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					BUS 785 ICW on cost of capital and more


   1. A company has preferred stock outstanding which pays a dividend of $8 per share a
      year. The current price of the preferred stock is $75 per share. The yield to maturity on
      firms’ long term bond is 4.5%. What is the cost of preferred stock?
   A) 6%
   B) 7.5%
   C) 10.67%
   D) 8.5%
   E) 8%


   2. A company has preferred stock outstanding which pays a dividend of $8 per share a
      year. The current price of the preferred stock is $75 per share. The yield to maturity on
      firms’ long term bond is 4.5%. What is the (pre-tax) cost of debt?
   A) 6%
   B) 7.5%
   C) 10.67%
   D) 4.5%
   E) 8%

  3. For a multi-product firm, if a new project's beta is different from that of the overall
      firm, then the
      A) project should be discounted at a rate commensurate with its risk level (which
           could be based on its beta)
      B) project should be discounted using the overall firm's PE ratio.
      C) project should be discounted at the Treasury-bill rate.
      D) project should be discounted at 7.5%.


   4. The market value of equity is $500 million. The market value of debt is $400
       million. The total market value of the firm is $900 million. The cost of equity is
       15%, the cost of debt is 10%, and the tax rate is 35%. What is the firm’s WACC?
   A) 9.09%
   B) 11.22%
   C) 13.78%
   D) 14.17%


 5. If a firm uses the same company cost of capital for evaluating all projects with very
   different risks, which of the following is likely?
   A. Rejecting good low risk projects
   B. Accepting poor high risk projects
   C. Both A and B
   D. Neither A nor B


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      6. Why are we interested in WACC in this course?
          (a) WACC is an interesting name
          (b) WACC is related to the amount of future cash flows of a project.
          (c) WACC is the approximation of the discount rate used in capital budgeting
          (d) WACC stands for “without Any Countable Cash”. That is an emergency issue
          for firm managers.



      7. A common stock issue is currently selling for $100 per share. You expect the next
         dividend to be $3 per share. If the firm has a dividend growth rate of 10% that is
         expected to remain constant indefinitely, what is the firm's cost of equity?
      A) 5%
      B) 10%
      C) 13%
      D) 20%
      E) 30%



8.      Which of the following should NOT be considered when calculating a firm's WACC?
        a. YTM on a firm's bonds.
        b. Cost of preferred stock.
        c. Cost of common stock.
        d. Cost of accounts payable.
        e. Corporate tax rate.


9.    A common stock issue is currently selling for $31 per share. You expect the next dividend to
          be $1.40 per share. If the firm has a dividend growth rate of 5% that is expected to
          remain constant indefinitely, what is the firm’s cost of equity?
      a.   9.5%
      b. 11.3%
      c. 13.8%
      d. 14.2%
      e. 15.1%



10.      A company estimates that a below-average risk project has a discount rate of 9
         percent, an average-risk project has a discount rate of 10 percent, and an above-
         average risk project has a discount rate of 11 percent. Which of the following
         independent projects should the company accept?



                                                                                                2
       a.    Project A has average risk and a return of 9.5 percent.
       b.    Project C has above-average risk and a return of 10.5 percent.
       c.    Project B has below-average risk and a return of 8.5 percent.
       d.    Project A and C should be accepted.
       e.    None of the projects above should be accepted.



11.Billick Brothers is estimating its WACC. The company has collected the following
information:
            Its capital structure consists of 40 percent debt and 60 percent common equity.
            The company has 20-year bonds outstanding with a 9 percent annual coupon that
             are trading at par ($1000).
            The company’s tax rate is 40 percent.
            The risk-free rate is 5.5 percent.
            The market risk premium is 5 percent.
            The stock’s beta is 1.4.


   What is the company’s WACC?

       a. 9.71%
       b. 9.66%
       c. 8.31%
       d. 11.18%
       e. 11.10%


12. A stock has a beta of 1.12 and a required return of 11.6 percent. The risk-free rate is
         4.2 percent. What is the market risk premium?

            A. 5.45 percent
            B. 6.61 percent
            C. 7.40 percent
            D. 8.28 percent
            E. 10.32 percent



13. Currently, you own a portfolio comprised of the following. What is the portfolio beta?


     Stock       Value    Beta
     A             $2,000          0.9
     B             $2,000            1
     C             $4,000          1.5




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   a. 1.225
   b. 1.133
   c. 1.000
   d. 0.980



14.If a stock's beta is -1 during a period when the market portfolio was down by 10%,
        then, in advance, we could expect the return on this individual stock to:
        A) go down by 10% .
        B) go up by 10%.
        C) have no change.
        D) go in no direction



BUS 785 ICW on cost of capital


   1. A company has preferred stock outstanding which pays a dividend of $8 per share a
      year. The current price of the preferred stock is $75 per share. The yield to maturity on
      firms’ long term bond is 4.5%. What is the cost of preferred stock?
   A) 6%
   B) 7.5%
   C) 10.67%
   D) 8.5%
   E) 8%


   2. A company has preferred stock outstanding which pays a dividend of $8 per share a
      year. The current price of the preferred stock is $75 per share. The yield to maturity on
      firms’ long term bond is 4.5%. What is the (pre-tax) cost of debt?
   A) 6%
   B) 7.5%
   C) 10.67%
   D) 4.5%
   E) 8%

   3. For a multi-product firm, if a new project's beta is different from that of the overall
       firm, then the
       A) project should be discounted at a rate commensurate with its risk level (which
            could be based on its beta)
       B) project should be discounted using the overall firm's PE ratio.
       C) project should be discounted at the Treasury-bill rate.
       D) project should be discounted at 7.5%.


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      5. The market value of equity is $500 million. The market value of debt is $400
          million. The total market value of the firm is $900 million. The cost of equity is
          15%, the cost of debt is 10%, and the tax rate is 35%. What is the firm’s WACC?
      A) 9.09%
      B) 11.22%
      C) 13.78%
      D) 14.17%


     5. If a firm uses the same company cost of capital for evaluating all projects with very
       different risks, which of the following is likely?
       A. Rejecting good low risk projects
       B. Accepting poor high risk projects
       C. Both A and B
       D. Neither A nor B




      6. Why are we interested in WACC in this course?
          (a) WACC is an interesting name
          (b) WACC is related to the amount of future cash flows of a project.
          (c) WACC is the approximation of the discount rate used in capital budgeting
          (d) WACC stands for “without Any Countable Cash”. That is an emergency issue
          for firm managers.



       7. A common stock issue is currently selling for $100 per share. You expect the next
          dividend to be $3 per share. If the firm has a dividend growth rate of 10% that is
          expected to remain constant indefinitely, what is the firm's cost of equity?
       A) 5%
       B) 10%
       C) 13%
       D) 20%
       E) 30%



8.       Which of the following should NOT be considered when calculating a firm's WACC?
         a. YTM on a firm's bonds.
         b. Cost of preferred stock.
         c. Cost of common stock.
         d. Cost of accounts payable.
         e. Corporate tax rate.



                                                                                                5
Cost of payable is not included in the formula of WACC.

9.    A common stock issue is currently selling for $31 per share. You expect the next dividend to
          be $1.40 per share. If the firm has a dividend growth rate of 5% that is expected to
          remain constant indefinitely, what is the firm’s cost of equity?
      a.   9.5%
      b. 11.3%
      c. 13.8%
      d. 14.2%
      e. 15.1%

=D1/P+g=1.40/31+0.05=0.095


10.      A company estimates that a below-average risk project has a discount rate of 9
         percent, an average-risk project has a discount rate of 10 percent, and an above-
         average risk project has a discount rate of 11 percent. Which of the following
         independent projects should the company accept?
         a.   Project A has average risk and a return of 9.5 percent.
         b.   Project C has above-average risk and a return of 10.5 percent.
         c.   Project B has below-average risk and a return of 8.5 percent.
         d.   Project A and C should be accepted.
         e.   None of the projects above should be accepted.


Project A, 9.5<10 (expected return<required return), reject
Project B, 8.5<9, reject
Project C, 10.5<11 , reject
Reject all projects.

11.Billick Brothers is estimating its WACC. The company has collected the following
information:
             Its capital structure consists of 40 percent debt and 60 percent common equity.
             The company has 20-year bonds outstanding with a 9 percent annual coupon that
              are trading at par ($1000).
             The company’s tax rate is 40 percent.
             The risk-free rate is 5.5 percent.
             The market risk premium is 5 percent.
             The stock’s beta is 1.4.


      What is the company’s WACC?

         a. 9.71%
         b. 9.66%
         c. 8.31%
         d. 11.18%

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       e. 11.10%

rd=YTM=9%, (When price is at par, YTM=coupon rate=9%),
Using CAPM, rs=rf+beta*market risk premium, so: re=5.5+1.4*5=12.5%
WACC=40%*0.09*(1-0.4)+60%*0.125=0.0966


12. A stock has a beta of 1.12 and a required return of 11.6 percent. The risk-free rate is
         4.2 percent. What is the market risk premium?

         A. 5.45 percent
         B. 6.61 percent
         C. 7.40 percent
         D. 8.28 percent
         E. 10.32 percent

According to CAPM, 11.6=4.2+1.12*Market risk premium,
11.6-4.2=1.12*Market risk premium
(11.6-4.1)/1.12= Market risk premium


13. Currently, you own a portfolio comprised of the following. What is the portfolio beta?


     Stock     Value    Beta
     A           $2,000          0.9
     B           $2,000            1
     C           $4,000          1.5


   a. 1.225
   b. 1.133
   c. 1.000
   d. 0.980

2000/(2000+2000+4000)=0.25, 2000/(2000+2000+4000)=0.25,
4000/(2000+2000+4000)=0.5
The weights are 25%, 25%, and 50%, respectively
0.25*0.9+0.25*1+0.5*1.5=1.225


14.If a stock's beta is -1 during a period when the market portfolio was down by 10%,
        then, in advance, we could expect the return on this individual stock to:
        A) go down by 10% .
        B) go up by 10%.
        C) have no change.
        D) go in no direction



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