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Unformatted text preview: Exercise for Topic 11
1. What appears to be the targeted debt ratio of a firm that issues $20
million in bonds and $30 million in equity to finance its new capital
projects?
a.
b.
c.
d. 15.00%
20.00%
40.00%
66.67% 2 proposed assets can be evaluated using the company cost of capital
providing that the:
a.
b.
c.
d. firm does not pay taxes.
firm is all equity financed.
cost of debt is less than the cost of equity.
new assets have the same risk as existing assets. 3. The company cost of capital for a firm with a 40/60 debt/equity split,
8% cost of debt, 15% cost of equity, and a 40% tax rate would be:
a.
b.
c.
d. 8.88%
10.80%
10.92%
12.20% 4. Why is debt financing said to include a tax shield for the company?
a.
b.
c.
d. Taxes are reduced by the amount of the debt.
Taxes are reduced by the amount of the interest.
Taxable income is reduced by the amount of the debt.
Taxable income is reduced by the amount of the interest. 5. What is the pretax cost of debt for a firm in the 40% tax bracket that
has a 10% aftertax cost of debt?
a.
b.
c.
d. 4.00%
6.00%
16.67%
25.00% 6. How much is added to a firm’s weighted average cost of capital for 50%
debt financing with a required rate of return of 12% and a tax rate of 35%?
a.
b.
c.
d. 3.9%
4.2%
6.0%
7.8% 7. What is the WACC for a firm with 60% debt and 40% equity that pays
12% on its debt, 20% on its equity, and has a 40% tax rate?
a.
b.
c.
d. 9.12%
12.00%
12.32%
15.20% 8. Company X has 2 million shares of common stock outstanding at a book
value of $2 per share. The stock trades for $2.50 per share. It also has $2.
million in face value of debt that trades at 120% of par. What is its ratio of
debt to value for WACC purposes?
a.
b.
c.
d. 16. 67%
19. 36%
20. 00%
25. 00% 9. What is the aftertax cost of preferred stock that sells for $5 per share
and offers a 75 cents dividend when the tax rate is 35%?
a.
b.
c.
d. 6.67%
9.75%
10.50%
15.00% 10. What is the WACC for a firm using 65% equity with a required return of
25%, 25% debt with a required return of 6%, 10% preferred stock with a
required return of 10%, and a tax rate of 35%?
a.
b.
c.
d. 10.333%
11.325%
11.725%
12.250% 11. Should a project be accepted if it offers an annual aftertax cash flow of
$2 million indefinitely, costs $10 million, is riskier than the firm’s average
projects, and the firm uses a 20% WACC?
a.
b.
c.
d. Yes, since NPV is positive.
Yes, since a zero NPV indicates marginal acceptability.
No, since NPV is zero.
No, since NPV is negative. 12. How much will a firm need in cash flow before tax and to satisfy
debtholder and equityholde if: the tax rate is 40%, there is $10 million in
common stock requiring a 14% return, and $7 million in bonds requiring an
8% return?
a.
b.
c.
d. $1,960,000
$2,744,000
$2,893,333
$3,266,666 13. Which of the following statements is incorrect the equity component of
the WACC?
a.
b.
c.
d. The value of retained earnings is not included
Market values should be used in the calculations
Preferred equity has a separate component
There is a tax shield such as with debt. 14. What will be the effect of using book valued of debt in WACC decisions
if interest rates have increased substantially since a firm’s longterm bonds
were issued?
a.
b.
c.
d. The debttovalue will be overstated
The debttovalue will be understated
There will be no effect on WACC decisions.
Cannot be determined without knowing interest rates. 15. Which component is more likely to be biased if book value is used in the
calculation of WACC rather than market values?
a.
b.
c.
d. Debt
Preferred stock
Common Stock
All categories should be equally biases 16. What would you estimate to be the required rate of return for equity
investors if a stock sells for $30 and will pay a $3.6 dividend that is expected
to grow at a constant rate of 4%?
a.
b.
c.
d. 7.6%
12.0%
12.6%
16.0% 17.
What is the expected growth rate in dividends for a firm in which
shareholders require a 16% rate of return and the dividend yield is 7%?
a.
b.
c.
d. 7%
9%
16%
23% 18.
What dividend is paid on preferred stock if investors require an 8%
rate of return and the stock has a market value of $50.00 per share and a
book value of $52.00 per share?
a.
b.
c.
d. $1.60
$4.00
$4.16
$8.00 19. If a firm earns the WACO as an average return on its averagerisk assets,
then:
a.
b.
c.
d. equityholders will be satisfied, but bondholders will not.
bondholders will be satisfied, but equityholders will not.
all investors will earn their minimum required rate of return.
the firm is investing in negative NPV projects. 20. As debt is added to the capital structure, the:
a.
b.
c.
d. WACO will Continually decline.
WACO will continually increase.
cost of debt can be expected to rise.
WACO will be unaffected. 21. An implicit cost of increasing the proportion of debt in a firm’s capital
structure is that:
a.
b.
c.
d. the firm’s asset beta will increase.
equityholders will demand a higher rate of return.
the tax shield will not apply to the added debt.
the equitytovalue ratio will decrease. ...
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 Spring '09
 EMA

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