1.

You were hired as a consultant to Keys Company, and you were provided with the
following data: Target capital structure: 40% debt, 10% preferred, and 50% common
equity. The after-tax cost of debt is 4.00%, the cost of preferred is 7.50%, and the cost of
retained earnings is 11.50%. The firm will not be issuing any new stock. What is the
firms WACC?

(Points: 5)
7.55%
7.73%
7.94%
8.10%
8.32%

WACC = W d K d + W p K p + We K e

Weighted cost of
Source of capital Cost of capital Weight capital
Debt 4% 40% 1.600%
Preferred capital 7.50% 10% 0.750%
Common Stock 11.50% 50% 5.750%
Weighted average cost of capital (WACC) = 8.100%

2.

Several years ago the Haverford Company sold a $1,000 par value bond that now has 25
years to maturity and an 8.00% annual coupon that is paid quarterly. The bond currently
sells for $900.90, and the companys tax rate is 40%. What is the component cost of debt
for use in the WACC calculation?

(Points: 5)
5.40%
5.73%
5.98%
6.09%
6.24%

Par value = 1,000

 Coupon interest (8%/4) 20
PV = -900.9
No. of years = 100
Cost of debt 2.25%
Cost of debt per annum 9%
After tax cost of debt = 5.4%

3.

Tapley Inc. recently hired you as a consultant to estimate the companys WACC. You
have obtained the following information. (1) Tapley's bonds mature in 25 years, have a
7.5% annual coupon, a par value of $1,000, and a market price of $936.49. (2) The
companys tax rate is 40%. (3) The risk-free rate is 6.0%, the market risk premium is
5.0%, and the stocks beta is 1.5. (4) The target capital structure consists of 30% debt
and 70% equity. Tapley uses the CAPM to estimate the cost of equity, and it does not
expect to have to issue any new common stock. What is its WACC?

(Points: 5)
9.89%
10.01%
10.35%
10.64%
10.91%

Par value = 1,000

Coupon interest (8%/4) 75
PV = -936.49
No. of years = 25
Cost of debt 8.1%
After tax cost of debt = 4.86%

Cost of common stock = r RF + (r M r RF) b

= 6% + (5%) 1.5
= 13.5%
WACC = 4.86% x 30% + 13.5% x 70%
= 10.91%

4.

Wagner Inc estimates that its average-risk projects have a WACC of 10%, its below-
average risk projects have a WACC of 8%, and its above-average risk projects have a
WACC of 12%. Which of the following projects (A, B, and C) should the company
accept?

(Points: 5)
Project A is of average risk and has a return of 9%.
Project B is of below-average risk and has a return of 8.5%.
Project C is of above-average risk and has a return of 11%.
None of the projects should be accepted.
All of the projects should be accepted.
Project B is of below-average risk and has a return of 8.5%.
Project B is of below average risk and so the rate to use is 8%. Since the project has a rate
higher than 8%, it should be selected.

5.

The Nunnally Company has equal amounts of low-risk, average-risk, and high-risk
projects. Nunnally estimates that its overall WACC is 12%. The CFO believes that this
is the correct WACC for the companys average-risk projects, but that a lower rate should
be used for lower risk projects and a higher rate for higher risk projects. However, the
CEO argues that, even though the companys projects have different risks, the WACC
used to evaluate each project should be the same because the company obtains capital for
all projects from the same sources. If the CEOs opinion is followed, what is likely to
happen over time?

(Points: 4)
The company will take on too many low-risk projects and reject too many high-
risk projects.
The company will take on too many high-risk projects and reject too many
low-risk projects.
Things will generally even out over time, and, therefore, the firms risk should
remain constant over time.
The companys overall WACC should decrease over time because its stock price
should be increasing.
The CEOs recommendation would maximize the firms intrinsic value.
The company will take on too many high-risk projects and reject too many low-risk projects.
Since the company will use the same rate for all projects, this would mean that high risk
projects which should be evaluated using a higher rate are evaluated at the lower average
rate and are selected while low risk projects which should be evaluated using a lower rate are
evaluated using a higher average rate and are rejected.
6.

MT 217 Corporation provided the following data: Target capital structure: 30% debt,
20% preferred, and 50% common equity. The after-tax cost of debt is 6.00%, the cost of
preferred is 9.00%, and the cost of retained earnings is 12.00%. What is the firms
WACC?

(Points: 8)
9.60%
10.00%
8.55%
9.85%
9.00%
WACC = W d K d (1-t) + W p K p + We K e
= 0.30 x 6% + 0.20 x 9% + 0.50 x 12%
= 1.8% + 1.8% + 6%
= 9.6%

7.

University Books Company provided the following data: Target capital structure: 50%
debt, 0% preferred, and 50% common equity. The after-tax cost of debt is 7.500%, and
the cost of common equity is 12.00%. What is the firms WACC?

(Points: 8)
10.00%
9.00%
9.75%
9.50%
9.25%

WACC = W d K d (1-t) + W p K p + We K e
= 0.50 x 6% + 0 + 0.50 x 12%
= 3% + 6%
= 9%