Question 1

How firms estimate their cost of capital: You are analyzing the cost of capital for a firm that is financed with $300 million of equity and $200 million of debt. The cost of debt capital for the firm is 9 percent, while the cost of equity capital is 19 percent. What is the overall cost of capital for the firm?

Accepted Answer

The answer of How firms estimate their cost of capital:...

Question 2

How firms estimate their cost of capital: The Diverse Co. has invested 40 percent of the firm's assets in a project with a beta of 0.4 and the remaining assets in a project with a beta of 1.8. What is the beta of the firm?

Accepted Answer

The firm's beta is calculated as a weighted average of the betas of its projects. The beta of the firm = (0.4 * 0.4) + (0.6 * 1.8) = 0.16 + 1.08 = 1.24.

Question 3

The appropriate risk-free rate to use when calculating the cost of equity for a firm is

Accepted Answer

The appropriate risk-free rate to use when calculating the cost of equity for a firm is a long-term Treasury rate because it reflects the time horizon of equity investors who are looking for long-term returns. Short-term rates may be appropriate for short-term investments, but equity investments are generally expected to have a longer time horizon. A 50/50 mix of short-term and long-term rates may be appropriate in some cases, but it depends on the specific circumstances of the firm and its investors.

Question 4

Bond issuance costs include

Accepted Answer

Bond issuance costs typically include investment banking fees, legal fees, and accountant fees. Therefore, the correct answer is D, which stands for "all of the above."

Question 5

Long-term debt typically describes

Accepted Answer

Long-term debt refers to debt with a maturity greater than one year, regardless of whether it is coupon or publicly traded. Therefore, option B and C are incorrect.

Question 6

Overall cost of capital: What is the beta of a firm whose equity has an expected return of 21.3 percent when the risk-free rate of return is 7.0 percent and the expected return on the market is 18.0 percent?

Accepted Answer

The formula for calculating beta is:
Beta = (Expected return on equity - Risk-free rate of return) / (Expected return on market - Risk-free rate of return)
Substituting the given values:
Beta = (21.3% - 7.0%) / (18.0% - 7.0%)
Beta = 14.3% / 11.0%
Beta = 1.30
Therefore, the answer is choice B.

Question 7

When analyzing a firm's cost of debt, we are typically interested in

Accepted Answer

The cost of debt is typically analyzed based on the current yield or interest rate at which the firm can borrow, reflecting the market conditions on the date of analysis.

Question 8

Income taxes have the effect of

Accepted Answer

The answer of Income taxes have the effect of
...

Question 9

Which of the following need to be excluded from the calculation of the firm's amount of permanent debt?

Accepted Answer

Revolving lines of credit are not considered permanent debt because they can be paid off and borrowed against multiple times without being fully repaid. Long-term debt and mortgage debt are typically considered permanent debt as they have a set maturity date and are not meant to be repaid before that date.

Question 10

How firms estimate their cost of capital: The WACC for a firm is 13.00 percent. You know that the firm's cost of debt capital is 10 percent and the cost of equity capital is 20%. \ What proportion of the firm is financed with debt?

Accepted Answer

The answer of How firms estimate their cost of capital:...

Question 11

Overall cost of capital: If the market risk premium is currently 6 percent and the risk-free rate of return is 4 percent, then what is the expected return on a common share with a beta equal to 2?

Accepted Answer

The formula for the expected return of a stock is:

Expected return = Risk-free rate + Beta*(Market risk premium)

Plugging in the values given:

Expected return = 4% + 2*(6%) = 16%

Therefore, the expected return on a common share with a beta equal to 2 is 16.0%. The correct answer is (D).

Question 12

The average risk-premium for the market from 1926 to 2009 was

Accepted Answer

The average market risk premium from 1926 to 2009 was approximately 6.01%.

Question 13

Overall cost of capital: Stryder, Inc., has 3 million shares outstanding at a current price of $15 per share. The book value of the shares is $10 per share. The firm also has $30 million in par value of bonds outstanding. The bonds are selling at a price equal to 101 percent of par. What is the market value of the firm?

Accepted Answer

To calculate the overall cost of capital, we need to find the market value of equity and debt separately and then add them up.

Market value of equity = Number of shares outstanding * Current price per share 
= 3,000,000 * $15 
= $45,000,000

Market value of debt = Par value of bonds outstanding * Bond price 
= $30,000,000 * 1.01 
= $30,300,000

Total market value of the firm = Market value of equity + Market value of debt 
= $45,000,000 + $30,300,000 
= $75,300,000

Therefore, the best choice is D.

Question 14

The recommended model to estimate the cost of common equity for a firm is

Accepted Answer

The Capital Asset Pricing Model (CAPM) is the recommended model to estimate the cost of common equity for a firm. It takes into account the risk-free rate, the market risk premium, and the beta of the stock, making it a widely used and accepted model in finance. The other models listed may be useful in certain situations, but the CAPM is the most commonly used and widely accepted model for estimating the cost of common equity.

Question 15

If a firm has bonds outstanding and the firm would like to calculate the current cost of debt for the bonds, then the firm would

Accepted Answer

The current yield to maturity reflects the current market interest rate for the bonds and is therefore the most accurate measure of the cost of debt for the bonds. The coupon rate is fixed when the bonds are issued and may be higher or lower than current market rates, and the current coupon yield only reflects the interest payment relative to the current market price of the bonds.

Question 16

How firms estimate their cost of capital: You are analyzing the cost of capital for a firm that is financed with 65 percent equity and 35 percent debt. The cost of debt capital is 8 percent, while the cost of equity capital is 20 percent for the firm. What is the overall cost of capital for the firm?

Accepted Answer

The answer of How firms estimate their cost of capital:...

Question 17

In order to use the WACC to evaluate a future project's flows, which of the following must hold?

Accepted Answer

The WACC is calculated using the firm's proportion of debt and equity financing and the overall systematic risk of the firm, so in order to use it to evaluate a future project's cash flows, the project must be financed with the same proportion of debt and equity as the firm (a) and have the same systematic risk as the overall firm (b). Additionally, the project must be viable, although this is not directly related to the use of the WACC as an evaluation tool.

Question 18

The cost of debt: Bellamee, Inc., has semiannual bonds outstanding with five years to maturity and are priced at $920.87. If the bonds have a coupon rate of 7 percent, then what is the YTM for the bonds?

Accepted Answer

The YTM is calculated using the bond price, coupon rate, and time to maturity. The bond's price is $920.87, the coupon rate is 7% (semiannual payments of 3.5%), and it has 10 periods (5 years * 2). Solving for YTM gives approximately 9% annually.

Question 19

How firms estimate their cost of capital: The WACC for a firm is 19.75 percent. You know that the firm is financed with $75 million of equity and $25 million of debt. The cost of debt capital is 7 percent. What is the cost of equity for the firm?

Accepted Answer

The formula to calculate WACC is: WACC = (cost of equity x weight of equity) + (cost of debt x weight of debt)

Plugging in the given values, we get: 
19.75% = (cost of equity x 0.75) + (7% x 0.25)

Solving for the cost of equity, we get: 
Cost of equity = (19.75% - 1.75%) / 0.75

Cost of equity = 24%

Therefore, the answer is B.

Question 20

A bond has a coupon rate of 6 percent and the bond makes semiannual coupon payments. The dollar amount of coupon interest received every six months is

Accepted Answer

The coupon rate is expressed as an annual rate, so to calculate the semiannual coupon payment, we divide the coupon rate by 2. Therefore, the dollar amount of coupon interest received every six months is 6%/2 = 3%. If the bond has a face value of $1,000, then the semiannual coupon payment would be $1,000 x 3% = $30.

Quiz 13: The Cost of Capital

How firms estimate their cost of capital: The Diverse Co. has invested 40 percent of the firm's assets in a project with a beta of 0.4 and the remaining assets in a project with a beta of 1.8. What is the beta of the firm?

The appropriate risk-free rate to use when calculating the cost of equity for a firm is

Bond issuance costs include

Long-term debt typically describes

Overall cost of capital: What is the beta of a firm whose equity has an expected return of 21.3 percent when the risk-free rate of return is 7.0 percent and the expected return on the market is 18.0 percent?

When analyzing a firm's cost of debt, we are typically interested in

Income taxes have the effect of

Which of the following need to be excluded from the calculation of the firm's amount of permanent debt?

How firms estimate their cost of capital: The WACC for a firm is 13.00 percent. You know that the firm's cost of debt capital is 10 percent and the cost of equity capital is 20%. \ What proportion of the firm is financed with debt?

Overall cost of capital: If the market risk premium is currently 6 percent and the risk-free rate of return is 4 percent, then what is the expected return on a common share with a beta equal to 2?

The average risk-premium for the market from 1926 to 2009 was

The recommended model to estimate the cost of common equity for a firm is

If a firm has bonds outstanding and the firm would like to calculate the current cost of debt for the bonds, then the firm would

In order to use the WACC to evaluate a future project's flows, which of the following must hold?

The cost of debt: Bellamee, Inc., has semiannual bonds outstanding with five years to maturity and are priced at $920.87. If the bonds have a coupon rate of 7 percent, then what is the YTM for the bonds?

How firms estimate their cost of capital: The WACC for a firm is 19.75 percent. You know that the firm is financed with $75 million of equity and $25 million of debt. The cost of debt capital is 7 percent. What is the cost of equity for the firm?

A bond has a coupon rate of 6 percent and the bond makes semiannual coupon payments. The dollar amount of coupon interest received every six months is