Reading 45: Cost of Capital - LOS h ～Q6-10 average, capital, white, style, black

mayanfang1

Q6. What is the weighted average cost of capital (WACC)?

A)   9.2%.

B)   10.3%.

C)   8.5%.

• The company has a target capital structure of 40% debt and 60% equity.

• Bonds pay 10% coupon (semi-annual payout), 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 is a constant growth firm that just paid a dividend of $2.00, sells for $27.00 per share, and has a growth rate of 8%.

• The company's marginal tax rate is 40%.

Q7. The after-tax cost of debt is:

A)   8.0%.

B)   7.2%.

C)   9.1%.

Q8. The cost of equity using the capital asset pricing model (CAPM) approach and the discounted cash flow approach is:

          CAPM                              Discounted Cash Flow

 

A)   16.0%                                    15.4%

B)   16.6%                                    15.4%

C)   16.0%                                    16.0%

Q9. Which of the following statements about the cost of capital is TRUE?

A)   In the weighted average cost of capital calculation, the cost of preferred stock must be adjusted for the cost to issue new preferred stock.

B)   Ideally, historical measures of the component costs from prior financing should be used in estimating the appropriate weighted average cost of capital.

C)   The cost of issuing new equity could possibly be lower than the cost of retained earnings if the market risk premium and risk-free rate decline by a substantial amount.

Q10. A firm has $4 million in outstanding bonds that mature in four years, with a fixed rate of 7.5% (assume annual payments). The bonds trade at a price of $98 in the open market. The firm’s marginal tax rate is 35%. Using the bond-yield plus method, what is the firm’s cost of equity risk assuming an add-on of 4%?

A)   11.50%.

B)   13.34%.

C)   12.11%.

mayanfang1

答案和详解如下：

Q6. What is the weighted average cost of capital (WACC)?

A)   9.2%.

B)   10.3%.

C)   8.5%.

Correct answer is C)

k_ce = (D₁ / P₀) + g
k_ce = 2 / 45 + 0.08 = 0.1244 = 12.44%
WACC = (0.4)(4.2) + (0.1)(5.6) + (0.5)(12.4) = 8.5%

• The company has a target capital structure of 40% debt and 60% equity.

• Bonds pay 10% coupon (semi-annual payout), 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 is a constant growth firm that just paid a dividend of $2.00, sells for $27.00 per share, and has a growth rate of 8%.

• The company's marginal tax rate is 40%.

Q7. The after-tax cost of debt is:

A)   8.0%.

B)   7.2%.

C)   9.1%.

Correct answer is B)

N = 40; PMT = 50; FV = 1,000; PV = 849.54; Compute i = 6%, double = 12%, now (12)(1 − 0.4) = 7.2%.

Q8. The cost of equity using the capital asset pricing model (CAPM) approach and the discounted cash flow approach is:

          CAPM                              Discounted Cash Flow

 

A)   16.0%                                    15.4%

B)   16.6%                                    15.4%

C)   16.0%                                    16.0%

Correct answer is C)

CAPM = 10 + (5)(1.2) = 16%.

Discounted Cash Flow: D₁ = 2(1.08) = 2.16, now (2.16 / 27) + 0.08 = 16%

Q9. Which of the following statements about the cost of capital is TRUE?

A)   In the weighted average cost of capital calculation, the cost of preferred stock must be adjusted for the cost to issue new preferred stock.

B)   Ideally, historical measures of the component costs from prior financing should be used in estimating the appropriate weighted average cost of capital.

C)   The cost of issuing new equity could possibly be lower than the cost of retained earnings if the market risk premium and risk-free rate decline by a substantial amount.

Correct answer is A)

The marginal cost of capital will increase or stay the same as more capital is raised. Marginal costs of capital, not historical costs, should be used in estimating the weighted average cost of capital.

Q10. A firm has $4 million in outstanding bonds that mature in four years, with a fixed rate of 7.5% (assume annual payments). The bonds trade at a price of $98 in the open market. The firm’s marginal tax rate is 35%. Using the bond-yield plus method, what is the firm’s cost of equity risk assuming an add-on of 4%?

A)   11.50%.

B)   13.34%.

C)   12.11%.

Correct answer is C)

If the bonds are trading at $98, the required yield is 8.11%, and the market value of the issue is $3.92 million. To calculate this rate using a financial calculator (and figuring the rate assuming a $100 face value for each bond), N = 4; PMT = 7.5 = (0.075 × 100); FV = 100; PV = -98; CPT → I/Y = 8.11. By adding the equity risk factor of 4%, we compute the cost of equity as 12.11%.

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