Cost Components of a Company's Capital Structure

In the last chapter, it was said thai, the weighted average cost of capital (WACC) is the blended cost of tlie components of the capital structure. In this chapter we explore each of those components.

MULTIPLE CHOICE QUESTIONS

1.   The relevant market "yield" in calculating the cost of debt is:

a.  Yield to maturity, yield-to-call date, or current yield.

b.  Yield to maturity or yield-to-call date but not current yield.

c.   Yield to maturity or current yield but not yield-to-call date.

d.  Current yield or yield-to-call date but not yield to maturity.

2.   In estimating the after-tax cost of debt for a potential new project, tlie best rate to use is usually:

a.  The current marginal rate.

b.  The marginal rate over the life of the investment .

c.  The average statutory rate.

d.  The average effective rate.

3.   In the late 1990s in the sale of small businesses and professional practices with at least 30% down, what was the typical percentage of the balance that insurance companies were charg­ ing to the buyer to guarantee the seller paper?

a.  1%

b.  3%

c.   5%

d.  6% or more

4.   Some companies, especially smaller ones, use short-term debt as if it were long-term debt. In such cases, it is a legitimate exercise of the analyst's judgment to reclassify (lie short-term debt as long-term debt.

5.   Research shows that the majority of corporations do not pay the

marginal statutory7 tax rate.

6. The major components of capital structure are:

In addition to the major components of capital structure, list five other possible variations of securities in a company's capital structure:

The cost of convertible debt or preferred stock can be analyzed as a combination of what two elements?

9.  What are the two components of return on common stock or partnership interests?

10. If a company's pretax cost of debt is 8% and Hie applicable tax rate is 20%, what is Hie com­pany's after-tax cost of debt?

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