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19) WineCellars Inc. currently has a weighted average cost of capital of 12%.
WineCellars has been

growing rapidly over the past several years, selling common stock in each year to finance its growth.
However, due to difficult economic times this year, WineCellars decides to cut its dividend and increase
its retained earnings so that the common equity portion of its capital structure will include only retained
earnings and no new common stock will be sold. WineCellars' weighted average cost of capital this year
should be
A) zero, since no new stock will be sold.
B) less than 12%.
C) equal to 12%.
D) greater than 12%.
Answer: B
Diff: 1 Page Ref: 308
Keywords: Weighted Average Cost of Capital
20) Beauty Inc. plans to maintain its optimal capital structure of 40 percent debt, 10 percent preferred
stock, and 50 percent common equity indefinitely. The required return on each component source of
capital is as follows: debt—8 percent; preferred stock—12 percent; common equity—16 percent.
Assuming a 40 percent marginal tax rate, what after-tax rate of return must the firm earn on its
investments if the value of the firm is to remain unchanged?
A) 12.40 percent
B) 12.00 percent
C) 11.12 percent
D) 10.64 percent
Answer: C
21) The DEF Company is planning a $64 million expansion. The expansion is to be financed by selling
$25.6 million in new debt and $38.4 million in new common stock. The before-tax required rate of return
on debt is 9 percent and the required rate of return on equity is 14 percent. If the company is in the 35
percent tax bracket, what is the firm's cost of capital?
A) 8.92%
B) 9.89%
C) 11.50%
D) 10.74%
Answer: D
22) CrochetCo is considering an investment in a project which would require an initial outlay of $350,000
and produce expected cash flows in years 1-5 of $95,450 per year. You have determined that the current
after-tax cost of the firm's capital (required rate of return) for each source of financing is as follows:
Cost of Long-Term Debt 7%

Cost of Preferred Stock 11%
Cost of CommonStock 15%
Long-term debt currently makes up 25% of the capital structure, preferred stock 15%, and common stock
60%. What is the net present value of this project?
A) -$9,306
B) $2,149
C) $5,983
D) $11,568
Answer: A
Keywords: Net Present Value, Weighted Average Cost of Capital
23) For a typical corporation, which of the following capital structures will result in the lowest weighted
average cost of capital?
A) 40% debt, 20% preferred stock, 40% common equity
B) 50% debt, 10% preferred stock, 40% common equity
C) 60% debt, 10% preferred stock, 30% common equity
D) 60% debt, 15% preferred stock, 25% common equity
Answer: D
Keywords: Capital Structure, Weighted Average Cost of Capital
24) Given the following information on S & G Inc.'s capital structure, compute the company's weighted
average cost of capital.
Percent of Capital Before-Tax

Type of Capital Structure Component Cost
Bonds 40% 7.5%
Preferred Stock 5% 11%
Common Stock (Internal Only) 55% 15%
The company's marginal tax rate is 40%.

A) 13.3%
B) 7.1%
C) 10.6%
D) 10%
Answer: C
25) Kokapeli, Inc. has a target capital structure of 40% debt and 60% common equity, and has a 40%
marginal tax rate. If the firm's yield to maturity on bonds is 7.5% and investors require a 15% return on
the firm's common stock, what is the firm's weighted average cost of capital?
A) 7.20%
B) 10.80%
C) 12.00%
D) 12.25%
Answer: B
26) PrimaCare has a capital structure that consists of $7 million of debt, $2 million of preferred stock, and
$11 million of common equity, based upon current market values. The firm's yield to maturity on its
bonds is 7.4%, and investors require an 8% return on the firm's preferred and a 14% return on
PrimaCare's common stock. If the tax rate is 35%, what is PrimaCare's WACC?
A) 7.21%
B) 8.12%
C) 10.18%
D) 12.25%
Answer: C
Keywords: Weighted Average Cost of Capital, Capital Structure
27) The average cost associated with each additional dollar of financing for investment projects is
A) the incremental return.
B) the marginal cost of capital.
C) CAPM required return.
D) the component cost of capital.
Answer: B
Keywords: Marginal Cost of Capital

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19) WineCellars Inc. currently has a weighted average cost of capital of 12%.

WineCellars has been

Cost of Long-Term Debt 7%

Percent of Capital Before-Tax

The company's marginal tax rate is 40%.

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