Question

Question 1
If Newbury, Inc. wants to issue new bonds with a market interest rate of 12%, what is the after-tax cost of debt if the marginal tax rate is 32%?
a. 9.52%
b. 3.84%
c. 8.16% d. 12.0%

Question 2
Calabassas Golf, Inc. has a beta of 1.9. The risk-free rate of interest is 4%, and the market portfolio has an expected return of 10%. What is the cost of equity (Ke) for this company based on the capital asset pricing model?
a. 14.0%
b. 15.4%
c. 11.4%
d. 23.0%

Question 3
What is the Acme Company’s weighted average cost of capital if its cost of before-tax debt is 8% (20% of overall capital structure), its cost of preferred stock is 9.5% (20% of capital structure) and is cost of internal equity is 15.5% (60% of the capital structure)? The marginal tax rate is 34%.
a. 11.7%
b. 12.3%
c. 12.8%
d. 11.8%

Question 4
Hayward Gunstocks is considering the purchase of new equipment. The expected NPV is $150,000 with a std. deviation of $80,000. What is the approximate probability that the project will have a negative return assuming a normal distribution? (Note: we covered this under Z-scores)
a. 1.88%
b. 3.04%
c. 15.87%
d. 0.30%

Question 5
Which of the following would you use as a proxy for the ABC Company’s cost of debt?
(1) Federal funds discount rate
(2) Coupon rate on debt previously issued by the ABC Company
(3) Yield to maturity on debt previously issued by the ABC Company
(4) Coupon rate on a bond issued today by another company that is very similar in capital structure and risk profile to the ABC Company and that were sold at face value

a. 1 and 2
b. 3 and 4
c. 2 and 4
d. 2 and 3

Question 6
Would you recommend a project that has a net investment at time 0 of $15,500 and a single net cash flow of $28,600 at the end of the fifth year if the required rate of return is 12.5%?
a. Yes, the project has a positive net present value of $2,093
b. No, the project has a negative net present value
c. Yes, the project has a net present value of zero
d. Yes, the project has a positive net present value of $371

Question 7
Rank the following assets from least to most risky:
(1) Common Equity
(2) High Yield Corporate Debt
(3) Long-term Treasury Debt
(4) High Quality Corporate Debt
a. (1), (2), (4), (3)
b. (3), (4), (2), (1)
c. (4), (3), (1), (2)
d. (3), (2), (4), (1)

Question 8
Herbert’s business has the following capital structure:
Finance Source % of Capital Structure
Debt (9% coupon, $1,000 par, 12 yr. to maturity) 27%
Preferred ($2 dividend, $25 par) 8%
Common equity 65%
Assume that he wants to raise capital without changing the financing proportions. The market price the current bonds is $1,075, the Preferred stock currently sells for $19 a share, and the market price of Herbert’s stock is $40, with a current dividend (D0) of $3.00 and an expected growth rate of 7%.
If the current tax rate is 40%, what would be the marginal cost of new capital if it was to come from the sale of new equity, new preferred shares, and new bonds? Assume that there are no issuance costs.
a. 11.91%
b. 10.51%
c. 12.52%
d. 11.51%

Question 9
What is the usual proxy for the risk-free rate (Rf)?
a. LIBOR
b. Prime Lending Rate
c. 10 Yr. Treasury Bonds
d. 3-6 mo. Treasury Bill

Question 10
Factors influencing financing sources include which of the following:
(1) Tax Rate
(2) Expected return
(3) Debt:Equity ratio
(4) Credit Rating
a. (3) and (4) only
b. (1), (3), and (4)
c. (2), (3), and (4)
d. (1), (2), (3), and (4)

Question 11
Which of the following would not be considered a cost of Internal Equity?
a. Opportunity cost of alternative investments to the company
b. Zero cost
c. Implied cost using CAPM
d. Implied cost using the Dividend Discount Model (DDM)

Question 12
Oldguy Inc. is considering two independent investments with the following cash flow streams:
initial Year 1 Year 2 Year 3 Year 4 Year 5
Proj A -50,000 +20,000 +20,000 +10,000 +5,000 +5,000
Proj B -50,000 +10,000 +10,000 +5,000 +5,000 +50,000

Oldguy uses a combination of NPV and Payback period to evaluate alternatives, with a requirement of a positive NPV using a 10% discount rate and a maximum payback of 3 years. Which project(s) should Oldguy select?

a. B only
b. A and B
c. A only
d. neither A nor B

Solution Preview

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Question 1
If Newbury, Inc. wants to issue new bonds with a market interest rate of 12%, what is the after-tax cost of debt if the marginal tax rate is 32%?
a. 9.52%
b. 3.84%
c. 8.16% = .12(1-.32)
d. 12.0%
The answer is option C.

Question 2
Calabassas Golf, Inc. has a beta of 1.9. The risk-free rate of interest is 4%, and the market portfolio has an expected return of 10%. What is the cost of equity (Ke) for this company based on the capital asset pricing model?
a. 14.0%
b. 15.4%
c. 11.4%
d. 23.0%
The answer is option B.
Ke = rf +b[E(Rm) – rf] = .04 +1.9[.10-.04] = 15.4%

Question 3
1. What is the Acme Company’s weighted average cost of capital if its cost of before-tax debt is 8% (20% of overall capital structure), its cost of preferred stock is 9.5% (20% of capital structure) and is cost of internal equity is 15.5% (60% of the capital structure)? The marginal tax rate is 34%.
a. 11.7%
b. 12.3%
c. 12.8%
d. 11.8%
The answer is option B.
WACC = %d(rd)(1-T) + %P(rp) + %E(re) = .2(.08)(1-.34)+.2(.095)+.6(.155)=.12256 rounds to .123 = 12.3%...

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