Cost Of Capital Test Bank Chapter 12

Chapter 12

Cost of Capital

Test Bank - Static

1. Katie owns 100 shares of ABC stock. Which one of the following terms is used to refer to the return that Katie and the other shareholders require on their investment in ABC?

A. Weighted average cost of capital

B. Pure play cost

C. Cost of equity

D. Subjective cost

E. Cost of debt

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Learning Objective: 12-01 Determine a firms cost of equity capital.

Section: 12.2 The Cost of Equity

Topic: Cost of equity

2. 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:

A. pure play cost.

B. cost of debt.

C. weighted average cost of capital.

D. subjective cost.

E. cost of equity.

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Learning Objective: 12-02 Determine a firms cost of debt.

Section: 12.3 The Costs of Debt and Preferred Stock

Topic: Cost of debt

3. 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.

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Learning Objective: 12-03 Determine a firms overall cost of capital.

Section: 12.4 The Weighted Average Cost of Capital

Topic: Weighted average cost of capital

4. Farmer's Supply is considering opening a clothing store, which would be a new line of business for the firm. Management has decided to use the cost of capital of a similar clothing store as the discount rate to evaluate this proposed expansion. Which one of the following terms describes this evaluation approach?

A. Equity approach

B. Aftertax approach

C. Subjective approach

D. Market play

E. Pure play approach

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Learning Objective: 12-04 Identify some of the pitfalls associated with a firms overall cost of capital and what to do about them.

Section: 12.5 Divisional and Project Costs of Capital

Topic: Divisional and project costs of capital

5. 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.

A. pure play

B. divisional rating

C. subjective

D. straight WACC

E. equity rating

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Learning Objective: 12-04 Identify some of the pitfalls associated with a firms overall cost of capital and what to do about them.

Section: 12.5 Divisional and Project Costs of Capital

Topic: Divisional and project costs of capital

6. Ted is trying to decide what cost of capital he should assign to a project. Which one of the following should be his primary consideration in this decision?

A. Amount of debt used to finance the project

B. Use, or lack, of preferred stock as a financing option

C. Mix of funds used to finance the project

D. Risk level of the project

E. Length of the project's life

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Learning Objective: 12-04 Identify some of the pitfalls associated with a firms overall cost of capital and what to do about them.

Section: 12.5 Divisional and Project Costs of Capital

Topic: Divisional and project costs of capital

7. Black Stone Furnaces wants to build a new facility. The cost of capital for this investment is primarily dependent on which one of the following?

A. The firm's overall source of funds

B. Source of the funds used to build the facility

C. Current tax rate

D. The nature of the investment

E. Firm's historical average rate of return

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Learning Objective: 12-04 Identify some of the pitfalls associated with a firms overall cost of capital and what to do about them.

Section: 12.5 Divisional and Project Costs of Capital

Topic: Divisional and project costs of capital

8. Which one of the following statements is correct related to the dividend growth model approach to computing the cost of equity?

A. The rate of growth must exceed the required rate of return.

B. The rate of return must be adjusted for taxes.

C. The annual dividend used in the computation must be for Year 1 if you are Time 0’s stock price to compute the return.

D. The cost of equity is equal to the return on the stock plus the risk-free rate.

E. The cost of equity is equal to the return on the stock multiplied by the stock's beta.

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Learning Objective: 12-01 Determine a firms cost of equity capital.

Section: 12.2 The Cost of Equity

Topic: Cost of equity

9. A firm has a return on equity of 12.4 percent according to the dividend growth model and a return of 18.7 percent according to the capital asset pricing model. The market rate of return is 13.5 percent. What rate should the firm use as the cost of equity when computing the firm's weighted average cost of capital (WACC)?

A. 12.4 percent because it is lower than 18.7 percent

B. 18.7 percent because it is higher than 12.4 percent

C. The arithmetic average of 12.4 percent and 18.7 percent

D. The arithmetic average of 12.4 percent, 13.5 percent, and 18.7 percent

E. 13.5 percent

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Learning Objective: 12-01 Determine a firms cost of equity capital.

Section: 12.2 The Cost of Equity

Topic: Cost of equity

10. When evaluating a project, the dividend growth model:

A. can only be used by firms that pay increasing dividends.

B. must be used by all dividend-paying firms.

C. is only applicable when the growth rate of the project exceeds the dividend growth rate.

D. is relatively simple to use.

E. must use the growth rate of the project as the rate of growth in the formula.

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Learning Objective: 12-01 Determine a firms cost of equity capital.

Section: 12.2 The Cost of Equity

Topic: Cost of equity

11. The results of the dividend growth model:

A. vary directly with the market rate of return.

B. can only be applied to projects that have a growth rate equal to that of the current firm.

C. are highly dependent upon the beta used in the model.

D. are sensitive to the rate of dividend growth.

E. are most reliable when the growth rate exceeds 10 percent.

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Learning Objective: 12-01 Determine a firms cost of equity capital.

Section: 12.2 The Cost of Equity

Topic: Cost of equity

12. In an efficient market, the cost of equity for a highly risky firm:

A. will be less than the market rate but higher than the risk-free rate.

B. must equal the market rate of return.

C. changes by 1 percent for every 1 percent change in the risk-free rate.

D. decreases as the beta of the firm's stock increases.

E. increases in direct relation to the stock's systematic risk.

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Learning Objective: 12-01 Determine a firms cost of equity capital.

Section: 12.2 The Cost of Equity

Topic: Cost of equity

13. Assume a firm has a beta of 1.2. All else held constant, the cost of equity for this firm will increase if the:

A. market risk premium decreases.

B. risk-free rate decreases.

C. market rate of return decreases.

D. beta decreases.

E. either the risk-free rate or the market rate of return decreases.

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Learning Objective: 12-01 Determine a firms cost of equity capital.

Section: 12.2 The Cost of Equity

Topic: Cost of equity

14. Which one of the following will increase the cost of equity, all else held constant?

A. Increase in the dividend growth rate

B. Decrease in beta

C. Decrease in future dividends

D. Increase in stock price

E. Decrease in market risk premium

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Learning Objective: 12-01 Determine a firms cost of equity capital.

Section: 12.2 The Cost of Equity

Topic: Cost of equity

15. An increase in a levered firm’s tax rate will:

A. decrease the cost of preferred stock.

B. increase both the cost of preferred stock and debt.

C. decrease the firm’s cost of capital.

D. decrease the cost of equity capital.

E. increase the firm’s WACC.

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Learning Objective: 12-02 Determine a firms cost of debt.

Section: 12.3 The Costs of Debt and Preferred Stock

Topic: Cost of debt

16. Which one of the following is used as the pretax cost of debt?

A. Average coupon rate on the firm's outstanding bonds

B. Coupon rate on the firm's latest bond issue

C. Weighted average yield to maturity on the firm's outstanding debt

D. Average current yield on the firm's outstanding debt

E. Annual interest divided by the market price per bond for the latest bond issue

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Learning Objective: 12-02 Determine a firms cost of debt.

Section: 12.3 The Costs of Debt and Preferred Stock

Topic: Cost of debt

17. Which one of the following will decrease the aftertax cost of debt for a firm?

A. Decrease in the firm's beta

B. Increase in tax rates

C. Increase in the risk-free rate of return

D. Decrease in the market price of the debt

E. Increase in a bond's yield to maturity

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Learning Objective: 12-02 Determine a firms cost of debt.

Section: 12.3 The Costs of Debt and Preferred Stock

Topic: Cost of debt

18. All else constant, an increase in a firm's cost of debt:

A. could be caused by an increase in the firm's tax rate.

B. will result in an increase in the firm's cost of capital.

C. will lower the firm's weighted average cost of capital.

D. will lower the firm's cost of equity.

E. will increase the firm's capital structure weight of debt.

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Learning Objective: 12-03 Determine a firms overall cost of capital.

Section: 12.4 The Weighted Average Cost of Capital

Topic: Weighted average cost of capital

19. The cost of preferred stock:

A. increases when a firm's tax rate decreases.

B. is constant over time.

C. is unaffected by changes in the market price of the stock.

D. is equal to the stock's dividend yield.

E. increases as the price of the stock increases.

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Learning Objective: 12-02 Determine a firms cost of debt.

Section: 12.3 The Costs of Debt and Preferred Stock

Topic: Cost of preferred stock

20. Which statement is true?

A. An increase in the market value of preferred stock will increase a firm's weighted average cost of capital.

B. The cost of preferred stock is unaffected by the issuer's tax rate.

C. Preferred stock is generally the cheapest source of capital for a firm.

D. The cost of preferred stock remains constant from year to year.

E. Preferred stock is valued using the capital asset pricing model.

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Learning Objective: 12-02 Determine a firms cost of debt.

Section: 12.3 The Costs of Debt and Preferred Stock

Topic: Cost of preferred stock

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

A. Decrease in the book value of a firm's equity

B. Decrease in a firm's tax rate

C. Increase in the market value of the firm's common stock

D. Increase in the market risk premium

E. Increase in the firm's beta

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Learning Objective: 12-03 Determine a firms overall cost of capital.

Section: 12.4 The Weighted Average Cost of Capital

Topic: Capital structure weights

22. Which one of the following statements concerning capital structure weights is correct?

A. Target capital structure rates for a firm are irrelevant to individual projects.

B. The weights are unaffected when a bond issue matures.

C. An increase in the debt-equity ratio will increase the weight of the common stock.

D. The repurchase of preferred stock will increase the weight of debt.

E. The issuance of additional shares of common stock will increase the weight of both the common and preferred stock.

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Learning Objective: 12-03 Determine a firms overall cost of capital.

Section: 12.4 The Weighted Average Cost of Capital

Topic: Capital structure weights

23. Which one of the following statements is correct? Assume the pretax cost of debt is less than the cost of equity.

A. A firm may change its capital structure if the government changes its tax policies.

B. A decrease in the dividend growth rate increases the cost of equity.

C. A decrease in the systematic risk of a firm will increase the firm's cost of capital.

D. A decrease in a firm's debt-equity ratio will decrease the firm's cost of capital.

E. The cost of preferred stock decreases when the tax rate increases.

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Learning Objective: 12-03 Determine a firms overall cost of capital.

Section: 12.4 The Weighted Average Cost of Capital

Topic: Weighted average cost of capital

24. Which one of the following represents the minimum rate of return a firm must earn on its assets if it is to maintain the current value of its securities?

A. Cost of equity

B. Pretax cost of debt

C. Aftertax cost of debt

D. Weighted average cost of capital

E. Weighted average cost of preferred and common stock

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Learning Objective: 12-03 Determine a firms overall cost of capital.

Section: 12.4 The Weighted Average Cost of Capital

Topic: Weighted average cost of capital

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

A. WACC should be used as the required return for all proposed investments.

B. A firm's WACC will decrease whenever the firm's tax rate decreases.

C. An increase in the market risk premium will decrease a firm's WACC.

D. The subjective approach totally ignores a firm's own WACC.

E. A reduction in the risk level of a firm will tend to decrease the firm's WACC.

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Learning Objective: 12-03 Determine a firms overall cost of capital.

Section: 12.4 The Weighted Average Cost of Capital

Topic: Weighted average cost of capital

26. Which statement is correct, all else held constant?

A. Beta is used to compute the return on equity and the standard deviation is used to compute the return on preferred.

B. A decrease in a firm's WACC will increase the attractiveness of the firm's investment options.

C. The aftertax cost of debt increases when the market price of a bond increases.

D. If you have both the dividend growth and the security market line's costs of equity, you should use the higher of the two estimates when computing WACC.

E. WACC is applicable only to firms that issue both common and preferred stock.

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Learning Objective: 12-03 Determine a firms overall cost of capital.

Section: 12.4 The Weighted Average Cost of Capital

Topic: Weighted average cost of capital

27. A firm has a cost of equity of 13 percent, a cost of preferred of 11 percent, an aftertax cost of debt of 5.2 percent, and a tax rate of 35 percent. Given this, which one of the following will increase the firm's weighted average cost of capital?

A. Increasing the firm's tax rate

B. Issuing new bonds at par

C. Redeeming shares of common stock

D. Increasing the firm's beta

E. Increasing the debt-equity ratio

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Learning Objective: 12-03 Determine a firms overall cost of capital.

Section: 12.4 The Weighted Average Cost of Capital

Topic: Weighted average cost of capital

28. All else constant, the weighted average cost of capital for a risky, levered firm will decrease if:

A. the firm's bonds start selling at a premium rather than at a discount.

B. the market risk premium increases.

C. the firm replaces some of its debt with preferred stock.

D. corporate taxes are eliminated.

E. the dividend yield on the common stock increases.

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Learning Objective: 12-03 Determine a firms overall cost of capital.

Section: 12.4 The Weighted Average Cost of Capital

Topic: Weighted average cost of capital

29. A firm that uses its weighted average cost of capital as the required return for all of its investments will:

A. maintain a constant value for its shareholders.

B. increase the risk level of the firm over time.

C. make the best possible accept and reject decisions related to those investments.

D. find that its cost of capital declines over time.

E. accept only the projects that add value to the firm's shareholders.

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Learning Objective: 12-04 Identify some of the pitfalls associated with a firms overall cost of capital and what to do about them.

Section: 12.5 Divisional and Project Costs of Capital

Topic: Divisional and project costs of capital

30. Old Town Industries has three divisions. Division X has been in existence the longest and has the most stable sales. Division Y has been in existence for five years and is slightly less risky than the overall firm. Division Z is the research and development side of the business. Given this, the firm should probably:

A. require the highest rate of return from Division X since it has been in existence the longest.

B. assign the highest cost of capital to Division Z because it is most likely the riskiest of the three divisions.

C. use the firm's WACC as the cost of capital for Division Z as it provides analysis for the entire firm.

D. use the firm's WACC as the cost of capital for Divisions A and B because they are part of the revenue-producing operations of the firm.

E. allocate capital funds evenly amongst the divisions to maintain the current capital structure of the firm.

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Learning Objective: 12-04 Identify some of the pitfalls associated with a firms overall cost of capital and what to do about them.

Section: 12.5 Divisional and Project Costs of Capital

Topic: Divisional and project costs of capital

31. A firm uses its weighted average cost of capital to evaluate the proposed projects for all of its varying divisions. By doing so, the firm:

A. automatically gives preferential treatment in the allocation of funds to its riskiest division.

B. encourages the division managers to recommend only their most conservative projects.

C. maintains the current risk level and capital structure of the firm.

D. automatically maximizes the total value created for its shareholders.

E. allocates capital funds evenly among its divisions.

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Learning Objective: 12-04 Identify some of the pitfalls associated with a firms overall cost of capital and what to do about them.

Section: 12.5 Divisional and Project Costs of Capital

Topic: Divisional and project costs of capital

32. Kurt, who is a divisional manager, continually brags that his division's required return for its projects is one percent lower than the return required for any other division of the firm. Which one of the following most likely contributes the most to the lower rate requirement for Kurt's division?

A. Kurt tends to overestimate the projected cash inflows on his projects.

B. Kurt tends to underestimate the variable costs of his projects.

C. Kurt has the most efficiently managed division.

D. Kurt's division is less risky than the other divisions.

E. Kurt's projects are generally financed with debt while the other divisions' projects are financed with equity.

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Learning Objective: 12-04 Identify some of the pitfalls associated with a firms overall cost of capital and what to do about them.

Section: 12.5 Divisional and Project Costs of Capital

Topic: Divisional and project costs of capital

33. 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

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Learning Objective: 12-04 Identify some of the pitfalls associated with a firms overall cost of capital and what to do about them.

Section: 12.5 Divisional and Project Costs of Capital

Topic: Divisional and project costs of capital

34. The cost of capital for a project depends primarily on which one of the following?

A. Source of funds used for the project

B. Division within the firm that undertakes the project

C. Project's modified internal rate of return

D. How the project uses its funds

E. Project's fixed costs

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Learning Objective: 12-04 Identify some of the pitfalls associated with a firms overall cost of capital and what to do about them.

Section: 12.5 Divisional and Project Costs of Capital

Topic: Divisional and project costs of capital

35. Marine Expeditors has three divisions. Division A is the core of the business and represents 80 percent of the firm's operations. Division B is involved only with contractual short-term projects and therefore has about ten percent less risk than Division A. Division C develops and markets new products and is about ten percent riskier than Division A and about equal in size to Division B. The manager of Division A has suggested that the operations of his division be increased by 10 percent next year. The proposed project should probably be assigned a required return that is equal to _____ percent of the firm's weighted average cost of capital.

A. 90

B. 33

C. 80

D. 100

E. 110

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Learning Objective: 12-04 Identify some of the pitfalls associated with a firms overall cost of capital and what to do about them.

Section: 12.5 Divisional and Project Costs of Capital

Topic: Divisional and project costs of capital

36. Which one of the following is most apt to cause a wise manager to increase a project's cost of capital? Assume the firm is levered.

A. Management decides to issue new stock to finance the project.

B. The initial cash outlay requirement is reduced.

C. She learns the project is riskier than previously believed.

D. The aftertax cost of debt just decreased.

E. The project's life is shortened.

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Learning Objective: 12-04 Identify some of the pitfalls associated with a firms overall cost of capital and what to do about them.

Section: 12.5 Divisional and Project Costs of Capital

Topic: Divisional and project costs of capital

37. 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?

A. Boone Brothers' cost of capital

B. Ace Builders' cost of capital

C. Average of Boone Brothers' and Ace Builders' cost of capital

D. Lower of Boone Brothers' or Ace Builders' cost of capital

E. Higher of Boone Brothers' or Ace Builders' cost of capital

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Learning Objective: 12-04 Identify some of the pitfalls associated with a firms overall cost of capital and what to do about them.

Section: 12.5 Divisional and Project Costs of Capital

Topic: Divisional and project costs of capital

38. 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?

A. Firm size

B. Firm location

C. Firm experience

D. Firm operations

E. Firm management

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Learning Objective: 12-04 Identify some of the pitfalls associated with a firms overall cost of capital and what to do about them.

Section: 12.5 Divisional and Project Costs of Capital

Topic: Divisional and project costs of capital

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

A. is based on the actual source of funds that will be used to fund the project.

B. creates a positive net present value for the project.

C. reflects the size and life of the project.

D. most closely correlates with the proposed investment's internal rate of return.

E. best matches the risk level of the proposed investment.

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Learning Objective: 12-04 Identify some of the pitfalls associated with a firms overall cost of capital and what to do about them.

Section: 12.5 Divisional and Project Costs of Capital

Topic: Divisional and project costs of capital

40. Derek's is a brick-and-mortar toy store. The firm is considering expanding its operations to include Internet sales. Which one of the following would be the best firm to use in a pure play approach to analyzing this proposed expansion?

A. Another brick-and-mortar store that also sells online

B. A wholesale toy distributor

C. A toy store that sells online only

D. The oldest online retailer of any product

E. Derek's own store

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Learning Objective: 12-04 Identify some of the pitfalls associated with a firms overall cost of capital and what to do about them.

Section: 12.5 Divisional and Project Costs of Capital

Topic: Divisional and project costs of capital

41. 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?

A. The current market rate of interest

B. Actual source of funds used to finance the project

C. The perceived risk level of project

D. The division within the firm that will be assigned to manage the project

E. The firm’s current debt-equity ratio

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Learning Objective: 12-04 Identify some of the pitfalls associated with a firms overall cost of capital and what to do about them.

Section: 12.5 Divisional and Project Costs of Capital

Topic: Divisional and project costs of capital

42. 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?

A. Assign every project a rate equal to the firm's cost of equity

B. Assign every investment a random rate that varies between the firm's cost of debt and its cost of equity

C. Assign every project a rate equal to the firm's WACC plus or minus a subjective adjustment

D. Determine the best pure play rate for each project

E. Assign every project a rate equal to the market rate of return at the time of the proposal

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Learning Objective: 12-04 Identify some of the pitfalls associated with a firms overall cost of capital and what to do about them.

Section: 12.5 Divisional and Project Costs of Capital

Topic: Divisional and project costs of capital

43. To value a non-dividend-paying firm, the terminal value used in the valuation calculation will most likely be based on a(n):

A. subjective value determined by the firm’s senior managers.

B. salvage value of zero.

C. target ratio.

D. pure play rate of return.

E. expected book value of equity.

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Learning Objective: 12-03 Determine a firms overall cost of capital.

Section: 12.6 Company Valuation with the WACC

Topic: Firm valuation

44. What is the primary reason why the cash flow from assets (CFA) is adjusted when used to value a firm?

A. Depreciation is a non-cash expense so both it and the depreciation tax shield must be eliminated from the CFA.

B. Net working capital (NWC) is excluded from firm valuations so the change in NWC must be added back to the "normal" CFA calculation

C. Interest expense is a financing cost and thus the tax benefit of this expense needs to be eliminated from the CFA.

D. CFA is normally based on historical performance but since firm valuations are forward looking the CFA must be adjusted for timing.

E. The CFA must be lowered by the amount of the noncash expenses to ascertain a more accurate firm value.

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Learning Objective: 12-03 Determine a firms overall cost of capital.

Section: 12.6 Company Valuation with the WACC

Topic: Firm valuation

45. KellyAnne Public Relations just paid an annual dividend of $1.27 on its common stock and increases its dividend by 3.4 percent annually. What is the rate of return on this stock if the current stock price is $38.56 a share?

A. 6.81 percent

B. 7.87 percent

C. 7.04 percent

D. 7.69 percent

E. 7.82 percent

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Learning Objective: 12-01 Determine a firms cost of equity capital.

Section: 12.2 The Cost of Equity

Topic: Cost of equity

46. City Equipment announced this morning that its next annual dividend will be decreased to $1.90 a share and that all future dividends will be decreased by an additional 1.9 percent annually. What is the current value per share if the required return is 16.8 percent?

A. $8.80

B. $10.16

C. $10.36

D. $9.88

E. $10.42

AACSB: Analytical Thinking

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Learning Objective: 12-01 Determine a firms cost of equity capital.

Section: 12.2 The Cost of Equity

Topic: Cost of equity

47. Fire Hydrant Pet Supply just paid its first annual dividend of $0.75 a share. The firm plans to increase the dividend by 2.9 percent per year indefinitely. What is the firm's cost of equity if the current stock price is $16.90 per share?

A. 14.64 percent

B. 7.47 percent

C. 9.78 percent

D. 4.33 percent

E. 5.34 percent

AACSB: Analytical Thinking

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Learning Objective: 12-01 Determine a firms cost of equity capital.

Section: 12.2 The Cost of Equity

Topic: Cost of equity

48. Mississippi Mud Products would like to issue new equity shares if its cost of equity declines to 9.5 percent. The company pays a constant annual dividend of $4.80 per share. What does the market price of the stock need to be for the firm to issue the new shares?

A. $49.33

B. $48.83

C. $50.53

D. $51.63

E. $52.13

AACSB: Analytical Thinking

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Learning Objective: 12-01 Determine a firms cost of equity capital.

Section: 12.2 The Cost of Equity

Topic: Cost of equity

49. The common stock of Serenity Homescapes has a beta of 1.21 and a standard deviation of 17.8 percent. The market rate of return is 13.5 percent and the risk-free rate is 3.2 percent. What is the cost of equity for this firm?

A. 15.66 percent

B. 13.61 percent

C. 13.93 percent

D. 16.25 percent

E. 14.90 percent

AACSB: Analytical Thinking

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Blooms: Remember

Difficulty: 1 Easy

Learning Objective: 12-01 Determine a firms cost of equity capital.

Section: 12.2 The Cost of Equity

Topic: Cost of equity

50. Trendsetters has a cost of equity of 14.6 percent. The market risk premium is 8.4 percent and the risk-free rate is 3.9 percent. The company is acquiring a competitor, which will increase the company's beta to 1.4. What effect, if any, will the acquisition have on the firm's cost of equity capital?

A. No effect

B. Decrease of .62 percent

C. Decrease of .84 percent

D. Increase of 1.06 percent

E. Increase of .13 percent

AACSB: Analytical Thinking

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Learning Objective: 12-01 Determine a firms cost of equity capital.

Section: 12.2 The Cost of Equity

Topic: Cost of equity

51. The common stock of Silent Motors has a beta that is 5 percent greater than the overall market beta. Currently, the market risk premium is 8.25 percent while the U.S. Treasury bill is yielding 2.8 percent. What is the cost of equity for this firm?

A. 11.66 percent

B. 10.86 percent

C. 11.81 percent

D. 11.46 percent

E. 10.75 percent

AACSB: Analytical Thinking

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Difficulty: 1 Easy

Learning Objective: 12-01 Determine a firms cost of equity capital.

Section: 12.2 The Cost of Equity

Topic: Cost of equity

52. Musical Charts just paid an annual dividend of $1.84 per share. This dividend is expected to increase by 2.1 percent annually. Currently, the firm has a beta of 1.12 and a stock price of $31 a share. The risk-free rate is 4.3 percent and the market rate of return is 13.2 percent. What is the cost of equity capital for this firm?

A. 13.28 percent

B. 11.21 percent

C. 12.29 percent

D. 11.95 percent

E. 13.42 percent

AACSB: Analytical Thinking

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Difficulty: 1 Easy

Learning Objective: 12-01 Determine a firms cost of equity capital.

Section: 12.2 The Cost of Equity

Topic: Cost of equity

53. Commercial Construction Builders has a beta of 1.34, a dividend growth rate of 2.1 percent for the foreseeable future, a stock price of $15 per share, and an expected annual dividend of $0.45 per share next year. The market rate of return is 12.8 percent and the risk-free rate is 4.2 percent. What is the firm's average cost of equity?

A. 8.79 percent

B. 10.41 percent

C. 10.35 percent

D. 10.77 percent

E. 8.51 percent

AACSB: Analytical Thinking

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Blooms: Remember

Difficulty: 1 Easy

Learning Objective: 12-01 Determine a firms cost of equity capital.

Section: 12.2 The Cost of Equity

Topic: Cost of equity

54. The market rate of return is 12.65 percent and the risk-free rate is 3.1 percent. Galaxy Co. has 15 percent more systematic risk than the overall market and has a dividend growth rate of 3.75 percent. The firm's stock is currently selling for $53 a share and has a dividend yield of 4.53 percent. What is the firm's average cost of equity?

A. 11.18 percent

B. 12.36 percent

C. 10.87 percent

D. 17.33 percent

E. 12.16 percent

AACSB: Analytical Thinking

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Blooms: Remember

Difficulty: 1 Easy

Learning Objective: 12-01 Determine a firms cost of equity capital.

Section: 12.2 The Cost of Equity

Topic: Cost of equity

55. Appalachian Mountain Goods has paid increasing dividends of $10, $.12, $.15, and $.20 a share over the past four years, respectively. The firm estimates that future increases in its dividends will be equal to the arithmetic average growth rate over these past four years. The stock is currently selling for $12.50 a share. The risk-free rate is 3.4 percent and the market risk premium is 8.1 percent. What is the cost of equity for this firm if its beta is 1.46?

A. 18.34 percent

B. 16.91 percent

C. 19.78 percent

D. 21.68 percent

E. 22.03 percent

AACSB: Analytical Thinking

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Blooms: Remember

Difficulty: 1 Easy

Learning Objective: 12-01 Determine a firms cost of equity capital.

Section: 12.2 The Cost of Equity

Topic: Cost of equity

56. Spartans has 6.5 percent bonds outstanding that mature in 18 years. The bonds pay interest semiannually and have a face value of $1,000. Currently, the bonds are selling for $985 each. What is the firm's pretax cost of debt?

A. 6.77 percent

B. 6.64 percent

C. 6.94 percent

D. 7.11 percent

E. 6.20 percent

AACSB: Analytical Thinking

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Blooms: Remember

Difficulty: 1 Easy

Learning Objective: 12-02 Determine a firms cost of debt.

Section: 12.3 The Costs of Debt and Preferred Stock

Topic: Cost of debt

57. 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?

A. 57.32 percent

B. 7.13 percent

C. 7.48 percent

D. 7.88 percent

E. 7.34 percent

AACSB: Analytical Thinking

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Blooms: Remember

Difficulty: 1 Easy

Learning Objective: 12-02 Determine a firms cost of debt.

Section: 12.3 The Costs of Debt and Preferred Stock

Topic: Cost of debt

58. Pride of Lions has bonds outstanding that carry an annual coupon of 5.75 percent. The bonds mature in 9 years and are currently priced at 98 percent of face value. What is the firm's pretax cost of debt?

A. 6.04 percent

B. 9.850 percent

C. 8.60 percent

D. 11.28 percent

E. 12.02 percent

AACSB: Analytical Thinking

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Blooms: Remember

Difficulty: 1 Easy

Learning Objective: 12-02 Determine a firms cost of debt.

Section: 12.3 The Costs of Debt and Preferred Stock

Topic: Cost of debt

59. 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?

A. 8.21 percent

B. 7.59 percent

C. 7.08 percent

D. 7.74 percent

E. 7.80 percent

AACSB: Analytical Thinking

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Blooms: Remember

Difficulty: 1 Easy

Learning Objective: 12-02 Determine a firms cost of debt.

Section: 12.3 The Costs of Debt and Preferred Stock

Topic: Cost of debt

60. Electronic Products has 22,500 bonds outstanding that are currently quoted at 101.6. The bonds mature in 8 years and pay an annual coupon payment of $90. What is the firm's aftertax cost of debt if the applicable tax rate is 34 percent?

A. 5.47 percent

B. 4.79 percent

C. 5.75 percent

D. 6.98 percent

E. 6.67 percent

AACSB: Analytical Thinking

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Blooms: Remember

Difficulty: 1 Easy

Learning Objective: 12-02 Determine a firms cost of debt.

Section: 12.4 The Weighted Average Cost of Capital

Topic: Cost of debt

61. USA Manufacturing issued 30-year, 7.5 percent semiannual bonds 6 years ago. The bonds currently sell at 101 percent of face value. What is the firm's aftertax cost of debt if the tax rate is 35 percent?

A. 4.82 percent

B. 5.62 percent

C. 3.76 percent

D. 3.59 percent

E. 4.40 percent

AACSB: Analytical Thinking

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Blooms: Remember

Difficulty: 1 Easy

Learning Objective: 12-02 Determine a firms cost of debt.

Section: 12.4 The Weighted Average Cost of Capital

Topic: Cost of debt

62. Great Lakes Packing has two bond issues outstanding. The first issue has a coupon rate of8 percent, matures in 6 years, has a total face value of $5 million, and is quoted at 101.2 percent of face value. The second issue has a 7.5 percent coupon, matures in 13 years, has a total face value of $18 million, and is quoted at 99 percent of face value. Both bonds pay interest semiannually. What is the firm's weighted average aftertax cost of debt if the tax rate is 34 percent?

A. 5.05 percent

B. 5.12 percent

C. 5.63 percent

D. 5.95 percent

E. 6.08 percent

AACSB: Analytical Thinking

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Blooms: Understand

Difficulty: 2 Medium

Learning Objective: 12-02 Determine a firms cost of debt.

Section: 12.4 The Weighted Average Cost of Capital

Topic: Cost of debt

63. The 7 percent preferred stock of Midwest Muffler and Towing is selling for $65 per 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?

A. 12.79 percent

B. 11.21 percent

C. 11.46 percent

D. 10.55 percent

E. 10.77 percent

AACSB: Analytical Thinking

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Blooms: Remember

Difficulty: 1 Easy

Learning Objective: 12-02 Determine a firms cost of debt.

Section: 12.3 The Costs of Debt and Preferred Stock

Topic: Cost of preferred stock

64. 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?

A. 8.57 percent

B. 9.20 percent

C. 10.45percent

D. 11.86 percent

E. 10.21 percent

AACSB: Analytical Thinking

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Blooms: Remember

Difficulty: 1 Easy

Learning Objective: 12-02 Determine a firms cost of debt.

Section: 12.3 The Costs of Debt and Preferred Stock

Topic: Cost of preferred stock

65. The preferred stock of Dolphin Pools pays an annual dividend of $5.25 a share and sells for $48a share. The tax rate is 35 percent. What is the firm's cost of preferred stock?

A. 9.67 percent

B. 10.94 percent

C. 15.07 percent

D. 15.59 percent

E. 16.47 percent

AACSB: Analytical Thinking

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Blooms: Analyze

Difficulty: 1 Easy

Learning Objective: 12-02 Determine a firms cost of debt.

Section: 12.3 The Costs of Debt and Preferred Stock

Topic: Cost of preferred stock

66. 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?

A. 48.20 percent

B. 50.00 percent

C. 48.15 percent

D. 62.91 percent

E. 50.08 percent

AACSB: Analytical Thinking

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Blooms: Remember

Difficulty: 1 Easy

Learning Objective: 12-03 Determine a firms overall cost of capital.

Section: 12.4 The Weighted Average Cost of Capital

Topic: Capital structure weights

67. 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. 12.49 percent

B. 9.00 percent

C. 8.24 percent

D. 11.84 percent

E. 13.63 percent

AACSB: Analytical Thinking

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Blooms: Remember

Difficulty: 1 Easy

Learning Objective: 12-03 Determine a firms overall cost of capital.

Section: 12.4 The Weighted Average Cost of Capital

Topic: Capital structure weights

68. Santa Claus Enterprises has 87,000 shares of common stock outstanding at a current price of $39 a share. The firm also has two bond issues outstanding. The first bond issue has a total face value of $230,000, pays 7.1 percent interest annually, and currently sells for 103.1 percent of face value. The second bond issue consists of 5,000 bonds that are selling for $887 each. These bonds pay 6.5 percent interest annually and mature in eight years. The tax rate is 35 percent. What is the capital structure weight of the firm's debt?

A. 57.93 percent

B. 51.39 percent

C. 55.50 percent

D. 60.52 percent

E. 71.86 percent

AACSB: Analytical Thinking

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Blooms: Remember

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Learning Objective: 12-03 Determine a firms overall cost of capital.

Section: 12.4 The Weighted Average Cost of Capital

Topic: Capital structure weights

69. Bermuda Cruises issues only common stock and coupon bonds. The firm has a debt-equity ratio of .45. The cost of equity is 17.6 percent and the pretax cost of debt is 8.9 percent. What is the capital structure weight of the firm's equity if the firm's tax rate is 35 percent?

A. 66.75 percent

B. 49.97 percent

C. 52.93 percent

D. 59.08 percent

E. 68.97 percent

AACSB: Analytical Thinking

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Blooms: Remember

Difficulty: 1 Easy

Learning Objective: 12-03 Determine a firms overall cost of capital.

Section: 12.4 The Weighted Average Cost of Capital

Topic: Capital structure weights

70. The Five and Dime Store has a cost of equity of 14.8 percent, a pretax cost of debt of 6.7 percent, and a tax rate of 34 percent. What is the firm's weighted average cost of capital if the debt-equity ratio is .46?

A. 10.18 percent

B. 11.72 percent

C. 11.53 percent

D. 13.49 percent

E. 14.93 percent

AACSB: Analytical Thinking

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Blooms: Remember

Difficulty: 1 Easy

Learning Objective: 12-03 Determine a firms overall cost of capital.

Section: 12.4 The Weighted Average Cost of Capital

Topic: Weighted average cost of capital

71. Country Cook's cost of equity is 16.2 percent and its aftertax cost of debt is 5.8 percent. What is the firm's weighted average cost of capital if its debt-equity ratio is .42 and the tax rate is 34 percent?

A. 12.54 percent

B. 11.47 percent

C. 13.12 percent

D. 12.28 percent

E. 13.01 percent

AACSB: Analytical Thinking

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Blooms: Remember

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Learning Objective: 12-03 Determine a firms overall cost of capital.

Section: 12.4 The Weighted Average Cost of Capital

Topic: Weighted average cost of capital

72. A firm wants to create a WACC of 11.2 percent. The firm's cost of equity is 16.8 percent and its pretax cost of debt is 8.7 percent. The tax rate is 35 percent. What does the debt-equity ratio need to be for the firm to achieve its target WACC?

A. .86

B. .67

C. 1.04

D. .94

E. 1.01

AACSB: Analytical Thinking

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Blooms: Remember

Difficulty: 1 Easy

Learning Objective: 12-03 Determine a firms overall cost of capital.

Section: 12.4 The Weighted Average Cost of Capital

Topic: Weighted average cost of capital

73. The Color Box uses a combination of common stock, preferred stock, and debt financing. The company wants preferred stock to represent 7 percent of the total financing. It also wants to structure the firm in a manner that will produce a weighted average cost of capital of 9.5 percent. The aftertax cost of debt is 4.8 percent, the cost of preferred is 8.9 percent, and the cost of common stock is 14.7 percent. What percentage of the firm's capital funding should be debt financing?

A. 48.42 percent

B. 52.03 percent

C. 54.15 percent

D. 44.78 percent

E. 39.21 percent

AACSB: Analytical Thinking

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Learning Objective: 12-03 Determine a firms overall cost of capital.

Section: 12.4 The Weighted Average Cost of Capital

Topic: Weighted average cost of capital

74. Gulf Coast Tours currently has a weighted average cost of capital of 12.4 percent based on a combination of debt and equity financing. The firm has no preferred stock. The current debt-equity ratio is .47 and the aftertax cost of debt is 6.1 percent. The company just hired a new president who is considering eliminating all debt financing. All else constant, what will the firm's cost of capital be if the firm switches to an all-equity firm?

A. 15.45 percent

B. 12.92 percent

C. 12.89 percent

D. 13.37 percent

E. 15.36 percent

AACSB: Analytical Thinking

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Blooms: Remember

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Learning Objective: 12-03 Determine a firms overall cost of capital.

Section: 12.4 The Weighted Average Cost of Capital

Topic: Weighted average cost of capital

75. Design Interiors has a cost of equity of 14.9 percent and a pretax cost of debt of 8.6 percent. The firm's target weighted average cost of capital is 11 percent and its tax rate is 34 percent. What is the firm's target debt-equity ratio?

A. 1.37

B. .87

C. .98

D. 1.02

E. .73

AACSB: Analytical Thinking

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Blooms: Remember

Difficulty: 1 Easy

Learning Objective: 12-03 Determine a firms overall cost of capital.

Section: 12.4 The Weighted Average Cost of Capital

Topic: Weighted average cost of capital

76. Western Electric has 21,000 shares of common stock outstanding at a price per share of $61 and a rate of return of 15.6 percent. The firm has 11,000 shares of $8 preferred stock outstanding at a price of $48 a share. The outstanding debt has a total face value of $275,000 and currently sells for 104 percent of face. The yield to maturity on the debt is 8.81 percent. What is the firm's weighted average cost of capital if the tax rate is 35 percent?

A. 14.52 percent

B. 13.44 percent

C. 14.19 percent

D. 14.37 percent

E. 13.92 percent

AACSB: Analytical Thinking

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Blooms: Analyze

Difficulty: 3 Hard

Learning Objective: 12-03 Determine a firms overall cost of capital.

Section: 12.4 The Weighted Average Cost of Capital

Topic: Weighted average cost of capital

77. City Rentals has 44,000 shares of common stock outstanding at a market price of $32 a share. The common stock just paid a $1.50 annual dividend and has a dividend growth rate of 2.5 percent. There are 7,500 shares of $9 preferred stock outstanding at a market price of $72 a share. The outstanding bonds mature in 11 years, have a total face value of $825,000, a face value per bond of $1,000, and a market price of $989 each, and a pretax yield to maturity of 8.3 percent. The tax rate is 35 percent. What is the firm's weighted average cost of capital?

A. 7.76 percent

B. 8.68 percent

C. 9.29 percent

D. 9.97 percent

E. 10.30 percent

AACSB: Analytical Thinking

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Blooms: Analyze

Difficulty: 3 Hard

Learning Objective: 12-03 Determine a firms overall cost of capital.

Section: 12.4 The Weighted Average Cost of Capital

Topic: Weighted average cost of capital

78. 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.)

A. -$698,400

B. -$187,100

C. $48,200

D. $333,300

E. $2,500

AACSB: Analytical Thinking

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Blooms: Understand

Difficulty: 2 Medium

Learning Objective: 12-04 Identify some of the pitfalls associated with a firms overall cost of capital and what to do about them.

Section: 12.5 Divisional and Project Costs of Capital

Topic: Divisional and project costs of capital

79. Orchard Farms has a pretax cost of debt of 7.29 percent and a cost of equity of 16.3 percent. The firm uses the subjective approach to determine project discount rates. Currently, the firm is considering a project to which it has assigned an adjustment factor of 1.25 percent. The firm's tax rate is 35 percent and its debt-equity ratio is .48. The project has an initial cost of $3.9 million and produces cash inflows of $1.26 million a year for 5 years. What is the net present value of the project?

A. $421,619

B. $446,556

C. $514,370

D. $561,027

E. $478,721

AACSB: Analytical Thinking

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Blooms: Understand

Difficulty: 2 Medium

Learning Objective: 12-04 Identify some of the pitfalls associated with a firms overall cost of capital and what to do about them.

Section: 12.5 Divisional and Project Costs of Capital

Topic: Divisional and project costs of capital

80. Piedmont Hotels is an all-equity firm with 48,000 shares of stock outstanding. The stock has a beta of 1.19 and a standard deviation of 14.8 percent. The market risk premium is 7.8 percent and the risk-free rate of return is 4.1 percent. The company is considering a project that it considers riskier than its current operations so has assigned an adjustment of 1.35 percent to the project's discount rate. What should the firm set as the required rate of return for the project?

A. 9.85 percent

B. 10.92 percent

C. 15.39 percent

D. 14.73 percent

E. 17.33 percent

AACSB: Analytical Thinking

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Blooms: Remember

Difficulty: 1 Easy

Learning Objective: 12-04 Identify some of the pitfalls associated with a firms overall cost of capital and what to do about them.

Section: 12.5 Divisional and Project Costs of Capital

Topic: Divisional and project costs of capital

81. Cromwell's Interiors is considering a project that is equally as risky as the firm's current operations. The firm has a cost of equity of 15.4 percent and a pretax cost of debt of 8.9 percent. The debt-equity ratio is .46 and the tax rate is 34 percent. What is the cost of capital for this project?

A. 11.97 percent

B. 12.40 percent

C. 11.02 percent

D. 11.62 percent

E. 12.38 percent

AACSB: Analytical Thinking

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Blooms: Remember

Difficulty: 1 Easy

Learning Objective: 12-04 Identify some of the pitfalls associated with a firms overall cost of capital and what to do about them.

Section: 12.5 Divisional and Project Costs of Capital

Topic: Divisional and project costs of capital

82. International Exchange has three divisions: A, B, and C. Division A has the least risk and Division C has the most risk. The firm has an aftertax cost of debt of 6.1percent and a cost of equity of 14.3 percent. The firm is financed with 37 percent debt and 63 percent equity. Division A's projects are assigned a discount rate that is 2.2 percent less than the firm's weighted average cost of capital. What is the discount rate applicable to Division A?

A. 7.98 percent

B. 8.27 percent

C. 9.07 percent

D. 9.48 percent

E. 6.87 percent

AACSB: Analytical Thinking

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Blooms: Remember

Difficulty: 1 Easy

Learning Objective: 12-04 Identify some of the pitfalls associated with a firms overall cost of capital and what to do about them.

Section: 12.5 Divisional and Project Costs of Capital

Topic: Divisional and project costs of capital

83. Swizer Industries has two separate divisions. Division X has less risk so its projects are assigned a discount rate equal to the firm's WACC minus .75 percent. Division Y has more risk and its projects are assigned a rate equal to the firm's WACC plus 1 percent. The company has a debt-equity ratio of .48 and a tax rate of 34 percent. The cost of equity is 15.4 percent and the aftertax cost of debt is 5.4 percent. Presently, each division is considering a new project. Division Y's project provides a return of 12.9percent while Division X's project is expected to earn 11.5 percent. Which project(s), if any, should the company accept?

A. Accept both X and Y

B. Accept X and reject Y

C. Reject X and accept Y

D. Reject both X and Y

E. The answer cannot be determined based on the information provided.

AACSB: Analytical Thinking

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Blooms: Remember

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Learning Objective: 12-04 Identify some of the pitfalls associated with a firms overall cost of capital and what to do about them.

Section: 12.5 Divisional and Project Costs of Capital

Topic: Divisional and project costs of capital

84. Bruceton’s is a specialty retailer with multiple brick-and-mortar stores and a cost of capital of 16.4 percent. Specialty Imports is a wholesaler of specialty items and has a cost of capital of 12.6 percent. Both firms are considering opening a new store in downtown Chicago at a cost of $1.1 million. Because this type of store would be trendy, it would have a life of only 8 years and no salvage value. The expected annual net cash flow is $229,000, regardless of which firm opens the store. Which company(ies), if either, should open the Chicago store?

A. Bruceton’s only

B. Specialty Imports only

C. Neither company

D. Both companies

E. The answer cannot be determined based on the information provided.

AACSB: Analytical Thinking

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Blooms: Understand

Difficulty: 2 Medium

Learning Objective: 12-04 Identify some of the pitfalls associated with a firms overall cost of capital and what to do about them.

Section: 12.5 Divisional and Project Costs of Capital

Topic: Divisional and project costs of capital

85. Lester's is a globally diverse company with multiple divisions and a cost of capital of 15.8 percent. Med, Inc., is a specialty firm in the medical equipment field with a cost of capital of 13.7 percent. With the aging of America, both firms recognize the opportunities that exist in the medical field and are considering expansion in this area. At present, there is an opportunity for multiple firms to be involved in a new medical devices project. Each project will require an initial investment of $8.4 million with annual returns of $2.2 million per year for seven years. Which company(ies), if either, should become involved in the new projects?

A. Lester's only

B. Med, Inc., only

C. Both Lester's and Med, Inc.

D. Neither Lester's nor Med, Inc.

E. The answer cannot be determined based on the information provided.

AACSB: Analytical Thinking

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Blooms: Understand

Difficulty: 2 Medium

Learning Objective: 12-04 Identify some of the pitfalls associated with a firms overall cost of capital and what to do about them.

Section: 12.5 Divisional and Project Costs of Capital

Topic: Divisional and project costs of capital

86. Bob's is a retail chain of specialty hardware stores. The firm has 18,000 shares of stock outstanding that are currently valued at $82 a share and provide a rate of return of 13.2 percent. The firm also has 600 bonds outstanding that have a face value of $1,000, a market price of $1,032, and a coupon rate of 7 percent. These bonds mature in 7 years and pay interest semiannually. The tax rate is 35percent. The firm is considering expanding by building a new superstore. The superstore will require an initial investment of $9.3 million and is expected to produce cash inflows of $1.07 million annually over its 10-year life. The risks associated with the superstore are comparable to the risks of the firm's current operations. The initial investment will be depreciated on a straight line basis to a zero book value over the life of the project. At the end of the 10 years, the firm expects to sell the superstore for an aftertax value of $4.7 million. Should the firm accept or reject the superstore project and why?

A. Accept; The project's NPV is $1.27 million.

B. Accept; The NPV is $4.89 million.

C. Reject; The NPV is $1.06 million.

D. Reject; The NPV -$1.15 million.

E. Reject; The NPV is -$5.71 million.

AACSB: Analytical Thinking

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Blooms: Analyze

Difficulty: 3 Hard

Learning Objective: 12-03 Determine a firms overall cost of capital.

Section: 12.4 The Weighted Average Cost of Capital

Topic: Project analysis and evaluation

87. Casper's is analyzing a proposed expansion project that is much riskier than the firm's current operations. Thus, the project will be assigned a discount rate equal to the firm's cost of capital plus 2.5 percent. The proposed project has an initial cost of $18.1 million that will be depreciated on a straight-line basis to a zero book value over 20 years. The project also requires additional inventory of $428,000 over the project's life. Management estimates the facility will generate cash inflows of $2.46 million a year over its 20-year life. After 20 years, the company plans to sell the facility for an aftertax amount of$1.4 million. The company has 58,000 shares of common stock outstanding at a market price of $52 a share. This stock just paid an annual dividend of $2.84 a share. The dividend is expected to increase by 3.6 percent annually. The firm also has 15,000 shares of 9 percent preferred stock with a market value of $87 a share. The preferred stock has a par value of $100. The company has $1.2 million of face value bonds with semiannual payments and a coupon rate of 9 percent. The bonds are currently priced at 102 percent of face value and mature in 13 years. The tax rate is 35 percent. Should the firm pursue the expansion project at this point in time? Why or why not?

A. Accept; The NPV is $2.6 million.

B. Accept; The NPV is $1.0 million.

C. Reject; the NPV is -$3.2 million.

D. Reject; the NPV is -$3.0 million.

E. Reject; the NPV is -$1.4 million.

AACSB: Analytical Thinking

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Blooms: Analyze

Difficulty: 3 Hard

Learning Objective: 12-03 Determine a firms overall cost of capital.

Section: 12.4 The Weighted Average Cost of Capital

Topic: Project analysis and evaluation

88. Tim's Tools just issued a dividend of $2.22 per share on its common stock. The company is expected to maintain a constant 2.8 percent growth rate in its dividends indefinitely. If the stock sells for $19 a share, what is the company's cost of equity?

A. 12.81 percent

B. 13.37 percent

C. 9.94 percent

D. 14.81 percent

E. 10.46 percent

AACSB: Analytical Thinking

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Blooms: Remember

Difficulty: 1 Easy

Learning Objective: 12-01 Determine a firms cost of equity capital.

Section: 12.2 The Cost of Equity

Topic: Cost of equity

89. Stock in ABC Enterprises has a beta of 1.28. The market risk premium is 7.4 percent, and T-bills are currently yielding 3.6 percent. ABC's most recently paid dividend was $1.62 per share, and dividends are expected to grow at an annual rate of 2 percent indefinitely. If the stock sells for $38 a share, what is your best estimate of ABC's cost of equity?

A. 9.78 percent

B. 7.82 percent

C. 9.71 percent

D. 9.41 percent

E. 7.41 percent

AACSB: Analytical Thinking

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Blooms: Remember

Difficulty: 1 Easy

Learning Objective: 12-01 Determine a firms cost of equity capital.

Section: 12.2 The Cost of Equity

Topic: Cost of equity

90. Traditional Bank has an issue of preferred stock with an annual dividend of $7.50 that just sold for $62 a share. What is the bank's cost of preferred stock?

A. 12.91 percent

B. 12.10 percent

C. 11.23 percent

D. 13.47 percent

E. 11.32 percent

AACSB: Analytical Thinking

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Blooms: Remember

Difficulty: 1 Easy

Learning Objective: 12-02 Determine a firms cost of debt.

Section: 12.3 The Costs of Debt and Preferred Stock

Topic: Cost of preferred stock

91. Rockingham Motors issued a 30-year, 8 percent semiannual bond 3 years ago. The bond currently sells for 103.1 percent of its face value. The company's tax rate is 34 percent. What is the aftertax cost of debt?

A. 2.72 percent

B. 5.10 percent

C. 5.69 percent

D. 5.72 percent

E. 5.99 percent

AACSB: Analytical Thinking

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Blooms: Remember

Difficulty: 1 Easy

Learning Objective: 12-02 Determine a firms cost of debt.

Section: 12.4 The Weighted Average Cost of Capital

Topic: Cost of debt

92. Healthy Snacks has a target capital structure of 60 percent common stock, 3 percent preferred stock, and 37 percent debt. Its cost of equity is 16.8 percent, the cost of preferred stock is 11.4 percent, and the pretax cost of debt is 8.3 percent. What is the company's WACC if the applicable tax rate is 34 percent?

A. 13.29 percent

B. 12.61 percent

C. 12.34 percent

D. 12.45 percent

E. 12.83 percent

AACSB: Analytical Thinking

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Blooms: Remember

Difficulty: 1 Easy

Learning Objective: 12-03 Determine a firms overall cost of capital.

Section: 12.4 The Weighted Average Cost of Capital

Topic: Weighted average cost of capital

93. Precision Cuts has a target debt-equity ratio of .48. Its cost of equity is 16.4 percent, and its pretax cost of debt is 8.2 percent. If the tax rate is 34 percent, what is the company's WACC?

A. 13.20 percent

B. 11.72 percent

C. 12.91 percent

D. 11.28 percent

E. 12.84 percent

AACSB: Analytical Thinking

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Blooms: Remember

Difficulty: 1 Easy

Learning Objective: 12-03 Determine a firms overall cost of capital.

Section: 12.4 The Weighted Average Cost of Capital

Topic: Weighted average cost of capital

94. Given the following information for Electric Transport, find the WACC. Assume the company's tax rate is 35 percent.

Debt:8,100, 6.9 percent coupon bonds outstanding. $1,000 par value, 17 years to maturity, selling for 101 percent of par, the bonds make semiannual payments.

Common stock: 175,000 shares outstanding, selling for $77 per share, beta is 1.32.

Preferred stock:9,000 shares of $7.50 preferred stock outstanding, currently selling for $73 per share.

Market: 7.9 percent market risk premium and 3.6 percent risk-free rate.

A. 10.4 percent

B. 12.0 percent

C. 12.4 percent

D. 11.1 percent

E. 9.8 percent

AACSB: Analytical Thinking

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Blooms: Analyze

Difficulty: 3 Hard

Learning Objective: 12-03 Determine a firms overall cost of capital.

Section: 12.4 The Weighted Average Cost of Capital

Topic: Weighted average cost of capital

95. You are given the following information concerning Around Town Tours:

Debt:7,500, 6.8 percent coupon bonds outstanding, with 11 years to maturity and a quoted price of 97.9. These bonds pay interest semiannually.

Common stock: 284,000 shares of common stock selling for $68 per share. The stock has a beta of 1.04 and will pay a dividend of $2.62 next year. The dividend is expected to grow by 2.5 percent per year indefinitely.

Preferred stock:9,000 shares of $8 preferred stock selling at $88 per share.

Market: 14.6 percent expected return, 4.1 percent risk-free rate

Company:34 percent tax rate.

Calculate the WACC for this firm.

A. 9.0 percent

B. 8.7 percent

C. 9.4 percent

D. 9.6 percent

E. 10.0 percent

AACSB: Analytical Thinking

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Blooms: Analyze

Difficulty: 3 Hard

Learning Objective: 12-03 Determine a firms overall cost of capital.

Section: 12.4 The Weighted Average Cost of Capital

Topic: Weighted average cost of capital

96. Lawler's is considering a new project. The company has a debt-equity ratio of .64. The company's cost of equity is 14.9 percent, and the aftertax cost of debt is 5.3 percent. The firm feels that the project is riskier than the company as a whole and that it should use an adjustment factor of +1.8 percent. What is the project cost of capital if the tax rate is 34 percent?

A. 12.53 percent

B. 12.98 percent

C. 12.95 percent

D. 15.14 percent

E. 15.68 percent

AACSB: Analytical Thinking

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Blooms: Remember

Difficulty: 1 Easy

Learning Objective: 12-04 Identify some of the pitfalls associated with a firms overall cost of capital and what to do about them.

Section: 12.5 Divisional and Project Costs of Capital

Topic: Divisional and project costs of capital

97. Country Markets has an EBIT of $42,650, an increase in net working capital of $2,615, interest expense of $4,300, net capital spending of $3,620, and a tax rate of 34 percent. The firm’s WACC is 11.2 percent and its growth rate is 3.1 percent. What is the adjusted value of the firm?

A. $287,097.17

B. $311,208.16

C. $270,543.21

D. $238,009.72

E. $308,315.22

AACSB: Analytical Thinking

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Blooms: Remember

Difficulty: 1 Easy

Learning Objective: 12-03 Determine a firms overall cost of capital.

Section: 12.6 Company Valuation with the WACC

Topic: Firm valuation

98. Big Tree Inn has an EBIT of $121,318, a decrease in net working capital of $1,204, interest expense of $5,200, net capital spending of $5,200, and a tax rate of 35 percent. The firm’s WACC is 12.6 percent and its growth rate is 2.7 percent. What is the adjusted value of the firm?

A. $694,311.08

B. $708,007.49

C. $756,168.69

D. $733,333.33

E. $789,022.15

AACSB: Analytical Thinking

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Blooms: Remember

Difficulty: 1 Easy

Learning Objective: 12-03 Determine a firms overall cost of capital.

Section: 12.6 Company Valuation with the WACC

Topic: Firm valuation

New

99. Mercury Racquetballs just paid an annual dividend of $2.03 on its common stock and increases its dividend by 2.75 percent annually. What is the rate of return on this stock if the current stock price is $49.50 a share?

A. 6.96 percent

B. 7.71 percent

C. 6.88 percent

D. 7.53 percent

E. 7.56 percent

AACSB: Analytical Thinking

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Blooms: Remember

Difficulty: 1 Easy

Learning Objective: 12-01 Determine a firms cost of equity capital.

Section: 12.2 The Cost of Equity

Topic: Cost of equity

100. Muttly Engineering announced this morning that its next annual dividend will be decreased to $2.45 a share and that all future dividends will be decreased by an additional 1.45 percent annually. What is the current value per share if the required return is 19.5 percent?

A. $10.33

B. $11.69

C. $11.89

D. $11.41

E. $11.95

AACSB: Analytical Thinking

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Blooms: Remember

Difficulty: 1 Easy

Learning Objective: 12-01 Determine a firms cost of equity capital.

Section: 12.2 The Cost of Equity

Topic: Cost of equity

101. Sheepdog Rescue just paid its first annual dividend of $1.95 a share. The firm plans to increase the dividend by 1.75 percent per year indefinitely. What is the firm's cost of equity if the current stock price is $31.45 per share?

A. 6.31 percent

B. 8.06 percent

C. 10.38 percent

D. 4.93 percent

E. 5.94 percent

AACSB: Analytical Thinking

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Blooms: Remember

Difficulty: 1 Easy

Learning Objective: 12-01 Determine a firms cost of equity capital.

Section: 12.2 The Cost of Equity

Topic: Cost of equity

102. 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?

A. $11.59

B. $11.09

C. $12.79

D. $13.89

E. $14.39

AACSB: Analytical Thinking

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Blooms: Remember

Difficulty: 1 Easy

Learning Objective: 12-01 Determine a firms cost of equity capital.

Section: 12.2 The Cost of Equity

Topic: Cost of equity

103. The common stock of Pedestrian Automotive has a beta of 0.89 and a standard deviation of 15.8 percent. The market rate of return is 12.25 percent and the risk-free rate is 2.9 percent. What is the cost of equity for this firm?

A. 11.22 percent

B. 9.16 percent

C. 9.48 percent

D. 11.80 percent

E. 10.45 percent

AACSB: Analytical Thinking

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Blooms: Remember

Difficulty: 1 Easy

Learning Objective: 12-01 Determine a firms cost of equity capital.

Section: 12.2 The Cost of Equity

Topic: Cost of equity

104. The common stock of Shaky Building Supply has a beta that is 22 percent greater than the overall market beta. Currently, the market risk premium is 9.56 percent while the U.S. Treasury bill is yielding 3.3 percent. What is the cost of equity for this firm?

A. 15.16 percent

B. 14.36 percent

C. 15.31 percent

D. 14.96 percent

E. 14.25 percent

AACSB: Analytical Thinking

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Blooms: Remember

Difficulty: 1 Easy

Learning Objective: 12-01 Determine a firms cost of equity capital.

Section: 12.2 The Cost of Equity

Topic: Cost of equity

105. Regulation Insurance has a beta of 0.90, a dividend growth rate of 2.5 percent for the foreseeable future, a stock price of $47 per share, and an expected annual dividend of $0.60 per share next year. The market rate of return is 13.9 percent and the risk-free rate is 3.4 percent. What is the firm's average cost of equity?

A. 6.69 percent

B. 8.31 percent

C. 8.25 percent

D. 8.67 percent

E. 6.41 percent

AACSB: Analytical Thinking

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Blooms: Remember

Difficulty: 1 Easy

Learning Objective: 12-01 Determine a firms cost of equity capital.

Section: 12.2 The Cost of Equity

Topic: Cost of equity

106. Cool Fire, Inc. has 7.2 percent bonds outstanding that mature in 15 years. The bonds pay interest semiannually and have a face value of $1,000. Currently, the bonds are selling for $975.

A. 7.61 percent

B. 7.48 percent

C. 7.78 percent

D. 7.95 percent

E. 7.04 percent

AACSB: Analytical Thinking

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Blooms: Remember

Difficulty: 1 Easy

Learning Objective: 12-02 Determine a firms cost of debt.

Section: 12.3 The Costs of Debt and Preferred Stock

Topic: Cost of debt

107. The 8.4 percent preferred stock of Dynachili Distributing is selling for $48 per 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?

A. 19.52 percent

B. 17.94 percent

C. 18.19 percent

D. 18.54 percent

E. 17.50 percent

AACSB: Analytical Thinking

Accessibility: Keyboard Navigation

Blooms: Remember

Difficulty: 1 Easy

Learning Objective: 12-02 Determine a firms cost of debt.

Section: 12.3 The Costs of Debt and Preferred Stock

Topic: Cost of preferred stock

108. 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?

A. 24.74 percent

B. 26.22 percent

C. 24.69 percent

D. 39.45 percent

E. 26.62 percent

AACSB: Analytical Thinking

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Blooms: Remember

Difficulty: 1 Easy

Learning Objective: 12-03 Determine a firms overall cost of capital.

Section: 12.4 The Weighted Average Cost of Capital

Topic: Capital structure weights