Question 1

What is the WACC for a firm with equal amounts of debt and equity financing, a 17% before-tax company cost of capital, a 35% tax rate, and a 10% coupon rate on its debt that is selling at par value?

Accepted Answer

We can calculate the weighted average cost of capital (WACC) by using the following formula:

WACC = (E/V x Re) + (D/V x Rd x (1 - T))

Where:

E = Market value of the firm's equity
D = Market value of the firm's debt
V = Total market value of the firm (i.e., E + D)
Re = Cost of equity
Rd = Cost of debt
T = Tax rate

Since the firm has equal amounts of debt and equity financing, we can assume that E = D. Therefore:

V = E + D = 2E

E/V = 1/2
D/V = 1/2

Re is not given in the question, but we can use the company's before-tax cost of capital (17%) as an estimate.

Rd = 10% (since the coupon rate is equal to the yield to maturity when the bond is selling at par value)

T = 35%

Plugging these values into the formula, we get:

WACC = (1/2 x 17%) + (1/2 x 10% x (1 - 35%)) = 15.25%

Therefore, the correct answer is C) 15.25%.

Question 2

What is the company cost of capital for a firm financed with 30% debt if the debt requires a 10% return and equity requires a 16% return?

Accepted Answer

The answer of What is the company cost of capital...

Question 3

What proportion of a firm is equity financed if the WACC is 14%, the after-tax cost of debt is 7.0%, the tax rate is 35%, and the required return on equity is 18%?

Accepted Answer

We can use the equation: 
WACC = (equity proportion)(required return on equity) + (debt proportion)(after-tax cost of debt)
Rearranging, we get:
equity proportion = (WACC - (debt proportion)(after-tax cost of debt)) / required return on equity
Plugging in the values:
0.14 = (equity proportion)(0.18) + (1 - equity proportion)(0.07)(0.65) 
Solving for equity proportion, we get:
equity proportion = 0.6364 or 63.64% 
Therefore, choice B is the correct answer.

Question 4

Calculate a firm's WACC given that the total value of the firm is $2,000,000, $600,000 of which is debt, the cost of debt and equity is 10% and 15% respectively, and the firm pays no taxes:

Accepted Answer

WACC formula = (E/V) x Re + (D/V) x Rd x (1 - T)
where, 
E = market value of equity
V = total value of the firm
Re = cost of equity
D = market value of debt
Rd = cost of debt
T = tax rate

Given:
Total value of the firm (V) = $2,000,000
Debt (D) = $600,000
Equity (E) = $2,000,000 - $600,000 = $1,400,000
Cost of equity (Re) = 15%
Cost of debt (Rd) = 10%
Tax rate (T) = 0%

= (1400000 / 2000000) x 15% + (600000 / 2000000) x 10%
= 0.7 x 0.15 + 0.3 x 0.1
= 0.105 + 0.03
= 0.135 or 13.5%

Therefore, the correct answer is C) 13.5%.

Question 5

What appears to be the targeted debt ratio of a firm that issues $15 million in bonds and $35 million in equity to finance its new capital projects?

Accepted Answer

The targeted debt ratio is calculated as the amount of debt divided by the total financing. Here, it's $15 million in bonds (debt) divided by the total financing of $50 million ($15 million in bonds + $35 million in equity), which equals 0.30 or 30%.

Question 6

Company X has 2 million shares of common stock outstanding at a book value of $2 per share.The stock trades for $3.00 per share.It also has $2 million in face value of debt that trades at 90% of par.What is its ratio of debt to value for WACC purposes?(Use the values in dollar.)

Accepted Answer

The total value of the equity is 2 million shares * $3.00 = $6 million. The total value of the debt is $2 million * 90% = $1.8 million. The total value of the firm is $6 million (equity) + $1.8 million (debt) = $7.8 million. The ratio of debt to total value is $1.8 million / $7.8 million = 23.08%.

Question 7

What return on equity do investors seem to expect for a firm with a $55 share price, an expected dividend of $5.50, a beta of.9 and a constant growth rate of 5.5%?

Accepted Answer

The answer of What return on equity do investors seem...

Question 8

How much is added to a firm's weighted average cost of capital for 45% debt financing with a required rate of return of 10% and a tax rate of 35%?

Accepted Answer

The cost of debt financing after taxes is calculated as the required rate of return on debt (10%) multiplied by (1 - tax rate), which is (1 - 0.35) or 0.65. So, 10% * 0.65 = 6.5%. Since the firm is using 45% debt financing, the amount added to the WACC for debt financing is 6.5% * 45% = 2.925%, which rounds to 2.93%.

Question 9

What is the WACC for a firm with equal amounts of debt and equity financing, a 16% before-tax company cost of capital, a 35% tax rate, and a 10% coupon rate on its debt that is selling at par value?

Accepted Answer

The answer of What is the WACC for a firm...

Question 10

What % age of value should be allocated to equity in WACC computations for a firm with $50 million in debt selling at 85% of par, $50 million in book value of equity, and $65 million in market value of equity?

Accepted Answer

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Question 11

According to CAPM estimates, what is the cost of equity for a firm with beta of 1.5 when the risk-free interest rate is 6% and the expected return on the market portfolio is 15%?

Accepted Answer

The cost of equity according to the Capital Asset Pricing Model (CAPM) is calculated using the formula: Cost of Equity = Risk-Free Rate + Beta * (Market Return - Risk-Free Rate). Plugging in the given values: 6% + 1.5 * (15% - 6%) = 6% + 1.5 * 9% = 6% + 13.5% = 19.5%.

Question 12

A project will generate $1 million net cash flow annually in perpetuity.If the project costs $7 million, what is the lowest WACC shown below that will make the NPV negative?

Accepted Answer

To find the WACC that will make the NPV negative, we need to calculate the NPV at each WACC and determine at what point it becomes negative. Using the perpetuity formula, we can calculate the present value of the $1 million cash flows:

PV = $1 million / WACC

Next, we can use the NPV formula to calculate the net present value of the project:

NPV = PV - $7 million

We can plug in each WACC option and calculate the corresponding NPV:

At 10% WACC, NPV = $3 million
At 12% WACC, NPV = $1 million
At 14% WACC, NPV = -$1 million
At 16% WACC, NPV = -$3 million

Therefore, the lowest WACC that will make the NPV negative is D) 16%.

Question 13

A company's CFO wants to maintain a target debt-to-equity ratio of 1/4.If the WACC is 18.6%, and the pretax cost of debt is 9.4%, what is the cost of common equity assuming a tax rate of 34%?

Accepted Answer

Given,
Debt-to-Equity Ratio=1/4
WACC=18.6%
Pretax cost of debt=9.4%
Tax rate=34%

Let the cost of common equity =Ke
Now, we can find the proportion of debt and equity in the company's capital structure by using the debt-to-equity ratio as follows:

Debt-to-Equity Ratio = Debt/Equity = 1/4

=> Debt = (1/5) Equity

=> Total Capital = Debt + Equity = (1/5) Equity + Equity

=> Total Capital = (6/5) Equity

=> Equity = Total Capital / (6/5) = (5/6) Total Capital

=> Debt = (1/6) Total Capital

Now we calculate the WACC using the above-proportioned cost of debt, cost of common equity, and equity and debt proportions:

WACC = (Cost of Equity)*(Equity/Total Capital) + (Cost of Debt)*(Debt/Total Capital)*(1-Tax Rate)

18.6% = Ke*(5/6) + 9.4%*(1/6)*(1-0.34)

Solving the above equation, we get:

Ke = 21.7%

Therefore, the cost of common equity assuming a tax rate of 34% is 21.7%. So, the best choice is C.

Question 14

What is the WACC for a firm with 50% debt and 50% equity that pays 12% on its debt, 20% on its equity, and has a 40% tax rate?

Accepted Answer

WACC = [0.5 × 0.12 × (1 − 0.40)] + (0.5 × 0.20) = 0.136, or 13.6%

Question 15

Find the required rate of return for equity investors of a firm with a beta of 1.3 when the risk free rate is 5%, the market risk premium is 5%, and the return on the market is 10%.

Accepted Answer

The required rate of return for equity investors can be calculated using the Capital Asset Pricing Model (CAPM) formula: Required Return = Risk-Free Rate + Beta * (Market Return - Risk-Free Rate). Plugging in the given values: Required Return = 5% + 1.3 * (10% - 5%) = 5% + 1.3 * 5% = 5% + 6.5% = 11.5%.

Question 16

If a firm has three times as much equity as debt in its capital structure, then the firm has:

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The answer of If a firm has three times as...

Question 17

XYZ Company issues common stock that is expected to pay a dividend over the next year of $4 at a price of $25 per share.If its expected growth rate is 5%, what is XYZ's cost of common equity?

Accepted Answer

The answer of XYZ Company issues common stock that is...

Question 18

What is the pretax cost of debt for a firm in the 35% tax bracket that has a 9% after-tax cost of debt?

Accepted Answer

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Question 19

What is the yield to maturity on Dotte Inc.'s bonds if its after-tax cost of debt is 10% and its tax rate is 35%?

Accepted Answer

The after-tax cost of debt is given as 10% and the tax rate is 35%.
So, the before-tax cost of debt would be:
Before-tax Cost of Debt = After-tax Cost of Debt / (1 - Tax Rate)
= 10% / (1 - 35%)
= 15.38%
This is the Yield to Maturity (YTM) on Dotte Inc.'s bonds. Therefore, the correct answer is option C.

Question 20

If a firm has twice as much equity as debt in its capital structure, then the firm has:

Accepted Answer

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Quiz 13: The Weighted-Average Cost of Capital and Company Valuation