Question 1

Why is it important to use market values rather than book values when determining the weighted-average cost of capital?

Accepted Answer

Book values represent the amount and terms of funding for a firm or a project as it was originally placed into existence.Because firms and projects are often long-lived, circumstances can change current values substantially from their original book values.These current, or market, values represent the consensus of the investment community as to the value of the firm or project at this point in time.Recalling that past values may represent sunk costs, it is imperative that values be determined with an eye toward their future benefits.

Question 2

If a firm earns the WACC as an average return on its average-risk assets, then:

Accepted Answer

A)  equity holders will be satisfied, but bondholders will not.
B)  bondholders will be satisfied, but equity holders will not.
C)  all investors will earn their minimum required rate of return.
D)  the firm is investing only in positive NPV projects. C

Question 3

How much cash flow before tax and interest is necessary to support a project that requires $4 million annually for equity investors and $2 million annually in interest payments if the firm's tax rate is 35%?

Accepted Answer

A)  $7.40 million
B)  $8.10 million
C)  $8.15 million
D)  $8.85 million C

Question 4

ABC company has a capital structure with debt and equity.Debt - $50 million face value bonds maturing in 15 years with a coupon rate of 4% paid semi-annually.Similar bonds are selling at 97.5.Equity - There are 2,000,000 shares outstanding.The investor's return is 10%.The next dividend is $3.5 with a growth rate of 4% into the future.Tax rate is 30%.Given the following information, calculate its WACC.

Accepted Answer

The answer of ABC company has a capital structure with...

Question 5

When determining the costs of each component of a firm's capital structure, the firm must evaluate the:

Accepted Answer

A)  marginal costs of new funds.
B)  total costs of new funds.
C)  average costs of new funds.
D)  average costs of old and new funds.

Question 6

Calculation of company costs of capital should be conducted with market values whenever possible.
TRUE

Accepted Answer

A) True 
 B)False

Question 7

The WACC is the rate of return that the firm must expect to earn on its average-risk investments in order to provide an acceptable return to its security holders.

Accepted Answer

A) True 
 B)False

Question 8

Suppose that Nexos, Inc.'s capital structure features 45% common shares, 20% preferred shares, 35% debt, and that its before-taxcost of debt is 9%, while its cost of equity for common shares and preferred shares are 12% and 15% respectively.If the appropriate weighted average tax rate is 40%, what will be Nexos's WACC?

Accepted Answer

The answer of Suppose that Nexos, Inc.'s capital structure features...

Question 9

There are two costs of debt finance.The explicit cost of debt is the rate of interest that bondholders demand.But there is also an implicit cost, because over-borrowing increases the required rate of return to equity.

Accepted Answer

A) True 
 B)False

Question 10

The company cost of capital is the return that is expected on a portfolio of the company's:

Accepted Answer

A)  existing securities.
B)  equity securities.
C)  debt securities.
D)  proposed securities.

Question 11

What decision should be made on a project of above-average risk if the project's IRR exceeds the WACC?

Accepted Answer

A)  accept the project; NPV is positive.
B)  reject the project; NPV is negative.
C)  decide after discounting at the IRR.
D)  decide after discounting at an appropriate rate.

Question 12

What is the after-tax cost of preferred stock that pays a 12% dividend and sells at par if the firm's tax rate is 35%?

Accepted Answer

A)  7.8%
B)  8.5%
C)  12.0%
D)  16.2%

Question 13

A company's CFO wants to maintain a target debt-to-equity ratio of 1/4.If the WACC is 18.6%, and the pretax cost of debt is 9.4%, what is the cost of common equity assuming a tax rate of 34%?

Accepted Answer

A)  19.90%
B)  20.90%
C)  21.70%
D)  22.73%

Question 14

Can WACC be used to value an entire business?

Accepted Answer

The answer of Can WACC be used to value an...

Question 15

With respect to the WACC:

Accepted Answer

A)  it is the proper discount rate for everything the company does.
B)  it is used to value all new projects.
C)  this benchmark discount rate is adjusted for the riskiness of the project.
D)  no adjustments need to be made when using it as the discount rate.

Question 16

An increase in a firm's debt ratio will have no effect on the required rate of return for equity holders.

Accepted Answer

A) True 
 B)False

Question 17

In addition to the tax shield offered by the federal government, debt has a lower required rate of return than equity.Why is it not common to see firms that have much larger debt components in their capital structure?

Accepted Answer

The answer of In addition to the tax shield offered...

Question 18

If a company's cost of capital is less than the required return on equity, then the firm:

Accepted Answer

A)  is financed with more than 50% debt.
B)  is perceived to be safe.
C)  has debt in its capital structure.
D)  cannot be using any debt.

Question 19

Which of the following changes would tend to increase the company cost of capital for a traditional firm?

Accepted Answer

A)  decrease the proportion of equity financing.
B)  increase the market value of the debt.
C)  decrease the proportion of debt financing.
D)  Decrease the market value of the equity.

Question 20

How much will a firm need in cash flow before tax and interest to satisfy debt holders and equity holders if: the tax rate is 35%, there is $13 million in common stock requiring a 10% return, and $6 million in bonds requiring an 6% return? (Use the values in dollar.)

Accepted Answer

A)  $1,392,000
B)  $1,488,000
C)  $2,360,000
D)  $2,480,000

Exam 13: The Weighted-Average Cost of Capital and Company Valuation

Why is it important to use market values rather than book values when determining the weighted-average cost of capital?

If a firm earns the WACC as an average return on its average-risk assets, then:

How much cash flow before tax and interest is necessary to support a project that requires $4 million annually for equity investors and $2 million annually in interest payments if the firm's tax rate is 35%?

When determining the costs of each component of a firm's capital structure, the firm must evaluate the:

Calculation of company costs of capital should be conducted with market values whenever possible. TRUE

The WACC is the rate of return that the firm must expect to earn on its average-risk investments in order to provide an acceptable return to its security holders.

There are two costs of debt finance.The explicit cost of debt is the rate of interest that bondholders demand.But there is also an implicit cost, because over-borrowing increases the required rate of return to equity.

The company cost of capital is the return that is expected on a portfolio of the company's:

What decision should be made on a project of above-average risk if the project's IRR exceeds the WACC?

What is the after-tax cost of preferred stock that pays a 12% dividend and sells at par if the firm's tax rate is 35%?

A company's CFO wants to maintain a target debt-to-equity ratio of 1/4.If the WACC is 18.6%, and the pretax cost of debt is 9.4%, what is the cost of common equity assuming a tax rate of 34%?

Can WACC be used to value an entire business?

With respect to the WACC:

An increase in a firm's debt ratio will have no effect on the required rate of return for equity holders.

In addition to the tax shield offered by the federal government, debt has a lower required rate of return than equity.Why is it not common to see firms that have much larger debt components in their capital structure?

If a company's cost of capital is less than the required return on equity, then the firm:

Which of the following changes would tend to increase the company cost of capital for a traditional firm?

How much will a firm need in cash flow before tax and interest to satisfy debt holders and equity holders if: the tax rate is 35%, there is $13 million in common stock requiring a 10% return, and $6 million in bonds requiring an 6% return? (Use the values in dollar.)