Chapter10solutions

# Chapter10solutions - Chapter 10 Determining the Cost of...

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Chapter 10 Determining the Cost of Capital ANSWERS TO END-OF-CHAPTER QUESTIONS 10-2 The WACC is an average cost because it is a weighted average of the firm's component costs of capital. However, each component cost is a marginal cost; that is, the cost of new capital. Thus, the WACC is the weighted average marginal cost of capital. 10-3 Probable Effect on r d (1 - T) r s WACC a. The corporate tax rate is lowered. + 0 + b. The Federal Reserve tightens credit. + + + c. The firm uses more debt; that is, it increases its debt/assets ratio. + + 0 d. The firm doubles the amount of capital it raises during the year. 0 or + 0 or + 0 or + e. The firm expands into a risky new area. + + + f. Investors become more risk averse. + + + 10-4 Stand-alone risk views a project’s risk in isolation, hence without regard to portfolio effects; within-firm risk, also called corporate risk, views project risk within the context of the firm’s portfolio of assets; and market risk (beta) recognizes that the firm’s stockholders hold diversified portfolios of stocks. In theory, market risk should be most relevant because of its direct effect on stock prices. SOLUTIONS TO END-OF-CHAPTER PROBLEMS 10-1 a. r d (1 - T) = 13%(1 - 0) = 13.00%. b. r d (1 - T) = 13%(0.80) = 10.40%. c. r d (1 - T) = 13%(0.65) = 8.45%. 10-2 r d (1 - T) = 0.08(0.65) = 5.2%. 10-3 V ps = \$50; D ps = \$4.50; F = 0%; r ps = ?

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r ps = ) F 1 ( V D ps ps = ) 0 . 0 1 ( 50 \$ 50 . 4 \$ = 9%. 10-4 r ps = ) 05 . 0 1 ( 00 . 70 \$ ) 06 . 0 ( 60 \$ = 50 . 66 \$ 60 . 3 \$ = 5.41%. 10-5 P 0 = \$36; D 1 = \$3.00; g = 5%; r s = ? r s = 0 1 P D + g = (\$3.00/\$36.00) + 0.05 = 13.33%. 10-6 r s = r RF + b i (RP M ) = 0.06 + 0.8(0.055) = 10.4%. 10-7 30% Debt; 5% Preferred Stock; 65% Equity; r d = 6%; T = 40%; r ps = 5.8%; r s = 12%. WACC = (w d )(r d )(1 - T) + (w ps )(r ps ) + (w ce )(r s ) WACC = 0.30(0.06)(1-0.40) + 0.05(0.058) + 0.65(0.12) = 9.17%. 10-8 40% Debt; 60% Equity; r d = 9%; T = 40%; WACC = 9.96%; r s = ? WACC = (w d )(r d )(1 - T) + (w ce )(r s ) 9.96% = (0.4)(9%)(1 - 0.4) + (0.6)r s 9.96% = 2.16% + 0.6r s 7.8% = 0.6r s r s = 13%. 10-9
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## This note was uploaded on 12/11/2011 for the course FINC 3630 taught by Professor Jensen,m during the Summer '08 term at Auburn University.

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Chapter10solutions - Chapter 10 Determining the Cost of...

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