financial problems

1)

If a firm’s marginal tax rate is
increased, this would, other things held constant, lower the cost of debt
used to calculate its WACC.

a.

True

b.

False

2)

The lower the firm’s tax rate, the
lower will be its after-tax cost of debt and WACC, other things held
constant.

a.

True

b.

False

3)

If investors’ aversion to risk
rose, causing the slope of the SML to increase, this would have a greater
impact on the required rate of return on equity, rs, than on the
interest rate on long-term debt, rd, for most firms. Other things held constant, this would lead
to an increase in the use of debt and a decrease in the use of equity. However, other things would not stay
constant if firms used a lot more debt, as that would increase the riskiness
of both debt and equity and thus limit the shift toward debt.

a.

True

b.

False

4)

Jackson Inc. uses only equity
capital, and it has 2 equally-sized divisions. Division A’s cost of capital
is 10.0%, Division B’s cost is 14.0%, and the composite WACC is 12.0%. All of Division A’s projects have the same
risk, as do all of Division B’s projects.
However, the projects in Division A have less risk than those in
Division B. Which of the following
projects should Jackson
accept?

a.

A Division B project with a 13%
return.

b.

A Division B project with a 12%
return.

c.

A Division A project with an 11%
return.

d.

A Division A project with a 9%
return.

e.

A Division B project with an 11%
return.

5)

Vang Inc. estimates that its
average-risk projects have a WACC of 10%, its below-average risk projects
have a WACC of 8%, and its above-average risk projects have a WACC of 12%. Which of the following projects (A, B, and
C) should the company accept?

a.

Project B is of below-average risk
and has a return of 8.5%.

b.

Project C is of above-average risk
and has a return of 11%.

c.

Project A is of average risk and
has a return of 9%.

d.

None of the projects should be
accepted.

e.

All of the projects should be
accepted.

6)

Nelson Enterprises, an all-equity
firm, has a beta of 2.0. Nelson’s
chief financial officer is evaluating a project with an expected return of
21%, before any risk adjustment. The
risk-free rate is 7%, and the market risk premium is 6%. The project being evaluated is riskier than
Nelson’s average project, in terms of both its beta risk and its total
risk. Which of the following
statements is CORRECT?

a.

The project should definitely be
accepted because its expected return (before any risk adjustments) is greater
than its required return.

b.

The project should definitely be
rejected because its expected return (before risk adjustment) is less than
its required return.

c.

Riskier-than-average projects
should have their expected returns increased to reflect their higher
risk. Clearly, this would make the
project acceptable regardless of the amount of the adjustment.

d.

The accept/reject decision depends
on the firm’s risk-adjustment policy.
If Nelson’s policy is to increase the required return on a
riskier-than-average project to 3% over rS, then it should reject
the project.

e.

Capital budgeting projects should
be evaluated solely on the basis of their total risk. Thus, insufficient
information has been provided to make the accept/reject decision.

7)

Which of the following statements
is CORRECT?

a.

The WACC is calculated using
before-tax costs for all components.

b.

The after-tax cost of debt usually
exceeds the after-tax cost of equity.

c.

For a given firm, the after-tax
cost of debt is always more expensive than the after-tax cost of preferred
stock.

d.

Retained earnings that were
generated in the past and are reflected on the firm’s balance sheet are
generally available to finance the firm’s capital budget during the coming
year.

e.

The WACC that should be used in
capital budgeting is the firm’s marginal, after-tax cost of capital.

8)

Assume that you are a consultant
to Magee Inc., and you have been provided with the following data: rRF
= 4.00%; RPM = 5.00%; and b = 1.15. What is the cost of equity from retained
earnings based on the CAPM approach?

a.

9.75%

b.

10.04%

c.

10.34%

d.

10.65%

e.

10.97%

9)

Lanser Inc. hired you as a
consultant to help them estimate its cost of capital. You have been provided with the following
data: D1 = $0.80; P0
= $22.50; and g = 5.00% (constant).
Based on the DCF approach, what is the cost of equity from retained
earnings?

a.

7.34%

b.

7.72%

c.

8.13%

d.

8.56%

e.

8.98%

10)

You were hired as a consultant to
Kroncke Company, whose target capital structure is 40% debt, 10% preferred,
and 50% common equity. The after-tax
cost of debt is 6.00%, the cost of preferred is 7.50%, and the cost of
retained earnings is 13.25%. The firm
will not be issuing any new stock.
What is its WACC?

a.

9.48%

b.

9.78%

c.

10.07%

d.

10.37%

e.

10.68%

11)

To help finance a major expansion,
Delano Development Company sold a noncallable bond several years ago that now
has 15 years to maturity. This bond
has a 10.25% annual coupon, paid semiannually, it sells at a price of $1,025,
and it has a par value of $1,000. If Delano’s tax rate is
40%, what component cost of debt should be used in the WACC calculation?

a.

5.11%

b.

5.37%

c.

5.66%

d.

5.96%

e.

6.25%

12)

Chambliss Inc. hired you as a
consultant to help estimate its cost of capital. You have been provided with the following
data: D0 = $0.90; P0
= $27.50; and g = 8.00% (constant).
Based on the DCF approach, what is the cost of equity from retained
earnings?

a.

10.41%

b.

10.96%

c.

11.53%

d.

12.11%

e.

12.72%

13)

You were recently hired by Nast
Media Inc. to estimate its cost of capital.
You were provided with the following data: D1 = $2.00; P0 = $55.00;
g = 8.00% (constant); and F = 5.00%.
What is the cost of equity raised by selling new common stock?

a.

11.24%

b.

11.83%

c.

12.42%

d.

13.04%

e.

13.69%

14)

Schadler Systems is expected to
pay a $3.50 dividend at year end (D1 = $3.50), the dividend is
expected to grow at a constant rate of 6.50% a year, and the common stock
currently sells for $62.50 a share.
The before-tax cost of debt is 7.50%, and the tax rate is 40%. The target capital structure consists of
40% debt and 60% common equity. What
is the company’s WACC if all equity is from retained earnings?

a.

8.35%

b.

8.70%

c.

9.06%

d.

9.42%

e.

9.80%

15)

Roxie Epoxy’s balance sheet shows
a total of $50 million long-term debt with a coupon rate of 8.00% and a yield
to maturity of 7.00%. This debt
currently has a market value of $55 million.
The balance sheet also shows that that the company has 20 million
shares of common stock, and the book value of the common equity (common stock
plus retained earnings) is $65 million.
The current stock price is $8.25 per share; stockholders’ required
return, rs, is 10.00%; and the firm’s tax rate is 40%. Based on market value weights, and assuming
the firm is currently at its target capital structure, what WACC should Roxie
use to evaluate capital budgeting projects?

a.

7.26%

b.

7.56%

c.

7.88%

d.

8.21%

e.

8.55%

16)

Assume that you are on the financial
staff of Michelson Inc., and you have collected the following data: (1) The yield on the company’s outstanding
bonds is 8.00%, and its tax rate is 40%.
(2) The next expected dividend is $0.65 a share, and the dividend is
expected to grow at a constant rate of 6.00% a year. (3) The price of Michelson’s stock is
$17.50 per share, and the flotation cost for selling new shares is F =
10%. (4) The target capital structure
is 45% debt and the balance is common equity.
What is Michelson’s WACC, assuming it must issue new stock to finance
its capital budget?

a.

6.63%

b.

6.98%

c.

7.34%

d.

7.73%

e.

8.12%

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