to get most of the investment projects? Why? If you were to try to estimate the appropriate cost of
capital for different divisions, what problems might you encounter? What are two techniques you
could use to develop a rough estimate for each division’s cost of capital?
9.
Leverage
Consider a levered firm’s projects that have similar risks to the firm as a whole. Is
the discount rate for the projects higher or lower than the rate computed using the security market

line? Why?
10. BetaWhat factors determine the beta of a stock? Define and describe each.
1.
Calculating Cost of Equity
The Dybvig Corporation’s common stock has a beta of 1.15. If the
risk-free rate is 4.5 percent and the expected return on the market is 11 percent, what is Dybvig’s
cost of equity capital?
2.
Calculating Cost of Equity
The Devon Co. just issued a dividend of $2.40 per share on its
common stock. The company is expected to maintain a constant 5.5 percent growth rate in its
dividends indefinitely. If the stock sells for $52 a share, what is the company’s cost of equity?
3.
Calculating Cost of Equity
Stock in Country Road Industries has a beta of .85. The market
risk premium is 8 percent, and T-bills are currently yielding 5 percent. The company’s most recent
dividend was $1.60 per share, and dividends are expected to grow at a 6 percent annual rate
indefinitely. If the stock sells for $37 per share, what is your best estimate of the company’s cost of
equity?
4.
Calculating Cost of Debt
Advance, Inc., is trying to determine its cost of debt. The firm has a
debt issue outstanding with 12 years to maturity that is quoted at 95 percent of face value. The
issue makes semiannual payments and has a coupon rate of 8 percent annually. What is Advance’s
pretax cost of debt? If the tax rate is 35 percent, what is the aftertax cost of debt?
5.
Calculating Cost of Debt
Shanken Corp. issued a 30-year, 7 percent semiannual bond 7 years
ago. The bond currently sells for 108 percent of its face value. The company’s tax rate is 35
percent.
1. What is the pretax cost of debt?
2. What is the aftertax cost of debt?
3. Which is more relevant, the pretax or the aftertax cost of debt? Why?
6.
Calculating Cost of Debt
For the firm in the previous problem, suppose the book value of the
debt issue is $60 million. In addition, the company has a second debt issue on the market, a zero
coupon bond with seven years left to maturity; the book value of this issue is $80 million and the
bonds sell for 73 percent of par. What is the company’s total book value of debt? The total market
value? What is your best estimate of the aftertax cost of debt now?
7.
Calculating WACC
Mullineaux Corporation has a target capital structure of 70 percent
common stock and 30 percent debt. Its cost of equity is 15 percent, and the cost of debt is 8
percent. The relevant tax rate is 35 percent. What is Mullineaux’s WACC?

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