CHAPTER 11—DETERMINING THE COST OF CAPITAL
76. Trahern Baking Co. common stock sells for $32.50 per share. It expects to earn $3.50 per share during the current
year, its expected dividend payout ratio is 65%, and its expected constant dividend growth rate is 6.0%. 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.
b.
c.
d.
e.
77. You are a finance intern at Chambers and Sons and they have asked you to help estimate the company’s cost of
common equity. You obtained the following data: D1 = $1.25; P0 = $27.50; g = 5.00% (constant); and F = 6.00%. What is
CHAPTER 11—DETERMINING THE COST OF CAPITAL
the cost of equity raised by selling new common stock?
a.
b.
c.
d.
e.
c
capital
78. You were recently hired by Garrett Design, Inc. to estimate its cost of common equity. 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.
b.
c.
d.
e.
capital
CHAPTER 11—DETERMINING THE COST OF CAPITAL
79. Quinlan Enterprises stock trades for $52.50 per share. It is expected to pay a $2.50 dividend at year end (D1 = $2.50),
and the dividend is expected to grow at a constant rate of 5.50% a year. 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 reinvested earnings?
a.
7.07%
b.
7.36%
c.
7.67%
d.
7.98%
e.
8.29%
c
WACC
80. Avery Corporation’s 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 common from reinvested earnings is 11.25%, and the
tax rate is 40%. The firm will not be issuing any new common stock. What is Avery’s WACC?
a.
8.15%
b.
8.48%
c.
8.82%
d.
9.17%
e.
9.54%
CHAPTER 11—DETERMINING THE COST OF CAPITAL
a
81. Westbrook’s Painting Co. 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%
c.
0.70%
d.
0.77%
e.
0.85%
c
CHAPTER 11—DETERMINING THE COST OF CAPITAL
Difficulty: Moderate
INTE.GENE.16.71 – LO: 11-3
United States – BUSPROG: Analytic
United States – OH – Default City – TBA
Taxes and cost of debt
TYPE: Multiple Choice: Problem
82. The CEO of Harding Media Inc. as asked you to help estimate its cost of common equity. 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
common from reinvested 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%
Difficulty: Challenging
INTE.GENE.16.75 – LO: 11-7
United States – BUSPROG: Analytic
United States – OH – Default City – TBA
Cost of common: DCF
TYPE: Multiple Choice: Problem
83. The president and CFO of Spellman Transportation are having a disagreement about whether to use market value or
book value weights in calculating the WACC. Spellman’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 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
CHAPTER 11—DETERMINING THE COST OF CAPITAL
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
Difficulty: Challenging
INTE.GENE.16.70 – LO: 11-8
United States – BUSPROG: Analytic
United States – OH – Default City – TBA
WACC and market cap. struc.
TYPE: Multiple Choice: Problem
84. As the winner of a contest, you are now CFO for the day for Maguire Inc. and your day’s job involves raising capital
for expansion. Maguire’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 exceed the cost of common from reinvested earnings?
CHAPTER 11—DETERMINING THE COST OF CAPITAL
a.
0.09%
b.
0.19%
c.
0.37%
d.
0.56%
e.
0.84%
c
85. Granby Foods’ (GF) 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 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. What is the sum of these three WACCs?
a.
b.
c.
d.
e.
c
CHAPTER 11—DETERMINING THE COST OF CAPITAL
86. To estimate the company’s WACC, Marshall Inc. recently hired you as a consultant. 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 common stock, and it does not expect to issue any new
shares. What is its WACC?
a.
7.16%
CHAPTER 11—DETERMINING THE COST OF CAPITAL
b.
7.54%
c.
7.93%
d.
8.35%
e.
8.79%
e
87. Assume that you are an intern with the Brayton Company, 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%
CHAPTER 11—DETERMINING THE COST OF CAPITAL
88. You have been hired by the CFO of Lugones Industries to help estimate its cost of common equity. 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 common 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%
CHAPTER 11—DETERMINING THE COST OF CAPITAL
Exhibit 11.1
The Collins Group, a leading producer of custom automobile accessories, has hired you 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%.
89. Refer to Exhibit 11.1. 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
United States – BUSPROG: Analytic
United States – AK – DISC: Capital budgeting and cost – DISC: Capital budgeting and cost of
United States – OH – Default City – TBA
Risk premium, CAPM, and DCF
TYPE: Multiple Choice: Problem
CHAPTER 11—DETERMINING THE COST OF CAPITAL
90. Refer to Exhibit 11.1. Based on the CAPM, what is the firm’s cost of common stock?
a.
b.
c.
d.
e.
91. Refer to Exhibit 11.1. Which of the following is the best estimate for the weight of debt for use in calculating the
firm’s WACC?
a.
b.
c.
CHAPTER 11—DETERMINING THE COST OF CAPITAL
d.
e.
a
92. Refer to Exhibit 11.1. What is the best estimate of the firm’s WACC?
a.
b.
c.
d.
e.
c
WACC
CHAPTER 11—DETERMINING THE COST OF CAPITAL