FNAN 522 EXAMPREP REVIEW SHEET
WITH TESTED QUESTIONS AND COMPLETE
SOLUTIONS
●● The aftertax cost of debt:
A. varies inversely to changes in market interest rates.
B. will generally exceed the cost of equity if the relevant tax rate is zero.
C. will generally equal the cost of preferred if the tax rate is zero.
D. is unaffected by changes in the market rate of interest.
E. has a greater effect on a firm's cost of capital when the debt-equity
ratio increases.
Answer: E. has a greater effect on a firm's cost of capital when the debt-
equity ratio increases.
●● Which one of the following statements is correct for a firm that uses
debt in its capital structure?
A. The WACC should decrease as the firm's debt-equity ratio increases.
B. When computing the WACC, the weight assigned to the preferred
stock is based on the coupon rate multiplied by the par value of the
preferred.
C. The firm's WACC will decrease as the corporate tax rate decreases.
,D. The weight of the common stock used in the computation of the
WACC is based on the number of shares outstanding multiplied by the
book value per share.
E. The WACC will remain constant unless a firm retires some of its debt.
Answer: A. The WACC should decrease as the firm's debt-equity ratio
increases.
●● Justice, Inc. has a capital structure which is based on 30 percent debt,
5 percent preferred stock, and 65 percent common stock. The flotation
costs are 11 percent for common stock, 10 percent for preferred stock,
and 7 percent for debt. The corporate tax rate is 37 percent. What is the
weighted average flotation cost?
A. 8.97 percent
B. 9.48 percent
C. 9.62 percent
D. 9.75 percent
E. 10.00 percent
Answer: D. 9.75 percent
●● Western Wear is considering a project that requires an initial
investment of $274,000. The firm maintains a debt-equity ratio of 0.40
and has a flotation cost of debt of 8 percent and a flotation cost of equity
of 10.5 percent. The firm has sufficient internally generated equity to
, cover the equity portion of this project. What is the initial cost of the
project including the flotation costs?
A. $280,409
B. $281,406
C. $288,005
D. $297,747
E. $302,762
Answer: A. $280,409
●● Electronics Galore has 950,000 shares of common stock outstanding
at a market price of $38 a share. The company also has 40,000 bonds
outstanding that are quoted at 106 percent of face value. What weight
should be given to the debt when the firm computes its weighted average
cost of capital?
A. 42 percent
B. 46 percent
C. 50 percent
D. 54 percent
E. 58 percent
Answer: D. 54 percent
WITH TESTED QUESTIONS AND COMPLETE
SOLUTIONS
●● The aftertax cost of debt:
A. varies inversely to changes in market interest rates.
B. will generally exceed the cost of equity if the relevant tax rate is zero.
C. will generally equal the cost of preferred if the tax rate is zero.
D. is unaffected by changes in the market rate of interest.
E. has a greater effect on a firm's cost of capital when the debt-equity
ratio increases.
Answer: E. has a greater effect on a firm's cost of capital when the debt-
equity ratio increases.
●● Which one of the following statements is correct for a firm that uses
debt in its capital structure?
A. The WACC should decrease as the firm's debt-equity ratio increases.
B. When computing the WACC, the weight assigned to the preferred
stock is based on the coupon rate multiplied by the par value of the
preferred.
C. The firm's WACC will decrease as the corporate tax rate decreases.
,D. The weight of the common stock used in the computation of the
WACC is based on the number of shares outstanding multiplied by the
book value per share.
E. The WACC will remain constant unless a firm retires some of its debt.
Answer: A. The WACC should decrease as the firm's debt-equity ratio
increases.
●● Justice, Inc. has a capital structure which is based on 30 percent debt,
5 percent preferred stock, and 65 percent common stock. The flotation
costs are 11 percent for common stock, 10 percent for preferred stock,
and 7 percent for debt. The corporate tax rate is 37 percent. What is the
weighted average flotation cost?
A. 8.97 percent
B. 9.48 percent
C. 9.62 percent
D. 9.75 percent
E. 10.00 percent
Answer: D. 9.75 percent
●● Western Wear is considering a project that requires an initial
investment of $274,000. The firm maintains a debt-equity ratio of 0.40
and has a flotation cost of debt of 8 percent and a flotation cost of equity
of 10.5 percent. The firm has sufficient internally generated equity to
, cover the equity portion of this project. What is the initial cost of the
project including the flotation costs?
A. $280,409
B. $281,406
C. $288,005
D. $297,747
E. $302,762
Answer: A. $280,409
●● Electronics Galore has 950,000 shares of common stock outstanding
at a market price of $38 a share. The company also has 40,000 bonds
outstanding that are quoted at 106 percent of face value. What weight
should be given to the debt when the firm computes its weighted average
cost of capital?
A. 42 percent
B. 46 percent
C. 50 percent
D. 54 percent
E. 58 percent
Answer: D. 54 percent
