# 2023 1 The weighted average cost of capital is the return the company needs to earn

2023 1 The weighted average cost of capital is the return the company needs to earn

 1. The weighted-average cost of capital is the return the company needs to earn after tax in order to satisfy all its security holders.  (Points : 5)

True
False

 Question 2. Why is debt financing said to include a tax shield for the company?  (Points : 5)

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.

 Question 3. What is the WACC for a firm with 50% debt and 50% equity that pays 12% on its debt, 20% on its equity, and has a 40% tax rate?  (Points : 5)

9.6%
12.0%
13.6%
16.0%

 Question 4. Calculate a firm’s WACC given that the total value of the firm is \$2,000,000, \$600,000 of which is debt, the cost of debt and equity is 10% and 15%, respectively, and the firm pays no taxes.  (Points : 5)

9%
11.5%
13.5%
14.4%

 Question 5. A company’s CFO wants to maintain a target debt-to-equity ratio of 1/4. If the WACC is 18.6%, and the pretax cost of debt is 9.4%, what is the cost of common equity assuming a tax rate of 34%?  (Points : 5)

19.90%
20.90%
21.70%
22.73%

 Question 6. If a firm has three times as much equity as debt in its capital structure, then the firm has:  (Points : 5)

25% debt
66.7% equity
40% debt
33.3% equity

 Question 7. What is the WACC for a firm with 40% debt, 20% preferred stock, and 40% equity if the respective costs for these components are 6% after tax, 12% after tax, and 18% before tax? The firm’s tax rate is 35%.  (Points : 5)

9.48%
11.16%
12.00%
15.60%

 Question 8. What is the WACC for a firm with 40% debt, 20% preferred stock, and 40% equity if the respective costs for these components are 9.23% before tax, 12% after tax, and 18% before tax? The firm’s tax rate is 35%.  (Points : 5)

9.48%
11.16%
12.00%
15.60%

 Question 9.  Based on the following information, make an estimate of the stock’s beta: Month 1 = Stock +1.5%, Market +1.1%; Month 2 = Stock +2.0%, Market +1.4%; Month 3 = Stock -2.5%, Market -2.0%.  (Points : 5)

Beta is greater than 1.0.

Beta is less than 1.0.

Beta equals 1.0.

There is no consistent pattern of returns.

 Question 10. Calculate the risk premium on stock C given the following information: risk-free rate = 5%, market return = 13%, stock C beta = 1.3. (Points : 5)

8%
10.4%
15.4%
16.9%

 Question 11.If Treasury bills yield 6.0% and the market risk premium is 9.0%, then a portfolio with a beta of 1.5 would be expected to yield:  (Points : 5)

12%
17%
19.5%
21.5%

 Question 12. An investor was expecting an 18% return on his portfolio with beta of 1.25 before the market risk premium increased from 8 to 10%. Based on this change, what return will now be expected on the portfolio?  (Points : 5)

20%
20.5%
22.5%
26%

 Question 13.What is the beta of a company with an expected return of 12% if Treasury bills yield 6% and the market risk premium is 8%?  (Points : 5)

0.5
0.75
0.9
1.5

 Question 14. A stock’s risk premium is equal to the:  (Points : 5)

expected market return times beta.

Risk-free return plus expected market return.

expected market risk premium multiplied by beta plus the risk-free return.

expected market risk premium times beta.

 Question 15. If a project is expected to increase inventory by \$17,000, increase accounts payable by \$10,000, and decrease accounts receivable by \$1,000, what effect does working capital have during the life of the project?  (Points : 5)

Increases NWC by \$4,000.

Increases NWC by \$5,000.

Increases NWC by \$6,000.

Working capital has no effect during the life of the project.

 Question 16. How does net working capital affect the NPV of a 5-year project if working capital is expected to increase by \$25,000 at end of 5 years and the firm has a 15% cost of capital?  (Points : 5)

NPV will increase by \$9,322.

NPV will increase by \$12,571.

NPV will decrease by \$25,000.

NPV will decrease by \$12,571.

 Question 17. Please consider the following information for the next 4 questions (Q17 – Q20). TAMU Inc. is for sale and there is a price tag of \$225,000. Your company, ABC, who is considering the purchase, has a beta of 1.5, the market is expected to have a 20% return and the risk-free rate is 5%. The forecasted free cash flows for the next 4 years for TAMU are 7000 (FCF1), 22000(FCF2), 0(FCF3), and 50000 (FCF4). The company is expected to grow at 4% indefinitely after that. Your company has a debt/equity ratio of 2/3 and the applicable tax rate is 35%. ABC’s cost of debt (before taxes) is 8%. What is the cost of equity for ABC company? (Points : 5)

35%
30%
27.5%
22.5%

 Question 18. Continuing with the information from Q17, what is ABC’s WACC? (Points : 5)

18.58%
19.70%
21.41%
15.88%

 Question 19. Continuing with the information from Q17, what is the terminal value for TAMUC Inc. after the 4th year (TV4)? (Points : 5)

342,935.53
254,769.21
269,106.57
356,652.95

 Question 20. Continuing with the information from Q17, what is the NPV of purchasing TAMU Inc.? (Points : 5)

positive 2,220.43
negative 2,220.43
positive 178,490.54
negative 178,490.54

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