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CFA CFA I Exam
CFA Level I Chartered Financial Analyst (Page 69 )

Updated On: 26-Jan-2026
Page 69 of 793
PDF with 3960 Questions

In an examination of several capital projects, the management of a large international conglomerate attempts to calculate the Weighted Average Cost of Capital for the firm. The Company is capitalized according to the following schedule based on market values: 55% debt
36% common stock
9% perpetual preferred stock
Additionally, assume the following information:
Yield on outstanding debt: 8.95%
Tax rate: 35%
Annual preferred dividend: $0.70
Preferred stock price: $8.90
Return on equity: 17.36%
Dividend payout ratio: 45%
Cost of common stock: 15.10%
Using this information, what is the WACC for this large multinational conglomerate?

  1. 10.11%
  2. 9.34%
  3. None of these answers.
  4. 9.29%
  5. 9.78%
  6. The answer cannot be completely calculated from the information provided.

Answer(s): B

Explanation:

In order to calculate the WACC, it is necessary to first calculate the component cost of debt, common equity, and preferred equity. Once the cost of these components is determined, they are imputed into the WACC equation, which is as follows: {WACC = [(% weight of debt securities * cost of debt) + (% weight of common stock * cost of common stock) + (% weight of preferred stock * cost of preferred stock)]} To calculate the component cost of debt, use the following equation:
{Cost of debt = [yield on outstanding debt securities * (1 - tax rate)} Factoring in the given information into this equation would yield the following:
{After-tax cost of debt = [8.95% * (1 - 0.35%)]} = 5.818%
To calculate the component cost of outstanding preferred stock, the following equation must be used:
{Cost of preferred stock = [annual dividend / preferred stock price]} {Cost of preferred stock - = [$0.70 / $8.90]} = 7.865%.
The final component of the WACC calculation, the cost of common equity, has been provided as 15.10%.
Now that the after-tax costs of debt, preferred stock, and common stock have been determined, the WACC calculation can be found. The calculation of the WACC is as follows:
{[0.55 * 0.05818] + [0.36 * 0.1510] + [0.09 * 0.07865]} = 9.344%.



Pierce Products is deciding whether it makes sense to purchase a new piece of equipment. The equipment costs $100,000 (payable at t = 0). The equipment will provide before-tax cash inflows of $45,000 a year at the end of each of the next four years (t = 1, 2, 3, 4). The equipment can be depreciated according to the following schedule:
t = 1: 0.33
t = 2: 0.45
t = 3: 0.15
t = 4: 0.07 At the end of four years the company expects to be able to sell the equipment for a salvage value of $10,000 (after-tax). The company is in the 40 percent tax bracket. The company has an after-tax cost of capital of 11 percent. Since there is more uncertainty about the salvage value, the company has chosen to discount the salvage value at 12 percent. What is the net present value of purchasing the equipment?

  1. $22,853.90
  2. $9,140.78
  3. $28.982.64
  4. $20,564.23
  5. $16,498.72

Answer(s): A

Explanation:

First, find the after-tax CFs associated with the project. This is accomplished by subtracting the depreciation expense from the raw CF, reducing this net CF by taxes and then adding back the depreciation expense.
For t = 1: ($45,000 - $33,000)(1 - 0.4) + $33,000 = $40,200.
Similarly, the after-tax CFs for t = 2, t = 3, and t = 4 are $45,000, $33,000, and $29,800, respectively.
Now, enter these CFs along with the cost of the equipment to find the pre-salvage NPV (note that the salvage value is not yet accounted for in these CFs). The appropriate discount rate for these CFs is 11%. This yields a pre-salvage NPV of $16,498.72. Finally, the salvage value must be discounted. The PV of the salvage value is:
N = 4, I = 12, PMT = 0, FV = -10,000, and PV = $6,355.18. Adding the PV of the salvage amount to the pre- salvage NPV yields the project NPV of $22,853.90.



Helms Aircraft has a capital structure, which consists of 60 percent debt and 40 percent common stock. The company's equity financing will come from issuing new common stock. The company recently issued bonds with a yield to maturity of 9 percent. The company's stock is currently trading at $40 a share. The year-end dividend is expected to be $4 a share (that is, D(1) = $4.00), and the dividend is expected to grow at a constant rate of 5 percent. The flotation costs associated with issuing new common stock are estimated to be 10 percent. The company's tax rate is 35 percent. What is the company's weighted average cost of capital?

  1. 11.84%
  2. 10.98%
  3. 8.33%
  4. 9.51%
  5. 9.95%

Answer(s): E

Explanation:

Calculate the after-tax cost of debt = (1 - 0.35) 9% = 5.85%.
Calculate the cost of new equity: k(e) = $4/[$40(1 - 0.1)] + 0.05 = 0.1611 or 16.11%. Compute WACC (Weighted Average Cost of Capital): 0.6(5.85%) + 0.4(16.11%) = 9.95%.



The capital budgeting director of Sparrow Corporation is evaluating a project, which costs $200,000, is expected to last for 10 years and produce after-tax cash flows, including depreciation, of $44,503 per year. If the firm's cost of capital is 14 percent and its tax rate is 40 percent, what is the project's IRR?

  1. 18%
  2. 8%
  3. 12%
  4. -5%
  5. 14%

Answer(s): A

Explanation:

$200,000 = $44,503(PVIFA(Irr,10))
PVIFA(Irr,10) = 4.49408 ;IRR = 18%.



Jackson Corporation is evaluating the following four independent, investment opportunities:
Project CostRate of Return
A$300,000 14%
B$150,000 10
C$200,000 13
D$400,000 11
Jackson's target capital structure is 60 percent debt and 40 percent equity. The yield to maturity on the company's debt is 10 percent. Jackson will incur flotation costs for a new equity issuance of 12 percent. The growth rate is a constant 6 percent. The stock price is currently $35 per share for each of the 10,000 shares outstanding. Jackson expects to earn net income of $100,000 this coming year and the dividend payout ratio will be 50 percent. If the company's tax rate is 30 percent, then which of the projects will be accepted?

  1. All of the investment projects will be taken.
  2. Projects A, C, and D.
  3. Projects A and
  4. None of the investment projects will be taken.
  5. Project A.

Answer(s): E

Explanation:

Calculate the after-tax component cost of debt as 10%(1 - 0.3) = 7%. If the company has earnings of $100,000 and pays out 50% or $50,000 in dividends, then it will retain earnings of $50,000. The retained earnings breakpoint is $50,000/0.4 = $125,000. Since it will require financing in excess of $125,000 to undertake any of the alternatives, we can conclude the firm must issue new equity. Therefore, the pertinent component cost of equity is the cost of new equity. Calculate the expected dividend per share as $50,000/10,000 = $5. Thus, the cost of new equity is $5/[($35(1 - 0.12)] + 6% = 22.23%. Jackson's WACC is 7%(0.6) + 22.23%(0.4) = 13.09%.
Only the return on Project A exceeds the WACC, so only Project A will be undertaken.



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