1)
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If a firm’s marginal tax rate is
increased, this would, other things held constant, lower the cost of debt
used to calculate its WACC.
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a.
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True
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b.
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False
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2)
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The lower the firm’s tax rate, the
lower will be its after-tax cost of debt and WACC, other things held
constant.
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a.
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True
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b.
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False
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3)
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If investors’ aversion to risk
rose, causing the slope of the SML to increase, this would have a greater
impact on the required rate of return on equity, rs, than on the
interest rate on long-term debt, rd, for most firms. Other things held constant, this would lead
to an increase in the use of debt and a decrease in the use of equity. However, other things would not stay
constant if firms used a lot more debt, as that would increase the riskiness
of both debt and equity and thus limit the shift toward debt.
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a.
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True
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b.
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False
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4)
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Jackson Inc. uses only equity
capital, and it has 2 equally-sized divisions. Division A’s cost of capital
is 10.0%, Division B’s cost is 14.0%, and the composite WACC is 12.0%. All of Division A’s projects have the same
risk, as do all of Division B’s projects.
However, the projects in Division A have less risk than those in
Division B. Which of the following
projects should Jackson
accept?
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a.
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A Division B project with a 13%
return.
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b.
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A Division B project with a 12%
return.
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c.
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A Division A project with an 11%
return.
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d.
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A Division A project with a 9%
return.
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e.
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A Division B project with an 11%
return.
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5)
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Vang Inc. estimates that its
average-risk projects have a WACC of 10%, its below-average risk projects
have a WACC of 8%, and its above-average risk projects have a WACC of 12%. Which of the following projects (A, B, and
C) should the company accept?
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a.
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Project B is of below-average risk
and has a return of 8.5%.
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b.
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Project C is of above-average risk
and has a return of 11%.
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c.
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Project A is of average risk and
has a return of 9%.
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d.
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None of the projects should be
accepted.
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e.
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All of the projects should be
accepted.
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6)
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Nelson Enterprises, an all-equity
firm, has a beta of 2.0. Nelson’s
chief financial officer is evaluating a project with an expected return of
21%, before any risk adjustment. The
risk-free rate is 7%, and the market risk premium is 6%. The project being evaluated is riskier than
Nelson’s average project, in terms of both its beta risk and its total
risk. Which of the following
statements is CORRECT?
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a.
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The project should definitely be
accepted because its expected return (before any risk adjustments) is greater
than its required return.
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b.
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The project should definitely be
rejected because its expected return (before risk adjustment) is less than
its required return.
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c.
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Riskier-than-average projects
should have their expected returns increased to reflect their higher
risk. Clearly, this would make the
project acceptable regardless of the amount of the adjustment.
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d.
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The accept/reject decision depends
on the firm’s risk-adjustment policy.
If Nelson’s policy is to increase the required return on a
riskier-than-average project to 3% over rS, then it should reject
the project.
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e.
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Capital budgeting projects should
be evaluated solely on the basis of their total risk. Thus, insufficient
information has been provided to make the accept/reject decision.
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7)
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Which of the following statements
is CORRECT?
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a.
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The WACC is calculated using
before-tax costs for all components.
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b.
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The after-tax cost of debt usually
exceeds the after-tax cost of equity.
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c.
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For a given firm, the after-tax
cost of debt is always more expensive than the after-tax cost of preferred
stock.
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d.
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Retained earnings that were
generated in the past and are reflected on the firm’s balance sheet are
generally available to finance the firm’s capital budget during the coming
year.
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e.
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The WACC that should be used in
capital budgeting is the firm’s marginal, after-tax cost of capital.
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8)
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Assume that you are a consultant
to Magee Inc., and you have been provided with the following data: rRF
= 4.00%; RPM = 5.00%; and b = 1.15. What is the cost of equity from retained
earnings based on the CAPM approach?
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a.
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9.75%
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b.
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10.04%
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c.
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10.34%
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d.
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10.65%
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e.
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10.97%
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9)
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Lanser Inc. hired you as a
consultant to help them estimate its cost of capital. You have been provided with the following
data: D1 = $0.80; P0
= $22.50; and g = 5.00% (constant).
Based on the DCF approach, what is the cost of equity from retained
earnings?
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a.
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7.34%
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b.
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7.72%
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c.
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8.13%
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d.
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8.56%
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e.
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8.98%
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10)
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You were hired as a consultant to
Kroncke Company, whose target capital structure is 40% debt, 10% preferred,
and 50% common equity. The after-tax
cost of debt is 6.00%, the cost of preferred is 7.50%, and the cost of
retained earnings is 13.25%. The firm
will not be issuing any new stock.
What is its WACC?
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a.
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9.48%
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b.
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9.78%
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c.
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10.07%
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d.
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10.37%
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e.
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10.68%
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11)
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To help finance a major expansion,
Delano Development Company sold a noncallable bond several years ago that now
has 15 years to maturity. This bond
has a 10.25% annual coupon, paid semiannually, it sells at a price of $1,025,
and it has a par value of $1,000. If Delano’s tax rate is
40%, what component cost of debt should be used in the WACC calculation?
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a.
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5.11%
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b.
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5.37%
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c.
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5.66%
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d.
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5.96%
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e.
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6.25%
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12)
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Chambliss Inc. hired you as a
consultant to help estimate its cost of capital. You have been provided with the following
data: D0 = $0.90; P0
= $27.50; and g = 8.00% (constant).
Based on the DCF approach, what is the cost of equity from retained
earnings?
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a.
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10.41%
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b.
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10.96%
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c.
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11.53%
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d.
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12.11%
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e.
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12.72%
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13)
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You were recently hired by Nast
Media Inc. to estimate its cost of capital.
You were provided with the following data: D1 = $2.00; P0 = $55.00;
g = 8.00% (constant); and F = 5.00%.
What is the cost of equity raised by selling new common stock?
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a.
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11.24%
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b.
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11.83%
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c.
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12.42%
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d.
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13.04%
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e.
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13.69%
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14)
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Schadler Systems is expected to
pay a $3.50 dividend at year end (D1 = $3.50), the dividend is
expected to grow at a constant rate of 6.50% a year, and the common stock
currently sells for $62.50 a share.
The before-tax cost of debt is 7.50%, and the tax rate is 40%. The target capital structure consists of
40% debt and 60% common equity. What
is the company’s WACC if all equity is from retained earnings?
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a.
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8.35%
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b.
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8.70%
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c.
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9.06%
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d.
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9.42%
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e.
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9.80%
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15)
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Roxie Epoxy’s balance sheet shows
a total of $50 million long-term debt with a coupon rate of 8.00% and a yield
to maturity of 7.00%. This debt
currently has a market value of $55 million.
The balance sheet also shows that that the company has 20 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 $8.25 per share; stockholders’ required
return, rs, is 10.00%; and the firm’s tax rate is 40%. Based on market value weights, and assuming
the firm is currently at its target capital structure, what WACC should Roxie
use to evaluate capital budgeting projects?
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a.
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7.26%
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b.
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7.56%
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c.
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7.88%
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d.
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8.21%
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e.
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8.55%
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16)
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Assume that you are on the financial
staff of Michelson Inc., and you have collected the following data: (1) The yield on the company’s outstanding
bonds is 8.00%, and its tax rate is 40%.
(2) The next expected dividend is $0.65 a share, and the dividend is
expected to grow at a constant rate of 6.00% a year. (3) The price of Michelson’s stock is
$17.50 per share, and the flotation cost for selling new shares is F =
10%. (4) The target capital structure
is 45% debt and the balance is common equity.
What is Michelson’s WACC, assuming it must issue new stock to finance
its capital budget?
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a.
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6.63%
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b.
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6.98%
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c.
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7.34%
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d.
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7.73%
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e.
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8.12%
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