Reading 45: Cost of Capital - LOS a ～ Q1-5

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Q1. A company has the following information:

A target capital structure of 40% debt and 60% equity.
$1,000 par value bonds pay 10% coupon (semi-annual payments), mature in 20 years, and sell for $849.54.
The company stock beta is 1.2.
Risk-free rate is 10%, and market risk premium is 5%.
The company's marginal tax rate is 40%.

The weighted average cost of capital (WACC) is closest to:

A) 13.0%.

B) 13.5%.

C) 12.5%.

Q2. 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%.

Q3. 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%.

Q4. 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%.

Q5. 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%.