Module 5: Examining the WACC

Suppose the risk-free rate, rf, is 3.00% and the market risk premium, (rm-Suppose the risk-free rate, rf, is 3.00% and the market risk premium, (rm-rf), is 6.00%. Acme Widgets is an all equity-financed firm with a stock β of 1.25. Acme's management is deciding whether to invest in a project that has "typical" risk (i.e., a project with a β of 1.25). What internal rate of return (IRR) will the project need to hurdle over if it is to be accepted?

10.%

Suppose the risk-free rate, rf, is 3.00% and the market risk premium, (rm-rf), is 6.00%. Acme Widgets is an all equity-financed firm with a stock β of 1.25. What expected rate will investors who buy the Acme's stock require?

10.50%

What is the rate required by BRT's equity holders? The risk-free rate is 6.35%. The market risk premium is 5.00%. The beta for BRT's stock is estimated to be 1.82.

15.45%

What is the market value of BRT's equity?

20 x 37 = 740

What percentage of BRT's enterprise value is attributable to debt?

26%

What is the book value of BRT's debt?

260 million

Suppose the risk-free rate, rf, is 3.00% and the market risk premium, (rm-rf), is 6.00%. What is the expected return for a stock with a β of 0.50?

6%

What percentage of BRT's enterprise value is attributable to equity?

74%

Teldar Paper is estimating its WACC. Teldar's capital structure weights on debt, preferred stock, and equity are 40%, 10%, and 50%, respectively. Its corporate tax rate is 35%. The expected returns required by holders of debt, preferred stock, and equity are 6.00%, 8.00%, and 11.50%, respectively. What is Teldar's WACC?

8.11%

WrenMart is estimating its WACC. WrenMart's capital structure weights on debt, preferred stock, and equity are 27%, 0%, and 73%, respectively. Its corporate tax rate is 25%. The expected returns required by holders of debt and equity are 7.47% and 9.30%, respectively. What is WrenMart's WACC?

8.3%

What is BRT's after-tax cost of debt? BRT has a $260 million commercial bank loan at 9.70%. BRT is in the 35% tax bracket.

9.7% x .35 = 6.3%

Which one of the following payments to a firm's providers of capital is a tax-deductible expense?

Interest paid to a firm's debt holders

If the theory that investors are risk averse is true, then what empirical relationship do we expect to observe across financial securities?

Over long periods, securities with more variable returns ought to show higher average returns.

Teldar Paper has estimated its WACC to be 8.11%. Teldar's management is deciding whether to invest in a project that has "typical" risk (i.e., a project with a risk profile that is average for the firm). What must be true if Teldar's management is to accept the project?

The project's internal rate of return (IRR) must exceed the WACC of 8.11%.

Acme's management is deciding whether to invest in a project that has "typical" risk (i.e., a project with a β of 1.25). The project offers an internal rate of return (IRR) of 8.00%. Should the project be accepted?

reject

WACC results, a percentage means that the investors can take their money__

somewhere else with the same risk ( so we can to compare it with the IRR)

debt is __

tax deductile (tax rat)

Consider drawing a best fit line drawn through a plot of a stock's return against the market return. The steeper the slope of the best fit line, then:

the higher the stock's estimated β.

The higher is a stock's estimated β:

the more we expect the stock's price to fall when the market is down, and the more we expect the stock's price to increase when the market is up.

What is BRT's WACC?

xx

WACC(hurdle rate) is the overall rate required by the _____

firm's provider of capital - debt and equity holders

WACC is not a fact but a ___

guestimation (educated guess)

Enterprise value?

Enterprise value is the sum of the market value of debt and equity. 1 BILLION

Acme's management is deciding whether to invest in a project that has "typical" risk (i.e., a project with a β of 1.25). The project offers an internal rate of return (IRR) of 14.00%. Should the project be accepted?

accept

For WACC, beta is the same for __ and __

assets and equity