Quiz4

Question 1

The book value of a firm’s equity is $100 million and its market value of equity is $200 million. The book value of its debt is $50 million and its market value of debt is $60 million. Assuming that the firm has no other liabilities, what is the market value of assets of the firm?

Answer 1

$260 million

Question 2

The after-tax cost of debt ________ the before-tax cost of debt for a firm that has a positive tax rate.

Answer 2

is always less than

Question 3

For an unlevered firm, the cost of capital can be determined by using the ________.

Answer 3

Capital Asset Pricing Model

Question 4

The after-tax cost of equity is ________ the pretax cost of equity.

Answer 4

the same as

Question 5

Assume the market value of Fords’ equity, preferred stock, and debt are $6 billion, $2 billion, and $13 billion, respectively. Ford has a beta of 1.7, the market risk premium is 8%, and the risk-free rate of interest is 3%. Ford’s preferred stock pays a dividend of $4 each year and trades at a price of $30 per share. Ford’s debt trades with a yield to maturity of 8.0%. What is Ford’s weighted average cost of capital if its tax rate is 30%?

Answer 5

9.48%

Question 6

6. Which of the following statements is FALSE? Assume no taxes.

Answer 6

As debt has a lower cost of capital than equity, higher leverage lowers a firm’s WACC.

Question 7

It is not correct to discount the cash flows of a levered firm with the cost of equity of the unlevered firm because ________.

Answer 7

leverage increases the risk of the equity of the firm

Question 8

Demand Cash Flow Probability
Weak $25,000 50%
Strong $45,000 50%
Suppose Blank Company has only one project with two equally possible states as forecast above, no debt and an unlevered cost of equity of 8%. In a tax-free world, what is the value of the company’s equity?

Answer 8

$32,407.40

Question 9

Suppose Blank Company has only one project with two equally possible states as forecast above, and an unlevered cost of equity of 8%. If the company issues debt at an interest rate of 5% such that $10,000 is payable next year and there are no taxes, what is the value of the company’s equity?

Answer 9

$22,883.59

Question 10

Which of the following statements is FALSE? Assume no taxes.

Answer 10

From MM proposition II, the cost of capital of levered equity is more than the sum of the cost of capital of unlevered equity plus a premium that is proportional to the debt-equity ratio.