Instructions: (1) For questions 1 to 9, do not show the calculation process. Provide your final answers for those questions. For question 10, show all calculation procedures. If not, you will get a score of zero for question 10. (2) Use the methods covered in this class. (3) Use four decimal places for your calculations. If you need to show your answers as a percent, take four decimal places from your calculation, converting them into a percent. For example, if your calculation results in 0.4567, show 45.67%, not 46%. To set your Texas Instrument BA II PLUS calculator at 4 decimal places, press [2ND] FORMAT 4 [ENTER]. Please follow the instructions for homework assignments on the syllabus.

Questions Part I (Concepts: True or False): Choose your answer.

(1) The cost of capital is the rate of return expected by corporate managers on a new project.

A. True

B. False

C. Insufficient information

(2) When a company uses short-term debt and preferred stock as sources of funding, they should not be included in the estimation of WACC since they are not capital components.

A. True

B. False

C. Insufficient information

(3) Short-term debt should be excluded in the estimation of WACC if it is a permanent source of financing.

A. True

B. False

C. Insufficient information

(4) Since the cost of capital is the minimum return required by the investors, managers should invest only in the projects that generate returns in excess of the cost of capital.

A. True

B. False

C. Insufficient information

Part II (WACC estimation): Use the following information to answer questions 5 to 10.

Waffle Corporation is estimating its WACC. Its target capital structure is 30 percent debt, 20 percent preferred stock, and 50 percent common equity. Its bonds have an 8 percent coupon, paid semiannually, a current maturity of 20 years, and sell at par of $1,000. The firm can sell, at par ($100), preferred stock which pays an 8.4 percent annual dividend, but flotation costs of 4 percent of the proceeds would be incurred. Waffle's beta is 1.0, the Treasury bond yield is 4 percent, and the market risk premium is 6 percent. Waffle is a constant-growth firm which just paid a dividend of $2.00, sells for $42.00 per share of common equity, and has a growth rate of 5 percent. The firm's policy is to use a risk premium of 2 percentage points when using the bondyield-plus-risk-premium method to find the cost of common equity (rs). The firm's marginal tax rate is 25 percent.

(5) What is Waffle's after-tax cost of debt?

(6) What is Waffle's cost of preferred stock?

(7) What is Waffle's cost of common stock using the CAPM approach?

(8) What is the firm's cost of internal equity using the discounted cash flow (DCF) approach?

(9) What is Waffle's cost of common stock using the bond-yield-plus-risk-premium approach?

(10)What is Waffle's WACC? Show all work