Corporate Finance MCQ - Corporate Finance Section 2

11 A firm’s estimated costs of debt, preferred stock, and common stock are 13%, 17%, and 22%, respectively. Assuming equal funding from each source and a 30% tax rate, the weighted average cost of capital is closest to:

WACC = Wd Rd (1 – t) + Wp Rp + We Re = [0.13 * (1 – 0.30) + 0.17 + 0.22] / 3 = 16.03%

12 An analyst gathers the following information about the capital structure and before-tax component costs for a company. The company’s marginal tax rate is 35 percent.

Capitalcomponent	Book Value(000)	Market Value(000)	Component cost
Debt x	€ 120	€ 100	6%
Preferred stock	€ 60	€ 60	9%
Common stock	€ 300	€ 240	13%

The company’s weighted average cost is closest to:

The company’s weighted average cost WACC is equal to:
WACC = Wd Rd (1 – t) + Wp Rp + We Re The target capital structure
is: Market value of equity = 240 / 400 = 60%
Market value of debt = 100 / 400 = 25%
Market value of preferred stock = 60 / 400 = 15%>
Rd (1 – t) = 6% (1 – 35%) = 3.90%, Re = 13%, Rp = 9%
WACC = 0.25 * 3.9% + 0.15 * 9% + 0.60 * 13% = 10.13%

13 A.F. Company has a debt to equity ratio of 60% and is subject to taxation at a rate of 40%. Its cost of equity is 17% while its cost of debt is 12.5%. A.F. Company’s weighted average cost of capital is closest to:

Wd = (D/E) / (1 + D/E) = 0.6 / (1 + 0.6) = 0.375
We = 1 - Wd = 1 – 0.375 = 0.625
WACC = Wd Rd (1 - t) + We Re
= 0.375 * 0.125 * (1 – 0.4) + 0.625 * 0.17 = 13.44%.

14 Golden Giants has the following capital structure which is funded from common stock, preferred stock and debt.

Source	Amount	Cost
Common Stock	100,000,000	16.0%
Preferred Stock	2,000,000	14.5%
Debt	18,000,000	12.0%
Total	120,000,000

If the tax rate is 35%, the company’s weighted average cost of capital is closest to:

WACC = Wd Rd (1 – t) + Wp Rp + We Re = [(18/120) * 0.12 * (1 – 0.35)] + [(2/120) * 0.145] + [(100/120) * 0.16] = 14.745%

15 Pamela Peterson computes the weighted average cost of capital (WACC) for the company Atom International. The information used for computation is as follows:

-Common equity has beta 1.2 while the risk free rate and market premium are 5% and 7% respectively. The preferred stock has value of $48 with a dividend worth $6.
-The corporate tax rate is 20%.
-Bonds are issued at par and have a coupon rate of 11%.
-Capital structure is 20% preferred stock, 35% debt and 45% common stock.

Atom International’s WACC is closest to:

WACC = Wd Rd (1 – t) + Wp Rp + We Re Re
= Risk free rate + β (Market risk premium)
Re = 5 + 1.2 (7) = 13.4%
Rd = Debt rate (1 - tax rate) Rd = 11 (1 - 0.2) = 8.8%
Rp = Dividend / Price = 6 / 48 = 12.5%
WACC = 0.134 * 0.45 + 0.088 * 0.35 + 0.125 * 0.20
WACC = 11.6%