s marginal tax rate is 40.00%, but Congress is considering a change in the corporate tax rate
to 30.00%. By how much would the component cost of debt used to calculate the WACC change if the new tax rate was
adopted?
a.
0.57%
b.
0.63%
MODERATE
10-7 Composite, or Weighted Average, Cost of Capital, WACC
WACC
CHAPTER 10—THE COST OF CAPITAL
c.
0.70%
d.
0.77%
e.
0.85%
c
MODERATE/CHALLENGING
10-3 Cost of Debt rd(1 – T)
83. S. Bouchard and Company hired you as a consultant to help estimate its cost of capital. You have obtained the
following data: D0 = $0.85; P0 = $22.00; and g = 6.00% (constant). The CEO thinks, however, that the stock price is
temporarily depressed, and that it will soon rise to $40.00. Based on the DCF approach, by how much would the cost of
equity from retained earnings change if the stock price changes as the CEO expects?
a.
−1.49%
b.
−1.66%
c.
−1.84%
d.
−2.03%
e.
−2.23%
c
CHAPTER 10—THE COST OF CAPITAL
MODERATE/CHALLENGING
10-5 The Cost of Retained Earnings, rs
84. Sapp Trucking’s balance sheet shows a total of noncallable $45 million long-term debt with a coupon rate of 7.00%
and a yield to maturity of 6.00%. This debt currently has a market value of $50 million. The balance sheet also shows that
the company has 10 million shares of common stock, and the book value of the common equity (common stock plus
retained earnings) is $65 million. The current stock price is $22.50 per share; stockholders’ required return, rs, is 14.00%;
and the firm’s tax rate is 40%. The CFO thinks the WACC should be based on market-value weights, but the president
thinks book weights are more appropriate. What is the difference between these two WACCs?
a.
1.55%
b.
1.72%
c.
1.91%
d.
2.13%
e.
2.36%
e
10-7 Composite, or Weighted Average, Cost of Capital, WACC
CHAPTER 10—THE COST OF CAPITAL
85. The CFO of Lenox Industries hired you as a consultant to help estimate its cost of capital. You have obtained the
following data: (1) rd = yield on the firm’s bonds = 7.00% and the risk premium over its own debt cost = 4.00%. (2) rRF =
5.00%, RPM = 6.00%, and b = 1.25. (3) D1 = $1.20, P0 = $35.00, and g = 8.00% (constant). You were asked to estimate
the cost of equity based on the three most commonly used methods and then to indicate the difference between the highest
and lowest of these estimates. What is that difference?
a.
1.13%
b.
1.50%
c.
1.88%
d.
2.34%
e.
2.58%
CHALLENGING
10-5 The Cost of Retained Earnings, rs
86. Eakins Inc.’s common stock currently sells for $45.00 per share, the company expects to earn $2.75 per share during
the current year, its expected payout ratio is 70%, and its expected constant growth rate is 6.00%. New stock can be sold
to the public at the current price, but a flotation cost of 8% would be incurred. By how much would the cost of new stock
CHAPTER 10—THE COST OF CAPITAL
exceed the cost of retained earnings?
a.
0.09%
b.
0.19%
c.
0.37%
d.
0.56%
e.
0.84%
c
Payout ratio
Current stk price
CHALLENGING
10-6 Cost of New Common Stock, re
87. Bolster Foods’ (BF) balance sheet shows a total of $25 million long-term debt with a coupon rate of 8.50%. The yield
to maturity on this debt is 8.00%, and the debt has a total current market value of $27 million. The balance sheet also
shows that the company has 10 million shares of stock, and the stock has a book value per share of $5.00. The current
stock price is $20.00 per share, and stockholders’ required rate of return, rs, is 12.25%. The company recently decided that
its target capital structure should have 35% debt, with the balance being common equity. The tax rate is 40%. Calculate
WACCs based on book, market, and target capital structures, and then find the sum of these three WACCs.
a.
28.36%
b.
29.54%
c.
30.77%
d.
32.00%
e.
33.28%
c
Tax rate
Coupon rate
Number of shares (millions)
CHAPTER 10—THE COST OF CAPITAL
88. Daves Inc. recently hired you as a consultant to estimate the company’s WACC. You have obtained the following
information. (1) The firm’s noncallable bonds mature in 20 years, have an 8.00% annual coupon, a par value of $1,000,
and a market price of $1,050.00. (2) The company’s tax rate is 40%. (3) The risk-free rate is 4.50%, the market risk
premium is 5.50%, and the stock’s beta is 1.20. (4) The target capital structure consists of 35% debt and the balance is
common equity. The firm uses the CAPM to estimate the cost of equity, and it does not expect to issue any new common
stock. What is its WACC?
a.
7.16%
b.
7.54%
c.
7.93%
d.
8.35%
e.
8.79%
e
CHALLENGING
10-7 Composite, or Weighted Average, Cost of Capital, WACC
CHAPTER 10—THE COST OF CAPITAL
CHALLENGING
10-7 Composite, or Weighted Average, Cost of Capital, WACC
89. Assume that you are on the financial staff of Vanderheiden Inc., and you have collected the following data: The yield
on the company’s outstanding bonds is 7.75%, its tax rate is 40%, the next expected dividend is $0.65 a share, the
dividend is expected to grow at a constant rate of 6.00% a year, the price of the stock is $15.00 per share, the flotation cost
for selling new shares is F = 10%, and the target capital structure is 45% debt and 55% common equity. What is the firm’s
WACC, assuming it must issue new stock to finance its capital budget?
a.
6.89%
b.
7.26%
c.
7.64%
d.
8.04%
e.
8.44%
CHALLENGING
10-7 Composite, or Weighted Average, Cost of Capital, WACC
CHAPTER 10—THE COST OF CAPITAL
90. Vang Enterprises, which is debt-free and finances only with equity from retained earnings, is considering 7 equal-
sized capital budgeting projects. Its CFO hired you to assist in deciding whether none, some, or all of the projects should
be accepted. You have the following information: rRF = 4.50%; RPM = 5.50%; and b = 0.92. The company adds or
subtracts a specified percentage to the corporate WACC when it evaluates projects that have above- or below-average
risk. Data on the 7 projects are shown below. If these are the only projects under consideration, how large should the
capital budget be?
Risk
Expected
Project
Factor
Return
1
−2.00%
7.60%
2
−1.00%
9.15%
3
0.00%
10.10%
4
1.00%
10.40%
5
2.00%
10.80%
6
2.00%
10.90%
7
2.00%
13.00%
a.
$100
b.
$ 75
c.
$ 50
d.
$ 25
e.
$ 0
a
1
CHALLENGING
10-9 Adjusting the Cost of Capital for Risk
United States – BUSPROG.FOFM.BRIG.16.03 – Analytic skills
United States – OH – DISC.FOFM.BRIG.16.03 – Capital budgeting and cost of capital
United States – OH – DISC.FOFM.BRIG.16.03 – Capital budgeting and cost of capital
WACC and equity from RE
Bloom’s: Analysis
Multiple Choice: Problem
CHAPTER 10—THE COST OF CAPITAL
Exhibit 10.1
Assume that you have been hired as a consultant by CGT, a major producer of chemicals and plastics, including plastic
grocery bags, styrofoam cups, and fertilizers, to estimate the firm’s weighted average cost of capital. The balance sheet
and some other information are provided below.
Assets
Current assets
$ 38,000,000
Net plant, property, and equipment
101,000,000
Total assets
$139,000,000
Liabilities and Equity
Accounts payable
$ 10,000,000
Accruals
9,000,000
Current liabilities
$ 19,000,000
Long-term debt (40,000 bonds, $1,000 par value)
40,000,000
Total liabilities
$ 59,000,000
Common stock (10,000,000 shares)
30,000,000
Retained earnings
50,000,000
Total shareholders’ equity
80,000,000
Total liabilities and shareholders’ equity
$139,000,000
The stock is currently selling for $15.25 per share, and its noncallable $1,000 par value, 20-year, 7.25% bonds with
semiannual payments are selling for $875.00. The beta is 1.25, the yield on a 6-month Treasury bill is 3.50%, and the
yield on a 20-year Treasury bond is 5.50%. The required return on the stock market is 11.50%, but the market has had an
average annual return of 14.50% during the past 5 years. The firm’s tax rate is 40%.
91. Refer to Exhibit 10.1. What is the best estimate of the after-tax cost of debt?
a.
4.64%
b.
4.88%
c.
5.14%
d.
5.40%
e.
5.67%
c
MODERATE
10-2 Basic Definitions
FOFM.BRIG.16.10.02 – Basic Definitions
United States – BUSPROG.FOFM.BRIG.16.03 – Analytic skills
Project risk
Bloom’s: Evaluation
Multiple Choice: Problem
CHAPTER 10—THE COST OF CAPITAL
92. Refer to Exhibit 10.1. Based on the CAPM, what is the firm’s cost of equity?
a.
11.15%
b.
11.73%
c.
12.35%
d.
13.00%
e.
13.65%
MODERATE
10-5 The Cost of Retained Earnings, rs
93. Refer to Exhibit 10.1. Which of the following is the best estimate for the weight of debt for use in calculating the
WACC?
a.
18.67%
b.
19.60%
c.
20.58%
d.
21.61%
e.
22.69%
a
MODERATE
10-7 Composite, or Weighted Average, Cost of Capital, WACC
CHAPTER 10—THE COST OF CAPITAL
94. Refer to Exhibit 10.1. What is the best estimate of the firm’s WACC?
a.
10.85%
b.
11.19%
c.
11.53%
d.
11.88%
e.
12.24%
c
MODERATE
10-7 Composite, or Weighted Average, Cost of Capital, WACC
WACC