Question Details

What is Quigley's WACC


1.	Which of the following statements is CORRECT?

a.	When calculating the cost of debt, a company needs to adjust for taxes, because interest payments are deductible by the paying corporation.
b.	When calculating the cost of preferred stock, companies must adjust for taxes, because dividends paid on preferred stock are deductible by the paying corporation.
c.	Because of tax effects, an increase in the risk-free rate will have a greater effect on the after-tax cost of debt than on the cost of common stock as measured by the CAPM.
d.	If a company- beta increases, this will increase the cost of equity used to calculate the WACC, but only if the company does not have enough retained earnings to take care of its equity financing and hence must issue new stock.
e.	Higher flotation costs reduce investors' expected returns, and that leads to a reduction in a company- WACC.
	

2.	Which of the following statements is CORRECT?

a.	A change in a company- target capital structure cannot affect its WACC.
b.	WACC calculations should be based on the before-tax costs of all the individual capital components.
c.	Flotation costs associated with issuing new common stock normally reduce the WACC.
d.	If a company- tax rate increases, then, all else equal, its weighted average cost of capital will decline.
e.	An increase in the risk-free rate will normally lower the marginal costs of both debt and equity financing.
		


3.	For a company whose target capital structure calls for 50% debt and 50% common equity, which of the following statements is CORRECT?

a.	The interest rate used to calculate the WACC is the average after-tax cost of all the company's outstanding debt as shown on its balance sheet.
b.	The WACC is calculated on a before-tax basis.
c.	The WACC exceeds the cost of equity.
d.	The cost of equity is always equal to or greater than the cost of debt.
e.	The cost of retained earnings typically exceeds the cost of new common stock.

4.	Several years ago the Jakob Company sold a $1,000 par value, noncallable bond that now has 20 years to maturity and a 7.00% annual coupon that is paid semiannually.  The bond currently sells for $925, and the company- tax rate is 40%.  What is the component cost of debt for use in the WACC calculation?

a.	4.28%
b.	4.46%
c.	4.65%
d.	4.83%
e.	5.03%
	
5.	Assume that Kish Inc. hired you as a consultant to help estimate its cost of capital.  You have obtained the following data:  D0 = $0.90; P0 = $27.50; and g = 7.00% (constant).  Based on the DCF approach, what is the cost of equity from retained earnings?

a.	9.29%
b.	9.68%
c.	10.08%
d.	10.50%
e.	10.92%
	
6.	Weaver Chocolate Co. expects to earn $3.50 per share during the current year, its expected dividend payout ratio is 65%, its expected constant dividend growth rate is 6.0%, and its common stock currently sells for $32.50 per share.  New stock can be sold to the public at the current price, but a flotation cost of 5% would be incurred.  What would be the cost of equity from new common stock?

a.	12.70%
b.	13.37%
c.	14.04%
d.	14.74%
e.	15.48%
	
7.	Sorensen Systems Inc. is expected to pay a $2.50 dividend at year end (D1 = $2.50), the dividend is expected to grow at a constant rate of 5.50% a year, and the common stock currently sells for $52.50 a share.  The before-tax cost of debt is 7.50%, and the tax rate is 40%.  The target capital structure consists of 45% debt and 55% common equity.  What is the company- WACC if all the equity used is from retained earnings?

a.	7.07%
b.	7.36%
c.	7.67%
d.	7.98%
e.    8.29%


8.	You were hired as a consultant to Quigley Company, whose target capital structure is 35% debt, 10% preferred, and 55% common equity.  The interest rate on new debt is 6.50%, the yield on the preferred is 6.00%, the cost of retained earnings is 11.25%, and the tax rate is 40%.  The firm will not be issuing any new stock.  What is Quigley's WACC?

a.	8.15%
b.	8.48%
c.	8.82%
d.	9.17%
e.	9.54%



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