FIN 357 Final Ch.14 Cost of Capital

14. A projects NPV without flotation costs is $1,000,000 and its flotation costs are $50,000. What is the true NPV?

$1,000,000 - $50,000 = $950,000

14. Market value of debt is $45 million and the market value of equity is $105 million, the total firm value is _______ ?

$150 million

14. ULC and LEV have EBIT of $110. LEV also has $20 of interest expense. Both companies are taxed at 21% ULC's aftertax earnings are ______ than LEV's after tax earnings

$86.9; $15.8 greater than LEV

14. A firm needs to sell enough equity to raise $950,000 after covering the flotation costs of 5%. How much will it pay in flotation costs?

$950,000 = Amount Raised * (1-.05) Amount Raised = $1,000,000 Flotation Costs = $1,000,000 - $950,000 = $50,000

14. What are the after-tax earnings for HIJ Corporation if it reports $200 in revenue, $90 in operating expenses, has a tax rate of 21% and pays $20 in interest on its bonds

(200-90-20) * (1 - .21) = $71.1

14. Dividend growth method use? What does it ignore?

-Can be used to estimate the cost of equity -It ignores risk

14. According to WACC, a firm with no debt or preferred stock will have a WACC of?

1 * Cost of equity

14. MNO preferred stock pays a dividend of $2 per year and has a price of #20. If MNO's tax rate is 21%, the require rate of return on its preferred stock is ____ percent

2/20 = 10% PV = C/R -> $20 = $2/R

14. if a preferred stock pays a dividend of $2 per year and is selling for $20, its yield is?

2/20= 10%

14. a firms earnings growth is 7% and its dividend yield is 3%, its cost of equity will be?

7+3=10%

14. Flotation costs are costs incurred to _______

Bring new security issues to the market

14. firm faces a risk-free rate of 2%, a beta of 1, and a market risk premium of 4%. What is its cost of capital if it is an ALL EQUITY FIRM?

CAPM = .02 + 1*(.04) = 6%

14. The most appropriate weights to use in the WACC are the _____ weights.

Market Value

14. other companies that specialize only in projects similar to the project your firm is considering are called _____?

Pure plays

14. All-equity firm discounts a project's cash flows with the firm's overall weighted average cost of capital, even though the project's beta is less than the firm's overall beta, it is possible that the project might be? ____

REJECTED, when it should be accepted

14. Barry corp expects free cash flow of $110k at the end of the year, and steady growth from here on. Its WACC is 12% and its expected growth rate is 5%. What is the value of Barry Corp today?

Vo = CFA*/(WACC - g) $110,000/(.12-.05) = $1,571,429

14. -Capital structure consists of 40% debt and 60% equity -Aftertax yield on debt is 2.5% -Cost of equity is 15% What discount rate should be used to estimate the projects NET PRESENT VALUE?

WACC = (.4 x .025) + (.6 x .15) = 10%

14. -Capital structure consists of 30% debt and 70% equity. -Bonds yield 10%, -Pretax Cost of equity is 16% -tax rate is 21% What is the WACC?

WACC = (.7*.16) + (.3*.1*(1-.21)) = .1357

14. Best way to include flotation costs is to _____

add them to the initial investment

14. The discount rate for the firm's projects equals the cost of capital for the firm as a whole when _____

all projects have the same risk as the current firm

14. Tax-deductible by firms

coupon interest paid on bonds

14. Book values are often similar to Market values for _________ Ideally, we should use ______ values in the WACC

debt market

14. To apply the dividend growth model to a particular stock, you need to assume that the firm's _______ will grow at a constant rate

dividend

14. firm has 20% debt, debt flotation costs of 5%, equity flotation costs of 10%, and wants to raise $9,100, not including flotation costs. What are the flotation costs?

fA = (E/V * fE) + (D/V * fD) = (.8*.1) + (.2*.05) =9% true cost = 9100/.91 = $10,000 flotation costs = $10,000 * .09 = $900

14. Under US tax law, a corporations _______ payments are tax deductible

interest

14. Finding a firm's overall cost of equity is difficult because?

it cannot be observed directly

14. A project should only be accepted if its return is above what is ____

required by investors

14. If a firm uses its overall cost of capital to discount cash flows from higher risk projects, it will accept ______ projects.

too many high-risk

14. To estimate a firm's equity cost of capital using the CAPM, we need to know the _____ - -

-Market risk premium -Stock's beta -risk-free rate

14. Components used in the construction of the WACC? - - -

-Cost of common stock -Cost of debt -Cost of preferred stock

14. Preferred stock _____? - -

-Pays a constant Dividend -Pays dividens in perpetuity

14. The rate used to discount project cash flows is known as the _____? - - -

-Required return -Cost of capital -Discount rate

14. the growth rate of dividends can be found using: - -

-Security analysts forecasts -Historical dividend growth rates

14. The SML approach requires estimates of: - -

-The market risk premium -The Beta coefficient

14. A firms cost of debt can be found ____ - - -

-by checking yields on publicly traded bonds -estimated easier than its cost of equity -obtained by talking to investment bankers

14. In reality, most firms cover the equity portion of their capital spending with _____ important advantage to this?

-internally generated cash flow -not having to pay flotation costs

14. A company has a borrowing rate of 15% and a tax rate of 21%. Wat is its aftertax cost of debt?

.15*(1-.79)

14. Firm has a target debt-equity ratio of .5, but it plans to finance a new project with all debt. What debt-equity ratio should be used when calculating the projects flotation costs?

.5! The target debt-equity ratio should be used when calculating flotation costs

14. B= ___ S= ___ Rb= ___ Tc= ___ Rs= ___ WACC = [S/(S+B)]*Rs + [B/(S+B)] * Rb * (1-Tc) What do all the letters mean?

B= market value of a firms debt S= market value of that same firms equity Rb = the before-tax yield on the firm's debt Tc = the corporate tax rate Rs = cost of equity

14. Some risk adjustment to a firm's WACC for projects of differing risk, even if it is subjective, is probably: ?

Better than no risk adjustment

14. Dang's Donuts has EBIT of $25,432, depreciation of $1,500, and a tax rate of 21%. The company will not be changing its NWC, but plans a capital expenditure of $6,324. What is dangs adjust cash flow from assests?

CFA* = EBIT * (1-Tc) + depreciation - change in NWC - capital spending $25,432 * (1-.21) + $1,500 - 0 - $6,324 = $15,267.28

14. WACC is used to discount ____________ _______________

Cash Flows

14. The return an investor in a security receives is ____ _____ the cost of the security to the company that issued it.

Equal to

14. Projects should always be discounted at the firm's overall cost of capital? T/F

FALSE - projects discount rates should reflect their particular level of risk

14. Economic Value Added is a mean of evaluating corporate performance? T/F

T

14. According to CAPM, what is the expected return on a stock if its beta is equal to 0?

THE RISK-FREE RATE