Cost of Capital

9 questions

1. 1. We have the following information about a company:

   • After-tax cost of debt = 10%.

   • Risk premium of equity over debt = 3%.

   • Tax rate = 30%.

   Using the above information, calculate the cost of equity for the company using the bond-yield-plus-premium approach.

   17.28%16%13%
2. 2. Which of the following statements is most likely to be true?

   The change in firm value in the presence of corporate taxes only is:

   Positive as equity holders face a lower effective tax rate. Positive as equity holders gain the tax shield on the debt interest.Negative because of the increased risk of default and fewer shares outstanding.
3. 3. The optimal capital structure of a firm:
   Minimizes the firm’s cost of debt capital.Is that combination of debt, preferred and common stock that maximizes the firm’s share value.Is one in which the weighted cost of capital is less than the IRR.
4. 4. Calculate the weighted average cost of capital of a project that is 35 percent debt and 65 percent equity. Assume that the firm pays 10 percent on debt and 15 percent on equity. Assume that the firm’s marginal tax rate is 33 percent.
   10.017%12.095%13.25%
5. 5. The cost of debt capital is:
   The interest rate that must be paid on the debt.The after-tax interest rate that must be paid on the debt.The future value of the debt less principal.
6. 6. A company has $100 face value, 9% preferred stock. The current market price of the preferred stock is $90. Calculate the company's cost of preferred equity.
   9%10%11%
7. 7. We have the following information about two companies:

   • Debt-equity ratio of company A = 1.8

   • Debt-equity ratio of comparable company B = 1.6

   • Beta of company B = 1.3

   • Marginal tax rate = 30%

   Calculate the beta of Company A using Pure Play method.

   0.6131.101.38
8. 8. Assume that a country was rated BB by a rating agency, which resulted in a default spread of 2.5%. The annualized standard deviation of the country’s equity index is 20%, and the annualized standard deviation for their bond market is 15%.

   Using this information, calculate the country risk premium.

   3.33%4%7.5%
9. 9. Which of the following is the most appropriate method of including flotation cost in calculating cost of equity?
   Incorporate flotation costs directly into the cost of capital by increasing cost of external equityIncrease the project's initial cash outflow by the flotation cost attributable to the projectBoth methods are inaccurate