CHAPTER 9
THE COST OF CAPITAL
(Difficulty:
E = Easy, M = Medium, and T = Tough)
Multiple Choice:
Problems
Easy:
Cost of common stock
Answer: d
Diff: E
1
.
Bouchard Company's stock sells for $20 per share, its last dividend (D
0
)
was $1.00, and its growth rate is a constant 6 percent.
What is its
cost of common stock, r
s
?
a.
5.0%
b.
5.3%
c. 11.0%
d. 11.3%
e. 11.6%
Cost of common stock
Answer: b
Diff: E
2
.
Your company's stock sells for $50 per share, its last dividend (D
0
) was
$2.00, and its growth rate is a constant 5 percent.
What is the cost
of common stock, r
s
?
a.
9.0%
b.
9.2%
c.
9.6%
d.
9.8%
e. 10.0%
Cost of common stock
Answer: e
Diff: E
3
.
The Global Advertising Company has a marginal tax rate of 40 percent.
The last dividend paid by Global was $0.90.
Global's common stock is
selling for $8.59 per share, and its expected growth rate in earnings
and dividends is 5 percent.
What is Global's cost of common stock?
a. 12.22%
b. 17.22%
c. 10.33%
d.
9.66%
e. 16.00%
Chapter 9 - Page 1

WACC with Flotation Costs
Answer: a
Diff: E
4
.
An analyst has collected the following information regarding
Christopher Co.:
•
The company’s capital structure is 70 percent equity, 30 percent
debt.
•
The yield to maturity on the company’s bonds is 9 percent.
•
The company’s year-end dividend is forecasted to be $0.80 a share.
•
The company expects that its dividend will grow at a constant rate
of 9 percent a year.
•
The company’s stock price is $25.
•
The company’s tax rate is 40 percent.
•
The company anticipates that it will need to raise new common
stock this year.
Its investment bankers anticipate that the total
flotation cost will equal 10 percent of the amount issued.
Assume
the company accounts for flotation costs by adjusting the cost of
capital.
Given this information, calculate the company’s WACC.
a. 10.41%
b. 12.56%
c. 10.78%
d. 13.55%
e.
9.29%
Medium:
WACC
Answer: d
Diff: M
5
.
A company’s balance sheets show a total of $30 million long-term debt
with a coupon rate of 9 percent.
The yield to maturity on this debt is
11.11 percent, and the debt has a total current market value of $25
million.
The balance sheets also show that that the company has 10
million shares of stock; the total of common stock and retained
earnings is $30 million.
The current stock price is $7.5 per share.
The current return required by stockholders, r
S
, is 12 percent.
The
company has a target capital structure of 40 percent debt and 60
percent equity.
The tax rate is 40%.
What weighted average cost of
capital should you use to evaluate potential projects?
a.
8.55%
b.
9.33%
c.
9.36%
d.
9.87%
e. 10.67%
Chapter 9 - Page 2

Cost of common stock
Answer: d
Diff: M
6
.
The common stock of Anthony Steel has a beta of 1.20.
The risk-free
rate is 5 percent and the market risk premium (r
M
- r
RF
) is 6 percent.
What is the company’s cost of common stock, r
s
?
a.
7.0%
b.
7.2%
c. 11.0%
d. 12.2%
e. 12.4%
Cost of common stock
Answer: b
Diff: M
7
.
Martin Corporation's common stock is currently selling for $50 per
share. The current dividend is $2.00 per share.
If dividends are
expected to grow at 6 percent per year, then what is the firm's cost of
common stock?

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