Question 1

Casper's is analyzing a proposed expansion project that is much riskier than the firm's current operations.Thus,the project will be assigned a discount rate equal to the firm's cost of capital plus 2.5 percent.The proposed project has an initial cost of $18.1 million that will be depreciated on a straight-line basis to a zero book value over 20 years.The project also requires additional inventory of $428,000 over the project's life.Management estimates the facility will generate cash inflows of $2.46 million a year over its 20-year life.After 20 years,the company plans to sell the facility for an aftertax amount of$1.4 million.The company has 58,000 shares of common stock outstanding at a market price of $52 a share.This stock just paid an annual dividend of $2.84 a share.The dividend is expected to increase by 3.6 percent annually.The firm also has 15,000 shares of 9 percent preferred stock with a market value of $87 a share.The preferred stock has a par value of $100.The company has $1.2 million of face value bonds with semiannual payments and a coupon rate of 9 percent.The bonds are currently priced at 102 percent of face value and mature in 13 years.The tax rate is 35 percent.Should the firm pursue the expansion project at this point in time? Why or why not?

Accepted Answer

A)  Accept; The NPV is $2.6 million.
B)  Accept; The NPV is $1.0 million.
C)  Reject; the NPV is -$3.2 million.
D)  Reject; the NPV is -$3.0 million.
E)  Reject; the NPV is -$1.4 million.F) A) and E)
G) A) and D)

Question 2

Farm Equipment announced this morning that its next annual dividend will be decreased to $1.67 a share and that all future dividends will be decreased by an additional 1.3 percent annually.What is the current value per share if the required return is 15.7 percent?

Accepted Answer

A)  $8.46
B)  $9.82
C)  $10.02
D)  $9.54
E)  $10.16F) A) and B)
G) A) and C)

Question 3

What is the primary reason why the cash flow from assets (CFA) is adjusted when used to value a firm?

Accepted Answer

A)  Depreciation is a non-cash expense so both it and the depreciation tax shield must be eliminated from the CFA.
B)  Net working capital (NW
C)   is excluded from firm valuations so the change in NWC must be added back to the "normal" CFA calculation
C)  Interest expense is a financing cost and thus the tax benefit of this expense needs to be eliminated from the CFA.
D)  CFA is normally based on historical performance but since firm valuations are forward looking the CFA must be adjusted for timing
E)  The CFA must be lowered by the amount of the noncash expenses to ascertain a more accurate firm value.F) All of the above
G) C) and D)

Question 4

S&W has 21,000 shares of common stock outstanding at a price of $29 a share.It also has 2,000 shares of preferred stock outstanding at a price of $71 a share.The firm has 7 percent,12-year bonds outstanding with a total market value of $386,000.The bonds are currently quoted at 100.6 percent of face and pay interest semiannually.What is the capital structure weight of the firm's preferred stock if the tax rate is 34 percent?

Accepted Answer

A)  12.49 percent
B)  9.00 percent
C)  8.24 percent
D)  11.84 percent
E)  13.63 percentF) A) and C)
G) A) and B)

Question 5

Appalachian Mountain Goods has paid increasing dividends of $.10,$.12,$.15,and $.20 a share over the past four years,respectively.The firm estimates that future increases in its dividends will be equal to the arithmetic average growth rate over these past four years.The stock is currently selling for $12.50 a share.The risk-free rate is 3.4 percent and the market risk premium is 8.1 percent.What is the cost of equity for this firm if its beta is 1.46?

Accepted Answer

A)  18.34 percent
B)  16.91 percent
C)  19.78 percent
D)  21.68 percent
E)  22.03 percentF) All of the above
G) A) and B)

Question 6

The 6.5 percent preferred stock of Home Town Brewers is selling for $42 a share.What is the firm's cost of preferred stock if the tax rate is 35 percent and the par value per share is $100?

Accepted Answer

A)  17.50 percent
B)  15.92 percent
C)  16.17 percent
D)  16.52 percent
E)  15.48 percentF) D) and E)
G) A) and E)

Question 7

Country Cook's cost of equity is 16.2 percent and its aftertax cost of debt is 5.8 percent.What is the firm's weighted average cost of capital if its debt-equity ratio is .42 and the tax rate is 34 percent?

Accepted Answer

A)  12.54 percent
B)  11.47 percent
C)  13.12 percent
D)  12.28 percent
E)  13.01 percentF) B) and E)
G) A) and E)

Question 8

All else constant,an increase in a firm's cost of debt:

Accepted Answer

A)  could be caused by an increase in the firm's tax rate.
B)  will result in an increase in the firm's cost of capital.
C)  will lower the firm's weighted average cost of capital.
D)  will lower the firm's cost of equity.
E)  will increase the firm's capital structure weight of debtF) B) and C)
G) C) and D)

Question 9

Ted is trying to decide what cost of capital he should assign to a project.Which one of the following should be his primary consideration in this decision?

Accepted Answer

A)  Amount of debt used to finance the project
B)  Use, or lack, of preferred stock as a financing option
C)  Mix of funds used to finance the project
D)  Risk level of the project
E)  Length of the project's lifeF) D) and E)
G) B) and C)

Question 10

Country Markets has an EBIT of $42,650,an increase in net working capital of $2,615,interest expense of $4,300,net capital spending of $3,620,and a tax rate of 34 percent.The firm&#8217;s WACC is 11.2 percent and its growth rate is 3.1 percent.What is the adjusted value of the firm?

Accepted Answer

A)  $287,097.17
B)  $311,208.16
C)  $270,543.21
D)  $238,009.72
E)  $308,315.22F) A) and E)
G) B) and E)

Question 11

The common stock of Contemporary Interiors has a beta of 1.13 and a standard deviation of 21.4 percent.The market rate of return is 12.7 percent and the risk-free rate is 4.1 percent.What is the cost of equity for this firm?

Accepted Answer

A)  13.82 percent
B)  11.76 percent
C)  12.08 percent
D)  14.40 percent
E)  13.05 percentF) B) and D)
G) C) and D)

Question 12

All else constant,the weighted average cost of capital for a risky,levered firm will decrease if:

Accepted Answer

A)  the firm's bonds start selling at a premium rather than at a discount.
B)  the market risk premium increases.
C)  the firm replaces some of its debt with preferred stock.
D)  corporate taxes are eliminated.
E)  the dividend yield on the common stock increases.F) A) and B)
G) B) and D)

Question 13

Which one of the following is the primary determinant of an investment's cost of capital?

Accepted Answer

A)  Life of the investment
B)  Amount of the initial cash outlay
C)  The investment&'s level of risk
D)  The source of funds used for the investment
E)  The investment's net present valueF) A) and E)
G) None of the above

Question 14

Boone Brothers remodels homes and replaces windows.Ace Builders constructs new homes.If Boone Brothers considers expanding into new home construction,it should evaluate the expansion project using which one of the following as the required return for the project?

Accepted Answer

A)  Boone Brothers' cost of capital
B)  Ace Builders' cost of capital
C)  Average of Boone Brothers' and Ace Builders' cost of capital
D)  Lower of Boone Brothers' or Ace Builders' cost of capital
E)  Higher of Boone Brothers' or Ace Builders' cost of capitalF) C) and D)
G) C) and E)

Question 15

Orchard Farms has a pretax cost of debt of 7.29 percent and a cost of equity of 16.3 percent.The firm uses the subjective approach to determine project discount rates.Currently,the firm is considering a project to which it has assigned an adjustment factor of 1.25 percent.The firm's tax rate is 35 percent and its debt-equity ratio is .48.The project has an initial cost of $3.9 million and produces cash inflows of $1.26 million a year for 5 years.What is the net present value of the project?

Accepted Answer

A)  $421,619
B)  $446,556
C)  $514,370
D)  $561,027
E)  $478,721F) B) and E)
G) A) and D)

Question 16

Which one of the following will affect the capital structure weights used to compute a firm's weighted average cost of capital?

Accepted Answer

A)  Decrease in the book value of a firm's equity
B)  Decrease in a firm's tax rate
C)  Increase in the market value of the firm's common stock
D)  Increase in the market risk premium
E)  Increase in the firm's betaF) B) and D)
G) C) and D)

Exam 12: Cost of Capital

Boone Brothers remodels homes and replaces windows.Ace Builders constructs new homes.If Boone Brothers considers expanding into new home construction,it should evaluate the expansion project using which one of the following as the required return for the project?

Correct Answer
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Ted is trying to decide what cost of capital he should assign to a project.Which one of the following should be his primary consideration in this decision?

Correct Answer
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The common stock of Contemporary Interiors has a beta of 1.13 and a standard deviation of 21.4 percent.The market rate of return is 12.7 percent and the risk-free rate is 4.1 percent.What is the cost of equity for this firm?

Correct Answer
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Country Cook's cost of equity is 16.2 percent and its aftertax cost of debt is 5.8 percent.What is the firm's weighted average cost of capital if its debt-equity ratio is .42 and the tax rate is 34 percent?

Correct Answer
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Correct Answer
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All else constant,the weighted average cost of capital for a risky,levered firm will decrease if:

Correct Answer
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Correct Answer
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Which one of the following will affect the capital structure weights used to compute a firm's weighted average cost of capital?

Correct Answer
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All else constant,an increase in a firm's cost of debt:

Correct Answer
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Farm Equipment announced this morning that its next annual dividend will be decreased to $1.67 a share and that all future dividends will be decreased by an additional 1.3 percent annually.What is the current value per share if the required return is 15.7 percent?

Correct Answer
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The 6.5 percent preferred stock of Home Town Brewers is selling for $42 a share.What is the firm's cost of preferred stock if the tax rate is 35 percent and the par value per share is $100?

Correct Answer
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Country Markets has an EBIT of $42,650,an increase in net working capital of $2,615,interest expense of $4,300,net capital spending of $3,620,and a tax rate of 34 percent.The firm’s WACC is 11.2 percent and its growth rate is 3.1 percent.What is the adjusted value of the firm?

Correct Answer
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What is the primary reason why the cash flow from assets (CFA) is adjusted when used to value a firm?

Correct Answer
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Which one of the following is the primary determinant of an investment's cost of capital?

Correct Answer
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Exam 12: Cost of Capital

Boone Brothers remodels homes and replaces windows.Ace Builders constructs new homes.If Boone Brothers considers expanding into new home construction,it should evaluate the expansion project using which one of the following as the required return for the project?

Correct AnswerverifiedShow Answer

Ted is trying to decide what cost of capital he should assign to a project.Which one of the following should be his primary consideration in this decision?

Correct AnswerverifiedShow Answer

The common stock of Contemporary Interiors has a beta of 1.13 and a standard deviation of 21.4 percent.The market rate of return is 12.7 percent and the risk-free rate is 4.1 percent.What is the cost of equity for this firm?

Correct AnswerverifiedShow Answer

Country Cook's cost of equity is 16.2 percent and its aftertax cost of debt is 5.8 percent.What is the firm's weighted average cost of capital if its debt-equity ratio is .42 and the tax rate is 34 percent?

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

All else constant,the weighted average cost of capital for a risky,levered firm will decrease if:

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Which one of the following will affect the capital structure weights used to compute a firm's weighted average cost of capital?

Correct AnswerverifiedShow Answer

All else constant,an increase in a firm's cost of debt:

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Farm Equipment announced this morning that its next annual dividend will be decreased to $1.67 a share and that all future dividends will be decreased by an additional 1.3 percent annually.What is the current value per share if the required return is 15.7 percent?

Correct AnswerverifiedShow Answer

The 6.5 percent preferred stock of Home Town Brewers is selling for $42 a share.What is the firm's cost of preferred stock if the tax rate is 35 percent and the par value per share is $100?

Correct AnswerverifiedShow Answer

Country Markets has an EBIT of $42,650,an increase in net working capital of $2,615,interest expense of $4,300,net capital spending of $3,620,and a tax rate of 34 percent.The firm’s WACC is 11.2 percent and its growth rate is 3.1 percent.What is the adjusted value of the firm?

Correct AnswerverifiedShow Answer

What is the primary reason why the cash flow from assets (CFA) is adjusted when used to value a firm?

Correct AnswerverifiedShow Answer

Which one of the following is the primary determinant of an investment's cost of capital?

Correct AnswerverifiedShow Answer

Correct Answer
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