Question Details

LaPango Inc. estimates that its average-risk projects have a WACC 



1.	Bankston Corporation forecasts that if all of its existing financial policies are followed, its proposed capital budget would be so large that it would have to issue new common stock.  Since new stock has a higher cost than retained earnings, Bankston would like to avoid issuing new stock.  Which of the following actions would REDUCE its need to issue new common stock?
a.	Increase the dividend payout ratio for the upcoming year.
b.	Increase the percentage of debt in the target capital structure.
c.	Increase the proposed capital budget.
d.	Reduce the amount of short-term bank debt in order to increase the current ratio.
e.	Reduce the percentage of debt in the target capital structure. 

2.	Schalheim Sisters Inc. has always paid out all of its earnings as dividends, hence the firm has no retained earnings.  This same situation is expected to persist in the future.  The company uses the CAPM to calculate its cost of equity, its target capital structure consists of common stock, preferred stock, and debt.  Which of the following events would REDUCE its WACC?
a.	The market risk premium declines.
b.	The flotation costs associated with issuing new common stock increase.
c.	The company- beta increases.
d.	Expected inflation increases.
e.	The flotation costs associated with issuing preferred stock increase.
3.	LaPango Inc. estimates that its average-risk projects have a WACC of 10%, its below-average risk projects have a WACC of 8%, and its above-average risk projects have a WACC of 12%.  Which of the following projects (A, B, and C) should the company accept?
a.	Project B, which is of below-average risk and has a return of 8.5%.
b.	Project C, which is of above-average risk and has a return of 11%.
c.	Project A, which is of average risk and has a return of 9%.
d.	None of the projects should be accepted.
e.	All of the projects should be accepted.


4.	Which of the following statements is CORRECT?
a.	The WACC as used in capital budgeting is an estimate of a company- before-tax cost of capital.
b.	The percentage flotation cost associated with issuing new common equity is typically smaller than the flotation cost for new debt.
c.	The WACC as used in capital budgeting is an estimate of the cost of all the capital a company has raised to acquire its assets.
d.	There is an “opportunity cost” associated with using retained earnings, hence they are not “free.”
e.	The WACC as used in capital budgeting would be simply the after-tax cost of debt if the firm plans to use only debt to finance its capital budget during the coming year.
5.	Bosio Inc.'s perpetual preferred stock sells for $97.50 per share, and it pays an $8.50 annual dividend.  If the company were to sell a new preferred issue, it would incur a flotation cost of 4.00% of the price paid by investors.  What is the company's cost of preferred stock for use in calculating the WACC?
a.	8.72%
b.	9.08%
c.	9.44%
d.	9.82%
e.	10.22%




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