Question

Q6.

If a firm’s before-tax cost of debt is 10% and the firm has a 10% marginal tax rate, what is the firm’s after-tax cost of debt?

		6.5%
		3.5%
		9.0%
		7.9%

Q7.

A company has preferred stock that can be sold for $100 per share. The preferred stock pays an annual dividend $6. Therefore, the cost of preferred stock is:

		4.0%
		5.0%
		6.0%
		10.0%

Q8.

Suppose your company has an equity beta of 1.5 and the current risk-free rate is 3.0%. If the expected market risk premium is 8.0%, what is your cost of equity capital?

		12.3%
		13.0%
		11.1%
		15.0%.

Q9.

A stock sells for $20 per share, its last dividend (D₀) was $1.00, and its growth rate is a constant 6%. What is its cost of common stock?

		5.3%
		11.0%
		11.3%
		11.6%

Q10.

A firm has a target capital structure of 30% debt, 20% preferred stock, and 50% common equity. The company's after-tax cost of debt is 5%, its cost of preferred stock is 8%, and its cost of retained earnings is 12%. The firm’s marginal tax rate is 21%. What is the company's weighted average cost of capital if retained earnings are used to fund the common equity portion?

		8.0%
		9.50%
		9.10%
		8.79%

Answer 1

Solution to Question-6

After-tax Cost of Debt = Before-tax Cost of Debt x (1 – Tax Rate)

= 10% x (1 – 0.10)

= 10% x 0.90

= 9.0%

Solution to Question-7

Cost of Preferred Stock = [Annual Preferred Dividend / Current selling price per share] x 100

= [$6 / $100] x 100

= 6.0%

Solution to Question-8

As per Capital Asset Pricing Model [CAPM], The cost of common equity is computed by using the following equation

The Cost of Common Equity = Risk-free Rate + [Beta x Market Risk Premium]

= 3% + [1.5 x 8%]

= 3.0% + 12.0%

= 15.0%

Solution to Question-9

As per Discounted cash flow model, The cost of common stock = [D0(1 + g) / P0] + g

Where, Dividend in next year (D0) = $1.00 per share

Dividend growth rate (g) = 6% per year

Current Share Price (P0) = $20.00 per share

Therefore, cost of common stock = [D0(1 + g) / P0] + g

= [$1.00(1 + 0.06) / $20.00] + 0.06

= [$1.06 / $20.00] + 0.06

= 0.0530 + .06

= 0.113 or

= 11.3%

Solution to Question-10

Weighted Average Cost of Capital (WACC)

Weighted Average Cost of Capital (WACC) = [After Tax Cost of Debt x Weight of Debt] + [Cost of Preferred stock x Weight of preferred stock] + [Cost of equity x Weight of Equity]

= [5% x 0.30] + [8% x 0.20] + [12% x 0.50]

= 1.50% + 1.60% + 6.00%

= 9.10%