# Weighted Average Cost of Capital and Common Stock

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CHAPTER 9

THE COST OF CAPITAL

(Difficulty: E = Easy, M = Medium, and T = Tough)

Multiple Choice: Problems

Easy:

Cost of common stock Answer: d Diff: E
[i]. Bouchard Company 's stock sells for \$20 per share, its last dividend (D0) was \$1.00, and its growth rate is a constant 6 percent. What is its cost of common stock, rs?

a. 5.0% b. 5.3% c. 11.0% d. 11.3% e. 11.6%

Cost of common stock Answer: b Diff: E
[ii]. Your company 's stock sells for \$50 per share, its last dividend (D0) was \$2.00, and its growth rate is a constant 5 percent. What is the cost of common stock, rs?

a. 9.0% b. 9.2% c. 9.6% d. 9.8% e. 10.0%

Cost of common
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6.2% c. 7.0% d. 7.2% e. 8.0%

WACC Answer: c Diff: M
[ix]. Johnson Industries finances its projects with 40 percent debt, 10 percent preferred stock, and 50 percent common stock.

• The company can issue bonds at a yield to maturity of 8.4 percent. • The cost of preferred stock is 9 percent. • The company 's common stock currently sells for \$30 a share. • The company 's dividend is currently \$2.00 a share (D0 = \$2.00), and is expected to grow at a constant rate of 6 percent per year. • Assume that the flotation cost on debt and preferred stock is zero, and no new stock will be issued. • The company’s tax rate is 30 percent.

What is the company’s weighted average cost of capital (WACC)?

a. 8.33% b. 9.32% c. 9.79% d. 9.99% e. 13.15%

WACC Answer: e Diff: M
[x]. Dobson Dairies has a capital structure which consists of 60 percent long-term debt and 40 percent common stock. The company’s CFO has obtained the following information:

1. The before-tax yield to maturity on the company’s bonds is 8 percent. 2. The company’s common stock is expected to pay a \$3.00 dividend at year end (D1 = \$3.00), and the dividend is expected to grow at a constant rate of 7 percent a year. The common stock currently sells for \$60 a share. 3. Assume the firm will be able to use retained earnings to fund the equity portion of its capital