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Lesson 5Cost Of Capital And Financial Policy1. Mulberry, Inc. has a weighted average cost of capital (ignoring taxes) of 20 percent. It can borrow at 10 percent. Mulberry has a target 12 debt/equity ratio. Using the M&M Proposition ll, what’s the cost of equity?A. 31 percentB. 29 percentC. 15 percentD. 25 percent2. U.S. Treasury bills are paying about 0.2 percent, and the estimated market risk premium (based on large common stocks) is about 8 percent.Apple (AAPL) has an estimated beta of 1.44. Using the SML approach, what’s the return on equity of Apple stock?A. 11 percentB. 10.32 percentC. 11.72 percentD. 11.32 percent3. River Walk Tours is expected to have an EBIT of $354,000 next year. Depreciation, the increase in net working capital, and capital spending, are expected to be $24,000, $2,000, and $33,000, respectively. All are expected to grow at 7 percent per year for three years. After year four, the adjusted cash flow assets is expected to grow at 3.2 percent indefinitely. The company’s WACC is 9.2 percent, and the tax rate is 34 percent. What’s the terminal value of the firm’s cash flows?A. $3,992,419B. $4,008,051C. $3,711,052D. $4,691,1894. What does the absolute priority rule establish?A. Priority of control of key stakeholdersB. Priority of claims in liquidationC. Priority of suppliersD. Priority of cash dividends5. Under the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, how long after a firm files for bankruptcy protection do creditors have to wait before submitting their own reorganization plan to the court?A. 45 daysB. 180 daysC. 18 monthsD. 12 months6. The unlevered cost of capital refers to the cost of capital forA. a privately owned entity.B. a governmental entity.C. a corporate shareholder.D. an all-equity firm.7. Alphabet, Inc. (GOOGL) has a 40 percent debt/asset ratio; assume a tax rate of 16 percent. The average yield to maturity on GOOGL’s bonds is 3 percent. Your market analyst estimates that the risk-free rate is 1 percent and that the market risk premium if 7 percent. The firm’s beta coefficient is 0.97. What’s Alphabet’s weighted average cost of capital (WACC)? (Round to the nearest tenth of a percent.)A. 7.3 percentB. 5.9 percentC. 6 percentD. 5.7 percent8. Which of the following is true about a firm with no equity financing?A. The return on equity = WACCB. The cost of debt = WACCC. The return on equity = cost of debtD. The after-tax cost of debt = WACC9. Deep Mines has 14 million shares of common stock outstanding with a beta of 1.15 and a market price of $42 a share. There are 900,000 shares of 9 percent preferred stock outstanding, valued at $80 a share. The 10 percent semiannual bonds have a face value of $1,000 and are selling at 91 percent of par. There are 220,000 bonds outstanding that mature in 17 years. The market risk premium is 1112 percent, T-bills are yielding712 percent, and the firm’s tax rate is 32 percent. What discount rate should the firm apply to a new project’s cash flows if the project has the same risk as the firm’s typical project?A. 13.15 percentB. 15.54 percentC. 14.72 percentD. 14.59 percent10. Fama’s Llamas has a weighted average cost of capital of 912 percent. The company’s cost of equity is 1512 percent, and its pretax cost of debt is 812 percent. The tax rate is 34 percent. What’s the company’s target debt-equity ratio?A. 1.54B. 0.89C. 1.01D. 0.9211. New Schools expects an EBIT of $87,000 every year, forever. The firm currently has no debt, and its cost of equity is 14.6 percent. The firm can borrow at 7.4 percent, and the corporate tax rate is 34 percent. What will the value of the firm be if it converts to 50 percent debt?A. $437,552.08B. $460,146.57C. $377,407.16D. $381,796.4712. Western Wear is considering a project that requires an initial investment of $260,000. The firm maintains a debt-equity ratio of .40, has a flotation cost of debt of 8 percent, and a flotation cost of equity of 1012 percent. The firm has sufficient internally generated equity to cover the equity portion of this project. What’s the initial cost of the project including the flotation cost?A. $266,082B. $272,005C. $297,747D. $281,40613. The Market Outlet is an all-equity financed firm with a beta of 1.38 and a cost of equity of 14.945 percent. The risk-free rate of return is 4.25 percent. What discount rate should the firm assign to a new project that has a beta of 1.25?A. 14.14 percentB. 13.54 percentC. 14.36 percentD. 13.94 percent14. When a firm has flotation costs equal to 6.8 percent of the funding need, project analysts shouldA. add 6.8 percent to the firm’s WACC to determine the discount rate for the project.B. increase the initial project cost by dividing that cost by (1-.068).C. increase the initial project cost by multiplying that cost by 1.068.D. increase the project’s discount rate to offset these expenses by dividing the firm’s WACC by (1-.068).15. What’s the concept of using debt to make a return known as?A. Financial leverage B. Debt relianceC. Financial liquidityD. Debt coverage16. Silo Mills is an all-equity financed firm that has a beta of 1.14 and a cost of equity of 12.8 percent. The risk-free rate of return is 2.8 percent. The firm is currently considering a project that has a beta of 1.03 and a project life of six years. What discount rate should be assigned to this project?A. 13.33 percentB. 13.62 percentC. 11.84 percentD. 12.09 percent17. What’s the relationship between the WACC and the structure of the firm?A. The lower the WACC, the lower the value of the firm.B. There’s no relationship between WACC and the value of the firm.C. The lower the WACC, the higher the value of the firm.D. The lower the WACC, the higher the value of the firm to a certain point; then the relationship reverses.18. Which one of these actions generally occurs first in a bankruptcy reorganization?A. Dividing creditors into classesB. Confirming the reorganization planC. Submitting a reorganization planD. Filing proofs of claim19. The biggest pitfall of the subjective approach is that it assumesA. that each project fits nicely in a category.B. that each project has the same amount of risk.C. that the market risk premium is constant.D. the same discount rate for all projects.20. Incorporating flotation costs into the analysis of a project willA. increase the project’s rate of return.B. increase the initial cash outflow of the project.C. have no effect on the present value of the project.D. cause the project to be improperly evaluated. ................
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