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practice_final

# practice_final - UC Davis Graduate School of Management...

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UC - Davis Graduate School of Management Management 205 Brad M. Barber Financial Theory and Policy Winter 2007 Final Answer Key 1. Multiple Choice (20 points: 1 point each) Quest. Answer Quest. Answer Quest. Answer Quest. Answer 1 E 6 D 11 B 16 D 2 D 7 C 12 E 17 D 3 B 8 A 13 B 18 C 4 D 9 E 14 C 19 B 5 C 10 D 15 D 20 D 2. Capital Structure (25 points – 5 points each) A. The market value of equity is \$40 x 10 million = \$400 million. Based on data we reviewed in class (lecture note 9), this would put Koxinga in the small cap category. Large cap firms have market caps in excess of \$1 billion, and the top 20% of NYSE firms have mean market caps close to \$40 billion. B. With a market value of equity of \$400 million (see above) and a market value of debt of \$200 million, Koxinga’s capital structure is 1/3 debt and 2/3 equity. Thus, the WACC = 1/3 * 5% * (1-.40) + 2/3 * 20% = 14.33%. The weighted average cost of capital is the overall cost of Koxinga’s capital, weighted by the proportion debt and equity used to finance their operations. C. Koxinga should use its WACC to evaluate new projects that are similar in risk to its current operations. If the project has risk different from the firm’s current operations, Koxinga would need to adjust its WACC to reflect the risk of the project. If the project changes the firm’s capital structure, then the WACC should also be adjusted.

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D. Using the MM II propositions, we can calculate the firm’s all-equity cost of capital: () ( ) () () () % 54 . 16 3 . 1 215 . 015 . 0 3 . 0 % 20 % 40 1 % 5 400 200 % 20 1 0 0 0 0 0 0 0 = = + = + = + = r r r r r r r r S B r r b o s τ E. The MM II proposition adjusts the all-equity cost of capital to reflect the increased risk that
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practice_final - UC Davis Graduate School of Management...

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