Chapter 14

$900

A 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?

0.5

A firm has a target debt-equity ratio of 0.5, but it plans to finance a new project with all debt. With debt-equity ratio should be used when calculating the project's flotation costs?

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

A firm's cost of debt can be ____________.

10%

A firms's capital structure consists of 40% debt and 60% equity. The aftertax yield on debt is 2.5% and the cost of equity is 15%. The project is about as risky as the overall firm. What discount rate should be used to estimate the project's net present value?

www.finra.org/marketdata

A good source for bond quotes is:

Required by investors

A project should only be accepted if its return is above what is:

$950,000

A project's NPV without flotation costs is $1,000,000 and its flotation costs are $50,000. What is the true NPV? $950,000

$15,267.28 = $25,432 + $1,500 - $5,340.72 - $6,324

Dang's Donut has EBIT of $25,432 depreciation $1,500, and a tax rate of 21%. The company will not be changing it's net working capital, but plans a capital expenditure of $6,324. What is Dant's adjusted cash flow from assets?

cannot

Dividends paid to common stockholders ___ be deducted from the payer's taxable income for tax purposes.

There is no way of directly observing the return that the firm's equity investors require on their investment

Finding a firm's overall cost of equity is difficult because:

True

Ideally, we should use market values in the WACC.

10%

If a preferred stock pays a dividend of $2 per year and is selling for $20, its yield is:

internally generated cash flow

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

When economic conditions chage quickly.

One of the disadvantages of using historical returns to estimate the market risk premium is that the past may not be a good guide to the future:

- Pays a constant dividend - Pays dividens in prepetuity

Preferred stock ___

Divison B

Sigma Corporation consists of two divisions: A and B. Division A is riskier than Division B. If Sigma Corporation uses the firm's overall WACC to evaluare both Divisions' project, which division will probably not receive enough resources to fund all of its potentially profitable projects.

True

T or F: A company can deduct interest paid on debt when computing taxable income.

True

T or F: Book values are often similar to market values for debt.

True

T or F: Economic Value Added (EVA) is a mean of evaluting corporate performance.

False - Projects' discount rates should reflect their particular level or risk.

T or F: Projects should always be discounted at the firm's overall cost of capital.

required return on equity

The CAPM can be used to estimate the _______.

E(Rg) = Rf+ B(E(Rm)- Rf)

The CAPM formula is:

- The market risk premium -The beta coefficient

The SML approach requires estimates of:

- its bondholders - Its stockholders

The WACC is the minimum return a company needs to earn to satisfy:

All projects have the same risk as the current firm

The discount rate for the firm's projects equals the costs of capital for the firm as a whole when ____________.

Flotation

The issuance cost of bonds and stocks are referred to as ___ costs.

market value

The most appropriate weights to use in the WACC are the _____________ weights.

- Required return - Cost of capital - Discount rate

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

Equal to

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

$86.9; $15.8 greater ULC = $110*(1-.21) = $86.9 LEV = $90*(1-.21) = $71.1

ULC and LEV have earnings before interest and taxes of $110. LEV also has $20 of interest expens. Both companies are taxed at 21%, ULC's aftertax earnings are ___, which is ___ than LEV's aftertax earnings.

Cash flows

WACC is used to discount:

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

What are components used in the construction of the WACC?

- Dividens to common stockholders are not fixed - Dividens to preferred stockholders are fixed.

What can we say about the dividens paid to common and preferred stockholders?

The dividend growth mode

Which of the following methods for calculating the cost of equity ignores risk?

1 x Cost of Equity

According the weighted average cost of capital (WACC) formula, a firm with no debt or preferred stock will have a WACC of:

The risk-free rate

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

Flotation cost

An important advantage to a firm raising equity internally is not having to pay ____.

Rejected, when it should be accepted

If an 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:

17% Re= 3% + 2 x 7% =

If an all-equity firm's beta is 2, the risk-free rate is 3%, and the historical market risk premium is 7%, what is the firm's cost of capital?

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

To estimate a firm's quity cost of a capital using the CAPM, we need to know the:

- Use security analysts forecasts - Use the historical dividend growth rate

To estimate the growth rate of a particular stock, we can _____________.

[S/(S+B)] x Rs + [B/(S+B)] x Rs x (1-Tc)

B = the market value of a firm's debt;S = the market value of that same firm's equity;Rs = 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 :

$1,571,429 Vo= 110,000/(0.12-0.05)

Barry Corporation expects free cash flow of $110 thousand 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 Corporation today?

$150 Value = Debt + Equity so = $45 mil + $105 Mil

If the market value of debt is $45 million and the market value of equity is $105 million, the total firm value is ___ million.