Fin 357 Chapter 14 Learn Smart

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

Including preferred stock in the WACC formula adds which term if P is the market value of preferred stock and Rp is the cost of preferred?

(P/V) + Rp

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

0.5

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

= 10% = 2/20

WACC is used to compute the following project NPV's: A = $100 B = $50 C = -$10 D = $40 which projects should the firm accept?

A, B, and D

the discount rate for the firm's projects = the cost of capital for the firm as a whole when

all projects have the same risk as the current firm

flotation costs are incurred to _______

bring new security issues to the market

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

equal to

If the firm is all-equity, the discount rate is equal to the firm's cost of _____ capital

equity

the issuance costs of bonds and stocks are referred to as _____ costs

flotation

an important advantage to a firm raising equity internally is not having to pay_____

flotation costs

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

internally generated cash flow new common stock issues are rare

the most appropriate weights to use in the WACC are the ____ weights

market value

Other companies that specialize only in projects similar to the project your firm is considering are called _____.

pure plays

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:

rejected when it should be accepted if the project's beta is less than the firm's overall beta, its cost of capital will be less than the overall cost of capital, and if the overall cost of capital is used, the project's cash flows will be discounted too severely, and it will most likely be rejected

a project should only be accepted if its rate of return is above what is ______

required by investors

The SML approach requires estimates of:

the market risk premium and the beta coefficient

If a firm uses its overall cost of capital to discount cash flows from projects in higher risk divisions, it will accept ____ projects.

too many high-risk if a firm uses a discount rate that is too low, it will accept projects that are too risky, and thus potentially reduce its profits

what are the after-tax earnings of HIJ corporation if it reports $200 in revenue , $90 in operating expenses, has a tax rate of 21% , and pays $20 in interest on its bonds

= $71.1 EBT= (revenue - operating expenses - interest) EBT= 90 = 200 - 90- 2 after tax earnings = EBT - (Tc * EBT) = 90 - (0.21 * 90)

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?

= $900 9% = 0.2* 0.05 + 0.8* 0.1 $9,100*(1 - 0.09) -$9,100 = $900

MNO preferred stock pays a dividend of $2 per year and has a price of $20. If MNO's tax rate is 40%, the after-tax rate of return on its preferred stock is:

= 10

If an analyst's forecast for a firm's earnings growth is 7%, and its dividend yield is 3%, its cost of equity will be _____.

= 10% R(E) = D1/P0 + g = 0.03 + 0.007

a firm's capital structure consists of 40% debt and 604% equity. the after-tax 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?

= 10% WACC = 0.4 * 0.025 + 0.6 * 0.15

a company has a borrowing rate of 15% and a tax rate of 21%. what is its after-tax cost of debt

= 11.85% After tax cost of debt = RD * (1 - Tc) 0.15 * (1 - 0.21)

a firm's capital structure consists of 30% debt and 70% equity. It's bonds yield 10% pretax. its cost of equity is 16%, and the tac rate is 21%. what is WACC

= 13.57% (0.7 * 0.16) + (0.3 * 0.1 * (1 - 0.21))

Suppose the risk-free rate is 5 percent, the market rate of return is 10 percent, and beta is 2. Find the required rate of return using the CAPM

= 15% R(E) = Rf + B*[Rm - Rf] 0.05 + 2*( 0.1 - 0.05)

if the market value of debt is $45MM and the market value of equity is $105MM, the total firm value is _______

= 150 Value= Equity + debt V = E + D = 105 + 45

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?

= 17% R(E) = Rf + B*[Rm - Rf] 0.03 + 2*( 0.07 )

which of the following variables is NOT required when using the CAPM to compute the cost of equity capital? a.) the market risk premium b.) the rate of inflation c.) the risk-free rate d.) the stock's beta

b

Which of the following are components used in the construction of WACC: a.) cost of accounts payable b.) cost of common stock c.) cost of debt d.) cost of preferred stock

b, c, and d

which of the following are tax-deductible to the firm? a.) dividends paid on preferred stock b.) principal amounts paid on debt c.) coupon interest payments on bonds d.) dividends paid on common stock

c

which of the following is true: a.) a company can deduct dividends paid to shareholders when computing its taxable income b.) a company cannot deduct interest paid on debt when computing taxable income c.) a company can deduct interest paid on debt when computing taxable income

c interest paid by a corporation is deductible for tax purposes. payments to stockholders, such as dividends are not.

preferred stock: a.) does not pay dividends b.) has a fixed maturity c.) pays a constant dividend d.) pays dividends in perpetuity

c and d

what can we say about the dividends paid to common and preferred stock holders: a.) dividends are guaranteed for both preferred and common stockholders b.) preferred stock dividends change every year based on the earnings of a firm c.) dividends to common stockholders are not fixed d.) dividends to preferred stockholders are fixed

c and d

The CAPM formula can be used to estimate:

required return on equity

Barry corporation expects free cash flow of $110,000 at the end of the year, and steady growth from here on. WACC is 12% and its expected growth rate is 5%. what is the value of Barry corporation today?

= $1,571

barry corporation expects free cash flow of $110,000 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?

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

dang's donuts has an EBIT of $25432, depreciation of $1500, and a tax rate of 21%. The company will not be changing its net working capital, but plans a capital expenditure of $6324. what is Dang's adjusted cash flow from assets?

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

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

= $50,000 amount raised * (1 - 0.05) Amount raised = $1,000,000 flotation costs = $1,000,000 - $950,000

the CAPM formula is:

E(RE) = Rf + B*[(Rm) - Rf)

the formula for calculating the cost of equity capital that is based on the dividend discount model is:

R(E) = D1/P0 + g

the market risk premium is defined as:

Rm - Rf

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:

WACC = [S/(S + B)] * Rs + ([B/(S +B)] *Rb) * (1 - Tc)

What doe WACC stand for?

Weighted average cost of capital

to estimate the growth rate of a particular stock we can: a.) use security analyst's forecasts b.) use the historical dividend growth rate c.) use the average bank's CD rate d.) use the average market's dividend yield

a and b

which of the following are true: a.) book values are often similar to market values for debt b.) ideally, we should use market values in the WACC c.) boo values are often similar to market values for equity d.) ideally, we should use the book values for WACC

a and b

If a firm has multiple projects, each project should be discounted using ___.

a discount rate that commensurates with the project's risk

a firm's cost of debt can be : a.) obtained by talking to investment bankers b.) calculated by using dividend growth model c.) obtained by checking yields on publicly traded bonds d.) estimated easier than its cost of equity

a, c, and d

the best way to include flotation costs is to ______

add them to the initial investment

Some risk adjustment to a firm's WACC for projects of differing risk, even if it is subjective, is probably:

better than no risk adjustment

WACC is used to discount

cash flows

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

cost of capital, required rate of return, discount rate

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 evaluate both Division's projects, which Division will probably not receive enough resources to fund all of its potentially profitable projects?

division b division a is riskier, so its cash flows should be discounted at a higher rate. because they're not, the projects in division a will look better than those in division b. division b's cash flows will be discounted using a higher rate than should be used, so they will appear less appealing and will be more often rejected

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

it cannot be observed directly

which of the following approaches ignores risk

the dividend growth approach

Economic Value Added (EVA) is a mean of evaluating corporate performance

true