ACT349H1F F07 Test 2 with solns v04 Privacy Code A

# ACT349H1F F07 Test 2 with solns v04 Privacy Code A - Your...

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UNIVERSITY OF TORONTO ACT349H1F FALL 2007 TERM TEST 2 ACT349H1F F07 Test 2 with solns v04 Privacy Code A 1. (Question of class October 17, 2007) You are given the following information for a corporation: Debt ratio D/(D+E) 0.7 Interest rate on debt rd: 5.50% Corporate tax rate T: 33.00% Market risk premium: 6.00% Risk-free interest rate: 5.00% Beta: 0.40 Calculate the after-tax WACC. (A) Less than 5.00% (B) 5.00% but less than 5.10% (C) 5.10% but less than 5.20% (D) 5.20% but less than 5.30% (E) 5.30% or more (A) Solution Debt ratio D/(D+E) 0.7 Interest rate on debt rd: 5.50% Corporate tax rate T: 33.00% Market risk premium: 6.00% Risk-free interest rate: 5.00% Beta: 0.40 Expected equity return: 7.40% WACC 4.80% E(R E ) = 5% + 0.40*6.00% = 7.400% WACC = = r D (1-T c ) D/V + r E E/V = 0.7 × (1-0.33) × 5.50% + 0.3 × 7.400% = 4.80%
UNIVERSITY OF TORONTO ACT349H1F FALL 2007 TERM TEST 2 ACT349H1F F07 Test 2 with solns v04 Privacy Code A 2. A cafe (just the business, not the building) will generate after-tax cash flows of \$225,000*(1.03) t for t=1, 2, 3, 4, 5. Then nothing. You use an after-tax rate of 10.21% per annum effective. What’s the maximum that you will pay for this business at time 0, just after any cash flow? (A)

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ACT349H1F F07 Test 2 with solns v04 Privacy Code A - Your...

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