3) Schalheim Sisters Inc. has always paid out all of its earnings as dividends; hence, the firm has no retained earnings. This same situation is expected to persist in the future. The company uses the CAPM to calculate its cost of equity, and its target capital structure consists of common stock, preferred stock, and debt. Which of the following events would REDUCE its WACC?

The market risk premium declines.

The flotation costs associated with issuing new common stock increase.

The company's beta increases.

Expected inflation increases.

The flotation costs associated with issuing preferred stock increase.

4) Duval Inc. uses only equity capital, and it has two equally-sized divisions. Division A's cost of capital is 10.0%, Division B's cost is 14.0%, and the corporate (composite) WACC is 12.0%. All of Division A's projects are equally risky, as are all of Division B's projects. However, the projects of Division A are less risky than those of Division B. Which of the following projects should the firm accept?

A Division B project with a 13% return.

A Division B project with a 12% return.

A Division A project with an 11% return.

A Division A project with a 9% return.

A Division B project with an 11% return.

5) The MacMillen Company has equal amounts of low-risk, average-risk, and high-risk projects. The firm's overall WACC is 12%. The CFO believes that this is the correct WACC for the company's average-risk projects, but that a lower rate should be used for lower-risk projects and a higher rate for higher-risk projects. The CEO disagrees, on the grounds that even though projects have different risks, the WACC used to evaluate each project should be the same because the company obtains capital for all projects from the same sources. If the CEO's position is accepted, what is likely to happen over time?

The company will take on too many high-risk projects and reject too many low-risk projects.

The company will take on too many low-risk projects and reject too many high-risk projects.

Things will generally even out over time, and, therefore, the firm's risk should remain constant over time.

The company's overall WACC should decrease over time because its stock price should be increasing.

The CEO's recommendation would maximize the firm's intrinsic value.

6) Bosio Inc.'s perpetual preferred stock sells for $97.50 per share, and it pays an $8.50 annual dividend. If the company were to sell a new preferred issue, it would incur a flotation cost of 4.00% of the price paid by investors. What is the company's cost of preferred stock for use in calculating the WACC?

8.72%

9.08%

9.44%

9.82%

10.22%

7) To help finance a major expansion, Castro Chemical Company sold a noncallable bond several years ago that now has 20 years to maturity. This bond has a 9.25% annual coupon, paid semiannually, sells at a price of $1,075, and has a par value of $1,000. If the firm's tax rate is 40%, what is the component cost of debt for use in the WACC calculation?

4.35%

4.58%

4.83%

5.08%

5.33%