You were hired as a consultant to Keys Company, and you were provided with the following data: Target capital structure: 40% debt, 10% preferred, and 50% common equity. The after-tax cost of debt is 4.00%, the cost of preferred is 7.50%, and the cost of retained earnings is 11.50%. The firm will not be issuing any new stock. What is the firm’s WACC?
Several years ago the Haverford Company sold a $1,000 par value bond that now has 25 years to maturity and an 8.00% annual coupon that is paid quarterly. The bond currently sells for $900.90, and the company’s tax rate is 40%. What is the component cost of debt for use in the WACC calculation?
Wagner Inc estimates that its average-risk projects have a WACC of 10%, its below-average risk projects have a WACC of 8%, and its above-average risk projects have a WACC of 12%. Which of the following projects (A, B, and C) should the company accept?
Project A is of average risk and has a return of 9%.
Project B is of below-average risk and has a return of 8.5%.
Project C is of above-average risk and has a return of 11%.
None of the projects should be accepted.
All of the projects should be accepted.
The Nunnally Company has equal amounts of low-risk, average-risk, and high-risk projects. Nunnally estimates that its overall WACC is 12%. The CFO believes that this is the correct WACC for the company’s average-risk projects, but that a lower rate should be used for lower risk projects and a higher rate for higher risk projects. However, the CEO argues that, even though the company’s projects have different risks, the WACC used to evaluate each project should be the same because the company obtains capital for all projects from the same sources. If the CEO’s opinion is followed, what is likely to happen over time?
The company will take on too many low-risk projects and reject too many high-risk projects.
The company will take on too many high-risk projects and reject too many low-risk projects.
Things will generally even out over time, and, therefore, the firm’s risk should remain constant over time.
The company’s overall WACC should decrease over time because its stock price should be increasing.
The CEO’s recommendation would maximize the firm’s intrinsic value.
5. You were hired as a consultant to Locke Company, and you were provided with the following data: Target capital structure: 40% debt, 10% preferred, and 50% common equity. The interest rate on new debt is 7.5%, the yield on the preferred is 7.0%, the cost of retained earnings is 11.50%, and the tax rate is 40%. The firm will not be issuing any new stock. What is the firm’s WACC? (Points: 4)
6. To help finance a major expansion, Dimkoff Development Company sold a bond several years ago that now has 20 years to maturity. This bond has a 7% annual coupon, paid quarterly, and it now sells at a price of $1,103.58. The bond cannot be called and has a par value of $1,000. If Dimkoff’s tax rate is 40%, what component cost of debt should be used in the WACC calculation? (Points: 4)
7. A company’s perpetual preferred stock currently trades at $80 per share and pays a $6.00 annual dividend per share. If the company were to sell a new preferred issue, it would incur a flotation cost of 4%. What would the cost of that capital be? (Points: 4)
8. Assume that you are a consultant to Morton Inc., and you have been provided with the following data: D1 = $1.00; P0 = $25.00; and g = 6% (constant). What is the cost of equity from retained earnings based on the DCF approach? (Points: 4)
9. Heino Inc. hired you as a consultant to help them estimate their cost of capital. You have been provided with the following data: rRF = 5.0%; MRP = 5.0%; and b = 1.1. Based on the CAPM approach, what is the cost of equity from retained earnings? (Points: 4)
Tapley Inc. recently hired you as a consultant to estimate the company’s WACC. You have obtained the following information. (1) Tapley's bonds mature in 25 years, have a 7.5% annual coupon, a par value of $1,000, and a market price of $936.49. (2) The company’s tax rate is 40%. (3) The risk-free rate is 6.0%, the market risk premium is 5.0%, and the stock’s beta is 1.5. (4) The target capital structure consists of 30% debt and 70% equity. Tapley uses the CAPM to estimate the cost of equity, and it does not expect to have to issue any new common stock. What is its WACC?
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