·
The company’s tax rate is 40 percent.
What is the company’s weighted average cost of capital (WACC)?
a.
12.00%
b.
8.03%
c.
9.34%
d.
8.00%
e.
7.68%
Page 14
Chapter 10: Determining the Cost of Capital -

Multiple part:
(The following information applies to the next six problems.)
Rollins Corporation is estimating its WACC.
Its target capital structure is
20 percent debt, 20 percent preferred stock, and 60 percent common equity.
Its bonds have a 12 percent coupon, paid semiannually, a current maturity of
20 years, and sell for $1,000.
The firm could sell, at par, $100 preferred
stock which pays a 12 percent annual dividend, but flotation costs of 5 per-
cent would be incurred.
Rollins' beta is 1.2, the risk-free rate is 10 per-
cent, and the market risk premium is 5 percent. Rollins is a constant-growth
firm which just paid a dividend of $2.00, sells for $27.00 per share, and has
a growth rate of 8 percent.
The firm's policy is to use a risk premium of 4
percentage points when using the bond-yield-plus-risk-premium method to find
r
s
.
The firm's marginal tax rate is 40 percent.
(10.2) Cost of debt
Answer: e
Diff: M
56
.
What is Rollins' component cost of debt?
a.
10.0%
b.
9.1%
c.
8.6%
d.
8.0%
e.
7.2%
(10.3) Cost of preferred stock
Answer: d
Diff: E
57
.
What is Rollins' cost of preferred stock?
a.
10.0%
b.
11.0%
c.
12.0%
d.
12.6%
e.
13.2%
(10.5) Cost of common stock: CAPM
Answer: c
Diff: E
58
.
What is Rollins' cost of common stock (r
s
) using the CAPM approach?
a.
13.6%
b.
14.1%
c.
16.0%
d.
16.6%
e.
16.9%
(10.6) Cost of common stock: DCF
Answer: c
Diff: E
59
.
What is the firm's cost of common stock (r
s
) using the DCF approach?
a.
13.6%
b.
14.1%
c.
16.0%
d.
16.6%
e.
16.9%
Chapter 10: Determining the Cost of Capital
Page 15

(10.7) Cost of common stock: Risk premium
Answer: c
Diff: E
60
.
What is Rollins' cost of common stock using the bond-yield-plus-risk-
premium approach?
a.
13.6%
b.
14.1%
c.
16.0%
d.
16.6%
e.
16.9%
(10.10) WACC
Answer: a
Diff: E
61
.
What is Rollins' WACC?
a.
13.6%
b.
14.1%
c.
16.0%
d.
16.6%
e.
16.9%
(The following information applies to the next three problems.)
J. Ross and Sons Inc. has a target capital structure that calls for 40 per-
cent debt, 10 percent preferred stock, and 50 percent common equity.
The
firm's current aftertax cost of debt is 6 percent, and it can sell as much
debt as it wishes at this rate.
The firm's preferred stock currently sells
for $90 per share and pays a dividend of $10 per share; however, the firm
will net only $80 per share from the sale of new preferred stock.
Ross's
common stock currently sells for $40 per share.
The firm recently paid a
dividend of $2 per share on its common stock, and investors expect the divi-
dend to grow indefinitely at a constant rate of 10 percent per year.
(10.3) Cost of preferred stock
Answer: b
Diff: E
62
.
What is the firm's cost of newly issued preferred stock, r
ps
?
a.
10.0%
b.
12.5%
c.
15.5%
d.
16.5%
e.
18.0%
(10.6) Cost of common stock
Answer: c
Diff: E
63
.
What is the firm's cost of common stock, r
s
?
a.
10.0%
b.
12.5%
c.
15.5%
d.
16.5%
e.
18.0%
Page 16
Chapter 10: Determining the Cost of Capital -

(10.10) WACC
Answer: d
Diff: E
64
.
What is the firm's weighted average cost of capital (WACC)?

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