corporation finance test bank chapter 14

Chapter 14 - Cost of Capital

66. Kelso's has 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

WACC = (1/1.55) (0.145) + (0.55/1.55) (0.048) = 11.06 percent

AACSB: Analytic Bloom's: Application Difficulty: Basic

Learning Objective: 14-3 Section: 14.4 Topic: WACC

67. 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 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 risk-free 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

Re = 0.036 + 1.2(0.085) = 0.138

Re = [($1.10 ? 1.02)/$19] + 0.02 = 0.0790526 Re Average = (0.138 + 0.0790526)/2 = 0.108526

WACC = (1/1.65) (0.108526) + (0.65/1.65) (0.098) (1 - 0.32) = 9.20 percent

AACSB: Analytic Bloom's: Application Difficulty: Basic

Learning Objective: 14-3 Section: 14.4 Topic: WACC

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Chapter 14 - Cost of Capital

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

AACSB: Analytic Bloom's: Application Difficulty: Basic

Learning Objective: 14-3 Section: 14.4 Topic: WACC

69. The Market Outlet has a beta of 1.38 and a cost of equity of 14.945 percent. The risk-free 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.

RE = 0.14945 = 0.0425 + (1.38 ? mrp); mrp = 0.0775 RProject = 0.0425 + (1.25 ? 0.0775) = 13.94 percent

AACSB: Analytic Bloom's: Application Difficulty: Basic

Learning Objective: 14-1 Section: 14.5

Topic: Discount rate

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Chapter 14 - Cost of Capital

70. 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 1.03 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.

RE = 0.119 = 0.028 + (0.87 ? mrp); mrp = 0.1046 RProject = 0.028 + (1.03 ? 0.1046) = 13.57 percent

AACSB: Analytic Bloom's: Application Difficulty: Basic

Learning Objective: 14-1 Section: 14.5

Topic: Discount rate

71. 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, $279,000, 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

WACC = (0.55 ? 0.13) + (0.05 ? 0.09) + [0.40 ? 0.075 ? (1 - 0.39)] =0.0943

NPV -$325,000 + ($87,000/1.0943) + ($279,000/1.09432) + ($116,000/1.09433) = $76,011.23

AACSB: Analytic Bloom's: Analysis Difficulty: Basic

Learning Objective: 14-3 Section: 14.5

Topic: Project NPV

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Chapter 14 - Cost of Capital

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 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. $15,411 B. $15,809 C. $16,333 D. $16,938 E. $17,840

WACC = (1/1.45) (0.127) + (0.45/1.45) (0.048) = 0.102483

NPV = -$102,000 + ($65,000/1.102483) + ($74,000/1.1024832) = $17,840

AACSB: Analytic Bloom's: Analysis Difficulty: Basic

Learning Objective: 14-3 Section: 14.5

Topic: Project NPV

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

WACC = 0.70(0.154) + 0.30(0.054) = 0.124 PV = $36,000/(0.124 - 0.03) = $382,979

AACSB: Analytic Bloom's: Application Difficulty: Basic

Learning Objective: 14-3 Section: 14.5

Topic: Project NPV

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