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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 1 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 3 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%. 4 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% 6 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 7