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Free CMA Exam Braindumps (page: 182)

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If k is the cost of debt and t is the marginal tax rate, the after-tax cost of debt. kk, is best represented by the formula

  1. ki = k /t
  2. ki=k/ .(1--t)
  3. ki=k(t)
  4. kj=k(1--t)

Answer(s): D

Explanation:

The after-tax cost of debt is the cost of debt times the quantity one minus the tax rate. For example, the after-tax cost of a 10% bond is 7% [10% x (1 -- 30%)] if the tax rate is 30%.



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Hi-Tech, Inc. has determined that it can minimize its weighted average cost of capital (WACC) by using a debt-equity ratio of 213. If the firm's cost of debt is 9% before taxes, me cost of equity is estimated to be 12% before taxes, and the tax rate is 40%. what is the firm's WACC?

  1. 6.48%
  2. 7.92%
  3. 9.36%
  4. 1080%

Answer(s): C

Explanation:

A firm's weighted-average cost of capital (WACC) is derived by weighting the (after-tax) cost of each component of the financing structure by its proportion of the financing structure as a whole Hi-Tech's WACC can be calculated as follows:



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Enert, Inc.'s current capital structure is shown below. This structure is optimal, and the company wishes to maintain it.
Debt 25%
Preferred equity 5
Common equity 7 0

Enert's management is planning to build a $75 million facility that will be financed according to this desired capital structure. Currently, $15 million of cash is available for capital expansion. The percentage of the $75 million that will come from a new issue of common stock is

  1. 52.50%.
  2. 50.00%.
  3. 7000%.
  4. 5600%.

Answer(s): D

Explanation:

Because $15 million is already available, the company must finance $60 million ($75 million -- $15 million).Of this amount, 70%, or $42 million, should come from the issuance of common stock to maintain the current capital structure. The $42 million represents 56% of the total $75 million.



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Which one of a firms sources of new capital usually has the lowest after-tax cost?

  1. Retained earnings.
  2. Bonds.
  3. Preferred stock.
  4. Common stock.

Answer(s): B

Explanation:

Debt financing, such as bonds, normally' has a lower after-tax cost than does equity financing. The interest on debt is tax deductible. whereas the dividends on equity are not. Also, bonds are slightly less risky than stock because the bond holders have a first right to assets at liquidation






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