公司理财习题库Chap015

企业理财习题库Chap015企业理财习题库Chap015企业理财习题库Chap015CHAPTER15CostofCapitalDEFINITIONSCOSTOFCAPITALa1.Theopportunitycostassociatedwiththefirm’scapitalinvestmentinaprojectiscalledits:ernalrateofreturn.COSTOFEQUITY2.Thereturnthatshareholdersrequireontheirinvestmentinthefirmiscalledthe:dividendyield.costofequity.capitalgainsyield.costofcapital.incomereturn.COSTOFDEBT3.Thereturnthatlendersrequireontheirloanedfundstothefirmiscalledthe:couponrate.currentyield.costofdebt.capitalgainsyield.costofcapital.CAPITALSTRUCTUREWEIGHTSd4.Theproportionsofthemarketvalueofthefirmassetsfinanced’sviadebt,commonstock,andpreferredstockarecalledthefirm:’sa.financingcosts.b.portfolioweights.c.betacoefficients.d.capitalstructureweights.e.costsofcapital.WACCe5.Theweightedaverageofthefirms’ofsequity,costpreferredstock,andaftertaxdebtisthe:rewardtoriskratioforthefirm.expectedcapitalgainsyieldforthestock.expectedcapitalgainsyieldforthefirm.portfoliobetaforthefirm.weightedaveragecostofcapital(WACC).DIVISIONALCOSTOFCAPITAL6.Forafirmwithmultiplebusinessunits,thecostofcapitaldevelopedforeachunitiscalleda:divisionalcostofcapital.pureplayapproach.subjectiveriskadjustment.stratifiedbetacoefficient.fundamentalbetacoefficient.PUREPLAYAPPROACH7.WhenfirmsdevelopaWACCforindividualprojectsbasedonthecostofcapitalforotherfirmsinsimilarlinesofbusinessastheproject,thefirmisutilizinga_____approach.subjectiveriskpureplaydivisionalcostofcapitalcapitaladjustmentsecuritymarketlineFLOTATIONCOSTS8.Thecostsincurredbythefirmwhennewissuesofstocksorbondsaresoldarecalled:requiredratesofreturn.costsofcapital.flotationcosts.capitalstructureweights.costsofequityanddebt.CONCEPTSCOSTOFCAPITAL9.Thecostofcapital:willdecreaseastherisklevelofafirmincreases.isprimarilydependentonthesourceofthefundsusedinaproject.impliesthataprojectwillproduceapositivenetpresentvalueonlywhentherateofreturnontheprojectislessthanthecostofcapital.remainsconstantforallprojectssponsoredbythesamefirm.dependsonhowthefundsaregoingtobeutilized.COSTOFCAPITALc

10.Theoverallcostofcapitalforaretailstore:a.isequivalenttotheafter-taxcostofthefirm’sliabilities.shouldbeusedastherequiredreturnwhenanalyzingapotentialacquisitionofawholesaledistributor.reflectsthereturninvestorsrequireonthetotalassetsofthefirm.remainsconstantevenwhenthedebt-equityratiochanges.isunaffectedbychangesincorporatetaxrates.CHAPTER15COSTOFEQUITY11.Afirm’soverallcostofequityis:I.directlyobservableinthefinancialmarkets.unaffectedbychangesinthemarketriskpremium.highlydependentuponthegrowthrateandrisklevelofafirm.IV.anestimateonly.IandIIIonlyIIandIVonlyIandIIonlyIIIandIVonlyIandIVonlyCOSTOFEQUITY12.Thecostofequityforafirmis:determinedbydirectlyobservingtherateofreturnrequiredbyequityinvestors.basedonestimatesderivedfromfinancialmodels.c.equivalenttoaleveragedfirm’scostofcapital.equaltotherisk-freerateofreturnplusthemarketriskpremium.equaltotherisk-freerateofreturnplusthedividendgrowthrate.DIVIDENDGROWTHMODEL13.Thedividendgrowthmodel:canbeusedtoestimatethecostofequityforanycorporation.isapplicableonlytofirmsthatpayaconstantdividend.ishighlydependentupontheestimatedrateofgrowth.isconsideredquitecomplex.considerstheriskofthefirm.DIVIDENDGROWTHMODEL14.Thedividendgrowthmodel:generallyproducesthesameestimatedcostofequityforafirmregardlessofthesourceofinformationusedtopredicttherateofgrowth.canonlybeusedifhistoricaldividendinformationisavailable.ignorestheriskthatfuturedividendsmayvaryfromtheirestimatedvalues.assumesthatboththedividendamountandthestockpricearenotconstantovertime.usesbetatomeasurethesystematicriskofthefirm.SECURITYMARKETLINEAPPROACH15.Themarketriskpremium:variesovertimeasboththerisk-freerateofreturnandthemarketrateofreturnvary.plustherisk-freerateofreturnequalsthecostofcapitalforanyfirmwithabetaofzero.isequaltoonepercentforarisk-freeasset.isequaltotherisk-freerateofreturnmultipliedbythebetaofafirm.ismodifiedbythestandarddeviationwhencomputingthecostofequity.SECURITYMARKETLINEAPPROACH16.Whichofthefollowingstatementsarecorrectconcerningthesecuritymarketline(SML)approach?TheSMLapproachconsiderstheamountofsystematicriskassociatedwithanindividualfirm.TheSMLapproachcanbeappliedtomorefirmsthanthedividendgrowthmodelcan.TheSMLapproachgenerallyreliesonthepasttopredictthefuture.IV.TheSMLapproachgenerallyassumesthatthereward-to-riskratioisconstant.IandIIIonlyIIandIVonlyIIIandIVonlyI,II,andIIIonlyI,II,III,andIVCOSTOFDEBT17.Thepre-taxcostofdebtforafirm:isequaltotheyieldtomaturityontheoutstandingbondsofthefirm.isequaltothecouponrateoftheoutstandingbondsofthefirm.isequivalenttothecurrentyieldontheoutstandingbondsofthefirm.isbasedontheyieldtomaturitythatexistedwhenthecurrentlyoutstandingbondswereoriginallyissued.hastobeestimatedasitcannotbedirectlyobservedinthemarket.COSTOFDEBTd18.Theafter-taxcostofdebtgenerallyincreaseswhen:afirm’sbondratingincreases.themarketrateofinterestincreases.taxratesdecrease.IV.bondpricesdecline.IandIIIonlyIIandIIIonlyI,II,andIIIonlyII,III,andIVonlyI,II,III,andIVCOSTOFPREFERREDSTOCK19.Thecostofpreferredstockiscomputedthesameas:thepre-taxcostofdebt.anannuity.theafter-taxcostofdebt.aperpetuity.anirregulargrowthcommonstock.COSTOFPREFERREDSTOCK20.Thecostofpreferredstock:isequaltothedividendyieldonthestock.isequaltotheyieldtomaturity.ishighlydependentonthegrowthrate.d.variesdirectlywiththestock’sprice.isdifficulttodetermine.CHAPTER15CAPITALSTRUCTUREWEIGHTS21.Thecapitalstructureweightsusedincomputingtheweightedaveragecostofcapitalare:constantovertimeprovidedthatthedebt-equityratiochangesinunisonwiththemarketvalues.b.basedonthefacevalueofthefirm’putedusingthebookvalueofthelong-termdebtandtheshareholder’sequity.d.basedonthemarketvalueofthefirm’sdebtandequitysecurities.e.limitedtothefirm’sdebtandcommonstock.CAPITALSTRUCTUREWEIGHTSofthedebt,allelseequal?anincreaseinthemarketpriceofthecommonstockanincreaseinthenumberofsharesofpreferredstockoutstandingc.anincreaseinthequotedpriceofthefirm’sbondsasapercentageoffacevaluetheexerciseofwarrantsbycompanyemployeestheconversionofconvertiblebondsintoequitysharesWEIGHTEDAVERAGECOSTOFCAPITALe23.Theweightedaveragecostofcapitalforafirmisdependentuponthefirm’s:taxrate.debt-equityratio.couponrateonthepreferredstock.IandIIIonlyIIandIVonlyI,II,andIVonlyI,III,andIVonlyI,II,III,andIVWEIGHTEDAVERAGECOSTOFCAPITAL24.Theweightedaveragecostofcapitalforafirmisthe:discountratewhichthefirmshouldapplytoalloftheprojectsitundertakes.overallratewhichthefirmmustearnonitsexistingassetstomaintainthevalueofitsstock.ratethefirmshouldexpecttopayonitsnextbondissue.maximumratewhichthefirmshouldrequireonanyprojectsitundertakes.e.rateofreturnthatthefirm’spreferredstockholdersshouldexpecttoearnoverthelongterm.WEIGHTEDAVERAGECOSTOFCAPITAL25.Whichoneofthefollowingstatementsiscorrectconcerningtheweightedaveragecostofcapital(WACC)?Thepre-taxrateofreturnonthedebtistheratethatisrelevanttothecomputationoftheWACC.WhencomputingtheWACC,theweightassignedtothepreferredstockisequaltothecouponratemultipliedbytheparvalueassignedtothepreferredstock.Afirm’sWACCwilldecreaseastheircorporatetaxratedecreases.TheweightofthecommonstockusedinthecomputationoftheWACCisbasedonthenumberofsharesoutstandingmultipliedbythebookvaluepershare.Theweightofthedebtcanbebasedonthefacevalueofthebondissue(s)outstandingmultipliedbythequotedprice(s)whenexpressedasapercentageofthefacevalue.WEIGHTEDAVERAGECOSTOFCAPITAL26.IfafirmusesitsWACCasthediscountrateforalloftheprojectsitundertakesthenthefirmwilltendto:rejectsomepositivenetpresentvalueprojects.acceptsomenegativenetpresentvalueprojects.favorlowriskprojectsoverhighriskprojects.IV.becomeriskierovertime.IandIIIonlyIIIandIVonlyIandIIonlyI,II,andIVonlyI,II,III,andIVDIVISIONALCOSTOFCAPITALd

27.divisionalprojectsshouldbeacceptedtheyshould:a.allocatemorefundstoDivisionAsinceitisthelargestofthetwodivisions.b.fundallofDivisionB’sprojectsfirstsincetheytendtobelessriskyandthenallocatetheremainingfundstotheDivisionAprojectsthathavethehighestnetpresentvalues.

’sallocatethecompanyfundstotheprojectswiththehighestnetpresentvaluesbasedonthefirm’sweightedaveragecostofcapital.assigndifferentdiscountratestoeachprojectandthenselecttheprojectswiththehighestnetpresentvalues.fundthehighestnetpresentvalueprojectsfromeachdivisionbasedonanallocationof65percentofthefundstoDivisionAand35percentofthefundstoDivisionB.DIVISIONALCOSTOFCAPITAL28.Ifafirmappliesitsoverallcostofcapitaltoallitsproposedprojects,thenthedivisionswithinthefirmwilltendto:poselessriskyprojectsthanifseparatediscountrateswereappliedtoeachproject.CHAPTER15PROJECTCOSTOFCAPITAL29.Thediscountrateassignedtoanindividualprojectshouldbebasedon:thefirm’sweightedaveragecostofcapital.theactualsourcesoffundingusedfortheproject.c.anaverageofthefirm’soverallostofcapitalforthepastfiveyears.thecurrentriskleveloftheoverallfirm.theriskleveloftheprojectitself.PROJECTCOSTOFCAPITAL30.Assigningseparatediscountratestoindividualprojectswhendeterminingwhichprojectsshouldbeacceptedbythefirm:maycausethefirm’soverallweightedaveragecostofcapitaltovaryovertimeiftheprojectsacceptedchangetheoverallrisklevelofthefirm.b.willcausethefirm’soverallcostofcapitaltoremainconstantrtimeove.c.willcausethefirm’soverallcostofcapitaltodecreaseovertime.willchangethedebt-equityratioofthefirmovertime.negatestheprinciplegoalofcreatingthemostvaluefortheshareholders.PROJECTCOSTOFCAPITALe

31.Thecostofcapitalassignedtoanindividualprojectshouldbethatratewhich:a.correspondstotherisklevelofthefirm’sdivisionwhichhasresponsibilityfortheproject.correspondstothesourceofthefundsusedfortheproject.correspondstothelatestpre-taxcostofdebtandequityfortheoverallfirm.isthefirm’scurrentweightedaveragecostofcapital.considersboththenatureandthecharacteristicsoftheactualproject.PUREPLAYAPPROACHd32.Wayne’sofNewYorkspecializesinclothingforfemaleexecutiveslivingandclothingforwomenwholiveandworkintheruralareasofWesternPennsylvania.Bothfirmsarecurrentlyconsideringexpandingtheirclothinglinetoencompass’scurrentlyhasacostofcapitalof11percentwhileAllenscost’ofcapitalis9percent.Theexpansionprojecthasaprojectednetpresentvalueof$36,900ata9percentdiscountrateandanetpresentvalueof-$13,200atan11percentdiscountrate.WhichfirmorfirmsshouldexpandintoruralNewYorkstate?Wayne’sonlyAllen’sonlyc.neitherWayne’snorAllen’sd.bothWayne’sandAllen’scannotbedeterminedfromtheinformationprovidedPUREPLAYAPPROACH33.TheJasperMountainCo.specializesinback-countrycampingfacilitiesacrossthenation.ThePlanItCo.specializesinmakingtravelreservationsandpromotingvacationtravel.Jasperhasanafter-taxcostofcapitalof12percentandPlanIthasanafter-taxcostofcapitalof10percent.Bothfirmsareconsideringbuildingwildernesscampgroundscompletewiththeirownlakesandnumerousmountaintrails.Theestimatednetpresentvalueofsuchaprojectisestimatedat$13,000atadiscountrateof10percentand-$6,500(negative)ata12percentdiscountrate.Whichfirmorfirms,ifeither,shouldacceptthisproject?JasperonlyPlanItonlybothJasperandPlanItneitherJaspernorPlanItecannotbedeterminedwithoutfurtherinformationSUBJECTIVEAPPROACHd

34.a.

Thesubjectiveapproachtoprojectanalysis:isusedonlywhenthefirm’scostofcapitalownisunkn.usesthemarketrateofreturnasthebaseratewhichisthenadjustedfortherisklevelofeachproject.isapurelyrandomallocationofdiscountratestovariousprojects.allowsmanagerstoadjustfortherisklevelofeachprojectwithoutknowingtheactualbetaoftheproject.usesthebetaofeachprojecttodeterminetheappropriatediscountratefortheproject.SUBJECTIVEAPPROACHd35.Whenafirmusesthesubjectiveapproachtoassigndiscountratestoprojects,thefirm:willassignitshighestdiscountratetothoseprojectswhicharemandatedbythegovernment.risksacceptingprojectswhichshouldhavebeenrejected.risksrejectingprojectswhichshouldhavebeenaccepted.IV.a.b.c.d.e.

generallymakesbetterdecisionsthanitwouldifitappliedthefirmcostofcapitaltoallprojects.IandIIIonlyIIandIVonlyI,II,andIIIonlyII,III,andIVonlyI,II,III,andIV

’sweightedaverageFLOTATIONCOSTSANDWACC36.Whenafirmhasflotationcostsequalto6percentofthefundingneed,itshould:increasetheweightedaveragecostofcapital(WACC)tooffsettheseexpensesbymultiplyingtheWACCby1.06.increasetheweightedaveragecostofcapital(WACC)tooffsettheseexpensesbydividingtheWACCby(1.06).add6percenttotheweightedaveragecostofcapitaltogetthediscountratefortheproject.increasetheinitialprojectcostbymultiplyingthatcostby1.06.e.increasetheinitialprojectcostbydividingthatcostby(1.06).CHAPTER15FLOTATIONCOSTSANDWACC37.Theflotationcostforafirmiscomputedas:thearithmeticaverageoftheflotationcostsofbothdebtandequity.theweightedaverageoftheflotationcostsassociatedwitheachformoffinancing.thegeometricaverageoftheflotationcostsassociatedwitheachformoffinancing.one-halfoftheflotationcostofdebtplusone-halfoftheflotationcostofequity.e.aweightedaveragebasedonthebookvaluesofthefirm’sdebtandequity.FLOTATIONCOSTSANDNPV38.Includingflotationcostsintothenetpresentvalueofaprojectwill:notaffectthatnetpresentvalue.increasethenetpresentvalueoftheproject.increasethediscountrateappliedtotheprojecttherebyloweringtheprojectpresentvalue.increasetheinitialcashoutflowoftheprojecttherebyloweringtheprojectpresentvalue.affectthenetpresentvaluebutthedirectionofthatimpactcannotbedetermined.FLOTATIONCOSTSANDNPV39.Flotationcostsshould:beignoredwhenanalyzingaprojectbecausetheyarenotanactualcostoftheproject.beaveragedoverthelifeoftheprojecttherebyreducingthecashflowsforeachyearoftheproject.onlybeconsideredwhentwoprojectshavethesamenetpresentvalue.besubtractedfromtheinitialcostofaprojectbeforethenetpresentvalueoftheprojectiscomputed.beincludedinprojectanalysisasanadditionalinitialcostoftheproject.COSTOFEQUITYd40.MartinIndustriesjustpaidanannualdividendof$1.20ashare.Themarketpriceofthestockis$26.60andthegrowthrateis4percent.Whatisthefirm’scostofequity?COSTOFEQUITY41.SwissCheeses,Inc.haspaidannualdividendsof$1.00,$1.04,$1.09,and$1.15pershareoverthelastfouryears,respectively.Thestockiscurrentlysellingfor$42a’scostofequity?

’snet’snetCOSTOFEQUITY42.NealEnterprisescommonstockiscurrentlypricedat$36.80ashare.Thecompanyisexpectedtopay$1.20persharenextmonthastheirannualdividend.Thedividendshavebeenincreasingby2percentannuallyandareexpectedtocontinuedoingso.WhatisthecostofequityforNealEnterprises?COSTOFEQUITYe43.ThecommonstockofBigBirdsUnlimitedhasarequiredreturnof8percentandagrowthrateof4percent.Thelastannualdividendwas$.60ashare.Whatisthecurrentpriceofthisstock?COSTOFEQUITY44.TheAdeptCo.haspaidannualdividendsof$.80,$.92,$.98,$1.04,and$1.09overthepastfiveyearsrespectively.Whatistheaveragedividendgrowthrate?COSTOFEQUITYc45.Ben’sIceCreamjustpaidtheirannualdividendof$.75ashare.Thestockhasamarketpriceof$32andabetaof.90.ThereturnontheU.S.Treasurybillis4percentandthemarkethasa12percentrateofreturn.Whatisthecostofequity?COSTOFEQUITY46.Rosie’sGrillhasabetaof1.2,astockpriceof$26andanexpectedannualdividendof$1.30asharewhichistobepaidnextmonth.Thedividendgrowthrateis4percent.Themarkethasa10percentrateofreturnandariskpremiumof6percent.WhatistheaverageexpectedcostofequityforRosie’sGrill?CHAPTER15COSTOFEQUITY47.Daniel’sEnterpriseshasabetaof1.98andagrowthrateof12percent.Thestockiscurrentlysellingfor$12ashare.Theoverallstockmarkethasan11percentrateofreturnandariskpremiumof8percent.WhatistheexpectedrateofreturnonDanielEnterprisesstock?COSTOFEQUITYc48.Martha’sInteriorshasacurrentbetaof1.2.Themarketriskpremiumis6percentandtherisk-freerateofreturnis4percent.Byhowmuchwillthecostofequityincreaseifthecompanycompletesanacquisitionsuchthattheircompanybetarisesto1.4?COSTOFDEBTbondiscurrentlysellingfor98percentofitsfacevalue.Whatisthecompany’spre-taxcostofdebt?COSTOFDEBTa50.Wilson’sCabinetshasbondsoutstandingthatmatureineightyears,havea6percentcouponandpayinterestannually.Thesebondshaveafacevalueof$1,000anda-taxcost’ofspredbt?COSTOFDEBT51.Katie’sBoutiquehaszero-couponbondsoutstandingthatmatureinfouryears.Thebondshaveafacevalueof$1,000andacurrentmarketpriceof$820.Whatisthecompany’spre-taxcostofdebt?COSTOFDEBT-taxcostof’spredebt?c.AFTER-TAXCOSTOFDEBT53.BlackwaterAdventureshasabondissueoutstandingthatmaturesinsixteenyears.Thebondspayinterestsemi-annually.Currently,thebondsarequotedat103percentoffirm’safter-taxcostofdebt?a.b.c.d.e.AFTER-TAXCOSTOFDEBTa54.TheoutstandingbondsofThePurpleFiddlearepricedat$898andmatureinnine’stax-tax’costafterofdebt?a.b.c.d.e.CHAPTER15AFTER-TAXCOSTOFDEBT55.Tom’sVentureshasazerocouponbondissueoutstandingthatmaturesinthirteenyears.Thebondsaresellingat48percentofparvalue.Thecompany’staxrateis34’-taxsaftercostofdebt?c.COSTOFPREFERREDe

56.Jensen’sTravelAgencyhasapercent7preferredstockoutstandingthatiscurrently’staxrateis’scostofpreferredstock?c.COSTOFPREFERREDd57.DonnellyandSonpay$8astheannualdividendontheirpreferredstock.Currently,’scostofpreferredstock?COSTOFPREFERRED58.Teri’sTireshas7percentpreferredstockoutstandingthatsellsfor$68ashare.WhatisTeri’scostofpreferredstock?CAPITALSTRUCTUREWEIGHTSbtheweightofthepreferredstockasitrelatestothefirm’sweightedaveragecostofcapital?10percent12percent14percent16percent18percentCAPITALSTRUCTUREWEIGHTS60.Watson’sAutomotivehasa$400,000bondissueoutstandingthatissellingat102percentoffacevalue.Watson’salsohas4,500sharesofpreferredstockand21,000sharesofcommonstockoutstanding.Thepreferredstockhasamarketpriceof$44athedebtasitrelatestothefirmhted’saverageweigcostofcapital?38percent39percent40percent41percent42percentCAPITALSTRUCTUREWEIGHTS61.Gillian’sBoutiquehas50,0008sharesofcommonstockoutstandingatamarketpriceof$16ashare.Thecompanyalsohas15,000bondsoutstandingthatarequotedat98percentoffacevalue.WhatweightshouldbegiventothecommonstockwhenGillian’scomputestheirweightedaveragecostofcapital?48percent49percent50percent51percent52percentWEIGHTEDAVERAGECOSTOFCAPITALc62.Jack’sConstructionCo.has80,000bondsoutstandingthataresellingatparvalue.is8percent.Jack’staxrateis35percent.WhatisJacktedaverage’costweighofcapital?WEIGHTEDAVERAGECOSTOFCAPITAL63.Peter’sAudioShophasacostofdebtof7percent,acostofequityof11percent,andacostofpreferredstockof8percent.Thefirmhas104,000sharesofcommonstockoutstandingatamarketpriceof$20ashare.Thereare40,000sharesofpreferredstock$500,000andsellsat102percentoffacevalue.Thecompany’staxrateis34percent.WhatistheweightedaveragecostofcapitalforPeter’sAudioShop?CHAPTER15WEIGHTEDAVERAGECOSTOFCAPITALc64.debt-equityratioisneededforthefirmtoachievetheirtargetedweightedaveragecostofcapital?a..33b..40c..50d..60e..67WEIGHTEDAVERAGECOSTOFCAPITALd65.Jake’sSoundSystemshas210,000sharesofcommonstockoutstandingatamarketpriceof$36ashare.Lastmonth,Jakenual’sdivipaidendananitheamountof’salsohas6,000bondsoutstandingwithafacevalueof$1,000perbond.Thebondscarrya7percentcoupon,’sweightedaveragecostofcapital?c.WEIGHTEDAVERAGECOSTOFCAPITALb66.Shirley’sandSonhavead-e’sweightedaveragecostofcapital?WEIGHTEDAVERAGECOSTOFCAPITAL’sweightedaveragecostofcapital?WEIGHTEDAVERAGECOSTOFCAPITAL68.Wilson’shas10,000sharesofcommonstockoutstandingatamarketpriceof$35ashare.Thefirmalsohasabondissueoutstandingwithatotalfacevalueof$250,000whichissellingfor102percentoffacevalue.Thecostofequityis11percentwhilethepre-taxcostofdebtis8percent.Thefirmhasabetaof1.1andataxrateof34percent.WhatisWilson’sweightedaveragecostofcapital?PROJECTCOSTOFCAPITALba.b.c.d.e.

discountratefortheprojectis:10.25percent.11.75percent.12.00percent.13.50percent.14.75percent.PROJECTCOSTOFCAPITALd70.OutsideJohnnierateofreturnis4.5percent.Johnnie’sisconsideringaprojectwithabetaof1.4andaprojectlifeofsixyears.Anappropriatediscountratefortheprojectis:12.33percent.12.50percent.12.78percent.12.90percent.13.11percent.CAPITALBUDGETINGPROBLEMa71.DouglassEnterpriseshasacapitalstructurewhichisbasedon40percentdebt,10percentpreferredstock,and50percentcommonstock.Theafter-taxcostofdebtis6percent,thecostofpreferredis7percent,andthecostofcommonstockis9percent.Thecompanyisconsideringaprojectthatisequallyasriskyastheoverallfirm.Thisprojecthasinitialcostsof$125,000andcashinflowsof$76,000ayearfortwoyears.Whatistheprojectednetpresentvalueofthisproject?CHAPTER15CAPITALBUDGETINGPROBLEMc72.Antonio’sisanalyzingaprojectwithaninitialcostof$45,000andcashinflowsof’scurrentpercent.Whatistheprojectednetpresentvalueofthisproject?a.b.c.d.e.CAPITALBUDGETINGPROBLEM73.O.K.,Inc.usesone-thirddebtandtwo-thirdscommonstocktofinancetheiroperations.Theafter-taxcostofdebtis4.5percentandthecostofequityis9percent.ThemanagementofO.K.,Inc.isconsideringasmallprojectthattheyconsidertobeequallyasriskyastheoverallfirm.Theprojecthasaninitialcashoutlayof$10,000.CAPITALBUDGETINGPROBLEM74.Tony’sPizzaisconsideringanewprojectthatheytconsidertobealittleriskierthantheircurrentoperations.Thus,managementhasdecidedtoaddanadditional2percentnetpresentvalueofthenewproject?DIVISIONALCOSTOFCAPITAL75.Benson’s,Inc.hasanoverallcostofequityof10.24percentandabetaof1.2.Thefirmisfinanced100percentwithcommonstock.Therisk-freerateofreturnis4percent.Whatisanappropriatecostofcapitalforadivisionwithinthefirmthathasanestimatedbetaof1.5?DIVISIONALCOSTOFCAPITALaa.b.c.d.e.

WhatisanappropriatecostofcapitalfordivisionAifthemarketriskpremiumis5percent?

’soperations.PUREPLAYAPPROACHc77.AlphaandBetaareseparatefirmsthatarebothconsideringanoilexplorationproject.Alphacurrentlyoperatesanoilrefininganddistributionnetworkandhasanafter-taxcostofcapitalof12percent.Betaownsoilfieldsandconcentratesonoilproduction.Beta’safter-taxcostofcapitalis15percent.Theprojectunderconsiderationhasinitialcostsof$150,000andanticipatedannualcashinflowsof$32,000ayearfortenyears.Whichfirm(s)shouldacceptthisproject,ifany?AlphaonlyBetaonlybothAlphaandBetaneitherAlphanorBetacannotbedeterminedwithoutfurtherinformationPUREPLAYAPPROACHb78.MartinEnterprisessellsmotorhomesandcampersandcurrentlyhasanafter-taxcostofcapitalof7percent.Nagle’ssells-roadoffdirtbikesandhasanafter-taxcostofcapitalof13percent.MartinEnterprisesisconsideringaddingdirtbikesaspartoftheirsaleslineup.Theyestimatethatsalesfromthesebikescouldbecome10percentoftheiroverallsales.Theinitialcashoutlayforthisprojectis$50,000.Theexpectednetcashinflowsare$8,000ayearfornineyears.WhatisthenetpresentvalueofthisprojecttoMartinEnterprises?CHAPTER15PUREPLAYAPPROACH79.TheDeltaCo.ownsretailstoresthatmarkethomebuildingsupplies.Largo,Inc.buildssinglefamilyhomesinresidentialdevelopments.Deltahasabetaof1.22andLargohasabetaof1.34.Therisk-freerateofreturnis4percentandthemarketriskpremiumis6.5percent.WhatshouldDeltauseastheircostofequityiftheydecidetopurchasesomelandandcreateanewresidentialcommunity?FLOTATIONCOSTANDWEIGHTEDAVERAGECOSTOFCAPITAL80.TheGilbertCo.uses60percentcommonstock,10percentpreferredstock,and30percentdebtastheircapitalstructure.Theflotationcostsare4percentfordebt,8percentforpreferredstock,and7percentforcommonstock.Whatistheweightedaverageflotationcost?FLOTATIONCOSTa81.TheJamestownCo.hasacapitalstructurewhichisbasedon40percentdebt,15percentpreferredstock,and45percentcommonstock.Theflotationcostsare8percentforcommonstock,9percentforpreferredstock,and4percentfordebt.Whatistheweightedaverageflotationcost?FLOTATIONCOST82.TheLingoCo.hasadebt-equityratioof.60.Thefirmisanalyzinganewprojectwhichrequiresaninitialcashoutlayof$450,000fornewequipment.Theflotationcostfornewequityis10percentandfordebt5percent.Whatistheinitialcostoftheprojectincludingtheflotationcosts?$413,438$483,750$486,486$486,563$489,796FLOTATIONCOST83.Youareconsideringaprojectwhichrequires$136,000inexternalfinancing.Theflotationcostofequityis11percentandthecostofdebtis4.5percent.Youwishtomaintainadebt-equityratioof.45.Whatistheinitialcostoftheprojectincludingtheflotationcosts?$138,009$143,367$149,422$154,004$155,283IV.

ESSAYSWACC84.Whyisitimportantforfinancialdecisionmakerstoobtainagoodestimateofthefirmcostofcapital?

’Thestudentshouldindicatethatmakingdecisionsthatmaximizefirmvalueisnotpossibleunlessoneemploystheappropriatediscountrate.WACCWhatroledoesthecostofcapitalplayintheoverallfinancialdecisionmakingofthefirmtopmanagers?Thisisaveryopen-endedquestion.Studentsshouldexplainthatusingtheappropriatediscountrateinmakingacapitalbudgetingdecisioniscrucialtoprojectanalysis.Usingthewrongdiscountrateeffectivelyunderminesallofthecaretakentomakesurecashflowestimatesarereasonable.SUBJECTIVEAPPROACHWhydoyouthinksomemanagersemploythesubjectiveapproachinassigningadiscountratetoproposedprojects?Studentsshouldexplainthattherearepracticaldifficultiesinvolvedindevelopinganappropriatediscountrateforeachandeveryproject.First,itmaybedifficulttocomeupwithaccurateestimates.Second,whileitmaybepossibletocomeupw