Question 1

Estimate a firm's NOPAT based on the following information: net sales = $2,000,000; EBIT = $600,000; net income = $20,000; and effective tax rate = 30%.

Accepted Answer

NOPAT (Net Operating Profit After Taxes) = EBIT x (1 - tax rate)
= $600,000 x (1 - 0.30)
= $420,000

Question 2

Your venture has net income of $600, taxable income of $1,000, operating profit of $1,200, total financial capital (including both debt and equity) of $9,000, a tax rate of 40%, and a WACC of 10%. What is your venture's EVA?

Accepted Answer

The answer of Your venture has net income of $600,...

Question 3

Venture investors generally use which of the following target rate ranges to discount the projected cash flows of ventures in the development stage of their life cycles:

Accepted Answer

Venture investors typically use a higher discount rate, such as 40%-60%, for ventures in the development stage due to the higher risk and uncertainty associated with early-stage investments.

Question 4

Venture capital holding period returns (all stages)for the 20-year period ending in 2018 were approximately:

Accepted Answer

According to the Cambridge Associates U.S. Venture Capital Index, the holding period return for all stages for the 20-year period ending in 2018 was approximately 21%.

Question 5

Calculate the weighted average cost of capital (WACC)based on the following information: the equity multiplier is 1.66; the interest rate on debt is 13%; the required return to equity holders is 22%; and the tax rate is 35%.

Accepted Answer

The answer of Calculate the weighted average cost of capital...

Question 6

A venture has raised $4,000 of debt and $6,000 of equity to finance its firm. Its cost of borrowing is 6%, its tax rate is 40%, and its cost of equity capital is 8%. What is the venture's weighted average cost of capital?

Accepted Answer

The venture's weighted average cost of capital (WACC) is calculated by weighting the cost of each type of capital (debt and equity) by its proportion in the total capital and adjusting the cost of debt for taxes. The calculation is as follows:- Total capital = $4,000 (debt) + $6,000 (equity) = $10,000- Proportion of debt = $4,000 / $10,000 = 0.4- Proportion of equity = $6,000 / $10,000 = 0.6- After-tax cost of debt = 6% * (1 - 0.4) = 3.6%- Cost of equity = 8%WACC = (0.4 * 3.6%) + (0.6 * 8%) = 1.44% + 4.8% = 6.24%Rounded to one decimal place, the WACC is approximately 6.2%.

Question 7

Use the SML model to calculate the cost of equity for a firm based on the following information: the firm's beta is 1.5; the risk-free rate is 5%; and the market risk premium is 2%.

Accepted Answer

The answer of Use the SML model to calculate the...

Question 8

Calculate the after-tax WACC based on the following information: nominal interest rate on debt = 12%; cost of common equity = 25%; common equity = $700,000; interest-bearing debt = $300,000; and tax rate = 25%.

Accepted Answer

The answer of Calculate the after-tax WACC based on the...

Question 9

Venture investors generally use which of the following target rate ranges to discount the projected cash flows of ventures in the startup stage of their life cycles:

Accepted Answer

Venture investors generally use a higher target rate range to discount the projected cash flows of ventures in the startup stage of their life cycles because of the high risk involved. The range of 30%-50% is a common target rate range used by venture investors in such cases. This allows them to compensate for the higher risk they take on when investing in early-stage startups.

Question 10

Estimate a firm's economic value added (EVA) based on the following information: NOPAT = $400,000; amount of financial capital used = $1,600,000; and WACC = 19%.

Accepted Answer

EVA = NOPAT - (WACC x amount of financial capital used)
EVA = $400,000 - (0.19 x $1,600,000)
EVA = $400,000 - $304,000
EVA = $96,000

Question 11

The difference between average annual returns on common stocks and returns on long-term government bonds is called a:

Accepted Answer

The difference between the average annual returns on common stocks and returns on long-term government bonds is referred to as the market risk premium. This reflects the additional return investors demand for taking on the higher risk associated with stocks compared to the relatively safer government bonds.

Question 12

Which of the following types of "premiums" would not be associated with corporate bonds?

Accepted Answer

Investment risk premium is not typically associated with corporate bonds. It is more relevant to investments in stocks or other securities where the return is highly dependent on the performance of the investment itself. Corporate bonds instead may have default risk, liquidity, and maturity premiums as they are related to the bond's credit risk, ease of trading, and time to maturity, respectively.

Question 13

Venture capital holding period returns (all stages)for the 10-year period ending in 2018 were approximately:

Accepted Answer

Venture capital holding period returns (all stages) for the 10-year period ending in 2018 were approximately 13%. This reflects the average annual return investors could expect from venture capital investments across all stages over this period.

Question 14

What has been the approximate long-run (90 or so years)average annual rate of return on publicly traded small-company stocks?

Accepted Answer

According to historical data, the approximate long-run average annual rate of return on publicly traded small-company stocks has been around 17%.

Question 15

Which of the following types of financing would be associated with the highest target compound rate of return on venture equity capital?

Accepted Answer

Seed financing involves investing in very early stage start-ups with high potential for growth. Due to the high risk involved, investors in seed financing typically demand a high return on their investment, leading to a higher target compound rate of return compared to later stage financing options.

Question 16

Calculate the after-tax WACC based on the following information: nominal interest rate on debt = 16%; cost of common equity = 30%; equity to value = 60%; debt to value = 40%; and tax rate = 25%.

Accepted Answer

The answer of Calculate the after-tax WACC based on the...

Question 17

Find a venture's economic value added (EVA) based on the following information: EBIT = $200,000; financial capital used = $500,000; WACC = 20%; and effective tax rate = 30%.

Accepted Answer

First, we need to calculate the weighted cost of capital (WACC) which is 20% in this scenario.

Next, we need to calculate the net operating profit after tax (NOPAT) which is:
NOPAT = EBIT x (1 - effective tax rate)
NOPAT = $200,000 x (1-0.30)
NOPAT = $140,000

Then we can calculate the economic value added (EVA) using the following formula:
EVA = NOPAT - (WACC x financial capital used)
EVA = $140,000 - (0.20 x $500,000)
EVA = $140,000 - $100,000
EVA = $40,000

Therefore, the answer is C) $40,000.

Question 18

The cost of equity for a firm is 20%. If the real interest rate is 5%, the inflation premium is 3%, and the market risk premium is 2%, what is the investment risk premium for the firm?

Accepted Answer

The answer of The cost of equity for a firm...

Question 19

Calculate the weighted average cost of capital (WACC)based on the following information: the capital structure weights are 50% debt and 50% equity; the interest rate on debt is 10%; the required return to equity holders is 20%; and the tax rate is 30%.

Accepted Answer

WACC = (Weight of Debt × Cost of Debt) + (Weight of Equity × Cost of Equity)
= (0.5 × 0.1 × (1-0.3)) + (0.5 × 0.2)
= 0.035 + 0.1
= 0.135 or 13.5%

Quiz 7: Types and Costs of Financial Capital