THE COST OF CAPITAL

(Difficulty: E = Easy, M = Medium, and T = Tough)

Multiple Choice: Problems

Easy:

Cost of common stockAnswer: d Diff: E

[i].Bouchard Company's stock sells for $20 per share, its last dividend (D0) was $1.00, and its growth rate is a constant 6 percent. What is its cost of common stock, rs?

a. 5.0%

b. 5.3%

c.11.0%

d.11.3%

e.11.6%

Cost of common stockAnswer: b Diff: E

[ii].Your company's stock sells for $50 per share, its last dividend (D0) was $2.00, and its growth rate is a constant 5 percent. What is the cost of common stock, rs?

a. 9.0%

b. 9.2%

c. 9.6%

d. 9.8%

e.10.0%

Cost of common stockAnswer: e Diff: E

[iii].The Global Advertising Company has a marginal tax rate of 40 percent. The last dividend paid by Global was $0.90. Global's common stock is selling for $8.59 per share, and its expected growth rate in earnings and dividends is 5 percent. What is Global's cost of common stock?

a.12.22%

b.17.22%

c.10.33%

d. 9.66%

e.16.00%

WACC with Flotation CostsAnswer: a Diff: E

[iv].An analyst has collected the following information regarding Christopher Co.:

• The company’s capital structure is 70 percent equity, 30 percent debt. • The yield to maturity on the company’s bonds is 9 percent. • The company’s year-end dividend is forecasted to be $0.80 a share. • The company expects that its dividend will grow at a constant rate of 9 percent a year. • The company’s stock price is $25.

• The company’s tax rate is 40 percent.

• The company anticipates that it will need to raise new common stock this year. Its investment bankers anticipate that the total flotation cost will equal 10 percent of the amount issued. Assume the company accounts for flotation costs by adjusting the cost of capital. Given this information, calculate the company’s WACC.

a.10.41%

b.12.56%

c.10.78%

d.13.55%

e. 9.29%

Medium:

WACCAnswer: d Diff: M

[v].A company’s balance sheets show a total of $30 million long-term debt with a coupon rate of 9 percent. The yield to maturity on this debt is 11.11 percent, and the debt has a total current market value of $25 million. The balance sheets also show that that the company has 10 million shares of stock; the total of common stock and retained earnings is $30 million. The current stock price is $7.5 per share. The current return required by stockholders, rS, is 12 percent. The company has a target capital structure of 40 percent debt and 60 percent equity. The tax rate is 40%. What weighted average cost of capital should you use to evaluate potential projects?

a. 8.55%

b. 9.33%

c. 9.36%

d. 9.87%

e.10.67%

Cost of common stockAnswer: d Diff: M

[vi].The common stock of Anthony Steel has a beta of 1.20. The risk-free rate is 5 percent and the market risk premium (rM - rRF) is 6 percent. What is the company’s cost of common stock, rs?

a. 7.0%

b. 7.2%

c.11.0%

d.12.2%

e.12.4%

Cost of common stockAnswer: b Diff: M

[vii].Martin Corporation's common stock is currently selling for $50 per share. The current dividend is $2.00 per share. If dividends are expected to grow at 6 percent per year, then what is the firm's cost of common stock?

a.10.0%

b.10.2%

c.10.6%

d.10.8%

e.11.0%

WACCAnswer: b Diff: M

[viii].A company has determined that its optimal capital structure consists of 40 percent debt and 60 percent equity. Given the following information, calculate the firm's weighted average cost of capital.

rd = 6%

Tax rate = 40%

P0 = $25...