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Exam 14: The Cost of Capital

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Question 21

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The last paid dividend is $2 for a share of common stock that is currently selling for $20.What is the cost of common equity if the long-term growth rate in dividends for the firm is expected to be 8%?

A) 10.8%
B) 12.8%
C) 14.8%
D) 16.8%
E) 18.8%

F) C) and E)
G) B) and C)

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Question 22

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Which of the following statements regarding calculating a firm's cost of capital is correct?

A) The after-tax cost of debt is generally more expensive than the after-tax cost of preference share.
B) Since retained earnings are readily available, the cost of retained earnings is generally lower than the cost of debt.
C) If a company's beta increases, this will increase the cost of capital.
D) The level of general economic conditions will determine whether a firm should utilize an arithmetic average cost of capital or a weighted average cost of capital.

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

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Question 23

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WACC = [kD(1 − T)× wD] + [kP × wP] + [kE × wE]

A firm's cost of capital is not affected by the amount of leverage it uses.

The after-tax cost of this debt issue is [blank].

Flotation costs increase the amount of funds that must be raised to finance an investment.

Tantasqua Paper Products is composed of three divisions: industrial paper products, commercial paper products and a forestry division which grows trees for wood pulp used in the paper-making process.Each of these divisions takes on a large number of projects with differing risk characteristics.Tantasqua now uses a single discount rate based on the company's WACC to evaluate all capital budgeting proposals.Discuss the advantages and disadvantages of switching to an approach based on separate discount rates for each division or even the risk level of each project.

Jen and Barry's Ice Cream needs $20 million in new capital to expand its production facilities.It will use 40% debt and 60% equity.The company's after-tax cost of debt is 5% and the cost of equity is 12.5%.Flotation costs will be 3% for debt and 9% for equity.What rate should be used to discount the cash flows from the expansion project?

Why is it important to use market-based weights rather than balance sheet weights when estimating a company's weighted average cost of capital?

If the before-tax cost of debt is 9% and the firm has a 34% marginal tax rate, the after-tax cost of debt is 5.94%.

The cost of newly issued common stock is greater than the current cost common equity because of

When calculating the weighted average cost of capital, which of the following has to be adjusted for taxes?

Briefly identify and describe some important uses of a firm's weighted average cost of capital.

Which of the following is the rate that has to be received from an investment in order to achieve the required rate of return for the creditors?

When investors increase their required rate of return, the cost of capital increases simultaneously.

Charlie's Grill has restaurants throughout the United States, Canada, and Western Europe.It is considering a proposal to open several restaurants in major cities of India and China.

Difficulties in estimating a divisional cost of capital:

Use the following information to answer the following question(s) . The following data concerning Dwight's Dollar Store capital structure is available. -The percentage of preference share in Dwight's weighted average cost of capital is [blank].

National Gridlock's capital structure consisted of $125 million of debt and $250 million of equity before it issued bonds to borrow an additional $125 million.The new funds will be used to finance infrastructure improvements and expansion.The company believes that the project will generate enough cash to retire one-fifth of the bonds each year.How does the borrowing and the repayment plan affect the discount rate(s)that should be used to evaluate this project?

The 'pure play' approach to estimating a division WACC involves