FMGT 2201 - Ch 13
SkiFree Incorporated has $20 million of debt and $80 million of equity outstanding. The market cost of debt is 6% and the cost of equity is 12%. The firm has a 35% corporate tax rate. What is SkiFree's WACC?
10.38%
Vandalay Industries has $30 million of debt and $70 million of equity outstanding. The market cost of debt is 8% and the cost of equity is 14%. The firm has a 35% corporate tax rate. What is Vandalay's WACC?
11.36%
Martin Co. has issued preferred stock with an annual dividend of $6.00. The current market price per share of this preferred stock is $47.00. What is the expected return on the Martin preferred stock?
12.8%
Potter National Bank has a beta of 1.8. The risk-free rate is currently quoted at 1.5% and the expected market risk premium is 7.5%. What is Potter's cost of equity?
15.0%
Spock Enterprises has a market value of $100 million in debt outstanding. They also have a market value of equity of $400 million. Spock's capital structure is ____ percent debt and ____ percent equity.
20; 80
The firm's cost of equity is usually calculated using the _______ equation.
CAPM
T or F: It is acceptable to use book values of debt and equity to calculate the weights of debt and equity for the company cost of capital calculation.
False
A project requires a $1 million initial investment and has an expected after-tax cash flow of $2.4 million per year in perpetuity. The weighted-average cost of capital (WACC) is 13%. What is the net present value (NPV) of the project?
NPV = -$1 million + ($2.4 million/.13) = $17.46 million
Which of the following best describes the firm's capital structure?
The firm's mix of debt and equity financing
T or F: the market value and book value of debt are often very similar, so many financial managers use book value in WACC calculations.
True
Vandalay Industries has $30 million of debt, $10 million of preferred stock and $60 million of common stock outstanding. The market cost of debt is 8%, the cost of preferred is 9% and the cost of common equity is 14%. The firm has a 35% corporate tax rate. What is Vandalay's WACC?
WACC = [$30/$100 x (1-.35)x8%] + ($10/$100 x 9%) +($60/$100 x 14%) = (0.3)(0.65).08+ (0.1).09 + (0.6).14 = 10.86%
The WACC is the return the company needs to earn after tax in order to satisfy
all its security holders
The weighted average cost of capital is the expected rate of return investors would demand on a portfolio of:
all the firm's outstanding securities
The WACC is the appropriate discount rate for use with ______ projects but should be adjusted ______ for lower risk ones.
average; downward
The WACC is the appropriate discount rate for use with ______ projects but should be adjusted ______ for higher risk ones
average; upward
On a large and healthy firm, the use of yield to maturity as the cost of debt when calculating WACC is appropriate because
bankruptcy is sufficiently low
If the corporate tax rate is not zero, increasing the proportion of debt in the capital structure causes the WACC to _______.
change
Another name for the WACC is the ___________.
company cost of capital
The company cost of capital is calculated as a weighted average of the firm's _______ and _______.
debt; equity
Preferred stock is valued like a perpetuity. The price of a preferred stock is therefore equal to:
dividend/r preferred
The increase in the rate that bondholders demand as the amount of debt borrowed increases is called the _______ cost of debt.
explicit
The cash flow available to distribute to investors after paying for new investments or additions to working capital is a firm's:
free cash flow
The ______ cost of debt is the increase in the required return on common equity as the amount of debt borrowed increases.
implicit
When a project's cash flows are discounted at the WACC and the NPV is exactly zero, then those cash flows are _________ to give debtholders and shareholders the returns they require.
just enough
The cost of capital used by firms should be based on _____ values of the firm's securities.
market
Increasing the amount debt makes debt ______ risky and equity _____ risky.
more; more
Free cash flow is often ___ in the beginning years of a firm due to heavy initial investing.
negative
If a firm uses its book value of debt instead of its market value of debt to calculate its WACC, then its WACC will likely be:
only slightly off
The ________ is usually accepted as a firm's cost of debt capital for WACC calculations.
promised yield to maturity on the firm's existing bonds
If the corporate tax rate is zero, then increasing the proportion of debt in a firm's capital structure causes the WACC to _______.
remain unchanged
If a project has ______ NPV, then the expected cash flows, discounted at the WACC, are just sufficient to provide returns debtholders and shareholders require.
zero
