Chapter 14
Practice Quiz 2- Answer Key
1. Cyclone Software Co. is trying to estimate its optimal capital structure. Cyclone’s current
capital structure consists of 25 percent debt and 75 percent equity; however, management
believes the firm should use more debt. The risk-free rate is 5 percent, the market risk
premium, is 6 percent, and the firm’s tax rate is 40 percent. Currently, Cyclone’s cost of equity
is 14 percent, which is determined on the basis of the CAPM. What would be Cyclone’s
estimated cost of equity if it were to change its capital structure from its present capital
structure to 50 percent debt and 50 percent equity?
A. 13%
B. 15%
C. 17%-ANSWER
D. 19%
2. Currently, Bloom Flowers Inc. has a capital structure consisting of 20 percent debt and 80
percent equity. Bloom’s debt currently has an 8 percent yield to maturity. The risk-free rate is
5 percent, and the market risk premium is 6 percent. Using the CAPM, Bloom estimates that
its cost of equity is currently 12.5 percent. The company has a 40 percent tax rate. What is
Bloom’s current WACC?
A. 10.88%
B. 10.96%-ANSWER
C. 11.05%
D. 11.13%
3.
A.
B.
C.
D.
Using the information from Problem 2, what is the current beta on Bloom’s common stock?
1.21
1.23
1.25-ANSWER
1.27
4. Using the information from Problem 2, what would Bloom’s beta be if the company had no
debt in its capital structure?
A. 1.02
B. 1.05
C. 1.06
D. 1.09-ANSWER
5. Continuing on from Problem 2, Bloom’s financial staff is considering changing its capital
structure to 40 percent debt and 60 percent equity. If the company went ahead with the
proposed change, the yield to maturity on the company’s bonds would rise to 9.5 percent. The
proposed change will have no effect on the company’s tax rate. What would be the company’s
new cost of equity if it adopted the proposed change in capital structure?
A. 14.13%-ANSWER
B. 14.17%
C. 14.23%
D. 14.27%