29) Which of the following should NOT be considered when calculating a firm’s WACC? A) after-tax YTM on a firm’s bonds B) after-tax cost of accounts payable C) cost of newly issued preferred stock D) cost of newly issued common stock
30) Kokapeli, Inc. has a target capital structure of 40% debt and 60% common equity, and has a 40% marginal tax rate. If the firm’s yield to maturity on bonds is 7.5% and investors require a 15% return on the firm’s common stock, what is the firm’s weighted average cost of capital? A) 7.20% B) 10.80% C) 12.00% D) 12.25%
31) PrimaCare has a capital structure that consists of $7 million of debt, $2 million of preferred stock, and $11 million of common equity, based upon current market values. The firm’s yield to maturity on its bonds is 7.4%, and investors require an 8% return on the firm’s preferred and a 14% return on PrimaCare’s common stock. If the tax rate is 35%, what is Parker’s WACC? A) 7.21% B) 8.12% C) 10.18% D) 12.25%
32) Meacham Corp. wants to issue bonds with a 9% coupon rate, a face value of $1,000, and 12 years to maturity. Meacham estimates that the bonds will sell for $1,090 and that flotation costs will equal $15 per bond. Meacham Corp. common stock currently sells for $30 per share. Meacham can sell additional shares by incurring flotation costs of $3 per share. Meacham paid a dividend yesterday of $4.00 per share and expects the dividend to grow at a constant rate of 5% per year. Meacham also expects to have $12 million of retained earnings available for use in capital budgeting projects during the coming year. Meacham’s capital structure is 40% debt and 60% common equity. Meacham’s marginal tax rate is 35%. a. Calculate the after-tax cost of debt assuming Meacham’s bonds are its only debt. b. Calculate the cost of retained earnings. c. Calculate the cost of new common stock. d. Calculate the weighted average cost of capital assuming Meacham’s total capital budget is $30 million.
33) Office Clean Corporation has a capital structure consisting of 30 percent debt and 70 percent common equity. Assuming the capital structure is optimal, what amount of total investment can be financed by a $35 million addition to retained earnings without selling new common stock?
Learning Objective 4
1) Calculating the cost of capital for divisions within a company is not recommended because the data is too fragmented and all divisions are part of the same company in any case.
2) The after-tax cost of debt is equal to one minus the marginal tax rate times the yield to maturity on the firm’s outstanding debt.
3) If the before-tax cost of debt is 7% and the firm has a 40% marginal tax rate, the after-tax cost of debt is 2.8%.
4) A corporate bond has a face value of $1,000 and a coupon rate of 5%. The bond matures in 15 years and has a current market price of $925. If the corporation sells more bonds it will incur flotation costs of $25 per bond. If the corporate tax rate is 35%, what is the after-tax cost of debt capital? A) 3.74% B) 4.45% C) 5.29% D) 6.78%
5) A corporate bond has a face value of $1,000 and a coupon rate of 9%. The bond matures in 14 years and has a current market price of $946. If the corporation sells more bonds it will incur flotation costs of $26 per bond. If the corporate tax rate is 35%, what is the after-tax cost of debt capital? A) 5.57% B) 6.56% C) 8.18% D) 7.31%