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FRL 301 - Chapter 14 - Part 2 Exam Questions And
Correct Answers (A+)
Boulder Furniture has bonds outstanding that mature in 13 years, have a 6 percent coupon, and pay interest annually. These bonds have a face value of $1,000 and a current market price of $1,040. What is the company's aftertax cost of debt if its tax rate is 32 percent?
A. 2.97 percent B. 3.32 percent C. 3.78 percent D. 5.21 percent E. 5.53 percent - ANSWER C. 3.78 percent
Enter: N= 13 PV = -1, PMT = 60 FV = 1,
Solve for: I/Y = 5.
Aftertax Rd = 0.055597 x (1 - 0.32) = 3.78 percent
Handy Man, Inc. has zero coupon bonds outstanding that mature in 8 years. The bonds have a face value of $1,000 and a current market price of $640. What is the company's
pre-tax cost of debt?
A. 2.55 percent B. 5.09 percent C. 5.66 percent D. 7.31 percent E. 7.48 percent - ANSWER C. 5.66 percent Enter:
N = 8 x 2 = 16 (zero coupon bonds are semi-annual) PV = - FV = 1000
Solve for:
I/Y = 2.82 x 2 = 5.
Dog Gone Good Engines has a bond issue outstanding with 17 years to maturity. These bonds have a $1000 face value, a 9 percent coupon, and pay interest semi-annually. The bonds are currently quotes at 87 percent of face value. What is the company's pre-tax cost of debt if the tax rate is 38 percent?
A. 4.10 percent B. 4.42 percent C. 6.61 percent D. 8.90 percent E. 10.67 percent - ANSWER E. 10.67 percent
Aftertax Rd = 0.087285 x (1 - 0.30) = 6.11 percent
The outstanding bonds of Tech Express are priced at $989 and mature in 8 years. These bonds have a 6 percent coupon and pay interest annually. The firm's tax rate is 39%. What is the firm's aftertax cost of debt?
A. 3.01 percent B. 3.22 percent C. 3.35 percent D. 3.77 percent E. 4.41 percent - ANSWER D. 3.77 percent
Enter: N= 8 PV= - PMT= 60 FV = 1000
Solve: I/Y = 6.
Aftertax Rd = 0.061784 x (1-0.39) = 3.77 percent
Simple Foods has a zero coupon bound issue outstanding that matures in 9 years. The bonds are selling at 42 percent of par value. What is the company's after tax cost of debt if the tax rate is 38 percent?
A. 5.48 percent B. 5.73 percent
C. 6.12 percent D. 7.73 percent E. 9.88 percent - ANSWER C. 6.12 percent
Enter: N = 9 x 2 = 18 PV = - FV = 1000
Solve: I/Y = 4.937471 x 2 = 9.
Aftertax Rd = 9.874943 x (1 - 0.38) = 6.12 percent
Grill Works are More has 8 percent preferred stock outstanding that is currently selling for $49 a share. The market rate of return is 14 percent and the firm's tax rate is 37 percent. What is the firm's cost of preferred stock?
A. 14.77 percent B. 15.29 percent C. 15.67 percent D. 16.33 percent E. 16.54 percent - ANSWER Rp = (0.08 x $100)/$49 = 16.33 percent
Samuelson Plastics has 7.5 percent preferred stock outstanding. Currently, this stock has a market value per share of $52 and a book value per share of $38. What is cost of preferred stock? - ANSWER Rp = (.075 x 100)/$52 = 14.42 percent
C. 7.75 percent D. 8.30 percent E. 8.80 percent - ANSWER E. 8.80 percent
Debt: $200,000 x 0.92 = $184, Preferred: 1500 x $35 = $52, Common: 15,000 x $24 =360, Total = 596,
Weight of Preferred Stock = $52,500/$596,500 = 8.80 percent
Electronic Galore has 950,000 shares of common stock outstanding at a market price of $38 a share. The company also has 40,000 bonds outstanding that are quoted at 106 percent of face value. What weight should be given to the debt when the firm computes its weighted average cost of capital?
A. 42 percent B. 46 percent C. 50 percent D. 54 percent E. 58 percent - ANSWER D. 54 percent
Debt: 40,000 x $1000 x 1.06 = $42.4m Common: 950,000 x $38 = $36.1m Total: 78.5m
Weight of Debt = $42.4m/$78.5m = 54 percent.
Phillps Equipment has 80,000 bonds outstanding that are selling at par. Bonds with similar characteristics are yielding at 6.75 percent. The company also has 7500, shares of 7 percent preferred stock and 2.5 million shares of common stock outstanding. The preferred stock selling for $53 a share. The common stock has a beta of 1.34 and sells for $42 a share. The U.S. Treasury bill is yielding 2.8 percent and the return on the market is 11.2 percent. The corporate tax rate is 38 percent. What is the firm's weighted average cost of capital?
A. 10.39 percent B. 10.64 percent C. 11.18 percent D. 11.30 percent E. 11.56 percent - ANSWER Re = 0.028 + 1.34(0.112 - 0.028) = 0. Rp= (0.07 x $100)/$53 = 0.
Debt: 80,000 x $1,000 = $80m Preferred: 750,000 x $53 = $39.75m Common: 2.5m x $42 = $105m Total: $224.75m
WACC = ($105m/$224.75m)(0.14056) + ($39.75m/$224.75m)(0.13208) + ($80m/224.75m)(0.0675)(1 - 0.38) = 10.39 percent
Wayco Industrial Supply has a pre-tax cost of debt of 7.6 percent, a cost of equity of 14. percent, and a cost of preferred stock of 8.5 percent. The firm has 220,000 shares of common stock outstanding at a market price of $27 a share. There are 25,000 shares of preferred stock outstanding at a market price of $41 a share. The bond issue has a face value of $550,000 and a market quote of 101.2. The company's tax rate is 37 percent. What is the firm's weighted average cost of capital?
A. 10.18 percent B. 10.84 percent
share. Next year's annual dividend is expected to be $1.55 a share. The dividend growth rate is 2 percent. The firm also has 7,500 bonds outstanding with a face value of $ per bond. The bonds carry a 7 percent coupon, pay interest semi-annually, and mature in 7.5 years. The bonds are selling at 98 percent of face value. The company's tax rate is 34 percent. What is the firm's weighted average cost of capital?
A. 5.4 percent B. 6.2 percent C. 7.5 percent D. 8.5 percent E. 9.6 percent - ANSWER B. 6.2 percent
Debt: 7,500 x $1,000 x 0.98 = $7.35m Common: 250,000 x $28 = $7.00m Total: $14.35m
Re = ($1.55/$28) + 0.02 = 0.
Enter: N = 7.5 x 2 = 15 PV = - PMT = 70/2 = 35 FV = 1,
Solve: I/Y: 3.675829 x 7.
WACC = ($7m/$14.35m)(0.075357) + ($7.35m/$14.35m)(0.0735166)(1 - 0.34) = 6. percent
Kelso's had a debt-equity ratio of 0.55 and a tax rate of 35 percent. The firm does not issue preferred stock. The cost of equity is 14.5 percent and the aftertax cost of debt is 4.8 percent. What is the weighted average cost of capital?
A. 10.46 percent B. 10.67 percent C. 11.06 percent D. 11.38 percent E. 11.57 percent - ANSWER WACC = (1/1.55)(0.145) + (0.55/1.55)(0.048) = 11.06 percent
Granite Works maintains a debt-equity ratio of 0.65 and has a tax rate of 32 percent. The firm does not issue preferred stock. The pre-tax cost of debt is 9.8 perfect. There are 25,000 shares of stock outstanding with a beta of 1.2 and a market price of $19 a share. The current market risk premium, is 8.5 percent and the current risk-free rate is 3. percent. This year, the firm pain an annual dividend of $1.40 a share and expects to increase that amount by 2 percent each year. Using an average expected cost of equity, what is the weighted average cost of capital?
A. 8.44 percent B. 8.78 percent C. 8.96 percent D. 9.13 percent E. 9.20 percent - ANSWER E. 9.20 percent
Re= 0.036 +1.2(0.085) = 0. Re= [($1.10 x 1.02)$19] +.02 = 0.
ReAverage = (0.138 + 0.0790526)/2 = 0.
Rproject=0.0425 + (1.25 x 0.0775) = 13.94 percent
Silo Mills has a beta of 0.87 and a cost of equity of 11.9 percent. The risk-free rate of return is 2.8 percent. The firm is currently considering a project that has a beta of 1. and a project life of 6 years. What discount rate should be assigned to this project?
A. 13.33 percent B. 13.57 percent C. 13.62 percent D. 13.84 percent E. 14.09 percent - ANSWER Re = 0.119 = 0.028 + (0.87 x mrp); mrp = 0. Rproject= 0.028 + (1.03 x 0.1046) = 13.57 percent
Travis & Sons has a capital structure which is based on 40 percent debt, 5 percent preferred stock, and 55 percent common stock. The pre-tax cost of debt is 7.5 percent, the cost of preferred is 9 percent, and the cost of common stock is 13 percent. The company's tax rate is 39 percent. The company is considering a project that is equally as risky as the overall firm. This project has initial costs of $325,000 and annual cash inflows of $87,000, $279,00, and $116,000 over the next three years, respectively. What is the projected net present value of this project?
A. 68,211. B. 68,879. C. 69,361. D. 74,208. E. 76,011.23 - ANSWER E. 76,011.
WACC = (0.55 x 0.13) + (0.05 x 0.09) + [0.40 x 0.075 x (1 - 0.39)] = 0. NPV = -325,000 + ($87,000/1.0943) + ($279,000/1.0943^2) + ($116,000/1.0943^3) = $76,011.
Panelli's is analyzing a project with initial cost of $102,000 and cash inflows of $65, in year one and $74,000 in year two. This project is an extension of the firm's current operations and thus is equally risky as the current firm. The firm uses only debt and common stock to finance its operations and maintains a debt-equity ratio of 0.45. The aftertax cost of debt is 4.8 percent, the cost of equity is 12.7 percent, and the tax rate is 35 percent. What is the projected net present value of this project?
A. $15, B. $15, C. $16, D. $16, E. $17,840 - ANSWER E. $17,
WACC = (1/1.45)(0.127) + (0.45/1.45)(0.048) =
Cfo= -$102, C01 = $65, Co2 = $74, I = 10.2483% NPV = 17,
Carson Electronics uses 70 percent common stock and 30 percent debt to finance its operations. The aftertax cost of debt is 5.4 percent and cost of equity is 15.4 percent. Management is considering a project that will produce a cash inflow of $36,000 in the first year. The cash inflows will then grow at 3 percent per year forever. What is the maximum amount the firm can initially invest in this project to avoid a negative net present value for the project?
A. $299, B. $382,
is financed solely with common stock. The risk-free rate of return is 3.4 percent. What is an appropriate cost of capital for a division within the firm that has an estimated beta of 1.18?
A. 12.37 percent B. 12.41 percent C. 12.54 percent D. 12.67 percent E. 12.80 percent - ANSWER E. 12.80 percent
0.136 = 0.034 + 128mrp; mrp= 0.
ReDivision = 0.034 + 1.18)0.0796875) = 12.80 percent
Miller Sisters has an overall beta of 0.64 and a cost of equity of 11.2 percent for the firm overall. The firm is 100 percent finances with common stock. Division A within the firm has an estimated beta of 1.08 and is the riskiest of all the firm's operations. What is an appropriate cost of capital for division A if the market risk premium is 9.5 percent?
A. 15.12 percent B. 15.38 percent C. 15.63 percent D. 15.77 percent E. 16.01 percent - ANSWER B. 15.38 percent
0.112 = rf + 0.64(0.095); rf = 0.
ReDivision = 0.0512 + 1.08(0.095) = 15.38 percent
Deep Mining and Precious Metals are separate firms that are both considering a silver exploration project. Deep Mining is in the actual mining business and has an aftertax cost of capital of 12.8 percent. Precious Metals is in the precious gem retail business and has an aftertax cost of capital of 10.6 percent. The project under consideration has initial costs of $575,000 and anticipated annual cash inflows of $102,000 a year for 10 years. Which firm(s), if either, should accept this project?
A. Company A only B. Company B only C. both Company A and Company B D. neither Company A or B E. Cannot be determined without further information. - ANSWER D. neither Company A or B
NPV = -$575,000 + $102,000 x {(1-[(1/(1 + 0.128)]^10}/0.128] = $-17,
Compute using calculator:
Co = -525, Cf1 -10 = 102, I = 12.8% CPT NPV = -17,
Neither company should accept this project as the applicable discount rate for both firms is 12.8 percent and the NPV is negative at this discount rate.
Sister Pools sells outdoor swimming pools and currently has an aftertax cost of capital of 11.6 percent. Al's Construction builds and sells water features and fountains and has an aftertax cost of capital of 10.8 percent. Sister Pools is considering building and selling its own water features and fountains. The sales manager of Sister Pools estimates that the water features and fountains would produce 20 percent of the firm's future total sales. The initial cash outlay for this project would be $85,000. The expected
Bleakly Enterprises has a capital structure of 55 percent common stock, 10 percent preferred stock, and 35 percent debt. The flotation costs are 4.5 percent for debt, 7 percent for preferred stock, and 9.5 percent for common stock. The corporate tax is 34 percent. What is the weighted average flotation cost?
A. 5.8 percent B. 6.2 percent C. 6.7 percent D. 7.0 percent E. 7.5 percent - ANSWER E. 7.5 percent
Average flotation cost = (0.55 x 0.095) + (0.10 x 0.07) + (0.35 x 0.045) = 7.5 percent
Justice, Inc. has a capital structure which is based on 30 percent debt, 5 percent preferred stock, and 65 percent common stock. The flotation costs are 11 percent for common stock, 10 percent for preferred stock, and 7 percent for debt. The corporate tax rate is 37 percent. What is the weighted average flotation cost?
A. 8.97 percent B. 9.38 percent C. 9.62 percent D. 9.75 percent E. 10 percent - ANSWER C. 9.62 percent D. 9.75 percent
Average flotation cost = (.65 x .11) + (.05 x .10) + (.30 x .07) = 9.75 percent
The Daily Brew has a debt-equity ratio of 0.72. The firm is analyzing a new project which required an initial cash outlay of $420,000 for equipment. The flotation cost is 9. percent for equity and 5.4 percent for debt. What is the initial cost of the project including the flotation costs?
A. $302,
B. $368,
C. $455,
D. $456,
E. $583,333 - ANSWER C. $455,
Average flotation cost = (1/1.72)(0.096) + (0.72/1.72)(0.054) = 0.
Initial cost = $420,000/(1-0.0784186) = $455,
You are evaluation a project which required $230,000 in external financing. The flotation cost of equity is 11.6 percent and the flotation cost of debt is 5.4 percent. What is the initial cost of the project including the flotation costs if you maintain a debt-equity ratio of 0.45?
A. $248, B. $249, C. $254, D. $255, E. $255,646 - ANSWER C. $254,
Average flotation cost = (1/1.45)(.116) + (.45/1.45)(.054) = 0.
Initial cost = $230,000/(1 - 0.0967586) = $254,
Western Wear is considering a project that requires an initial investment of $274,000. The firm maintains a debt-equity ratio of 0.40 and has a flotation cost of debt of 7 percent and a flotation cost of equity of 10.5 percent. The firm has sufficient internally
