Exam 13: Estimating the Cost of Capital

In computing the cost of equity for a firm,which of the following are recommended steps in estimating the CAPM beta using regression analysis? I.Use a sample size equal to or greater than 60. II.Use daily returns. III.Use a diversified value-weighted index. IV.Watch for possible distortions from market bubbles.

You are analyzing a distressed bond with one year to maturity.If the probability of default rises for this bond,the yield to maturity will likely increase,while the cost of debt will likely decrease.

Bloomberg's recommended adjustment to a firm's beta will:

Researchers have concluded that an appropriate range of the equity risk premium for use in valuation models should be 10 to 12 percent.

Which of the following is NOT a property necessary for a consistent estimate of the WACC?

Briefly explain the two methods of estimating market returns.

Which of the following is/are FALSE regarding risk-free rates? I )The 30-year Treasury bonds match the cash flow streams of a company better,and therefore should be used over 10-year bonds in estimating the risk-free rate. II )One should use government bond yields denominated in the same currency as the company's cash flow to estimate the risk-free rate. III )One should ensure that the inflation rate embedded in the cash flows is consistent with the inflation rate embedded in the government bond rate being used.

A firm has 4,000,000 shares of stock outstanding with a price per share equal to $22.There are 200,000 bonds outstanding each priced at $995 each.The cost of equity is 14 percent,the cost of debt is 8 percent,and the corporate tax rate is 34 percent.What is the WACC?

An analyst gathers the following information for Firm A and Firm B.Using the information to compute the industry unlevered beta,what is the appropriate beta for each company for use in the WACC? (Assume that the debt beta for each firm equals zero. ) Firm A: CAPM beta = 0.9;debt-to-equity ratio = 0.4 Firm B: CAPM beta = 1.2;debt-to-equity ratio = 2

Which of the following are true concerning the index recommended for use in the CAPM? I.It should include both traded and untraded investments. II.The S&P 500 is the most common proxy for U.S.stocks. III.The S&P 500 and the

An analyst gathers the following information for Firm A and Firm B.Use the information to compute the industry unlevered beta and the appropriate beta for Firm B to use in the WACC. Firm A: CAPM beta = 1.6;debt-to-equity ratio = 1.2 Firm B: CAPM beta = 1.0;debt-to-equity ratio = 0.8 The appropriate beta for Firm B is closest to:

Theoretically,one should discount each year's cash flow at a cost of equity that matches the maturity of the cash flow.However,for practical purposes,analysts typically choose a single yield to maturity that best matches the cash flow stream being valued.

Yield to maturity should be calculated on liquid,option-free,short-term debt.

Which of the following practices are appropriate in estimating a firm's cost of debt? I.Use the coupon rate on outstanding debt that is investment grade. II.Use the yield to maturity on outstanding debt that is investment grade. III.Use the yield to maturity on outstanding debt that is below investment grade. IV.Use the adjusted present value (APV )method to value firms that have debt that is below investment grade.

An analyst should use the pretax cost of equity and the pretax cost of debt to estimate the cost of capital.

If an observable market value is not readily available,book value of debt can be used to calculate capital structure.

If interest rates have changed since the company's last valuation or if the company has entered into financial distress,book value is a reasonable approximation of market value.

A firm has a target debt-to-equity ratio of 1.Its cost of equity equals 12 percent,the cost of debt is 8 percent,and the tax rate is 30 percent.What is the weighted average cost of capital (WACC)?

A firm has 1,200,000 shares of stock outstanding with a price per share equal to $14.There are 10,000 bonds outstanding,priced at $1,125 each.The cost of equity is 14 percent,the cost of debt is 8 percent,and the corporate tax rate is 40 percent.What is the WACC?

The cost of capital must include the cost of capital for all investors-debt,preferred stock,and common stock.