92.
Cookie Dough Manufacturing has a target debt-equity ratio of 0.5. Its cost
of equity is 15 percent, and its cost of debt is 11 percent. What is the firm’s
WACC given a tax rate of 31 percent?
93.
Fama’s Llamas has a weighted average cost of capital of 9.5 percent. The
company’s cost of equity is 15.5 percent, and its pretax cost of debt is 8.5
percent. The tax rate is 34 percent. What is the company’s target debt–
equity ratio?
94.
Jungle, Inc. has a target debt-equity ratio of 0.72. Its WACC is 11.5 percent
and the tax rate is 34 percent. What is the cost of equity if the aftertax cost
of debt is 5.5 percent?
95.
Titan Mining Corporation has 14 million shares of common stock
outstanding, 900,000 shares of 9 percent preferred stock outstanding and
220,000 ten percent semiannual bonds outstanding, par value $1,000 each.
The common stock currently sells for $42 per share and has a beta of 1.15,
the preferred stock currently sells for $80 per share, and the bonds have 17
years to maturity and sell for 91 percent of par. The market risk premium is
11.5 percent, T-bills are yielding 7.5 percent, and the firm’s tax rate is 32
percent. What discount rate should the firm apply to a new project’s cash
flows if the project has the same risk as the firm’s typical project?
96.
Suppose your company needs $14 million to build a new assembly line. Your
target debt-equity ratio is 0.84. The flotation cost for new equity is 9.5
percent, but the floatation cost for debt is only 2.5 percent. What is the true
cost of building the new assembly line after taking flotation costs into
account?
Essay Questions
97.
What role does the weighted average cost of capital play when determining
a project’s cost of capital?
98.
What are some advantages of the subjective approach to determining the
cost of capital and why do you think that approach is utilized?
99.
Give an example of a situation where a firm should adopt the pure play
approach for determining the cost of capital for a project.
100.
Suppose your boss comes to you and asks you to re-evaluate a capital
budgeting project. The first evaluation was in error, he explains, because it
ignored flotation costs. To correct for this, he asks you to evaluate the
project using a higher cost of capital which incorporates these costs. Is your
boss’ approach correct? Why or why not?
101.
Explain how the use of internal equity rather than external equity affects the
analysis of a project.