1215

A firm is planning a $25 million expansion project. The project will be financed with $10 million in debt and $15 million in equity stock (equal to the company's current capital structure). The before-tax required return on debt is 10% and 15% for equity. If the company is in the 35% tax bracket, what cost of capital should the firm use to determine the project's net present value (NPV)?

A) 12.5%.

B) 9.6%.

C) 11.6%.

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WACC = (E / V)(R_E) + (D / V)(R_D)(1 ? TC)

WACC = (15 / 25)(0.15) + (10 / 25)(0.10)(1 ? 0.35) = 0.09 + 0.026 = 0.116 or 11.6%

1215

A firm has $100 in equity and $300 in debt. The firm recently issued bonds at the market required rate of 9%. The firm's beta is 1.125, the risk-free rate is 6%, and the expected return in the market is 14%. Assume the firm is at their optimal capital structure and the firm's tax rate is 40%. What is the firm's weighted average cost of capital (WACC)?

A) 8.6%.

B) 5.4%.

C) 7.8%.

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CAPM = R_E = R_F + B(R_M ? R_F) = 0.06 + (1.125)(0.14 ? 0.06) = 0.15

WACC = (E ÷ V)(R_E) + (D ÷ V)(R_D)(1 ? t)

V = 100 + 300 = 400

WACC = (1 ÷ 4)(0.15) + (3 ÷ 4)(0.09)(1 ? 0.4) = 0.078

1215

Hatch Corporation's target capital structure is 40% debt, 50% common stock, and 10% preferred stock. Information regarding the company's cost of capital can be summarized as follows:

• The company's bonds have a nominal yield to maturity of 7%.
• The company's preferred stock sells for $40 a share and pays an annual dividend of $4 a share.
• The company's common stock sells for $25 a share and is expected to pay a dividend of $2 a share at the end of the year (i.e., D₁ = $2.00). The dividend is expected to grow at a constant rate of 7% a year.
• The company has no retained earnings.
• The company's tax rate is 40%.

What is the company's weighted average cost of capital (WACC)?

A) 10.18%.

B) 10.59%.

C) 10.03%.

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WACC = (w_d)(k_d)(1 ? t) + (w_ps)(k_ps) + (w_ce)(k_ce)

where:
w_d = 0.40
w_ce = 0.50
w_ps = 0.10
k_d = 0.07

k_ps = D_ps / P = 4.00 / 40.00 = 0.10

k_ce = D₁ / P₀ + g = 2.00 / 25.00 + 0.07 = 0.08 + 0.07 = 0.15

WACC = (0.4)(0.07)(1 ? 0.4) + (0.1)(0.10) + (0.5)(0.15) = 0.0168 + 0.01 + 0.075 = 0.1018 or 10.18%

1215

A company is planning a $50 million expansion. The expansion is to be financed by selling $20 million in new debt and $30 million in new common stock. The before-tax required return on debt is 9% and the required return for equity is 14%. If the company is in the 40% tax bracket, the marginal weighted average cost of capital is closest to:

A) 9.0%.

B) 10.0%

C) 10.6%.

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(0.4)(9%)(1 - 0.4) + (0.6)(14%) = 10.56%