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72. An analyst gathers the following information about the capital structure and before-tax component costs for a company. The company’s marginal tax rate is 40 percent.

Capital component	Book Value (000)	Market Value (000)	Component cost
Debt Preferred stock Common stock	$100        $20        $100	$80          $20         $200	8%        10%        12%

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

A. 8.55%.
B. 9.95%.
C. 10.80%.

Answer: B
“Cost of Capital,” Yves Courtois, CFA, Gene C. Lai, and Pamela P. Peterson,
CFA 2009 Modular Level I, Volume 4, pp. 36-41
Study Session 11-45-a, c
Calculate and interpret the weighted average cost of capital (WACC) of a company.
Describe alternative methods of calculating the weights used in the weighted average cost of capital, including the use of the company’s target capital structure.
Because the target capital weights are not given, market value weights are used to compute the WACC. The market value weights for debt, preferred stock and equity are 0.2667, 0.0667, and 0.6667 respectively.
WACC = × × (1 – t) + × + ×= 0.2667 × 8% × (1 – 0.4) + 0.0667 × 10% + 0.6667 × 12% = 9.95%

73. A company is considering issuing a 10-year, option-free, semiannual coupon bond with a 9 percent coupon rate. The bond is expected to sell at 95 percent of par value. If the company’s marginal tax rate is 30 percent, then the after-tax cost of debt is closest to:
A. 6.30%.
B. 6.86%.
C. 9.80%.

Answer: B
“Cost of Capital,” Yves Courtois, CFA, Gene C. Lai, and Pamela P. Peterson, CFA
2009 Modular Level I, Volume 4, pp. 43-45
Study Session 11-45-f Calculate and interpret the cost of fixed rate debt capital using the yield-tomaturity approach and the debt-rating approach.
Using a financial calculator: N = 20, PMT = 45, PV = –950, FV = 1000; solve for I/Y = 4.90%. The annual yield is twice the semiannual yield = 4.90% × 2 = 9.80%. The after-tax cost of debt = annual yield × (1 – t) = 9.80% × (1 – 0.30) = 6.86%

74. A company plans to issue nonconvertible, noncallable, fixed-rate perpetual preferred stock with a $6 annual dividend. The preferred stock is expected to sell for $40. If the company’s marginal tax rate is 30 percent, then the cost of preferred stock is closest to:

A. 6.67%.
B. 10.5%.
C. 15.0%.

Answer: C
“Cost of Capital,” Yves Courtois, CFA, Gene C. Lai, and Pamela P. Peterson, CFA 2009 Modular Level I, Volume 4, pp. 46-47
Study Session 11-45-g
Calculate and interpret the cost of noncallable, nonconvertible preferred stock.
The cost of a perpetuity is the annual cash flow divided by the selling price. In this case, the cost of preferred ( ) = 6.00 / 40 = 15.0%. Because the preferred stock dividend is not tax deductible to the issuing company, there is no after-tax adjustment.

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69. A large corporation accepts a project which generates no revenue and has a negative net present value. The project most likely is classified in which of the following categories?

A. Replacement project.
B. New product or service.
C. Regulatory or environmental project.

Answer: C
“Capital Budgeting,” John D. Stowe, CFA, and Jacques R. Gagné, CFA 2009 Modular Level I, Volume 4, pp. 6-8
Study Session 11-44-a Explain the capital budgeting process, including the typical steps of the process, and distinguish among the various categories of capital projects.
Regulatory, safety, and environmental projects are often mandated by governmental agencies. They may generate no revenue and might not be undertaken by a company maximizing its own private interests. For example, a corporation may be required to install equipment to meet a regulatory standard, and the cost of satisfying the standard is born by the corporation. In this case, the corporation selects the lowest cost alternative that meets the requirement, i.e., the alternative with the least negative net present value.

70. A company recently opened a limestone quarry at a location outside its traditional service area. Because limestone is a major ingredient in concrete, if the quarry is successful the company plans to build a ready-mix concrete plant at the same location. The investment in the concrete plant is best described as:

A. an externality.
B. project sequencing.
C. an example of investment synergy.

Answer: B
“Capital Budgeting,” John D. Stowe, CFA, and Jacques R. Gagné, CFA 2009 Modular Level I, Volume 4, pp. 8-10
Study Session 11-44-c Explain how the following project interactions affect the evaluation of a capital project: (1) independent versus mutually exclusive projects, (2) project sequencing, and (3) unlimited funds versus capital rationing. Project sequencing occurs when the investment in one project creates the option to invest in future projects.

71. An analyst determines the following cash flows for a capital project:

Year	0	1	2	3	4	5
Cash flow (