WACC Review

If a firm has $10 million of debt with a debt beta of .4 and $30 million of equity with equity beta of 2, then the firm's asset beta is

($10/$40)(.4) + ($30/$40)(2) = 1.6

What are the after-tax earnings for HIJ Corporation if it reports $200 in revenue, $90 in operating expenses, has a tax rate of 30%, and pays $20 in interest on its bonds (assume all interest is tax deductible

($200 - $90 - $20) × (1 -0.3) = $63

A company has a borrowing rate of 15% and a tax rate of 30%. What is its aftertax cost of debt (assume all interest is tax deductible)?

15% × (1 - .3) = 10.5%

Suppose a 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?

2% + 1 × 4% = 6%

Which of the following are the more likely sources for a firm's forecasts of the market risk premium?

A consensus of forecasts Value Line The firm's own subjective forecast

Reed Machinery just signed a capital lease agreement with a present value of $130,000. How would this lease first appear on Reed Machinery's balance sheet?

Assets under capital lease $130,000; Obligations under capital lease $130,000

The dividend discount model for a stock can be generalized to the market as a whole.

Reason: According to the Wall Street Journal, the average dividend yield for the stocks that comprise the S&P 500 Index was approximately 1.8%.

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

Reason: f0 = .2 × 5% + .8 × 10% = 9% $9,100/(1 - .09) - $9,100 = $900

The market risk premium is defined as _

Rm-rf

Suppose a firm has a target debt-equity ratio of 2.5. What is the firm's target capital structure weight for common stock?

S/(S + B) = 1/3.5 = 28.57%

If a point plotted above the security market line (SML) represents a project being considered by an all-equity firm, the project's IRR must be greater than the cost of ______.

The cost of equity is the cost of capital for an all-equity firm

Suppose Bill's Burgers is considering acquiring Ken's Kampground. Ken's is not publicly traded, so Bill's estimates Ken's future cash flows and calculates the value of Ken's using its own (Bill's) WACC. What assumption of the WACC method is Bill's violating?

The use of Bill's WACC assumes Ken's has the same business risk as Bill's.

Which of the following variables do we need to compute the beta for a company's stock?

The variance of the market index's returns. The covariance between the stock and the market index's returns.

Which of the following are true about U.S. Treasury instruments?

They have never defaulted. They are not expected to default at this time.

ULC and LEV have earnings before interest and taxes of $110. LEV also has $20 of interest expense. Both companies are taxed at 30%, ULC's aftertax earnings are ___ , which is ___ than LEV's aftertax earnings (assume all interest can be deducted).

ULC = $110 × (1 - .3) = $77 LEV= $90 × (1 - .3) = $63

B = the market value of a firm's debt; S = the market value of that same firm's equity; RB = the before-tax yield on the firm's debt; TC = the corporate tax rate; RS = the cost of equity. Given the definitions above, the weighted average cost of capital formula can be written as:

[S/(S+B)]×RS + [B/(S+B)]×RB×(1-Tc)

Through standard regression technique, the intercept is commonly called

alpha

The covariance between the stock and the market index's returns divided by the variance of the market index's returns represents the

beta for a company's stock.

If the operations of a firm are different than its industry, the firm's

beta should be used to estimate the firm's cost of equity capital.

Flotation costs are costs incurred to

bring new security issues to the market

If a lease is for 35 years the IRS will classify the lease as

conditional sale

The discount rate of a project is said to be its

cost of capital

Dividends and capital gains given to the new shareholders represent

costs to the firm

A lease with which one of these characteristics would not be qualified by the IRS?

early-balloon payments

In reality, most firms cover the equity portion of their capital spending with

internally generated cash flow

A firm with debt in its capital structure is said to be:

levered

To estimate the dividend yield of a particular stock, we can

multiply last year's dividend by (1 + g) use security analysts' forecasts

When using the WACC to value an acquisition, one assumes debt-equity ratio will:

remain constant

The rate used to discount project cash flows is known as the

required return cost of capital discount rate

The CAPM can be used to estimate the _

required return on equity

Dividends and capital gains given to the new shareholders represent

returns to the shareholders

If Alby's leases equipment directly from the equipment's manufacturer the lease must be a:

sales-type lease

The ____ of the characteristic line of a stock's returns versus those of the market measures the stock's systematic risk.

slope, beta

The firm's cost of equity capital is

the required rate of return to the shareholders

The weighted average cost of capital (RWACC) is the overall expected return the firm must earn on its existing assets to maintain its

value

The weighted average cost of capital (RWACC) is the overall expected return the firm must earn on its existing assets to maintain its ___

value

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

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