Student ID: 21458913
Exam: 500304RR - Cost of Capital and Financial Policy
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Questions 1 to 20: Select the best answer to each question. Note that a question and its answers may be split across a page
break, so be sure that you have seen the entire question and all the answers before choosing an answer.
1. The Shoe Outlet has paid annual dividends of $.65, $.70, $.72, and $.75 per share throughout the last
four years, respectively. The stock is currently selling for $9 a share. What's this firm's cost of equity?
A. 11.79 percent
B. 13.65 percent
C. 8.74 percent
D. 9.53 percent
2. Key Motors has a cost of equity of 11.29 percent and an unlevered cost of capital of 10.4 percent. The
company has $22,000 in debt that's selling at par value. The levered value of the firm is $64,000, and the
tax rate is 34 percent. What's the pretax cost of debt?
A. 7.82 percent
B. 6.59 percent
C. 6.18 percent
D. 5.73 percent
3. Mulberry, Inc. has a weighted average cost of capital (ignoring taxes) of 20 percent. It can borrow at 10
percent. Mulberry has a target ½ debt/equity ratio. Using the M&M Proposition II, what's the cost of
equity?
A. 15 percent
B. 29 percent
C. 25 percent
D. 31 percent
4. Under the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, how long after a firm
files for bankruptcy protection do creditors have to wait before submitting their own reorganization plan to
the court?
A. 45 days
B. 12 months
C. 180 days
D. 18 months
5. A friend approaches you with an investment opportunity—a property in an area of rapidly appreciating
property values. You can get a loan for $1 million with a $60,000 down payment. Your friend estimates
that you'll be able to sell the property in one year for $1.1 million, which means you could make $100,000
in a year, a very large annual return. Why should you be skeptical?
A. The rate of return is too high.
B. The rate of return is too low.
C. Banks can't be trusted.
D. A highly leveraged investment, such as this one, is risky.
6. What's the relationship between the WACC and the structure of the firm?
A. The lower the WACC, the higher the value of the firm to a certain point; then the relationship reverses.
B. The lower the WACC, the higher the value of the firm.
C. The lower the WACC, the lower the value of the firm.
D. There's no relationship between WACC and the value of the firm.
7. Deep Mines has 14 million shares of common stock outstanding with a beta of 1.15 and a market price
of $42 a share. There are 900,000 shares of 9 percent preferred stock outstanding, valued at $80 a share.
The 10 percent semiannual bonds have a face value of $1,000 and are selling at 91 percent of par. There
are 220,000 bonds outstanding that mature in 17 years. The marke.
Student ID 21458913 Exam 500304RR - Cost of Capital and .docx
1. Student ID: 21458913
Exam: 500304RR - Cost of Capital and Financial Policy
When you have completed your exam and reviewed your
answers, click Submit Exam. Answers will not be recorded until
you
hit Submit Exam. If you need to exit before completing the
exam, click Cancel Exam.
Questions 1 to 20: Select the best answer to each question. Note
that a question and its answers may be split across a page
break, so be sure that you have seen the entire question and all
the answers before choosing an answer.
1. The Shoe Outlet has paid annual dividends of $.65, $.70,
$.72, and $.75 per share throughout the last
four years, respectively. The stock is currently selling for $9 a
share. What's this firm's cost of equity?
A. 11.79 percent
B. 13.65 percent
C. 8.74 percent
D. 9.53 percent
2. Key Motors has a cost of equity of 11.29 percent and an
unlevered cost of capital of 10.4 percent. The
company has $22,000 in debt that's selling at par value. The
2. levered value of the firm is $64,000, and the
tax rate is 34 percent. What's the pretax cost of debt?
A. 7.82 percent
B. 6.59 percent
C. 6.18 percent
D. 5.73 percent
3. Mulberry, Inc. has a weighted average cost of capital
(ignoring taxes) of 20 percent. It can borrow at 10
percent. Mulberry has a target ½ debt/equity ratio. Using the
M&M Proposition II, what's the cost of
equity?
A. 15 percent
B. 29 percent
C. 25 percent
D. 31 percent
4. Under the Bankruptcy Abuse Prevention and Consumer
Protection Act of 2005, how long after a firm
files for bankruptcy protection do creditors have to wait before
submitting their own reorganization plan to
the court?
A. 45 days
B. 12 months
C. 180 days
3. D. 18 months
5. A friend approaches you with an investment opportunity—a
property in an area of rapidly appreciating
property values. You can get a loan for $1 million with a
$60,000 down payment. Your friend estimates
that you'll be able to sell the property in one year for $1.1
million, which means you could make $100,000
in a year, a very large annual return. Why should you be
skeptical?
A. The rate of return is too high.
B. The rate of return is too low.
C. Banks can't be trusted.
D. A highly leveraged investment, such as this one, is risky.
6. What's the relationship between the WACC and the structure
of the firm?
A. The lower the WACC, the higher the value of the firm to a
certain point; then the relationship reverses.
B. The lower the WACC, the higher the value of the firm.
C. The lower the WACC, the lower the value of the firm.
D. There's no relationship between WACC and the value of the
firm.
4. 7. Deep Mines has 14 million shares of common stock
outstanding with a beta of 1.15 and a market price
of $42 a share. There are 900,000 shares of 9 percent preferred
stock outstanding, valued at $80 a share.
The 10 percent semiannual bonds have a face value of $1,000
and are selling at 91 percent of par. There
are 220,000 bonds outstanding that mature in 17 years. The
market risk premium is 11½ percent, T-bills
are yielding 7½ percent, and the firm's tax rate is 32 percent.
What discount rate should the firm apply to a
new project's cash flows if the project has the same risk as the
firm's typical project?
A. 14.59 percent
B. 14.72 percent
C. 15.54 percent
D. 13.15 percent
8. What are the two risk components that determine a firm's cost
of equity?
A. Interest rate risk and the risk inherent in a firm's operations
B. The risk inherent in a firm's operations, plus financial
structure risk
C. Management risk and financial structure risk
D. Financial structure risk and interest rate risk
9. Deep Mining and Precious Metals are separate firms that are
both considering a silver exploration
project. Deep Mining is in the actual mining business and has
5. an aftertax cost of capital of 16.7 percent.
Precious Metals is in the precious gem retail business and has
an aftertax cost of capital of 12.6 percent.
The project under consideration has initial costs of $755,000
and anticipated annual cash inflows of
$152,000 a year for 10 years. Which firm(s), if either, should
accept this project?
A. Both Deep Mining and Precious Metals
B. Deep Mining only
C. Precious Metals only
D. Neither Deep Mining nor Precious Metals
10. The Bankruptcy Abuse Prevention and Consumer Protection
Act of 2005
A. prevents firms from filing for bankruptcy protection more
than once.
B. permits key employee retention plans, only if an employee
has another job offer.
C. prevents creditors from submitting any reorganization plans.
D. permits creditors to file a prepack immediately after a firm
files for bankruptcy protection.
11. D. L. Tuckers has $48,000 of debt outstanding that's selling
at par and has a coupon rate of 6.75
6. percent. The tax rate is 35 percent. What's the present value of
the tax shield?
A. $2,106
B. $16,800
C. $16,200
D. $3,240
12. Because the WACC varies with the use of funds rather than
the source of funds, some firms evaluate
new projects based on the WACC of companies in similar lines
of business. This approach is called the
A. pure play approach.
B. DuPont approach.
C. divisional approach.
D. subjective approach.
13. Which one of these actions generally occurs first in a
bankruptcy reorganization?
A. Dividing creditors into classes
B. Filing proofs of claim
C. Confirming the reorganization plan
D. Submitting a reorganization plan
14. Dagwood, Inc. has a weighted average cost of capital
7. (ignoring taxes) of 16 percent. It can borrow at 6
percent. Dagwood has a target capital structure of 40 percent
equity and 60 percent debt. Using the M&M
Proposition II, what's the cost of equity?
A. 15 percent
B. 31 percent
C. 29 percent
D. 21 percent
15. Analysts project Microsoft (MSFT) will have an annualized
dividend of $1.50 and a long-term growth
rate of 10 percent. Currently, the stock price is $60. Using the
dividend growth model approach, what's the
implied cost of equity?
A. 11 percent
B. 12.5 percent
C. 2.5 percent
D. 10 percent
16. Galaxy Products is comparing two different capital
structures, an all-equity plan (Plan I) and a levered
plan (Plan II). Under Plan I, the company would have 175,000
shares of stock outstanding. Under Plan II,
there would be 90,000 shares of stock outstanding and $1.4
million in debt. The interest rate on the debt is
7 percent, and there are no taxes. What's the break-even EBIT?
A. $341,414.14
8. B. $287,878.78
C. $351,111.11
End of exam
D. $201,764.71
17. Which of the following is not a problem when using the
dividend growth model?
A. It's complicated and difficult to implement.
B. It doesn't explicitly consider risk.
C. It's very sensitive to the estimated growth rate and assumes
dividends grow at a constant rate.
D. It's only applicable to companies that pay dividends.
18. What's the process by which a firm is no longer considered a
"going concern" and involves selling off
all firm assets?
A. Reorganization
B. Capital structuring
C. Liquidation
D. Bankruptcy
19. What's the concept of using debt to make a return known as?
9. A. Financial liquidity
B. Debt coverage
C. Financial leverage
D. Debt reliance
20. The unlevered cost of capital refers to the cost of capital for
A. a corporate shareholder.
B. a privately owned entity.
C. an all-equity firm.
D. a governmental entity.