Question 1

Assume that Expansion Ltd is a diversified company that is considering an expansion project in a mining division.The company has a target debt-equity ratio of 1:2 and this ratio will not be affected by the new project.The company's manager has identified Dig-it-out Ltd as a company with the same business risk as the new project (equity beta of 1.5).Dig-it-out has a debt-equity ratio of 1:3.Estimate the project's cost of equity for Expansion if the risk-free rate of interest is 7 per cent and the risk premium of the market portfolio is 10 per cent.

Accepted Answer

A) 18.25% 
B) 22.0% 
C) 24.5% 
D) 23.88%

Question 2

If the preference shares are redeemable on a predetermined date,the calculation of the cost of preference shares is the same as the calculation of the:

Accepted Answer

A) effective interest rate on debt. 
B) marginal interest rate on debt. 
C) average interest rate on debt. 
D) cost of short-term debt.

Question 3

During the year,Success Ltd shares have increased from $8 to $9 and shareholders received a final dividend of 50 cents per share,fully franked at the company tax rate of 30 per cent.Calculate the dividend yield after personal taxes for shareholders with a tax rate of 47 per cent (using the beginning of the year share price)on Success shares.

Accepted Answer

A) 6.25% 
B) 4.7% 
C) 5% 
D) 6.7%

Question 4

The cost of capital of a project should never be estimated based on another listed company,even if that company's sole operations are of the same systematic risk as the project being assessed.

Accepted Answer

A) True 
 B)False

Question 5

If the cost of equity capital is 15% p.a. ,the market value of equity is $5 million,the company tax rate is 30%,the cost of debt is 12% p.a.and 
=0)60,what is the cost of capital?

Accepted Answer

A) 11.9% 
B) 11.7% 
C) 12.8% 
D) 12.6%

Question 6

From the estimates,calculate the return on equity (after tax)if Rf = 5%,E(Rm)= 13%,franking premium = 3%,beta = 1.5 and the corporate tax rate is 30 per cent.

Accepted Answer

A) 15.05% 
B) 21.5% 
C) 18.8% 
D) 15%

Question 7

For a diversified company,the use of the WACC is likely to result in incorrect investment decisions.

Accepted Answer

A) True 
 B)False

Question 8

Under what conditions can a company's current capital structure be used to calculate the weights for each source of funds?

Accepted Answer

A) When implementing a new project will alter a company's capital structure. 
B) When implementing a new project is not expected to alter a company's capital structure. 
C) When reliable market weights can be obtained. 
D) Only when preference shares are not included in the measure for WACC.

Question 9

The weighted average cost of capital is calculated as: k' = ke [E/V] + kd (1 - te)[D/V]

Accepted Answer

A) True 
 B)False

Question 10

From the following information,calculate the weighted average cost of debt:

Accepted Answer

A) 7.2% 
B) 5.6% 
C) 16.5% 
D) 8.8%

Question 11

Bank overdraft is not included in the calculation of the WACC.

Accepted Answer

A) True 
 B)False

Question 12

The ____________________ requires that the definition of cash flows in the numerator should match the definition of the discount rate in the denominator of a NPV calculation.

Accepted Answer

The answer of The ____________________ requires that the definition of...

Question 13

Under which of the following conditions is it appropriate to estimate a project's cost of capital using the company's cost of capital?

Accepted Answer

A) When a company is a diversified conglomerate. 
B) When the systematic risk of a project is similar to that of some other divisions. 
C) When a company operates in a sole industry. 
D) When a company operates in more than one industry but less than five.

Question 14

When can the cost of capital for a company as a whole be a valid measure of the cost of capital for a particular project?

Accepted Answer

A) When market data are available. 
B) When it is not practicable to estimate the cost of capital for individual projects. 
C) When the risk of a new project is the same as the risk of the company's existing assets. 
D) When CAPM is used as an EX POST model.

Question 15

The cost of capital is an ____________ because capital suppliers require a projects rate of return to be at least as high as the return they can obtain on other investments of equivalent risk.

Accepted Answer

The answer of The cost of capital is an ____________...

Question 16

The certainty equivalent approach to project valuation may have an advantage over the risk-adjusted discount rate approach when:

Accepted Answer

A) the certainty equivalent factor does not decrease at a constant rate. 
B) the certainty equivalent factor does decrease at a constant rate. 
C) valuing investments in government bonds. 
D) comparing projects of unequal lives.

Question 17

The cost of capital of a project:

Accepted Answer

A) depends on the characteristics of the company undertaking the project. 
B) depends on the characteristics of the investors. 
C) is considered on a project-by-project basis. 
D) depends on the correlation of the proposed project's cash flows with the existing cash flows of the company.

Question 18

The shares of ABC Ltd have a market price of $4 and an annual dividend of 17.5 cents per share fully franked at the tax rate of 30 per cent.Calculate the dividend yield on the shares of ABC that would be reported in the financial press.

Accepted Answer

A) 22.85% 
B) 4.375% 
C) 1.312% 
D) Cannot be calculated as not enough information is provided.

Question 19

A problem with the dividend growth model is:

Accepted Answer

A) that it is difficult to estimate the value of any tax credits. 
B) that it is difficult to obtain market prices for shares listed on the stock exchange. 
C) that it is extremely sensitive to estimates of the future growth rate in dividends. 
D) none of the given options.

Question 20

Calculate the cost of equity capital using CAPM if the risk-free rate of interest is 5 per cent,the return on the market portfolio is 12 per cent,beta is 0.8 and the franking premium is 2 per cent.

Accepted Answer

A) 10.6% 
B) 14% 
C) 12.2% 
D) 12%

Exam 14: The Cost of Capital and Taxation Issues in Project Evaluation

If the preference shares are redeemable on a predetermined date,the calculation of the cost of preference shares is the same as the calculation of the:

The cost of capital of a project should never be estimated based on another listed company,even if that company's sole operations are of the same systematic risk as the project being assessed.

If the cost of equity capital is 15% p.a. ,the market value of equity is $5 million,the company tax rate is 30%,the cost of debt is 12% p.a.and =0) 60,what is the cost of capital?

From the estimates,calculate the return on equity (after tax) if Rf = 5%,E(Rm) = 13%,franking premium = 3%,beta = 1.5 and the corporate tax rate is 30 per cent.

For a diversified company,the use of the WACC is likely to result in incorrect investment decisions.

Under what conditions can a company's current capital structure be used to calculate the weights for each source of funds?

The weighted average cost of capital is calculated as: k' = ke [E/V] + kd (1 - te)[D/V]

From the following information,calculate the weighted average cost of debt:

Bank overdraft is not included in the calculation of the WACC.

The ____________________ requires that the definition of cash flows in the numerator should match the definition of the discount rate in the denominator of a NPV calculation.

Under which of the following conditions is it appropriate to estimate a project's cost of capital using the company's cost of capital?

When can the cost of capital for a company as a whole be a valid measure of the cost of capital for a particular project?

The cost of capital is an ____________ because capital suppliers require a projects rate of return to be at least as high as the return they can obtain on other investments of equivalent risk.

The certainty equivalent approach to project valuation may have an advantage over the risk-adjusted discount rate approach when:

The cost of capital of a project:

The shares of ABC Ltd have a market price of $4 and an annual dividend of 17.5 cents per share fully franked at the tax rate of 30 per cent.Calculate the dividend yield on the shares of ABC that would be reported in the financial press.

A problem with the dividend growth model is:

Calculate the cost of equity capital using CAPM if the risk-free rate of interest is 5 per cent,the return on the market portfolio is 12 per cent,beta is 0.8 and the franking premium is 2 per cent.