Question Details

What is the firm- component cost of debt for purposes of calculating the WACC 



1.	Wyden Brothers has no retained earnings.  The company uses the CAPM to calculate the cost of equity capital.  The company- capital structure consists of common stock, preferred stock, and debt.  Which of the following events will reduce the company- WACC?

a.	A reduction in the market risk premium.  
b.	An increase in the flotation costs associated with issuing new common stock.
c.	An increase in the company- beta.
d.	An increase in expected inflation.
2.	Dick Boe Enterprises, an all-equity firm, has a corpor¬ate beta coefficient of 1.5.  The financial manager is evaluating a proj¬ect with an expected return of 21 percent, before any risk adjustment.  The risk-free rate is 10 percent, and the required rate of return on the market is 16 percent.  The project being evaluated is risk¬ier than Boe- average project, in terms of both beta risk and total risk.  Which of the following statements is most correct?

a.	The project should be accepted since its expected return (before risk adjustment) is greater than its required return.
b.	The project should be rejected since its expected return (before risk adjustment) is less than its re¬quired return.
c.	The accept/reject decision depends on the risk-adjustment policy of the firm.  If the firm- policy were to reduce a riskier-than-average project- expected return by 1 percentage point, then the project should be accepted.   
d.	Riskier-than-average projects should have their expected returns increased to reflect their added riskiness.  Clearly, this would make the project acceptable regardless of the amount of the adjustment.
3.	Conglomerate Inc. consists of 2 divisions of equal size, and Conglomerate is 100 percent equity financed.  Division A- cost of equity capital is 9.8 percent, while Division B- cost of equity capital is 14 percent.  Conglomerate- composite WACC is 11.9 percent.  Assume that all Division A projects have the same risk and that all Division B projects have the same risk.  However, the projects in Division A are not the same risk as those in Division B.  Which of the following projects should Conglomerate accept?

a.	Division A project with an 11 percent return. 
b.	Division B project with a 12 percent return.
c.	Division B project with a 13 percent return.
d.	Statements a and c are correct.
4.      Flaherty Electric has a capital structure that consists of 70 percent equity and 30 percent debt.  The company- long-term bonds have a before-tax yield to maturity of 8.4 percent.  The company uses the DCF approach to determine the cost of equity.  Flaherty- common stock currently trades at $40.5 per share.  The year-end dividend (D1) is expected to be $2.50 per share, and the dividend is expected to grow forever at a constant rate of 7 percent a year.  The company estimates that it will have to issue new common stock to help fund this year- projects.  The company- tax rate is 40 percent.  What is the company- weighted average cost of capital, WACC?

a.	10.73%  
b.	10.30%
c.	11.31%
d.	 7.48%
5.      Hamilton Company- 8 percent coupon rate, quarterly payment, $1,000 par value bond, which matures in 20 years, currently sells at a price of $686.86.  The company- tax rate is 40 percent.  What is the firm- component cost of debt for purposes of calculating the WACC ?

a.	 3.05%
b.	 7.32%   
c.	 7.36%
d.	12.20%




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