ypical firm

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September 20, 2019

ypical firm

1. For a typical firm, which of the following is correct? All rates are after taxes, and assume the firm operates at its target capital structure. (rd= rate on debt; re= rate on equity (ROE), rs= rate on company’s stock, WACC= weighted average cost of capital)

(Points : 4)
rd > re > rs > WACC.
rs > re > rd > WACC.
WACC > re > rs > rd.
re > rs > WACC > rd.
WACC > rd > rs > re.

2. You were hired as a consultant to Keys Company, and you were provided with the following data: Target capital structure: 40% debt, 10% preferred, and 50% common equity. The after-tax cost of debt is 4.00%, the cost of preferred is 7.50%, and the cost of retained earnings is 11.50%. The firm will not be issuing any new stock. What is the firm’s WACC?

(Points : 4)
7.55%
7.73%
7.94%
8.10%
8.32%

= ( 0.4 × 4) + (0.10 × 7.5) + (0.40 × 11.50)

= 8.10%

3. Which of the following is not a capital component when calculating the weighted average cost of capital (WACC)?

(Points : 4)
Long-term debt.
Common stock.
Retained earnings.
Accounts payable.
Preferred stock.

4. Assume that you are a consultant to Morton Inc., and you have been provided with the following data: D1 = $1.00; P0 = $25.00; and g = 6% (constant). What is the cost of equity from retained earnings based on the DCF approach?

(Points : 4)
9.79%
9.86%
10.00%
10.20%
10.33%

 

5. To help finance a major expansion, Dimkoff Development Company sold a bond several years ago that now has 20 years to maturity. This bond has a 7% annual coupon, paid quarterly, and it now sells at a price of $1,103.58. The bond cannot be called and has a par value of $1,000. If Dimkoff’s tax rate is 40%, what component cost of debt should be used in the WACC calculation?

(Points : 4)
3.03%
3.28%
3.66%
3.85%
4.04%

6. Which of the following statements is CORRECT?

(Points : 4)
Because of tax effects, an increase in the risk-free rate will have a greater effect on the after-tax cost of debt than on the cost of common stock.
When calculating the cost of preferred stock, companies must adjust for taxes, because dividends paid on preferred stock are deductible by the paying corporation.
When calculating the cost of debt, a company needs to adjust for taxes, because interest payments are deductible by the paying corporation.
If a company’s beta increases, this will increase the cost of equity used to calculate the WACC, but only if the company has does not have enough retained earnings to take care of its equity financing and hence needs to issue new stock.
Higher flotation costs reduce investor returns, and that leads to a reduction in a company’s WACC.

7. For a company whose target capital structure calls for 50% debt and 50% common equity, which of the following statements is CORRECT?

(Points : 4)
The cost of equity is usually greater than or equal to the cost of debt.
The WACC exceeds the cost of equity.
The WACC is calculated on a before-tax basis.
The interest rate used to calculate the WACC is the average cost of all the debt the company has outstanding and shown on its balance sheet.
The cost of retained earnings typically exceeds the cost of new common stock.

8. Which of the following statements about the cost of capital is CORRECT?

(Points : 4)
A change in a company’s target capital structure cannot affect its WACC.
WACC calculations should be based on the before-tax costs of all the individual capital components.
If a company’s tax rate increases, then, all else equal, its weighted average cost of capital will decrease.
Flotation costs associated with issuing new common stock normally lead to a decrease in the WACC.
An increase in the risk-free rate will normally lower the marginal costs of both debt and equity financing.

9. Which of the following statements is CORRECT?

(Points : 4)
If a company’s tax rate increases but the YTM of its noncallable bonds remains the same, the after-tax cost of its debt will fall.
All else equal, an increase in a company’s stock price will increase its marginal cost of retained earnings, rs.
All else equal, an increase in a company’s stock price will increase its marginal cost of new common equity, re.
Since the money is readily available, the after-tax cost of retained earnings is usually much lower than the after-tax cost of debt.
When calculating the cost of preferred stock, a company needs to adjust for taxes, because preferred stock dividends are tax deductible.

10. Thomson Electric Systems is considering a project that has the following cash flow and WACC data. What is the project’s NPV? Note that a project’s projected NPV can be negative, in which case it will be rejected. (cash flows are: -$1,000, $500, $500, $500 in periods 0, 1, 2, 3 respectively)
WACC = 10%
Year: 0 1 2 3
Cash flows: -$1,000 $500 $500 $500

(Points : 4)
$243.43
$221.30
$268.91
$272.46
$289.53

11. Blanchford Enterprises considering a project that has the following cash flow and WACC data. What is the project’s NPV? Note that a project’s projected NPV can be negative, in which case it will be rejected.
WACC = 10%
Year: 0 1 2 3 4
Cash flows: -$1,000 $475 $475 $475 $475

(Points : 4)
$482.16
$496.38
$505.69
$519.05
$459.71

12. Blanchford Enterprises is considering a project that has the following cash flow data. What is the project’s payback?
Year: 0 1 2 3
Cash flows: -$1,000 $500 $500 $500

(Points : 4)
1.50 years
1.75 years
2.00 years
2.25 years
2.50 years

13. Tapley Dental Associates is considering a project that has the following cash flow data. What is the project’s payback?
Year: 0 1 2 3 4 5
Cash flows: -$1,000 $300 $310 $320 $330 $340

(Points : 4)
2.11 years
2.50 years
2.71 years
3.05 years
3.21 years

14. Assume a project has normal cash flows. All else equal, which of the following statements is CORRECT?

(Points : 4)
The project’s IRR increases as the WACC declines.
The project’s NPV increases as the WACC declines.
The project’s MIRR is unaffected by changes in the WACC.
The project’s regular payback increases as the WACC declines.
The project’s discounted payback increases as the WACC declines.

15. Edison Electric Systems is considering a project that has the following cash flow and WACC data. What is the project’s NPV? Note that a project’s projected NPV can be negative, in which case it will be rejected.
WACC = 10%
Year: 0 1 2 3
Cash flows: -$1,000 $450 $460 $470

(Points : 4)
$142.37
$129.43
$166.51
$173.26
$189.94

16. Tapley Dental Associates is considering a project that has the following cash flow and WACC data. What is the project’s NPV? Note that a project’s projected NPV can be negative, in which case it will be rejected.
WACC = 10%
Year: 0 1 2 3 4 5
Cash flows: -$1,000 $300 $300 $300 $300 $300

(Points : 4)
$124.76
$123.15
$128.47
$131.96
$137.24

17. The Seattle Corporation has an investment opportunity that will yield cash flows of $30,000 per year in Years 1 through 4, $35,000 per year in Years 5 through 9, and $40,000 in Year 10. This investment will cost $150,000 today, and the firm’s WACC is 10%. What is the payback period for this investment?

(Points : 4)
5.23 years
4.86 years
4.00 years
6.12 years
4.35 years

18. Which of the following statements is CORRECT? (Points : 4)
One defect of the IRR method is that it does not take account of cash flows over a project’s full life.
One defect of the IRR method is that it does not take account of the time value of money.
One defect of the IRR method is that it does consider the time value of money.
One defect of the IRR method is that it values a dollar received today the same as a dollar that will not be received until some time in the future.
One defect of the IRR method is that it assumes that the cash flows to be received from a project can be reinvested at the IRR itself, and that assumption is rarely trun in the real world.

19. . Which of the following statements is CORRECT?

(Points : 4)
The NPV method assumes that cash flows will be reinvested at the WACC, while the IRR method assumes reinvestment at the IRR.
The NPV method assumes that cash flows will be reinvested at the risk-free rate, while the IRR method assumes reinvestment at the IRR.
The NPV method assumes that cash flows will be reinvested at the WACC, while the IRR method assumes reinvestment at the risk-free rate.
The NPV method does not consider all relevant cash flows, particularly, cash flows beyond the payback period.
The IRR method does not consider all relevant cash flows, particularly, cash flows beyond the payback period.

 

 

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