# Questions involving WACC

1. (Answer using Excel) Finding the WACC: Given the following information for Huntington Power Co., find the WACC. Assume the company's tax rate is 35 percent.

Debt: 5,000 6 percent coupon bonds outstanding, $1,000 par value, 25 years to maturity, selling for 105 percent of par: the bonds make semiannual payments.

Common Stock: 175,000 shares outstanding, selling for $58 per share; the beta is 1.10.

Market: 7 percent market risk premium and 5 percent risk-free.

a. Find the WACC.

2. (Answer using Excel) Finding the WACC: Titan Mining Corporation has 9.3 million shares of common stock outstanding and 260,000 6.8 percent semiannual bonds outstanding, par value $1,000 each. The common stock currently sells for $34 per share and has a beta of 1.20, and the bonds have 20 years to maturity and sell for 104 percent of par. The market risk premium is 7 percent, T-bills are yielding 3.5 percent and Titan Mining's tax rate is 35 percent.

a. What is the firm's market value capital structure?

b. If Titan Mining is evaluating a new investment project that has the same risk as the firm's typical project, what rate should the firm use to discount the project's cash flows?

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#### Solution Summary

The following posting helps with questions involving WACC. Concepts covered include market risk premiums, bonds outstanding and market value capital structure.

Finance Questions: Cost of debt, capital structure, operating leveragem output methods

Question 6: Which of the following statements is CORRECT?

A When calculating the cost of debt, a company needs to adjust for taxes, because interest payments are deductible by the paying corporation.

B When calculating the cost of preferred stock, companies must adjust for taxes, because dividends paid on preferred stock are deductible by the paying corporation.

C Because of tax effects, an increase in the risk-free rate will have no effect on the after-tax cost of debt than on the cost of common stock.

D If a company's beta increases, this will decrease the cost of equity used to calculate the WACC.

E Higher flotation costs reduce investor returns, and that leads to a reduction in a company's WACC.

Question 7: Which of the following statements is CORRECT?

A A change in a company's target capital structure cannot affect its WACC.

B WACC calculations should be based on the before-tax costs of all the individual capital components.

C Flotation costs associated with issuing new common stock normally reduce the WACC.

D If a company's tax rate increases, then, all else equal, its weighted average cost of capital will decline.

E An increase in the risk-free rate will normally lower the marginal costs of both debt and equity financing.

Question 8: Suppose the September CBOT Treasury bond futures contract has a quoted price of 89-09. The T-bond is a 20-year 6% coupon bond and the interest is paid semi-annually. What is the implied annual interest rate inherent in this futures contract?

A 6.32%

B 6.65%

C 7.00%

D 7.35%

E 7.72%

Question 9: Which of the following statements is CORRECT?

A In general, a firm with low operating leverage also has a small proportion of its total costs in the form of fixed costs.

B There is no reason to think that changes in the personal tax rate would affect firms' capital structure decisions.

C A firm with high business risk is more likely to increase its use of financial leverage than a firm with low business risk, assuming all else equal.

D If a firm's after-tax cost of equity exceeds its after-tax cost of debt, it can always reduce its WACC by increasing its use of debt.

E Suppose a firm has less than its optimal amount of debt. Increasing its use of debt to the point where it is at its optimal capital structure will decrease the costs of both debt and equity financing.

Question 10: Roxie Epoxy's balance sheet shows a total of $50 million long-term debt with a coupon rate of 8.00% and a yield to maturity of 7.00%. This debt currently has a market value of $55 million. The balance sheet also shows that that the company has 20 million shares of common stock, and the book value of the common equity (common stock plus retained earnings) is $65 million. The current stock price is $8.25 per share; stockholders' required return, rs, is 10.00%; and the firm's tax rate is 40%. Based on market value weights, and assuming the firm is currently at its target capital structure, what WACC should Roxie use to evaluate capital budgeting projects?

A 7.26%

B 7.56%

C 7.88%

D 8.21%

E 8.55%

Question 11: The Congress Company has identified two methods for producing playing cards. One method involves using a machine having a fixed cost of $10,000 and variable costs of $1.00 per deck of cards. The other method would use a less expensive machine (fixed cost = $5,000), but it would require greater variable costs ($1.50 per deck of cards). If the selling price per deck of cards will be the same under each method, at what level of output will the two methods produce the same net operating income (EBIT)?

A 5,000 decks

B 10,000 decks

C 15,000 decks

D 20,000 decks

E 25,000 decks

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