finance data bank
62. Phillips Equipment has 80,000 bonds outstanding
that are selling at par. Bonds with similar characteristics are yielding 6.75
percent. The company also has 750,000 shares of 7 percent preferred stock and
2.5 million shares of common stock outstanding. The preferred stock sells 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
63. Wayco Industrial Supply has a pretax cost of debt
of 7.6 percent, a cost of equity of 14.3 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
C. 11.32 percent
D. 12.60 percent
E. 12.81 percent
64. Central Systems, Inc. desires a weighted average
cost of capital of 8 percent. The firm has an aftertax cost of debt of 4.8
percent and a cost of equity of 15.2 percent. What debtequity ratio is needed
for the firm to achieve its targeted weighted average cost of capital?
A. 0.38
B. 0.44
C. 1.02
D. 2.25
E. 2.63
65. R.S. Green has 250,000 shares of common stock
outstanding at a market price of $28 a 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 $1,000 per bond. The
bonds carry a 7 percent coupon, pay interest semiannually, 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
66. Kelso's has a debtequity 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
67. Granite Works maintains a debtequity ratio of
0.65 and has a tax rate of 32 percent. The firm does not issue preferred stock.
The pretax cost of debt is 9.8 percent. 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 riskfree rate is 3.6 percent.
This year, the firm paid an annual dividend of $1.10 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
68. Delta Lighting has 30,000 shares of common stock
outstanding at a market price of $17.50 a share. This stock was originally
issued at $31 per share. The firm also has a bond issue outstanding with a
total face value of $280,000 which is selling for 86 percent of par. The cost
of equity is 16 percent while the aftertax cost of debt is 6.9 percent. The
firm has a beta of 1.48 and a tax rate of 30 percent. What is the weighted
average cost of capital?
A. 11.07 percent
B. 13.14 percent
C. 14.36 percent
D. 15.29 percent
E. 15.47 percent
69. The Market Outlet has a beta of 1.38 and a cost of
equity of 14.945 percent. The riskfree rate of return is 4.25 percent. What
discount rate should the firm assign to a new project that has a beta of
1.25?
A. 13.54 percent.
B. 13.72 percent.
C. 13.94 percent.
D. 14.14 percent.
E. 14.36 percent.
70. Silo Mills has a beta of 0.87 and a cost of equity
of 11.9 percent. The riskfree rate of return is 2.8 percent. The firm is
currently considering a project that has a beta of 1.03 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.
71. Travis & Sons has a capital structure which is
based on 40 percent debt, 5 percent preferred stock, and 55 percent common
stock. The pretax 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, $279,000, and $116,000 over the next three years,
respectively. What is the projected net present value of this project?
A. $68,211.04
B. $68,879.97
C. $69,361.08
D. $74,208.18
E. $76,011.23
72. Panelli's is analyzing a project with an initial
cost of $102,000 and cash inflows of $65,000 in year one and $74,000 in year
two. This project is an extension of the firm's current operations and thus is
equally as risky as the current firm. The firm uses only debt and common stock
to finance its operations and maintains a debtequity 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. $15,411
B. $15,809
C. $16,333
D. $16,938
E. $17,840
73. 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 the 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. $299,032
B. $382,979
C. $411,406
D. $434,086
E. $441,414
74. The Bakery is considering a new project it
considers to be a little riskier than its current operations. Thus, management
has decided to add an additional 1.5 percent to the company's overall cost of
capital when evaluating this project. The project has an initial cash outlay of
$62,000 and projected cash inflows of $17,000 in year one, $28,000 in year two,
and $30,000 in year three. The firm uses 25 percent debt and 75 percent common
stock as its capital structure. The company's cost of equity is 15.5 percent
while the aftertax cost of debt for the firm is 6.1 percent. What is the
projected net present value of the new project?
A. $6,208
B. $5,964
C. $2,308
D. $1,427
E. $1,573
75. The Oil Derrick has an overall cost of equity of
13.6 percent and a beta of 1.28. The firm is financed solely with common stock.
The riskfree 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
76. 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
financed with common stock. Division A within the firm has an estimated beta of
1.08 and is the riskiest of all of 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
77. 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 ten
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 Company B
E. cannot be determined without further information
78. 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 net cash inflows are $16,000 a year for 7 years. What is the net
present value of the Sister Pools project?
A. $11,044
B. $9,115
C. $7,262
D. $4,508
E. $1,219
79. Decker's is a chain of furniture retail stores.
Furniture Fashions is a furniture maker and a supplier to Decker's. Decker's
has a beta of 1.38 as compared to Furniture Fashion's beta of 1.12. The
riskfree rate of return is 3.5 percent and the market risk premium is 8
percent. What discount rate should Decker's use if it considers a project that
involves the manufacturing of furniture?
A. 12.46 percent
B. 12.92 percent
C. 13.50 percent
D. 14.08 percent
E. 14.54 percent
80. 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 rate 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
81. 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. 9.48 percent
C. 9.62 percent
D. 9.75 percent
E. 10.00 percent
82. The Daily Brew has a debtequity ratio of 0.72.
The firm is analyzing a new project which requires an initial cash outlay of
$420,000 for equipment. The flotation cost is 9.6 percent for equity and 5.4
percent for debt. What is the initial cost of the project including the
flotation costs?
A. $302,400
B. $368,924
C. $455,738
D. $456,400
E. $583,333
83. You are evaluating a project which requires
$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 debtequity ratio of
0.45?
A. $248,494
B. $249,021
C. $254,638
D. $255,551
E. $255,646
84. Western Wear is considering a project that
requires an initial investment of $274,000. The firm maintains a debtequity
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 generated
equity to cover the equity portion of this project. What is the initial cost of
the project including the flotation costs?
A. $279,592
B. $281,406
C. $288,005
D. $297,747
E. $302,762
85. Yesteryear Productions is considering a project
with an initial start up cost of $960,000. The firm maintains a debtequity
ratio of 0.50 and has a flotation cost of debt of 6.8 percent and a flotation
cost of equity of 11.4 percent. The firm has sufficient internally generated
equity to cover the equity cost of this project. What is the initial cost of
the project including the flotation costs?
A. $979,417
B. $982,265
C. $992,386
D. $1,038,513
E. $1,065,089
Essay
Questions
86. What role does the weighted average cost of capital play when determining a project's cost of capital?
87. What are some advantages of the subjective approach to determining the cost of capital and why do you think that approach is utilized?
88. Give an example of a situation where a firm should adopt the pure play approach for determining the cost of capital for a project.
89. Suppose your boss comes to you and asks you to reevaluate a capital budgeting project. The first evaluation was in error, he explains, because it ignored flotation costs. To correct for this, he asks you to evaluate the project using a higher cost of capital which incorporates these costs. Is your boss' approach correct? Why or why not?
90. Explain how the use of internal equity rather than external equity affects the analysis of a project.

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