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Exam 12: Cost of Capital

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Question 1

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Which one of the following is the primary determinant of an investment's cost of capital?

A) Life of the investment
B) Amount of the initial cash outlay
C) The investment's level of risk
D) The source of funds used for the investment
E) The investment's net present value

F) B) and C)
G) A) and B)

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Question 2

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The weighted average cost of capital is defined as the weighted average of a firm's:

A) return on all of its investments.
B) cost of equity, cost of preferred, and its aftertax cost of debt.
C) pretax cost of debt and its preferred and common equity securities.
D) bond coupon rates.
E) common and preferred stock.

F) A) and C)
G) B) and D)

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Question 3

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Madison Square Stores has a $20 million bond issue outstanding that currently has a market value of $19.4 million.The bonds mature in 6.5 years and pay semiannual interest payments of $35 each.What is the firm's pretax cost of debt?

Which one of the following will affect the capital structure weights used to compute a firm's weighted average cost of capital?

Dee's Dress Emporium has 50,000 shares of common stock outstanding at a price of $27 a share.It also has 1000 shares of preferred stock outstanding at a price of $20 a share.There are 800bonds outstanding that have a semiannual coupon payment of $25.The bonds mature in four years, have a face value of $1,000, and sell at 97 percent of par.What is the capital structure weight of the common stock?

Which statement is true?

Beta Industries is considering a project with an initial cost of $6.9 million.The project will produce cash inflows of $1.52 million a year for seven years.The firm uses the subjective approach to assign discount rates to projects.For this project, the subjective adjustment is +2.2 percent.The firm has a pretax cost of debt of 9.1 percent and a cost of equity of 17.7 percent.The debt-equity ratio is .57 and the tax rate is 34 percent.What is the net present value of the project? (Round the answer to the nearest $100.)

The 5.25 percent preferred stock of Robert Bruce Security is selling for $50.26 a share.What is the firm's cost of preferred stock if the tax rate is 21 percent and the par value per share is $100?

Three years ago, the Fairchildress Co.issued 20-year, 7.75 percent semiannual coupon bonds at par.Today, the bonds are quoted at 102.6.What is this firm's pretax cost of debt?

When using the pure play approach for a proposed investment, a firm is primarily seeking a rate of return that:

Boone Brothers remodels homes and replaces windows.Ace Builders constructs new homes.If Boone Brothers considers expanding into new home construction, it should evaluate the expansion project using which one of the following as the required return for the project?

Lester lent money to The Corner Store by purchasing bonds issued by the store.The rate of return that he and the other lenders require is referred to as the:

Bluff City Sushi Distributors would like to issue new equity shares if its cost of equity declines to 16.5 percent.The company pays a constant annual dividend of $2.11 per share.What does the market price of the stock need to be for the firm to issue the new shares?

Empire Plumbing Supply has 100,000 shares of common stock outstanding at a price of $37 a share.It also has 6,000 shares of preferred stock outstanding at a price of $30 a share.There are 5,000 bonds outstanding that have a semiannual coupon payment of $25.The bonds mature in four years, have a face value of $1,000, and sell at 110 percent of par.What is the capital structure weight of the common stock?

You want to use the pure play approach to assign a cost of capital to a proposed investment.Which one of the following characteristics should you most concentrate on as you search for an appropriate pure play firm?

Kelly's uses the firm's WACC as the required return for some of its projects.For other projects, the firms uses a rate equal to WACC plus one percent, while another set of projects is assigned rates equal to WACC minus some amount.Which one of the following factors should be the key factor the firm uses to determine the amount of the adjustment it will make when assigning a discount rate to a specific project?

Which one of the following statements is accurate for a levered firm?

Kate is the CFO of a major firm and has the job of assigning discount rates to each project under consideration.Kate's method of doing this is to assign an incrementally higher rate as the risk level of the project increases and a lower rate as the risk level declines.Kate is applying the ___ approach.

S&W has 21,000 shares of common stock outstanding at a price of $29 a share.It also has 2,000 shares of preferred stock outstanding at a price of $71 a share.The firm has 7 percent, 12-year bonds outstanding with a total market value of $386,000.The bonds are currently quoted at 100.6 percent of face and pay interest semiannually.What is the capital structure weight of the firm's preferred stock if the tax rate is 34 percent?

A firm has multiple divisions of similar nature, yet varying degrees of risk.Which one of the following would be the most appropriate, yet relatively easy, means of assigning discount rates to each of its numerous proposed investments?