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A firm uses its weighted average cost of capital to evaluate the proposed projects for all of its varying divisions.By doing so, the firm:


A) automatically gives preferential treatment in the allocation of funds to its riskiest division.
B) encourages the division managers to recommend only their most conservative projects.
C) maintains the current risk level and capital structure of the firm.
D) automatically maximizes the total value created for its shareholders.
E) allocates capital funds evenly among its divisions.

F) C) and E)
G) A) and B)

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The common stock of Shaky Building Supply has a beta that is 22 percent greater than the overall market beta.Currently, the market risk premium is 9.56 percent while the U.S.Treasury bill is yielding 3.3 percent.What is the cost of equity for this firm?


A) 15.16 percent
B) 14.36 percent
C) 15.31 percent
D) 14.96 percent
E) 14.25 percent

F) A) and E)
G) A) and D)

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Tim's Tools just issued a dividend of $2.22 per share on its common stock.The company is expected to maintain a constant 2.8 percent growth rate in its dividends indefinitely.If the stock sells for $19 a share, what is the company's cost of equity?


A) 12.81 percent
B) 13.37 percent
C) 9.94 percent
D) 14.81 percent
E) 10.46 percent

F) A) and B)
G) A) and C)

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Old Town Industries has three divisions.Division X has been in existence the longest and has the most stable sales.Division Y has been in existence for five years and is slightly less risky than the overall firm.Division Z is the research and development side of the business.Given this, the firm should probably:


A) require the highest rate of return from Division X since it has been in existence the longest.
B) assign the highest cost of capital to Division Z because it is most likely the riskiest of the three divisions.
C) use the firm's WACC as the cost of capital for Division Z as it provides analysis for the entire firm.
D) use the firm's WACC as the cost of capital for Divisions A and B because they are part of the revenue-producing operations of the firm.
E) allocate capital funds evenly amongst the divisions to maintain the current capital structure of the firm.

F) B) and E)
G) B) and C)

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Santa Claus Enterprises has 87,000 shares of common stock outstanding at a current price of $39 a share.The firm also has two bond issues outstanding.The first bond issue has a total face value of $230,000, pays 7.1 percent interest annually, and currently sells for 103.1 percent of face value.The second bond issue consists of 5,000 bonds that are selling for $887 each.These bonds pay 6.5 percent interest annually and mature in eight years.The tax rate is 35 percent.What is the capital structure weight of the firm's debt?


A) 57.93 percent
B) 51.39 percent
C) 55.50 percent
D) 60.52 percent
E) 71.86 percent

F) A) and E)
G) C) and D)

Correct Answer

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Lawler's is considering a new project.The company has a debt-equity ratio of .64.The company's cost of equity is 14.9 percent, and the aftertax cost of debt is 5.3 percent.The firm feels that the project is riskier than the company as a whole and that it should use an adjustment factor of +1.8 percent.What is the project cost of capital if the tax rate is 34 percent?


A) 12.53 percent
B) 12.98 percent
C) 12.95 percent
D) 15.14 percent
E) 15.68 percent

F) B) and D)
G) A) and E)

Correct Answer

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Spartans has 6.5 percent bonds outstanding that mature in 18 years.The bonds pay interest semiannually and have a face value of $1,000.Currently, the bonds are selling for $985 each.What is the firm's pretax cost of debt?


A) 6.77 percent
B) 6.64 percent
C) 6.94 percent
D) 7.11 percent
E) 6.20 percent

F) A) and B)
G) C) and E)

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Cromwell's Interiors is considering a project that is equally as risky as the firm's current operations.The firm has a cost of equity of 15.4 percent and a pretax cost of debt of 8.9 percent.The debt-equity ratio is .46 and the tax rate is 34 percent.What is the cost of capital for this project?


A) 11.97 percent
B) 12.40 percent
C) 11.02 percent
D) 11.62 percent
E) 12.38 percent

F) A) and B)
G) A) and C)

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Which one of the following will decrease the aftertax cost of debt for a firm?


A) Decrease in the firm's beta
B) Increase in tax rates
C) Increase in the risk-free rate of return
D) Decrease in the market price of the debt
E) Increase in a bond's yield to maturity

F) A) and B)
G) B) and C)

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Ted is trying to decide what cost of capital he should assign to a project.Which one of the following should be his primary consideration in this decision?


A) Amount of debt used to finance the project
B) Use, or lack, of preferred stock as a financing option
C) Mix of funds used to finance the project
D) Risk level of the project
E) Length of the project's life

F) A) and B)
G) D) and E)

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Fire Hydrant Pet Supply just paid its first annual dividend of $0.75 a share.The firm plans to increase the dividend by 2.9 percent per year indefinitely.What is the firm's cost of equity if the current stock price is $16.90 per share?


A) 14.64 percent
B) 7.47 percent
C) 9.78 percent
D) 4.33 percent
E) 5.34 percent

F) C) and D)
G) None of the above

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Katie owns 100 shares of ABC stock.Which one of the following terms is used to refer to the return that Katie and the other shareholders require on their investment in ABC?


A) Weighted average cost of capital
B) Pure play cost
C) Cost of equity
D) Subjective cost
E) Cost of debt

F) B) and E)
G) A) and D)

Correct Answer

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The preferred stock of Dolphin Pools pays an annual dividend of $5.25 a share and sells for $48a share.The tax rate is 35 percent.What is the firm's cost of preferred stock?


A) 9.67 percent
B) 10.94 percent
C) 15.07 percent
D) 15.59 percent
E) 16.47 percent

F) B) and E)
G) A) and E)

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When evaluating a project, the dividend growth model:


A) can only be used by firms that pay increasing dividends.
B) must be used by all dividend-paying firms.
C) is only applicable when the growth rate of the project exceeds the dividend growth rate.
D) is relatively simple to use.
E) must use the growth rate of the project as the rate of growth in the formula.

F) A) and D)
G) B) and D)

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Design Interiors has a cost of equity of 14.9 percent and a pretax cost of debt of 8.6 percent.The firm's target weighted average cost of capital is 11 percent and its tax rate is 34 percent.What is the firm's target debt-equity ratio?


A) 1.37
B) .87
C) .98
D) 1.02
E) .73

F) B) and E)
G) A) and E)

Correct Answer

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The common stock of Pedestrian Automotive has a beta of 0.89 and a standard deviation of 15.8 percent.The market rate of return is 12.25 percent and the risk-free rate is 2.9 percent.What is the cost of equity for this firm?


A) 11.22 percent
B) 9.16 percent
C) 9.48 percent
D) 11.80 percent
E) 10.45 percent

F) A) and E)
G) A) and D)

Correct Answer

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Sheepdog Rescue just paid its first annual dividend of $1.95 a share.The firm plans to increase the dividend by 1.75 percent per year indefinitely.What is the firm's cost of equity if the current stock price is $31.45 per share?


A) 6.31 percent
B) 8.06 percent
C) 10.38 percent
D) 4.93 percent
E) 5.94 percent

F) C) and E)
G) None of the above

Correct Answer

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Which one of the following will increase the cost of equity, all else held constant?


A) Increase in the dividend growth rate
B) Decrease in beta
C) Decrease in future dividends
D) Increase in stock price
E) Decrease in market risk premium

F) C) and D)
G) A) and B)

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Which one of the following represents the minimum rate of return a firm must earn on its assets if it is to maintain the current value of its securities?


A) Cost of equity
B) Pretax cost of debt
C) Aftertax cost of debt
D) Weighted average cost of capital
E) Weighted average cost of preferred and common stock

F) C) and D)
G) B) and E)

Correct Answer

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Precision Cuts has a target debt-equity ratio of .48.Its cost of equity is 16.4 percent, and its pretax cost of debt is 8.2 percent.If the tax rate is 34 percent, what is the company's WACC?


A) 13.20 percent
B) 11.72 percent
C) 12.91 percent
D) 11.28 percent
E) 12.84 percent

F) C) and E)
G) A) and E)

Correct Answer

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