AF208, S1, 2025 TUTORIAL QUESTIONS – CHAPTER 14
TUTORIAL 5
[TO BE DISCUSSED IN WEEK 6 – WEEK BEGINNING 31ST MARCH 2025]
COST OF CAPITAL
CONCEPTS REVIEW AND CRITICAL THINKING QUESTIONS
1. WACC[LO3] On the most basic level, if a firm’s WACC is 12 percent, what does this mean?
4. WACC and Taxes [LO3] Why do we use an aftertax figure for cost of debt but not for cost of
equity?
7. Cost of Debt Estimation [LO2] How do you determine the appropriate cost of debt for a
company? Does it make a difference if the company’s debt is privately placed as opposed to
being publicly traded? How would you estimate the cost of debt for a firm whose only debt
issues are privately held by institutional investors.
10. Divisional Cost of Capital [LO5] Under what circumstances would it be appropriate for a
firm to use different costs of capital for its different operating divisions? If the overall firm
WACC were used as the hurdle rate for all divisions, would the riskier divisions or the more
conservative divisions tend to get most of the investment projects? Why? If you were to try to
estimate the appropriate cost of capital for different divisions, what problems might you
encounter? What are two techniques you could use to develop rough estimate for each division’s
cost of capital?
BASIC
1. Calculating Cost of Equity [LO1] The Snow Owl Co. just issued a dividend of $3.15 per
share on its common stock. The company is expected to maintain a constant 4.5 percent
growth rate in its dividends indefinitely. If the stock sells for $56 a share, what is the
company’s cost of equity?
5. Calculating Cost of Preferred Stock [LO1] Kimono, Inc., has an issue of preferred stock
with a stated dividend of $3.95 that just sold for $73 per share. What is the bank’s cost of
preferred stock?
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6. Calculating Cost of Debt [LO2] Watanabe, Inc., is trying to determine its cost of debt. The
firm has a debt issue outstanding with 19 years to maturity that is quoted at 94 percent of face
value. The issue makes semiannual payments and has an embedded cost of 5 percent annually.
What is the company’s pretax cost of debt? If the tax rate is 21 percent, what is the after-tax cost
of debt?
9. Calculating WACC[LO3] Nuttenhall Corporation has a target capital structure of 70 percent
common stock, 5 percent preferred stock, and 25 percent debt. Its cost of equity is 13 percent, the
cost of preferred stock is 6 percent, and the pretax cost of debt 7 percent. The relevant tax rate is
23 percent.
a. What is the company’s WACC?
b. The company president has approached you about the company’s capital structure. He wants
to know why the company doesn’t use more preferred stock financing because it costs less than
debt. What would you tell the president?
16. Finding the WACC [LO3] Agrats Corporation has 6.7 million shares of common stock
outstanding, 200,000 shares of 4.5 percent preferred stock outstanding, par value of $100, and
125,000 bonds with a semiannual coupon of 4.8 percent outstanding, par value $1,000 each. The
common stock currently sells for $57 per share and has a beta of 1.08, the preferred stock
currently sells for $92 per share, and the bonds have 15 years to maturity and sell for 91 percent
of par. The market risk premium is 6.5 percent, T-bills are yielding 5.3 percent, and the
company’s tax rate is 22 percent. :
INTERMEDIATE
20. WACC and NPV [LO3, LO5] Leblanc, Inc., is considering a project that will result in
initial aftertax cash savings of $3.1 million at the end of the first year, and these savings will
grow at a rate of 2 percent per year indefinitely. The firm has a target debt-equity ratio of .55, a
cost of equity of 11 percent, and an aftertax cost of debt of 5.1 percent. The cost-saving proposal
is somewhat riskier than the usual project the firm undertakes; management uses the subjective
approach and applies an adjustment factor of +3 percent to the cost of capital for such risky
projects. Under what circumstances should the company take on the project?
22. Calculating the Cost of Debt [LO2] Ying Import has several bond issues outstanding, each
making semiannual interest payments. The bonds are listed in the following table. If the
corporate tax rate is 22 percent, what is the aftertax cost of the company’s debt?
Bond Coupon Rate Price Quote Maturity Face Value
1 5.00% 102.85 5 years $45,000,000
2 7.10 112.80 8 years 40,000,000
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3 6.30 107.45 15.5 years 75,000,000
4 5.90 102.75 25 years 65,000,000
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