Module 7 Flashcards
If the CAPM is used to estimate the cost of equity capital, the expected excess market return is equal to the:
return on the market minus the risk-free rate.
Companies will generally have a ________ beta if their:
A) low; stock price is relatively low.
B) high; sales are highly dependent on the market cycle.
C) high; sales are growing at a steady rate of increase
D) high; sales are high compared to other firms in their industry
E) low; production costs are primarily fixed in nature.
B) high; sales are highly dependent on the market cycle.
Comparing two otherwise equivalent firms, the beta of the common stock of the levered firm is ________ the beta of the common stock of the unlevered firm.
greater than
A firm with cyclical earnings is characterized by:
revenue patterns that vary with the business cycle.
When computing the weighted average cost of capital, which of these are adjusted for taxes?
Cost of debt
A firm’s WACC can be correctly used to discount the expected cash flows of a new project when that project will:
have the same level of risk as the firm’s current operations.
What is the cost of equity for a firm that has a beta of 1.2 if the risk-free rate of return is 2.9 percent and the expected market return is 11.4 percent?
13.1 percent
CAPM = Rf + b(Rm-Rf)
The Shoe Box pays an annual dividend of $3.80 on its preferred stock. What is the cost of preferred if the stock currently sells for $42.70 a share and the tax rate is 21 percent?
8.90 percent
Dividend / Stock price
Consolidated Construction has a beta of 1.3. The risk-free rate of return is 2.7 percent and the expected market return is 14.2 percent. What is Consolidated’s cost of equity?
17.65
CAPM = Rf + b(Rm-Rf)
Jack’s Construction Co. has 70 bonds outstanding that are selling at their par value of $1,000 each. Bonds with similar characteristics are yielding a pretax 8.2 percent return. The firm also has 4,500 shares of common stock outstanding. The stock has a beta of 1.3 and sells for $50 a share. The U.S. T-bill is yielding 4 percent, the market risk premium is 11 percent, and the firm’s tax rate is 26 percent. Assuming its earnings are sufficient to classify all interest as a tax deductible.
What is the pre-tax cost of debt?
8.2
Jack’s Construction Co. has 70 bonds outstanding that are selling at their par value of $1,000 each. Bonds with similar characteristics are yielding a pretax 8.2 percent return. The firm also has 4,500 shares of common stock outstanding. The stock has a beta of 1.3 and sells for $50 a share. The U.S. T-bill is yielding 4 percent, the market risk premium is 11 percent, and the firm’s tax rate is 26 percent. Assuming its earnings are sufficient to classify all interest as a tax deductible.
What is the weighting for debt?
23.73
Debt/(Equity + Debt)
70 bonds1000/(70 bonds1000+4500 shares*$50)
70000/(70000+225000)
Jack’s Construction Co. has 70 bonds outstanding that are selling at their par value of $1,000 each. Bonds with similar characteristics are yielding a pretax 8.2 percent return. The firm also has 4,500 shares of common stock outstanding. The stock has a beta of 1.3 and sells for $50 a share. The U.S. T-bill is yielding 4 percent, the market risk premium is 11 percent, and the firm’s tax rate is 26 percent. Assuming its earnings are sufficient to classify all interest as a tax deductible.
What is the after-tax cost of debt?
6.07
Pretax - (1-Tc)
8.2 - (1-.26)
Jack’s Construction Co. has 70 bonds outstanding that are selling at their par value of $1,000 each. Bonds with similar characteristics are yielding a pretax 8.2 percent return. The firm also has 4,500 shares of common stock outstanding. The stock has a beta of 1.3 and sells for $50 a share. The U.S. T-bill is yielding 4 percent, the market risk premium is 11 percent, and the firm’s tax rate is 26 percent. Assuming its earnings are sufficient to classify all interest as a tax deductible.
What is the cost of equity?
18.3
CAPM = Rf + b(Rm-Rf)
Note: (Rm-Rf) given as 11
=4+1.3(11)
Jack’s Construction Co. has 70 bonds outstanding that are selling at their par value of $1,000 each. Bonds with similar characteristics are yielding a pretax 8.2 percent return. The firm also has 4,500 shares of common stock outstanding. The stock has a beta of 1.3 and sells for $50 a share. The U.S. T-bill is yielding 4 percent, the market risk premium is 11 percent, and the firm’s tax rate is 26 percent. Assuming its earnings are sufficient to classify all interest as a tax deductible.
What is the weighting for equity?
76.27
Equity/(Equity + Debt)
4500 shares$50/(4500 shares$50+70 bonds*1000)
225000/(70000+225000)
Jack’s Construction Co. has 70 bonds outstanding that are selling at their par value of $1,000 each. Bonds with similar characteristics are yielding a pretax 8.2 percent return. The firm also has 4,500 shares of common stock outstanding. The stock has a beta of 1.3 and sells for $50 a share. The U.S. T-bill is yielding 4 percent, the market risk premium is 11 percent, and the firm’s tax rate is 26 percent. Assuming its earnings are sufficient to classify all interest as a tax deductible.
What is the WACC?
15.4
WACC formula
