Financial Management: Weighted Avg. Cost of Capital & Optimal Capital Structure

Question 1

WACC=

Answer 1

(Cost of Equity X Equity Capital Structure Percentage)+ (Weighted Avg. Cost of debt X Percentage debt in capital structure)

Question 2

YTM

Answer 2

Effective Annual Interest Payment/ Debt Cash Available

Question 3

Long-term elements

Answer 3

Long-term debt, preferred stock, common stock and retained earnings

Question 4

Short-term elements

Answer 4

Interest-bearing debt, other forms of current liabilities A/P & Accruals

Question 5

3 common methods of computing Costs of retained earnings

Answer 5

a) CAPM
b) Discounted Cash Flow
c) Bond yield plus risk premium

Question 6

After tax cost of debt Or Net cost of Debt

Answer 6

YTM X(1-T)

Question 7

Pretax ncost of debt Weighted Average interest Rate

Answer 7

Effective annual interest payments/ Debt Cash available

Par X C Outflow/ Net Inflow

Question 8

After- Tax cost of debt

Answer 8

Pretax cost of debt X (1- Tax rate)

Question 9

Cost of Preferred Cost > Cost Debt

Answer 9

• Dividends are not tax deductible

- PS assume more risk, bc they are paid last

Question 10

Cost of Preferred stock formula

Answer 10

Preferred stock dividends/ Net proceeds of pref. stocks

=Par x%/ Net Inflow

Ex: Dividend paid ($20 par value × 9% dividend) $ 1.80

Net proceeds ($40 selling price − $5 floatation) ÷ 35.00

Cost of preferred shares 5.1%

Question 11

CAPM

Answer 11

Beta> 1 riskier

Beta

Question 12

CAPM Formula

Answer 12

Risk-free rate+ Risk Premium
Risk- free rate + (Beta X Market Risk Premium)
Risk free rate + (BetaX(Market Return - Risk free return)

Question 13

Discounted Cash Flow Formula

-Cost of Retained Earnings

Answer 13

D/P +G
P= Current Market Price
D= Dividend per share expected at the end of the year
G= The constant rate of growth in dividends

Question 14

Bond yield plus risk premium

“Pre-tax”

Answer 14

Pretax cost of long-term debt ( you can use YTM)+ Market risk premium
Market risk premium = reward for buying riskier CE

Question 15

The over all cost of capital is the WACC

Answer 15

Rate of return on assets that covers the costs associated with the funds employed

Question 16

The benefits of debt financing over equity financing are likely to be highest

Answer 16

High marginal tax rates and few noninterest tax benefits.

Question 17

Weighted-average cost of capital

Answer 17

rate is most commonly compared to the internal rate of return to evaluate whether to make an investment

Question 18

If a firm has an increase in the corportae income tax rate. What will that cause them to do?

Answer 18

It will cause the firm to increase the debt in its financial structure

Question 19

The cost of debt most frequently is measured as:

Answer 19

Actual interest rate minus tax savings

Question 20

What is a company’s objective when it comes to WACC?

Answer 20

To minimize the WACC

Question 21

Which one of a firm’s sources of new capital usually has the lowest after tax cost

Answer 21

Bonds

Question 22

The three elements needed to estimate the cost of equity capital are:

Answer 22

Current dividends per share (D)

Expected growth rate in dividends (G) and

Current market price per share of common stock (P)

Question 23

Are Dividends tax deductible?

Answer 23

No, Dividends are NOT tax deductible