Weighted Average Cost of Capital
This chapter tests concepts such as when to use the weighted average cost of capital (WACC), how to compute WACC for both public and private companies, and what capital structure is appropriate in different valuation scenarios.
1. Ail of the following statements about the use of WACC are true EXCEPT:
a. The most obvious instance in which to use WACC is when valuing the entire capital
structure of a company,
b. WACC is commonly used in discounting or capitalizing returns to common equity
holders.
c. Sometimes WACC is used to value the entire capital structure and then subtract the mar
ket value of debt to estimate the value of equity.
d. WACC is especially appropriate for project selection in capital budgeting.
2. Which of the following is appropriate to use as the after-tax cost of debt for a public com
pany with bonds issued and outstanding?
a. The coupon rate on the face value of the bonds.
b. The current yield on the market value of the bonds.
c. The yield to maturity of the bonds.
d. None of the above.
If a minority interest is valued by first valuing the overall ca and then subtracting debt, Ihen a hypothetical capital structure
(e.g., an industry-average capital structure) may be used in the
calculation of WACC.
The cost of capital may be greater for a private company than for
a public company, even though they are in the same industry
and are the same size, because the private company may not
have equivalent access to the capital markets. True False
5. The relative weightings of debt and equity or other capital components used in calculating
the WACC for a company are based on the.................. valises of each component,
not on the_____________ values.
6. The weighted average cost of capital (WACC) is based on the cost of each capital component of any corporate-level tax effect on that component.
7. One of the processes used to estimate market value weights for the capital structure of a private company is an one.
8. Assuming that the book value of equity is lower than its market valise, then using the capital structure weightings at. book values tends to ____________________________________ the WACC and
______________ the value of equity.
The following are known about public Company XYZ:
4 million shares of common stock issued and
Closing common stock price per share: $10
2 million shares of preferred stock issued and outstanding
Closing preferred stock price per share: $ 16
S10 million face valise of bonds issued and outstanding
Closing bond price: 80 (80% of face value)
Cost of common equity for XYZ: 25%
Cumulative, nonparticipating dividend on the preferred stock: $2.40 per share every year
Cost of debt before tax effect: 10%
Combined federal and state income tax rate: 40%
9. The cost of preferred equity for Company XYZ is:
a. 24%
b. 15%
c. 9%
10. The after-tax cost of debt for Company XYZ is:
a. 4%
b. 10%
c. 9%
d. 6%
1 1. Compute the market value of invested capital (VIVTC) and the weights for each capital structure component for Company XYZ.
12. The W ACC for Company XYZ is:
a. 19.5%
b. 17.1%
c. 19.1%
d. 18.9%
10% 9% 20% 1,000,000 $7.00 500,000 $4.50 33,000,000 30% |
13. Given the following:
Pretax cost of debt
Cost of preferred stock
Cost of common equity
Shares of common stock
Price per share of common stock
Shares of preferred stock
Price per share of preferred stock
Face value of debt (same as market value)
Tax rate
Compute the WACC.
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