Session 10 Quiz

Session 10 Quiz Material

Greg Fisher

Place your answer to the following essay and problem questions in the Drop Box by 12:00 Noon on

Thursday. You can receive partial credit for partially complete submissions, despite not having a correct final answer. So please submit your work. (15 points total)

Essay

1. How would each of the following affect a firm's cost of debt, rd(I-T)i its cost of equity, r., and its weighted average cost of capital, WACC? Indicate by a plus (+), a minus (-), or a zero (0) if the factor would raise, lower, or have an indeterminate effect on the item in question. Assume other things are held constant. (3 points)

| | |EFFECT ON | |

| |r (l-t) |r |WACC |

|The firm uses more debt |+ |+ |0 |

|The firm expands into a risk new area |+ |+ |+ |

2. In 75 words or less, describe in what sense WACC is an average cost and in what sense is it a marginal cost. (3 points)

The WACC is marginal when the firm is looking at gaining new capital. It also is a marginal cost because it looks at current conditions, not past market conditions. The WACC is an average cost when the proportions between debt and equity are equal.

Problems

3. A company has determined that its optimal capital structure consists of 40 percent debt and 60 percent equity. Given the following information, calculate the firm's weighted average cost of capital. (3 points)

rd = 6%

Tax rate = 40% Po = $25 Growth = 0%

Do = $2.00

|a. |6.0% |

|b. |6.2% |

|c. |7.0% |

|d. |7.2% |

|e. |8.0% |

Rs = 2/25 = 8%

WACC = .04(.06)(1-.4) + .6(.08)

WACC = .0144+.048 = 6.24%

4. Rollins...