Exam3SP09 – sample exam from another professor
Multiple Choice
Identify the choice that best completes the statement or answers the question.
____
1.
Pearson Plastics has two equalsized divisions, Division A and Division B. The company estimates that if the
divisions operated as independent companies Division A would have a cost of capital of 8 percent, while
Division B would have a cost of capital of 12 percent. Since the two divisions are the same size, Pearson's
composite weighted average cost of capital (WACC) is 10 percent. In the past, Pearson has assigned separate
hurdle rates to each division based on their relative risk. Now, however, Pearson has chosen to use the
corporate WACC, which is currently 10 percent, for both divisions. Which of the following is likely to occur
as a result of this change? Assume that this change is likely to have no effect on the average risk of each
division and market conditions remain unchanged.
Ch. 10
a.
Over time, the overall risk of the company will increase.
b.
Over time, Division B will become a larger part of the overall company.
c.
Over time, the company's corporate WACC will increase.
d.
All of these statements are correct.
____
2.
Clark Communications has a capital structure that consists of 70 percent common stock and 30 percent long
term debt. In order to calculate Clark's weighted average cost of capital (WACC), an analyst has accumulated
the following information:
ch. 10
•
The company currently has 15year bonds outstanding with annual coupon payments of 8
percent. The bonds have a face value of $1,000 and sell for $1,075.
I would have written this
problem with semiannual coupon payments, but do the problem as written. This is a good
WACC problem.
•
The riskfree rate is 5 percent.
•
The market risk premium is 4 percent.
•
The beta on Clark's common stock is 1.1.
•
The company's retained earnings are sufficient so that they do not have to issue any new
common stock to fund capital projects.
•
The company's tax rate is 38 percent.
Given this information, what is Clark's WACC?
Jackson Company
The Jackson Company has just paid a dividend of $3.00 per share on its common stock, and it expects this
dividend to grow by 10 percent per year, indefinitely. The firm has a beta of 1.50; the riskfree rate is 10
percent; and the expected return on the market is 14 percent. The firm's investment bankers believe that new
issues of common stock would have a flotation cost equal to 5 percent of the current market price.
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 Spring '08
 Bulmash
 Net Present Value, Weighted average cost of capital

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