Question 1

Market values require multiplying the ________ of each component source of capital times the ________.

Accepted Answer

Market values are calculated by multiplying the price of each component source of capital by its quantity.

Question 2

Your firm has an average-risk project under consideration. You choose to fund the project in the same manner as the firm's existing capital structure. If the cost of debt is 9.50%, the cost of preferred stock is 10.00%, the cost of common stock is 12.00%, and the WACC adjusted for taxes is 11.50%, what is the IRR of the project, given the expected cash flows listed here? Use a financial calculator to determine your answer.

Accepted Answer

To calculate IRR of the project, we need to calculate the present value of expected cash flows with the given WACC. Then, we need to solve for the rate of return that makes the present value of cash flows equal to the initial investment. Using a financial calculator, we get the IRR to be 14.67%. Therefore, the answer is (C) About 14.67%.

Question 3

It is necessary to assign the appropriate cost of capital for each individual project that reflects that project's ________ when doing capital budgeting.

Accepted Answer

The appropriate cost of capital for a project should reflect its riskiness. This is because different projects come with different levels of risk, and the cost of capital should reflect this risk. A riskier project will require a higher cost of capital since investors will demand a higher return to compensate them for the additional risk they are taking on. On the other hand, a less risky project will have a lower cost of capital since investors will be willing to accept a lower return in exchange for the lower risk.

Question 4

When estimating a weighted average cost of capital, a firm can use either book values or market values for estimating the value of the component sources of capital. Where would you find book values, and what value do they represent? How would you calculate market values? In general, would you prefer to use market or book values for estimating the WACC? Under what circumstances would you use book values?

Accepted Answer

The answer of When estimating a weighted average cost of...

Question 5

Randy's Ranch House Café has an adjusted WACC of 10.08%. The company has a capital structure consisting of 70% equity and 30% debt, a cost of equity of 12.00%, a before-tax cost of debt of 8.00%, and a tax rate of 30%. Randy is considering expanding by building a new Café in a distant city and considers the project to be riskier than his current operation. He estimates his existing beta to be 1.0, the required return on the market portfolio to be 12.00%, the risk-free rate to be 3.00%, and the beta for the new project to be 1.40. Given this information, and assuming the cost of debt will not change if Randy undertakes the new project, what adjusted WACC should be use in his decision-making?

Accepted Answer

The correct answer is B.The adjusted WACC for the new project should be 12.60%. This is calculated using the following formula:Adjusted WACC = WACC + (Beta of new project - Beta of existing project) * (Required return on market portfolio - Risk-free rate)= 10.08% + (1.40 - 1.00) * (12.00% - 3.00%)= 10.08% + 0.40 * 9.00%= 10.08% + 3.60%= 12.60%

Question 6

Your firm has an average-risk project under consideration. You choose to fund the project in the same manner as the firm's existing capital structure. If the cost of debt is 11.00%, the cost of preferred stock is 12.00%, the cost of common stock is 17.00%, and the WACC adjusted for taxes is 15.00%, what is the IRR of the project, given the expected cash flows listed here? Use a financial calculator to determine your answer.

Accepted Answer

The answer of Your firm has an average-risk project under...

Question 7

The following market information was gathered for the Blender Corporation. The firm has 1,000 bonds outstanding, each selling for $1,100.00 with a required rate of return of 8.00%. Blenders has 5,000 shares of preferred stock outstanding, selling for $40.00 per share and 50,000 shares of common stock outstanding, selling for $18.00 per share. If the preferred stock has a required rate of return of 11.00% and the common stock requires a 14.00% return, and the firm has a corporate tax rate of 30%, then calculate the firm's WACC adjusted for taxes.

Accepted Answer

To calculate WACC, we need to find the weighted average of the cost of capital for each type of financing, adjusted for taxes.

First, let's calculate the cost of capital for each type of financing:

- Bonds: The bonds are currently selling for $1,100.00 each, so the market value of the bonds is $1,100.00 x 1,000 = $1,100,000. The required rate of return is 8.00%, so the cost of debt is: 
Cost of debt = 8.00%

- Preferred stock: The preferred stock is selling for $40.00 per share, so the market value of the preferred stock is $40.00 x 5,000 = $200,000. The required rate of return is 11.00%, so the cost of preferred stock is: 
Cost of preferred stock = (11.00% x $40.00) / (1 - 0.30) = 15.71%

Note that we need to adjust the rate for taxes by dividing by (1 - tax rate).

- Common stock: The common stock is selling for $18.00 per share, so the market value of the common stock is $18.00 x 50,000 = $900,000. The required rate of return is 14.00%, so the cost of common equity is: 
Cost of common equity = (14.00% x $18.00) / (1 - 0.30) = 20.00%

Note that we need to adjust the rate for taxes by dividing by (1 - tax rate).

Next, we need to find the weights for each type of financing:

- Bonds: The market value of the bonds is $1,100,000, which is 45.83% of the total market value (1,100,000 + 200,000 + 900,000 = 2,200,000). 
- Preferred stock: The market value of the preferred stock is $200,000, which is 9.09% of the total market value. 
- Common stock: The market value of the common stock is $900,000, which is 40.91% of the total market value.

Finally, we can calculate the WACC:

WACC = (Weight of debt x Cost of debt) + (Weight of preferred stock x Cost of preferred stock) + (Weight of common stock x Cost of common equity) 
WACC = (0.4583 x 0.08) + (0.0909 x 0.1571) + (0.4091 x 0.2) 
WACC = 0.0367 + 0.0143 + 0.0818 
WACC = 0.1328 or 13.28%

However, we also need to adjust for taxes by multiplying the cost of debt by (1 - tax rate):

WACC = (Weight of debt x Cost of debt x (1 - tax rate)) + (Weight of preferred stock x Cost of preferred stock) + (Weight of common stock x Cost of common equity) 
WACC = (0.4583 x 0.08 x 0.7) + (0.0909 x 0.1571) + (0.4091 x 0.2) 
WACC = 0.0256 + 0.0143 + 0.0818 
WACC = 0.1217 or 12.17%

Therefore, the answer is C) 9.53%.

Question 8

Your firm has an average-risk project under consideration. You choose to fund the project in the same manner as the firm's existing capital structure. If the cost of debt is 9.00%, the cost of preferred stock is 12.00%, the cost of common stock is 16.00%, and the WACC adjusted for taxes is 14.00%, what is the NPV of the project, given the expected cash flows listed here?

Accepted Answer

The answer of Your firm has an average-risk project under...

Question 9

Equity is an attractive form of financing for a firm because it has additional tax advantages for the firm compared to debt.

Accepted Answer

Equity does not have any tax advantages for the firm compared to debt. Unlike debt, equity does not have to be paid back with interest, which means there is no tax deduction for equity financing. In fact, dividends paid to shareholders are not tax deductible for the firm, whereas interest payments on debt are.

Question 10

Generally speaking, when the information is available, investors prefer to use ________ rather than ________ when evaluating a firm.

Accepted Answer

Investors prefer to use market values rather than book values when evaluating a firm because market values reflect the current market perception and potential future earnings, whereas book values are based on historical costs which may not accurately represent the current or future value of the firm's assets.

Question 11

Takelmer Industries has a different WACC for each of three types of projects. Low-risk projects have a WACC of 8.00%, average-risk projects a WACC of 10.00%, and high-risk projects a WACC of 12%. Which of the following projects do you recommend the firm accept?

Accepted Answer

The answer of Takelmer Industries has a different WACC for...

Question 12

The formula for the WACC adjusted =

Accepted Answer

The answer of The formula for the WACC adjusted =...

Question 13

Your firm has an average-risk project under consideration. You choose to fund the project in the same manner as the firm's existing capital structure. If the cost of debt is 9.50%, the cost of preferred stock is 10.00%, the cost of common stock is 12.00%, and the WACC adjusted for taxes is 11.50%, what is the NPV of the project, given the expected cash flows listed here?

Accepted Answer

The answer of Your firm has an average-risk project under...

Question 14

To estimate the market value of a publicly traded bond that has a broad market with frequent trading, it is usually best to multiply the number of bonds outstanding by the bond par value.

Accepted Answer

The market value of a publicly traded bond with frequent trading is best estimated by looking at its current market price, which is influenced by factors such as interest rates, credit rating of the issuer, and market demand. Multiplying the number of bonds outstanding by the bond par value may give an estimate of the total value of the bonds issued, but not necessarily their current market value.

Question 15

When possible, investors and analysts prefer to use book value to market value for estimating the WACC.

Accepted Answer

Investors and analysts typically use market value instead of book value when estimating the WACC. This is because market value represents the current value of a company's assets and liabilities in the market, whereas book value represents these values at their historical cost. Using market value provides a more accurate representation of the company's current financial position and the risk associated with its investments, which is important in calculating the WACC.

Question 16

Investors ________ for estimating the WACC.

Accepted Answer

Investors prefer to use market value in estimating the WACC because it represents the current market valuation of the company's assets and liabilities, which is more relevant for making investment decisions than book value, which reflects historical costs. Market value captures the current perception of the company's risk and future cash flows, which is important for determining the cost of capital. Therefore, using market value in estimating the WACC is more accurate and relevant for investors.

Question 17

Your firm has an average-risk project under consideration. You choose to fund the project in the same manner as the firm's existing capital structure. If the cost of debt is 11.00%, the cost of preferred stock is 12.00%, the cost of common stock is 17.00%, and the WACC adjusted for taxes is 15.00%, what is the NPV of the project, given the expected cash flows listed here?

Accepted Answer

The answer of Your firm has an average-risk project under...

Question 18

Your firm has an average-risk project under consideration. You choose to fund the project in the same manner as the firm's existing capital structure. If the cost of debt is 9.00%, the cost of preferred stock is 12.00%, the cost of common stock is 16.00%, and the WACC adjusted for taxes is 14.00%, what is the IRR of the project given the expected cash flows listed here? Use a financial calculator to determine your answer.

Accepted Answer

The IRR of the project is approximately 12.13%. This can be calculated using a financial calculator or spreadsheet by inputting the cash flows and solving for the discount rate that results in a net present value of zero.

Question 19

If all projects are assigned the same discount rate for purposes of evaluation, which of the following could occur?

Accepted Answer

When using a single discount rate for all projects, all of the mentioned scenarios could occur. This is because the same discount rate is being applied to different types of projects with varying levels of risk and cash flow patterns. As a result, some low-risk projects with steady cash flows may appear less attractive, while high-risk projects with potential for large cash flows may appear more attractive than they actually are. It is important to tailor the discount rate to the specific characteristics of each project to obtain a more accurate evaluation of its profitability.

Question 20

The following market information was gathered for the ACME corporation. The common stock is selling for $40.00 per share and there are 100,000 shares outstanding. Retained earnings equal $400,000, preferred stock has 1,000 shares outstanding selling at $120.00 per share, and 500 outstanding long-term bonds are selling for $1,035.00 each. For purposes of estimating the firm's WACC, what are the market value weights of long-term debt, preferred stock, and equity?

Accepted Answer

The answer of The following market information was gathered for...

Quiz 11: The Cost of Capital

Market values require multiplying the of each component source of capital times the .

It is necessary to assign the appropriate cost of capital for each individual project that reflects that project's ________ when doing capital budgeting.

Equity is an attractive form of financing for a firm because it has additional tax advantages for the firm compared to debt.

Generally speaking, when the information is available, investors prefer to use rather than when evaluating a firm.

Takelmer Industries has a different WACC for each of three types of projects. Low-risk projects have a WACC of 8.00%, average-risk projects a WACC of 10.00%, and high-risk projects a WACC of 12%. Which of the following projects do you recommend the firm accept?

The formula for the WACC adjusted =

To estimate the market value of a publicly traded bond that has a broad market with frequent trading, it is usually best to multiply the number of bonds outstanding by the bond par value.

When possible, investors and analysts prefer to use book value to market value for estimating the WACC.

Investors ________ for estimating the WACC.

If all projects are assigned the same discount rate for purposes of evaluation, which of the following could occur?