Question 1

SAP Inc. received a $1.5 million grant under its Small Business Innovation program. SAP invested the grant money and developed a system to remove metal contaminants from storm water in shipyards. The firm estimates that each shipyard spends $500,000 a year on storm water clean-up efforts. If SAP is able to sign up and retain four shipyards in the first year onwards, what is the present value (PV)of the project (net of investment)if the cost of capital for SAP is 14% per year? Assume a cost of operations and other costs for SAP equal 50% of revenue.

Accepted Answer

A) $4.51 million 
B) $4.80 million 
C) $5.93 million 
D) $5.64 million

Question 2

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

Accepted Answer

A) equity 
B) debt 
C) preferred stock 
D) retained earnings

Question 3

Anheuser Busch, a manufacturer of beverages, is planning to purchase Six Flags theme parks. Anheuser Busch should use the ________ to evaluate the business of Six Flags.

Accepted Answer

A) WACC of Anheuser Busch 
B) WACC of Six Flags 
C) average market return 
D) divisional cost of capital

Question 4

The WACC does not depend on the risk of a company's line of business.

Accepted Answer

A) True 
 B)False

Question 5

Epiphany is an all-equity firm with an estimated market value of $500,000. The firm sells $150,000 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

A) 0.15, 0.85 
B) 0.18, 0.82 
C) 0.30, 0.70 
D) 0.70, 0.30

Question 6

Assume Ford Motors expects a new hybrid-engine project to produce incremental cash flows of $90 million each year and expects these to grow at 3% each year. The upfront project costs are $900 million and Ford's weighted average cost of capital is 9%. If the issuance costs for external finances are $20 million, what is the net present value (NPV)of the project?

Accepted Answer

A) $986 million 
B) $696 million 
C) $609 million 
D) $580 million

Question 7

Your estimate of the market risk premium is 6%. The risk-free rate of return is 4% and General Motors has a beta of 1.4. What is General Motors' cost of equity capital?

Accepted Answer

A) 11.2% 
B) 12.4% 
C) 11.8% 
D) 13.0%

Question 8

Your estimate of the market risk premium is 9%. The risk-free rate of return is 4.1% and General Motors has a beta of 1.8. What is General Motors' cost of equity capital?

Accepted Answer

A) 20.3% 
B) 18.3% 
C) 19.3% 
D) 21.3%

Question 9

A firm has $2 million market value and it sells preferred stock with a par value of $100. If the coupon rate on the preferred stock is 6% and the preferred stock trades at $98, what is the cost of preferred stock capital?

Accepted Answer

A) 5.82% 
B) 6.12% 
C) 6.43% 
D) 6.73%

Question 10

A firm is considering investing in a new project with an upfront cost of $400 million. The project will generate an incremental free cash flow of $50 million in the first year and this cash flow is expected to grow at an annual rate of 3% forever. If the firm's WACC is 12%, what is the value of this project?

Accepted Answer

A) $155.6 million 
B) $555.6 million 
C) $583.3 million 
D) $183.3 million

Question 11

When a firm is evaluating the purchase of a business that is unrelated to its current business, it is appropriate to use the current WACC of the firm that is purchasing the business.

Accepted Answer

A) True 
 B)False

Question 12

The ________ of a firm's debt can be used as the firm's current cost of debt.

Accepted Answer

A) current yield 
B) coupon rate 
C) yield to maturity 
D) discount yield

Question 13

Assume SAP Inc. received a $1 million grant under its Small Business Innovation program. SAP invested the grant money and developed a system to remove metal contaminants from storm water in shipyards. The firm estimates that each shipyard spends $500,000 a year on storm water clean-up efforts. If SAP is able to sign up and retain four shipyards from the first year onwards, what is the present value (PV)of the project (net of investment)if the cost of capital for SAP is 20% per year? Assume a cost of operations and other costs for SAP equal 60% of revenue.

Accepted Answer

A) $3.00 million 
B) $3.30 million 
C) 3.60 million 
D) $3.90 million

Question 14

The outstanding debt of Berstin Corp. has eight years to maturity, a current yield of 7%, and a price of $85. What is the pretax cost of debt if the tax rate is 40%?

Accepted Answer

A) 5.1% 
B) 5.9% 
C) 8.5% 
D) more information needed

Question 15

A firm incurs $40,000 in interest expenses each year. If the tax rate of the firm is 30%, what is the effective after-tax interest rate expense for the firm?

Accepted Answer

A) $21,000.00 
B) $22,400.00 
C) $23,800.00 
D) $28,000.00

Question 16

A firm's cost of debt is the rate of interest it would have to pay to refinance its existing debt.

Accepted Answer

A) True 
 B)False

Question 17

An all-equity firm had a dividend expense of $30,000 last year. The market value of the firm is $900,000 and the dividend is expected to increase at 6% each year. What is the cost of equity for this firm?

Accepted Answer

A) 9.53% 
B) 10.01% 
C) 10.96% 
D) 11.44%

Question 18

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

Accepted Answer

A) $150 million 
B) $160 million 
C) $260 million 
D) $250 million

Question 19

Holding everything else constant, an increase in cash ________ a firm's net debt.

Accepted Answer

A) will decrease 
B) will have no impact on 
C) will increase 
D) may increase or decrease

Question 20

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

Accepted Answer

A) yield on the traded debt 
B) Capital Asset Pricing Model 
C) dividend yield 
D) preferred stock yield

Exam 13: The Cost of Capital

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

Anheuser Busch, a manufacturer of beverages, is planning to purchase Six Flags theme parks. Anheuser Busch should use the ________ to evaluate the business of Six Flags.

The WACC does not depend on the risk of a company's line of business.

Epiphany is an all-equity firm with an estimated market value of $500,000. The firm sells $150,000 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.

Your estimate of the market risk premium is 6%. The risk-free rate of return is 4% and General Motors has a beta of 1.4. What is General Motors' cost of equity capital?

Your estimate of the market risk premium is 9%. The risk-free rate of return is 4.1% and General Motors has a beta of 1.8. What is General Motors' cost of equity capital?

A firm has $2 million market value and it sells preferred stock with a par value of $100. If the coupon rate on the preferred stock is 6% and the preferred stock trades at $98, what is the cost of preferred stock capital?

When a firm is evaluating the purchase of a business that is unrelated to its current business, it is appropriate to use the current WACC of the firm that is purchasing the business.

The ________ of a firm's debt can be used as the firm's current cost of debt.

The outstanding debt of Berstin Corp. has eight years to maturity, a current yield of 7%, and a price of $85. What is the pretax cost of debt if the tax rate is 40%?

A firm incurs $40,000 in interest expenses each year. If the tax rate of the firm is 30%, what is the effective after-tax interest rate expense for the firm?

A firm's cost of debt is the rate of interest it would have to pay to refinance its existing debt.

An all-equity firm had a dividend expense of $30,000 last year. The market value of the firm is $900,000 and the dividend is expected to increase at 6% each year. What is the cost of equity for this firm?

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

Holding everything else constant, an increase in cash ________ a firm's net debt.

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