# Multiple choice

OilAmerica Inc. (“OA”) operates express oil change shops in Oklahoma. An investment analyst with a private equity fund which owns some of OA’s stock is wanting to estimate the company’s weighted average cost of capital. OA’s Chief Financial Officer told the investment analyst that OA will not invest in any project which cannot earn at least a 17% Free Cash Flow Return on Assets. The company has 6 million shares of stock outstanding and these shares are valued at $55.50 per share. The company has a stock beta that is estimated to be 1.72. Assume the current average stock market return is 14.50% and the relevant current U.S. Treasury Note interest rate in the market is 4.20%. The company also has some bonds outstanding with 9 years to maturity, are trading at $933.00 per bond with a $1,000 face value, and the company has 400,000 of these bonds outstanding. The bonds pay interest annually based on a 7.50% coupon interest rate. OA is planning to issue $100 million of new preferred stock, which will have a par value of $100 per share, dividends per share of $10, and per-share flotation costs of $4.75 per share. The company has a marginal income tax rate of 31%. Calculate to 4 decimal places.

What is OA’s Pre-Tax Cost of Debt? After-Tax Cost of Debt?

Answer

A. 6.7236% and 4.5048%

B. 7.7236% and 5.2188%

C. 8.5994% and 5.9336%

D. 8.6124% and 5.4303%

OilAmerica Inc. (“OA”) operates express oil change shops in Oklahoma. An investment analyst with a private equity fund which owns some of OA’s stock is wanting to estimate the company’s weighted average cost of capital. OA’s Chief Financial Officer told the investment analyst that OA will not invest in any project which cannot earn at least a 17% Free Cash Flow Return on Assets. The company has 6 million shares of stock outstanding and these shares are valued at $55.50 per share. The company has a stock beta that is estimated to be 1.72. Assume the current average stock market return is 14.50% and the relevant current U.S. Treasury Note interest rate in the market is 4.20%. The company also has some bonds outstanding with 9 years to maturity, are trading at $933.00 per bond with a $1,000 face value, and the company has 400,000 of these bonds outstanding. The bonds pay interest annually based on a 7.50% coupon interest rate. OA is planning to issue $100 million of new preferred stock, which will have a par value of $100 per share, dividends per share of $10, and per-share flotation costs of $4.75 per share. The company has a marginal income tax rate of 31%. Calculate to 4 decimal places.

What is OA’s Pre-Tax Cost of Preferred Stock? After-Tax Cost of Preferred Stock?

Answer

A. 5.4348% and 3.6413%

B. 10.4986% and 10.4986%

C. 10.8696% and 10.8696%

D. 10.8696% and 7.2826%