Question 1

TLS expects to pay a dividend of $4 next year and expects these dividends to grow at 7% a year? The price of TLS is $90 per share. What is TLS' cost of equity capital?

Accepted Answer

We can use the Gordon Growth Model to calculate the cost of equity capital:

Cost of Equity = (Dividend / Price) + Growth Rate

Plugging in the numbers given:

Cost of Equity = (4 / 90) + 0.07 = 0.044 + 0.07 = 0.1144 or 11.44%

Therefore, the best choice for the cost of equity capital for TLS is B, 11.44%.

Question 2

Outstanding debt of Flight Centre (FLT) trades with a yield to maturity of 6%. The tax rate of FLT is 40%. What is the effective cost of debt of FLT?

Accepted Answer

The effective cost of debt is calculated as the yield to maturity multiplied by (1 - tax rate). Thus, 6% * (1 - 0.40) = 3.6%.

Question 3

Green Motors expects a new hybrid-engine project to produce incremental cash flows of $45million each year, and expects these to grow at 5% each year. The upfront project costs are $380 million and Green's weighted average cost of capital is 8%. If the issuance costs for external finances are $10 million, what is the net present value (NPV) of the project?

Accepted Answer

To calculate the NPV, we need to discount the future cash flows back to their present value using the weighted average cost of capital (WACC).

First, we need to calculate the present value of the future cash flows using the perpetuity formula:

PV = Cash Flow / (Discount Rate - Growth Rate)

PV = $45 million / (0.08 - 0.05) = $1.5 billion

Next, we need to calculate the present value of the project costs:

PV of Project Costs = $380 million + $10 million = $390 million

Finally, we can calculate the NPV by subtracting the present value of the costs from the present value of the cash flows:

NPV = $1.5 billion - $390 million = $1.11 billion or $1,110 million.

Therefore, the correct answer is C.

Question 4

The fact that the after-tax cost of debt is lower than the pretax cost of debt implicitly assumes thatinterest expense can be

Accepted Answer

Interest expense is tax-deductible, which reduces the effective cost of debt for a company, making the after-tax cost lower than the pretax cost.

Question 5

Brisbane Broncos Limited has raised all its capital via equity rather than debt. Such a firm is also referred to as a(n) firm.

Accepted Answer

An unlevered firm is one that has raised all its capital via equity and does not have any debt on its balance sheet.

Question 6

Different divisions with differing lines of business use different costs of capital because their cost ofcould be different.

Accepted Answer

The answer of Different divisions with differing lines of business...

Question 7

A firm has $2 million market value and it sells preference shares for $100 per share. If the annualdividend on the preference share is $8 and it trades at $90, what is the cost of preference share capital?

Accepted Answer

Number of preference shares = Market value of firm / Price per preference share = $2,000,000 / $100 = 20,000
Total annual dividend on preference shares = 20,000 x $8 = $160,000
Cost of preference share capital = Annual dividend / Market value per preference share = $160,000 / ($90 x 20,000) = 8.89%

Question 8

For an unlevered firm, the cost of capital for the firm can be determined by using th?

Accepted Answer

The cost of capital for an unlevered firm can be determined by using the Capital Asset Pricing Model (CAPM), which takes into account the risk-free rate, the expected market return, and the beta of the firm's equity. This approach is widely used to estimate the cost of equity for companies. Preferred stock yield, yield on traded debt, and dividend yield are all relevant to the cost of capital for levered firms, but not necessarily for an unlevered firm.

Question 9

The firm's overall cost of capital that is a blend of the costs of the different sources of capital is known as the firm's

Accepted Answer

The weighted average cost of capital (WACC) is the overall cost of capital that takes into account the proportion of each source of capital (debt, preferred stock, equity) and their respective costs. It is used as a discount rate in capital budgeting decisions.

Question 10

Outstanding debt of Flight Centre (FLT) trades with a yield to maturity of 8%. The tax rate of FLT is 35%. What is the effective cost of debt of FLT?

Accepted Answer

The effective cost of debt is the after-tax cost of debt. It is calculated as the yield to maturity multiplied by (1 - tax rate). In this case, the effective cost of debt is 8% * (1 - 0.35) = 5.2%.

Question 11

A levered firm is one that ha?

Accepted Answer

A levered firm is one that has debt, which means it has taken on financial leverage to finance its operations. This debt increases the firm's financial risk, but it can also provide tax benefits and increase the return on equity for shareholders. Preferred stock, equity, and equity options do not necessarily imply financial leverage.

Question 12

Assume JBH has debt with a book value of $20 million, trading at 120% of par value. The firm hasbook equity of $20 million, and 2 million shares trading at $18 per share. What weights should JBH use in calculating its WACC?

Accepted Answer

To calculate the WACC, we need to determine the weights of debt and equity in the firm's capital structure. 
The book value of debt is $20 million, trading at 120% par value, so the market value of debt is:
$20 million x 120% = $24 million

To find the weight of debt:
Weight of Debt = Market Value of Debt / (Market Value of Debt + Market Value of Equity)
Weight of Debt = $24 million / ($24 million + (2 million shares x $18 per share))
Weight of Debt = $24 million / $60 million
Weight of Debt = 0.4 or 40%

To find the weight of equity:
Weight of Equity = Market Value of Equity / (Market Value of Debt + Market Value of Equity)
Weight of Equity = (2 million shares x $18 per share) / ($24 million + (2 million shares x $18 per share))
Weight of Equity = $36 million / $60 million
Weight of Equity = 0.6 or 60%

Therefore, the weights used in calculating the WACC are 40% for debt and 60% for equity, making choice B the best answer.

Question 13

The relative proportion of debt, equity, and other securities that a firm has outstanding constitute
its

Accepted Answer

The relative proportion of debt, equity, and other securities that a firm has outstanding constitute its capital structure. The asset ratio refers to the proportion of a firm's assets to its liabilities and does not take into consideration the type of securities issued. The current ratio measures a firm's ability to pay back its current liabilities with current assets, but again does not specifically pertain to the type of securities issued. Therefore, the correct answer is B) capital structure.

Question 14

Sirtex Medical has $10 million of outstanding equity and $10 million of bank debt. The bank debt costs 7% per year. The estimated equity beta is 2. If the market risk premium is 6% and the risk-free rate is 5%, compute the weighted average cost of capital if the firm's tax rate is 30%.

Accepted Answer

First, we calculate the cost of debt: 
cost of debt = bank debt interest rate * (1 - tax rate) 
cost of debt = 7% * (1 - 0.30) = 4.9% 
Next, we calculate the cost of equity using the Capital Asset Pricing Model (CAPM): 
cost of equity = risk-free rate + beta * market risk premium 
cost of equity = 5% + 2 * 6% = 17% 
Now, we can calculate the weighted average cost of capital (WACC): 
WACC = (equity / total capital) * cost of equity + (debt / total capital) * cost of debt 
WACC = (10 / 20) * 17% + (10 / 20) * 4.9% = 10.95% 
Therefore, the answer is D.

Question 15

Green Motors expects a new hybrid-engine project to produce incremental cash flows of $60 million each year, and expects these to grow at 4% each year. The upfront project costs are $420 million and Green's weighted average cost of capital is 9%. If the issuance costs for external finances are $15 million, what is the net present value (NPV) of the project?

Accepted Answer

The answer of Green Motors expects a new hybrid-engine project...

Question 16

A firm has outstanding debt with a coupon rate of 9%, nine years maturity, and a price of $1000 per $1000 face value. What is the after-tax cost of debt if the marginal tax rate of the firm is 30%?

Accepted Answer

The after-tax cost of debt is calculated as the coupon rate multiplied by (1 - tax rate). Here, it is 9% * (1 - 0.30) = 6.3%.

Question 17

Green Motors expects a new hybrid-engine project to produce incremental cash flows of $100 million each year and expects these to grow at 4% each year. The upfront project costs are $900 million and Green's weighted average cost of capital is 9%. If the issuance costs for external finances are $10 million, what is the net present value (NPV) of the project?

Accepted Answer

The answer of Green Motors expects a new hybrid-engine project...

Question 18

A firm has $3 million market value and it sells preference shares at $100 per share. If the annualdividend on the preference share is $9 and it trades at $95, what is the cost of preference share capital?

Accepted Answer

The cost of preference share capital is calculated as the annual dividend divided by the market price of the preference share. In this case, the annual dividend is $9 and the market price of the preference share is $95. Therefore, the cost of preference share capital is $9/$95 = 9.47%.

Question 19

Assume JBH has debt with a book value of $20 million, trading at 120% of par value. The bonds have a yield to maturity of 6%. The firm has book equity of $20 million, and 2 million shares trading at $18 per share. The firm's cost of equity is 12%. What is JBH's WACC if the firm's marginal tax rate is 30%?

Accepted Answer

To calculate the WACC, we need to first find the market value of debt and equity.

Market value of debt = $20 million * 120% = $24 million 
Market value of equity = 2 million shares * $18 per share = $36 million

Total market value of the firm = $24 million + $36 million = $60 million

Next, we need to calculate the cost of debt:

Coupon rate = 6% 
Yield to maturity = 6% 
Since the bonds are trading above par, the current yield is lower than the yield to maturity. Let's assume the current yield is 5.5%, which gives us a price of 120.65% of par value.

Cost of debt = 5.5% * (1 - 0.3) = 3.85%

Finally, we can calculate the WACC:

WACC = (24/60) * 3.85% + (36/60) * 12% * (1 - 0.3) 
WACC = 0.1288 or 12.88%

However, the answer choices are given in percentage points rather than decimal form, so we multiply by 100:

WACC = 12.88% * 100 = 128.8% 
We round this to the nearest basis point, which gives us answer choice B: 8.88%.

Question 20

Epiphany is an all-equity firm with an estimated market value of $300,000. The firm sells $100,000 of debt and uses the proceeds to purchase outstanding equity. Compute the weight in equity and the weight in debt after the proposed financing and repurchase of equity.

Accepted Answer

After selling $100,000 of debt and using it to repurchase equity, the firm will have $200,000 in equity ($300,000 - $100,000) and $100,000 in debt. The total value of the firm remains $300,000. The weight in equity is $200,000/$300,000 = 0.67, and the weight in debt is $100,000/$300,000 = 0.33.

Quiz 13: The Cost of Capital