Multiple Choice Answers

1.You are a consultant to Pillbriar Company. Pillbriar’s target capital structure is 36% debt, 14% preferred, and 50% common equity. The interest rate on new debt is 7.8%, the yield on the preferred is 7.00%, the cost of retained earnings is 11.75%, and the tax rate is 38%. The firm will not be issuing any new stock. What is Pillbriar’s WACC?
2.What are three methods for estimating the cost of common stock from retained earnings? Which of these methods provides the most accurate and reliable estimate?
3. Which of the following statements is most correct?
If a company’s tax rate increases but the yield to maturity of its noncallable bonds remains the same, the company’s marginal cost of debt capital used to calculate its weighted average cost of capital will fall.
All else equal, an increase in a company’s stock price will increase the marginal cost of retained earnings.
All else equal, an increase in a company’s stock price will increase the marginal cost of issuing new common equity.
The first two answers are both correct.
The second and third answers are correct.
4. Which of the following factors in the discounted cash flow (DCF) approach to estimating the cost of common equity is the least difficult to estimate?
Expected growth rate, g
Dividend yield,
Required return, rs
Expected rate of return,
All of the above are equally difficult to estimate.
5. If a firm can shift its capital structure so as to change its weighted average cost of capital (WACC), which of the following results would be preferred? (Points : 1)
The firm should try to decrease the WACC because such an action will increase the value of the firm.
The firm should try to increase the WACC because such an action will increase the value of the firm.
The firm should try to decrease the WACC because such an action will decrease the value of the firm.
The firm should try to increase the WACC because such an action will decrease the value of the firm.
The firm should not try to change the WACC because changing the WACC will not change the value of the firm.
6. Alice Stewart, who is the CFO of Meyers Foods, is teaching an upper-level course in corporate finance at the University of Phoenix. One of the assignments Alice gave her class was to compute the component costs of capital for Meyers Foods. Meyers Foods uses debt and common stock (no preferred stock) to finance its investments. Students in the class did not reach the same conclusions about the relationships among the components costs–that is, the after-tax cost of debt, rdT, the cost of retained earnings (i.e., internal equity), rs, and the cost of new, or external, equity, re. Which of the following relationships should be correct for Meyers Foods? (Points : 1)
rdT < rs < re
rs < rdT < re
re < rdT < rs
re < rs < rdT
None of the above is a correct relationship.

7. Bouchard Company’s stock sells for $20 per share, its last dividend (D0) was $1.00, its growth rate is a constant 6 percent, and the company would incur a flotation cost of 20 percent if it sold new common stock. Retained earnings for the coming year are expected to be $1,000,000, and the common equity ratio is 60 percent. If Bouchard has a capital budget of $2,000,000, what component cost of common equity will be built into the WACC for the last dollar of capital the company raises? (Points : 1)
11.30%
11.45%
11.80%
12.15%
12.63%
8. Diggin Tools just issued new preferred stock, which sold for $85 in the stock markets. Holders of the stock will receive an annual dividend equal to $9.35. The flotation costs associated with the new issue were 6 percent and Diggin’s marginal tax rate is 30 percent. What is Diggin’s cost of preferred stock, rps? (Points : 1)
11.0%
7.7%
8.2%
11.7%
10.3%
9. Allison Engines Corporation has established a target capital structure of 40 percent debt and 60 percent common equity. The firm expects to earn $600 in after-tax income during the coming year, and it will retain 40 percent of those earnings. The current market price of the firm’s stock is P0 = $28; its last dividend was D0 = $2.20, and its expected dividend growth rate is 6 percent. Allison can issue new common stock at a 15 percent flotation cost. What will Allison’s marginal cost of equity capital (not the WACC) be if it must fund a capital budget requiring $600 in total new capital? (Points : 1)
15.8%
13.9%
7.9%
14.3%
9.7%
10. SW Ink’s preferred stock, which pays a $5 dividend each year, currently sells for $62.50. The company’s marginal tax rate is 40 percent. What is the cost of preferred stock, rps, that should be included in the computation of the SW Ink’s weighted average cost of capital (WACC)? (Points : 1)
8.0%
4.8%
3.2%
The dividend growth rate is needed to compute rps; so not enough information is given to answer this question.
None of the above is correct.