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Exam 14: Cost of Capital

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Question 31

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Incorporating flotation costs into the analysis of a project will:

A) cause the project to be improperly evaluated.
B) increase the net present value of the project.
C) increase the project's rate of return.
D) increase the initial cash outflow of the project.
E) have no effect on the present value of the project.

F) A) and B)
G) B) and E)

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Question 32

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Chelsea Fashions is expected to pay an annual dividend of $0.80 a share next year.The market price of the stock is $19.60 and the growth rate is 5 percent.What is the firm's cost of equity?

A) 7.58 percent
B) 7.91 percent
C) 8.24 percent
D) 9.08 percent
E) 10.00 percent

F) D) and E)
G) A) and B)

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Question 33

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Assigning discount rates to individual projects based on the risk level of each project:

Which one of the following statements is correct for a firm that uses debt in its capital structure?

The aftertax cost of debt generally increases when: I.a firm's bond rating increases. II.the market rate of interest increases. III.tax rates decrease. IV.bond prices rise.

Kelso's has a debt-equity ratio of 0.6 and a tax rate of 35 percent.The firm does not issue preferred stock.The cost of equity is 14.5 percent and the aftertax cost of debt is 4.8 percent.What is the weighted average cost of capital?

You are evaluating a project which requires $230,000 in external financing.The flotation cost of equity is 11.6 percent and the flotation cost of debt is 5.4 percent.What is the initial cost of the project including the flotation costs if you maintain a debt-equity ratio of 0.45?

The cost of preferred stock is computed the same as the:

The dividend growth model can be used to compute the cost of equity for a firm in which of the following situations? I.firms that have a 100 percent retention ratio II.firms that pay a constant dividend III.firms that pay an increasing dividend IV.firms that pay a decreasing dividend

Phillips Equipment has 80,000 bonds outstanding that are selling at par.Bonds with similar characteristics are yielding 7.5 percent.The company also has 750,000 shares of 7 percent preferred stock and 2.5 million shares of common stock outstanding.The preferred stock sells for $65 a share.The common stock has a beta of 1.34 and sells for $42 a share.The U.S.Treasury bill is yielding 2.8 percent and the return on the market is 11.2 percent.The corporate tax rate is 38 percent.What is the firm's weighted average cost of capital?

The pre-tax cost of debt:

Morris Industries has a capital structure of 55 percent common stock,10 percent preferred stock,and 45 percent debt.The firm has a 60 percent dividend payout ratio,a beta of 0.89,and a tax rate of 38 percent.Given this,which one of the following statements is correct?

The Bakery is considering a new project it considers to be a little riskier than its current operations.Thus,management has decided to add an additional 1.5 percent to the company's overall cost of capital when evaluating this project.The project has an initial cash outlay of $58,000 and projected cash inflows of $17,000 in year one,$28,000 in year two,and $30,000 in year three.The firm uses 25 percent debt and 75 percent common stock as its capital structure.The company's cost of equity is 15.5 percent while the aftertax cost of debt for the firm is 6.1 percent.What is the projected net present value of the new project?

Markley and Stearns is a multi-divisional firm that uses its WACC as the discount rate for all proposed projects.Each division is in a separate line of business and each presents risks unique to those lines.Given this,a division within the firm will tend to:

The discount rate assigned to an individual project should be based on:

Phil's is a sit-down restaurant that specializes in home-cooked meals.Theresa's is a walk-in deli that specializes in specialty soups and sandwiches.Both firms are currently considering expanding their operations during the summer months by offering pre-wrapped donuts,sandwiches,and wraps at a local beach.Phil's currently has a WACC of 14 percent while Theresa's WACC is 10 percent.The expansion project has a projected net present value of $12,600 at a 10 percent discount rate and a net present value of -$2,080 at a 14 percent discount rate.Which firm or firms should expand and offer food at the local beach during the summer months?

All else constant,which one of the following will increase a firm's cost of equity if the firm computes that cost using the security market line approach? Assume the firm currently pays an annual dividend of $1 a share and has a beta of 1.2.

Deep Mining and Precious Metals are separate firms that are both considering a silver exploration project.Deep Mining is in the actual mining business and has an aftertax cost of capital of 12.8 percent.Precious Metals is in the precious gem retail business and has an aftertax cost of capital of 10.6 percent.The project under consideration has initial costs of $575,000 and anticipated annual cash inflows of $102,000 a year for ten years.Which firm(s) ,if either,should accept this project?

Jiminy's Cricket Farm issued a 30-year,8 percent,semiannual bond 6 years ago.The bond currently sells for 114 percent of its face value.What is the aftertax cost of debt if the company's tax rate is 31 percent?

Scholastic Toys is considering developing and distributing a new board game for children.The project is similar in risk to the firm's current operations.The firm maintains a debt-equity ratio of 0.40 and retains all profits to fund the firm's rapid growth.How should the firm determine its cost of equity?