Question 1

Epiphany is an all-equity firm with an estimated market value of $500,000.The firm sells $200,000 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 the firm sells $200,000 of debt and uses it to repurchase equity, the total market value of the firm remains $500,000. The new equity value is $500,000 - $200,000 = $300,000. Therefore, the weight in equity is $300,000 / $500,000 = 0.6, and the weight in debt is $200,000 / $500,000 = 0.4.

Question 2

GM has a market value of $8 billion of equity and a market value of $12 billion of debt.What are the weights in equity and debt that are used for calculating the WACC?

Accepted Answer

To calculate the weights of equity and debt, we need to divide the market value of each by the total market value of the firm:

Weight of equity = market value of equity / (market value of equity + market value of debt) = 8 / (8 + 12) = 0.4

Weight of debt = market value of debt / (market value of equity + market value of debt) = 12 / (8 + 12) = 0.6

Therefore, the weights in equity and debt are 0.4 and 0.6, respectively. The correct choice is C.

Question 3

The book value of equity of a firm is $100 million and the market value of equity is $200 million.The face value of debt of the firm is $50 million and the market value of debt is $60 million.What is the market value of assets of the firm?

Accepted Answer

The market value of assets can be derived using the equation:

Market Value of Assets = Market Value of Equity + Market Value of Debt

Substituting the given values in the equation, we get:

Market Value of Assets = $200 million + $60 million
Market Value of Assets = $260 million

Therefore, the market value of assets of the firm is $260 million. Option C is the correct answer.

Question 4

A levered firm is one that has ________ outstanding.

Accepted Answer

A levered firm is one that has debt outstanding. This means that the company has taken on debt as a means of financing its operations or growth, which makes it leveraged. The other options, such as equity, preferred stock, equity options, and accounts receivable, are not necessarily indicative of a levered firm.

Question 5

Barley Corp has debt with a book value of $19 million,currently trading at 90% of book value.It also has book value of equity of $15 million,and 10 million shares of common stock trading at $2.45 per share.What weights should Barley Corp use for debt and equity in calculating its WACC?

Accepted Answer

The market value of debt is $17.1 million (90% of $19 million). The market value of equity is $24.5 million (10 million shares * $2.45). The total market value is $41.6 million. The weight of debt is $17.1 million / $41.6 million = 0.41, and the weight of equity is $24.5 million / $41.6 million = 0.59.

Question 6

Epiphany is an all-equity firm with an estimated market value of $400,000.The firm sells $300,000 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 the proposed financing and repurchase of equity, the market value of the firm remains unchanged at $400,000, but the amount of equity and debt change.

If the firm sells $300,000 of debt, then $300,000 of that $400,000 market value is debt. That leaves $100,000 in equity.

Weight in equity = $100,000 / $400,000 = 0.25 or 25%
Weight in debt = $300,000 / $400,000 = 0.75 or 75%

Therefore, the best choice is B.

Question 7

To attract capital from outside investors,a firm must offer potential investors an expected return that is commensurate with the level of risk that they can bear.

Accepted Answer

This statement is true. Investors are willing to invest only if the expected return is higher than the risk they are taking. The potential return on investment should be sufficient to compensate investors for the risk they are assuming.

Question 8

Asterix Corp has debt with a book value of $20 million,currently trading at 85% of book value.It also has book value of equity of $30 million,and 2 million shares of common stock trading at $4.75 per share.What weights should Asterix use for debt and equity in calculating its WACC?

Accepted Answer

The correct weights are 0.64 for debt and 0.36 for equity. This is because the debt is trading at 85% of book value, which means that the market value of the debt is $20 million * 0.85 = $17 million. The market value of the equity is 2 million shares * $4.75 per share = $9.5 million. The total market value of the firm is $17 million + $9.5 million = $26.5 million. The weight of debt is $17 million / $26.5 million = 0.64, and the weight of equity is $9.5 million / $26.5 million = 0.36.

Question 9

The total market value of General Motors (GM)is $10 billion.GM has a market value of $7 billion of equity and a face value of $10 billion of debt.What are the weights in equity and debt that are used for calculating the WACC?

Accepted Answer

The weights in equity and debt are calculated as follows:
Equity weight = Market value of equity / Total market value = $7 billion / $10 billion = 0.7
Debt weight = Face value of debt / Total market value = $10 billion / $10 billion = 1. Therefore, the total weights add up to more than 1 which indicates an error in the question. A reasonable assumption could be that the debt weight should be calculated using the market value of debt instead of the face value, which would result in a debt weight of 0.3. Thus, the best choice is B with weights of 0.7 for equity and 0.3 for debt.

Question 10

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 definition given in the question perfectly matches with the definition of Weighted Average Cost of Capital (WACC). Therefore, the correct choice is A. Cost of equity infusion, cost of debt, cost of preferred stock, and cost of financing are all important components of WACC but not the overall term for the blend of these costs.

Question 11

For an unlevered firm,the cost of capital of the firm can be determined by using the:

Accepted Answer

The cost of capital of an unlevered firm is determined by the Capital Asset Pricing Model (CAPM), which takes into account the risk-free rate, the market rate of return, and the beta of the specific company. The other options, such as yield on traded debt, dividend yield, preferred stock yield, or market value of equity, do not provide a comprehensive analysis of the cost of capital of an unlevered firm.

Question 12

Apple computers 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 through equity rather than debt. This means that the firm has no financial leverage and is not exposed to the risks and costs associated with debt financing, such as interest payments and the risk of default. Apple is an example of an unlevered firm.

Question 13

Billy Burger Corp has a market value of debt of $245 million,and a market value of equity of $815 million.What weights should Billy Burger use for debt and equity in calculating its WACC?

Accepted Answer

The weights of debt and equity should be based on their market values.

Weight of Debt = Market Value of Debt / (Market Value of Debt + Market Value of Equity) 
= $245 million / ($245 million + $815 million) 
= 0.23

Weight of Equity = Market Value of Equity / (Market Value of Debt + Market Value of Equity) 
= $815 million / ($245 million + $815 million) 
= 0.77

Therefore, the weights that Billy Burger should use for debt and equity in calculating its WACC are 0.23 and 0.77, respectively. Choice B is the only option that matches these weights.

Question 14

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

The answer of Epiphany is an all-equity firm with an...

Question 15

Financial managers do not need to use all sources of financing in order to determine the cost of capital.

Accepted Answer

The answer of Financial managers do not need to use...

Question 16

Timbuktu Corp has a market value of debt of $2.5 billion,and a market value of equity of $1.5 billion.What weights should Timbuktu use for debt and equity in calculating its WACC?

Accepted Answer

The weights of debt and equity are calculated as:

Weight of debt = Market value of debt / (Market value of debt + Market value of equity) = 2.5 / (2.5 + 1.5) = 0.625

Weight of equity = Market value of equity / (Market value of debt + Market value of equity) = 1.5 / (2.5 + 1.5) = 0.375

Therefore, the answer is D) 0.625, 0.375.

Question 17

A firm's sources of financing,which usually consists of debt and equity,represent its:

Accepted Answer

The sources of financing represent the firm's capital, which is the total amount of money the firm can use to invest in assets or pay off liabilities.

Question 18

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

Accepted Answer

Capital structure refers to the relative mix of debt and equity that a company uses to finance its operations. This can include other securities such as preferred stock or convertible bonds. The capital structure is an important aspect of a company's financial profile as it can impact its cost of capital and financial risk.

Question 19

One should use accounting-based book values rather than market values of debt and equity to determine the weights for the different sources of capital.

Accepted Answer

Market values of debt and equity are preferred over book values because they more accurately reflect the current cost of capital and the investment community's perception of the firm's value and risk.

Question 20

Leverage is the amount of ________ on a firm's balance sheet.

Accepted Answer

Leverage refers to the use of debt to finance a company's assets. Therefore, the correct answer is B – debt. The amount of debt a company has on its balance sheet is an important determinant of its financial health and risk. A heavily leveraged company is at greater risk of default if it is unable to meet its debt obligations, while a company with lower leverage is generally considered less risky. Therefore, understanding a company's leverage is important for both investors and creditors.

Quiz 12: Determining the Cost of Capital