Question 1

From the estimates,calculate the return on equity (after tax)if Rf = 5%,E(Rm)= 13%,franking premium = 3%,beta = 1.5 and the corporate tax rate is 30 per cent.

Accepted Answer

The answer of From the estimates,calculate the return on equity...

Question 2

A problem with the dividend growth model is:

Accepted Answer

The dividend growth model relies heavily on estimating the future growth rate in dividends. This growth rate is difficult to predict with accuracy and can greatly influence the estimated value of a stock. Small changes in the growth rate can lead to significant differences in the estimated value of the stock. Therefore, the model is extremely sensitive to these estimates.

Question 3

The ____________________ requires that the definition of cash flows in the numerator should match the definition of the discount rate in the denominator of a NPV calculation.

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The answer of The ____________________ requires that the definition of...

Question 4

Assume that Expansion Ltd is a diversified company that is considering an expansion project in a mining division.The company has a target debt-equity ratio of 1:2 and this ratio will not be affected by the new project.The company's manager has identified Dig-it-out Ltd as a company with the same business risk as the new project (equity beta of 1.5).Dig-it-out has a debt-equity ratio of 1:3.Estimate the project's cost of equity for Expansion if the risk-free rate of interest is 7 per cent and the risk premium of the market portfolio is 10 per cent.

Accepted Answer

1. Calculate the levered beta of Dig-it-out:

βL = βU [1 + (1 - tax rate) x (D/E)]
βL = 1.5 [1+ (1-0.30) x (1/3)]
βL = 1.65

2. Estimate the cost of equity for Dig-it-out:

rE = rf + βL x market risk premium
rE = 0.07 + 1.65 x 0.10
rE = 0.2385 or 23.88%

3. Use the same levered beta to estimate the cost of equity for Expansion:

rE = rf + βL x market risk premium
rE = 0.07 + 1.65 x 0.10
rE = 0.2385 or 23.88%

Therefore, the project's cost of equity for Expansion is 23.88%. The answer is D.

Question 5

What is the effective annual interest rate for a bank overdraft with an interest rate of 15% p.a.paid twice a year?

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The answer of What is the effective annual interest rate...

Question 6

Given that shares have an expected dividend stream of 10 cents in perpetuity and that the current market price of the shares is $2.40,calculate the cost of equity capital of these shares.

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The answer of Given that shares have an expected dividend...

Question 7

When using the CAPM to estimate the cost of equity for evaluation of investment proposals,the appropriate substitute for the risk-free rate of interest is:

Accepted Answer

The appropriate substitute for the risk-free rate of interest in the CAPM for evaluating investment proposals is the yield on a government security whose term to maturity matches the life of the proposed project. This approach aligns the duration of the risk-free asset with the investment horizon, ensuring that the risk-free rate accurately reflects the time value of money over the investment period.

Question 8

During the year,Success Ltd shares have increased from $8 to $9 and shareholders received a final dividend of 50 cents per share,fully franked at the company tax rate of 30 per cent.Using the information above,calculate the dividend yield after company tax but before personal tax (using the beginning of the year share price)on Success shares.

Accepted Answer

The answer of During the year,Success Ltd shares have increased...

Question 9

Which of the following statements describes a limitation of the WACC approach?

Accepted Answer

The WACC approach is limited because it assumes that the risk profile of new projects is identical to the company's existing operations, making it less suitable for evaluating projects with different risk characteristics.

Question 10

Under what conditions can a company's current capital structure be used to calculate the weights for each source of funds?

Accepted Answer

The current capital structure can be used to calculate the weights for each source of funds when implementing a new project is not expected to alter the company's capital structure because in such a scenario, the current capital structure represents the current financing mix of the company. If there are any anticipated changes to the capital structure due to the new project, then the current capital structure would not be an accurate representation of future financing mix, and reliable market weights would need to be used instead. The inclusion of preference shares does not affect the use of the current capital structure to calculate weights.

Question 11

The _____________________ approach is considered the superior method of risk adjustment where the risk per unit of time is not constant.

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The answer of The _____________________ approach is considered the superior...

Question 12

Calculate the weighted average cost of preference shares and ordinary shares if there are: 1 million preference shares with market value of $2.50 each and an opportunity cost of 10.8%;10 million ordinary shares with market value of $4.50 each and an opportunity cost of 16.5%.

Accepted Answer

Weighted average cost of preference shares = (1,000,000 x $2.50 x 10.8%) / (1,000,000 x $2.50) = 10.8%
Weighted average cost of ordinary shares = (10,000,000 x $4.50 x 16.5%) / (10,000,000 x $4.50) = 16.5%
Therefore, the weighted average cost of preference shares and ordinary shares = (10.8% + 16.5%) / 2 = 16.2%.
Hence, the correct choice is C.

Question 13

Under which of the following conditions is it appropriate to estimate a project's cost of capital using the company's cost of capital?

Accepted Answer

When a company operates in a sole industry, the systematic risk of any project it undertakes is likely to be similar to the company's overall systematic risk. Therefore, using the company's cost of capital to estimate a project's cost of capital is appropriate because the risk profile of the project aligns closely with that of the company as a whole.

Question 14

In the calculation of WACC,each of the debt and equity securities is weighted according to its ___________ values.

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The answer of In the calculation of WACC,each of the...

Question 15

The cost of capital is an ____________ because capital suppliers require a projects rate of return to be at least as high as the return they can obtain on other investments of equivalent risk.

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The answer of The cost of capital is an ____________...

Question 16

Assume that Expansion Ltd is a diversified company that is considering an expansion project in a mining division.The company has a target debt-equity ratio of 1:2 and this ratio will not be affected by the new project.The company's manager has identified Dig-it-out Ltd as a company with the same business risk as the new project (equity beta of 1.5).Dig-it-out has a debt-equity ratio of 1:3.What is the beta estimate of Expansion Ltd?

Accepted Answer

1. Calculate the unlevered beta of Dig-it-out Ltd using the debt-equity ratio:
Unlevered beta = Equity beta / (1 + (1 - tax rate) * Debt/Equity)
Unlevered beta = 1.5 / (1 + (1-0.3) * 1/3) = 1.2

2. Calculate the beta estimate of Expansion Ltd using the unlevered beta and target debt-equity ratio:
Beta estimate = Unlevered beta * (1 + (1 - tax rate) * Debt/Equity)
Beta estimate = 1.2 * (1 + (1-0.3) * 1/2) = 1.69

Therefore, the answer is A) 1.69.

Question 17

From the following information,calculate the weighted average cost of debt:

Accepted Answer

The answer of From the following information,calculate the weighted average...

Question 18

A consequence for a company that uses a single discount rate to evaluate projects is that:

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The answer of A consequence for a company that uses...

Question 19

During the year,Success Ltd shares have increased from $8 to $9 and shareholders received a final dividend of 50 cents per share,fully franked at the company tax rate of 30 per cent.Calculate the dividend yield after personal taxes for shareholders with a tax rate of 47 per cent (using the beginning of the year share price)on Success shares.

Accepted Answer

Dividend yield after personal taxes = ((dividend received * (1-company tax rate)) / beginning of year share price) * (1-personal tax rate)
= ((0.5 * (1-0.3)) / 8) * (1-0.47)
= 0.047 or 4.7% (rounded to one decimal place)

Therefore, the correct choice is B, which is the closest answer (4.7%) to the calculated dividend yield after personal taxes.

Question 20

During the year,Success Ltd shares have increased from $8 to $9 and shareholders received a final dividend of 50 cents per share,fully franked at the company tax rate of 30 per cent.Calculate first the conventional rate of return and second,the dividend yield (using the beginning of the year share price)on Success shares.

Accepted Answer

The conventional rate of return is calculated as the change in share price plus the dividend yield, divided by the beginning share price. The dividend yield is calculated as the dividend per share divided by the beginning share price.In this case, the change in share price is $9 - $8 = $1. The dividend yield is 50 cents / $8 = 6.25%. Therefore, the conventional rate of return is (1 + 6.25%) / 8 = 18.75%.

Quiz 14: The Cost of Capital and Taxation Issues in Project Evaluation

From the estimates,calculate the return on equity (after tax) if Rf = 5%,E(Rm) = 13%,franking premium = 3%,beta = 1.5 and the corporate tax rate is 30 per cent.