Smartbook 14
Dang's Donuts has EBIT of $25,432 Depreciation of $1,500 Tax rate of 21% The company will not be changing its net working capital but plans a capital expenditure of $6,324. what is Dang's adjusted cash flow from assets?
$15,267.28
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?
$50,000 950,000 = Amount Raised * (1 - 0.5) Amount Raised = $1,000,000 Flotation Costs = $1,000,000 - $950,000 = $50,000
What are the after-tax earnings for 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
$71.10 ($200 - $90 - $20) * (1 - 0.21) =
Including preferred stock in the WACC adds the term:
(P/V) * RP
Which of the following are true?
- ideally, we should use market values in the WACC - book values are often similar to market values for debt
A firm's cost of debt can be ___
- obtained by talking to investment bankers - obtained by checking yields on publicly traded bonds - estimated easier than its cost of equity
The growth rate of dividends can be found using:
- security analysts' forecasts - historical dividend growth rates
To estimate the growth rate of particular stock, we can ___
- use security analysts' forecasts - use the historical dividend growth rate
If a preferred stock pays a dividend of $2 per year and is selling for $20, its yield is:
10% $2 / $20 preferred stock price / stock sale price
A firm'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 preset value?
10% 0.4 * 2.5% + 0.6 * 15% =
MNO preferred stock pays a dividend of $2 per year and has a price of $20. If MNO's tax rate is 21%, the required rate of return on its preferred stock is ___ %
10% $2 / $20 =
A company has a borrowing rate of 15% and a tax rate of 21%. What is its aftertax cost of debt?
11.85% 15% * (1-.21) =
Which of the following are components used in the construction of the WACC?
Cost of debt Cost of common stock Cost of preferred stock
The CAPM formula is:
E(RE) = RF + B(E(RM)-RF)
What is the required return on a stock (RE), according to the constant dividend growth model, if the growth rate (g) is zero?
RE = D1 / P0
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:
[S/(S+B)] * RS + [B/(S+B)]*RB*(1-TC)
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
Flotation costs are costs incurred to ___
bring new security issues to the market
Dividends paid to common stockholders ___ be deducted from the payer's taxable income for tax purposes
cannot
WACC is used to discount ___ ___
cash flows
Which of the following are tax-deductible to the firm?
coupon interest paid on bonds
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
The most appropriate weights to use in the WACC are the ___ weight
market value
Other companies that specialize only in projects similar to the project your firm is considering are called ___
pure plays
A project should only be accepted if its return is above what is ___
required by investors
The CAPM can be used to estimate the ___
required return on equity
Finding a firm's overall cost of equity is difficult because:
there is no way of directly observing the return that the firm's equity investors require on their investment
If a firm uses its overall cost of capital to discount cash flows from higher risk projects, it will accept ___ projects
too many high-risk
What does WACC stand for?
weighted average cost of capital
Barry Corporation expects a 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?
$1,571,429 $110,000 / (0.12 - 0.05) = free cash flow / (WACC - expected growth rate) = current value
If the market value of debt is $45 million and the market value of equity is $105 million, the total firm value is...
$150 million market value of debt + market value of equity
ULC and LEV have earnings before interest and taxes of $110. LEV also has $20 of interest expense. Both companies are taxed at 21%, ULC's aftertax earnings are ___, which is ___ than LEV's after-tax earnings
$86.90 ULC's aftertax earnings ULC = $110 * (1 - 0.21) = $86.90 LEV = $90 * (1 - 0.21) = $71.10
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 NPV without flotation costs - flotation costs = true NPV
According the weighted average cost of capital (WACC) formula, a firm with no debt or preferred stock will have a WACC of:
1 * Cost of equity
A firm's capital structure consists of 30% debt and 70% equity. Its bond yield 10%, pretax, its cost of equity is 16%, and the tax rate is 21%. What is its WACC?
13.57% (0.7 * 0.16) + (0.3 * 0.1 * (1-0.21)) =
If an all-equity's firm 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% RE = 3% + 2 * 7%
A firm has 20% debt, debt flotation cost of 5%, equity flotation cost of 10%, and wants to raise $9,100, not including flotation costs. What are the flotation costs?
= (debt * debt flotation costs) + ((1-debt) * equity flotation cost) = (0.2 * 0.05) + ((1-0.2)*0.1) = 0.09 --> weighted average flotation cost = value to be raised / (1 - $9,100/(1-.09)-$9,100 $900
WACC was used to compute the following project NPVs: Project A = $100 Project B = -$50 Project C = -$10 Project D = $40 Which projects should the firm accept?
A and D
What can we say about dividends paid to common and preferred stockholders?
Dividends to preferred stockholders are fixed Dividends to common stockholders are NOT fixed
Which one of the following is true? 1. Under US tax law, all company interest payments are taxable to the company 2. Under international tax law, all company interest payments are taxable to the company 3. Under US tax law, a corporation's interest payments are tax-deductible 4. Under international tax law, all company interest payments are tax-deductible
Under US tax law, a corporation's interest payments are tax-deductible
If a firm has multiple projects, each project should be discounted using ___
a discount rate that commensurates with the project's risk
The bets way to include flotation costs is to ___
add them to the initial investment
The discount rate for the firm's project equals the cost of capital for the firm as a whole when___
all projects have the same risk as the current firm
To apply the dividend growth model to a particular stock, you need to assume that the firm's ___ will grow at a constant rate
dividend
One method for estimating the cost of equity is based on the ___ model
dividend growth
The return an investor in a security receives is ___ ___ the cost of security to the company that issued it
equal to
The return an investor in a security receives is ___ ___ the cost of the security to the company that issued it
equal to
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
If an all-equity firm discounts a project's cash flow 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
To estimate a firm's equity cost of capital using the CAPM, we need to know the ___
stock's beta market risk premium risk-free rate
The cost of capital is an appropriate name since a project must earn enough to pay those who ___ the capital
supply
Which of the following methods for calculating the cost of equity ignores risk?
the dividend growth model
The SML approach requires estimates of:
the market risk premium the beta coefficient
Economic Value Added (EVA) is a means of evaluating corporate performance?
True
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:
when economic conditions change quickly
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 Divisions' 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. More projects will be accepted in Division A. 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
Suppose the risk-free rate is 5%, the market rate of return is 10%, and beta is 2. Find the required rate of return using the CAPM
15% 5% + (2 * (10% - 5%)) =
A good source for bond quotes is:
www.finra.org/marketdata
A firm has a target debt-equity ratio of 0.5, but it has plans to finance a new project with all debt. What debt-equity ratio should be used when calculating the project's flotation costs?
0.5
