Fin Mod 8

The WACC is computed as the weighted average of the cost of equity and the cost of debt. What would you use to compute the cost of equity?

All three: The CAPM, Gordon Growth Model, average return on the firm's equity over the last 5 years

A firm believes that demand and supply conditions are likely to remain the same for the next five years, so that the number of units sold will remain constant. It also expects inflation to be 5% a year for the next five year. Sales for the year just ended were $1m.

Forecasted revenues will rise to $1.05m next year and will increase at 5% per year for the next four years.

The WACC is used to discount project cashflows because:

It is the rate of return required by investors on projects of similar risk in the market place, firm's cost of funds, any projects not earning this rate will reduce the value of the firm,allll

The WACC computation requires you to use the weighted average of the after-tax cost of debt and the cost of equity, using appropriate proportions for debt and equity. Your firm's balance sheet shows $30m of debt and $70 of equity. The market value of your firm's equity is $120m. The new project is different from the existing projects that the firm has invested in; other firms that have investments similar to the new project tend to use a mix of 20% debt and 80% equity. Which of the following opinions regarding debt: equity proportions should you use in computing the WACC?

Sean disagrees with John and Frank and believes you should use 20:80 (i.e. 20%:80%) because that is the appropriate financing proportion for the current project; he thinks the firm's current financing practice is irrelevant.

The WACC is computed as the weighted average of the cost of equity and the cost of debt. The firm does not have any recently issued bonds. Which of these statements is correct?

The cost of debt is the yield on corporate bonds with the same bond rating as the firm's debt.

The WACC is computed as the weighted average of the cost of equity and the cost of debt. Which of these statements is correct? The cost of debt is:

The coupon rate on the firms' recently issue bond, if the bond was issued at par.

The discount rate to be used for discount cashflows from a project is:

WACC

Your project manager has forecast savings from a proposed investment to most likely be $10m a year for the next 10 years. However, he believes that there is a 10% chance that it will be $12m and a 10% chance that it will be $8m. You run the numbers and discover that the NPV on the project is negative using an $8m number for savings. You present your analysis to your colleagues and receive the following three opinions. Which opinion is the most correct

weighted average is positive so accept