CF2 Day 2 NYIF PA

Assuming a company is partially debt financed, which of the following statements describes the discount rate that is likely the most appropriate for valuing a firm’s common equity?

• The firm’s weighted average cost of capital (WACC).

• The yield to maturity on bonds having similar maturity and credit risk as the company’s debt.

• The expected rate of return on similar projects of equivalent risk.

• The require rate of return based on the Capital Asset Pricing Model (CAPM) using, the security’s beta, risk-free rate and expected return on the market.

Which of the following statements describe the discount rate that is likely the most appropriate for estimating the cost of a privately held firm’s debt capital?

• The firm’s weighted average cost of capital (WACC).

• The yield to maturity on bonds having similar maturity and credit risk as the company’s debt.

• The expected rate of return on similar projects of equivalent risk.

• The require rate of return based on the Capital Asset Pricing Model (CAPM) using, the security’s beta, risk-free rate and expected return on the market.

A discounted cash flow valuation of a firm should be based on:

• an appropriate opportunity cost of capital.

• the firm’s weighted average cost of capital based on debt and equity securities’ par values.

• the firm’s weighted average cost of capital based on debt and equity securities’ book values.

• the firm’s weighted average cost of capital based on debt and equity securities’ market values.

A company intends to raise capital by issuing common stock. The company currently pays no dividends on its common shares and has publicly announced it has no intention to institute cash dividend payments for the foreseeable future. Which of the following statements best describes the cost of the new equity to the firm?

• The present value of the projected future dividend payments.

• Zero since the firm is not obligated to make any distributions to the shareholders.

• The expected return on the shares which current owners are foregoing by selling a portion of the firm to buyers of the newly issued shares.

• An opportunity cost of capital equal to the foregone interest income the share buyers could have earned had they purchased T-bills rather than the company’s equity.

An early stage growth company that is currently 100% equity financed and pays no dividend has decided to issue debt to raise additional capital. The firm believes the debt issuance will increase the value of the firm by reducing its weighted average cost of capital (WACC). Which of the following statements most accurately characterized the rationale for believing an issuance of debt would reduce the company’s WACC?

• Being partially debt funded reduces the risk of the firm’s capital structure.

• The yield to maturity on the new debt is below the expected return on the company’s shares.

• The coupon payments on the new debt issue will be lower than the company’s future common stock dividends.

• A company’s first debt offering is going to be less expensive debt capital than its later when it is a more mature company.

The following information is available for a company and its single outstanding debt issue:

Debt/Total capital ratio: 60%

Bond coupon rate: 7 1/2 %

Bond yield to maturity: 8%

Tax rate: 21%

The company’s after-tax cost of debt (kd) is closest to:

• 3.79%

• 5.93%

• 6.32%

• 7.50%

The following information is available for a company and its single issue of outstanding preferred stock:

Par value per preferred share: $100

Stated preferred dividend rate: 6%

Market price of preferred shares: $120

Expected rate of return on common shares: 12%

Yield to maturity on company debt: 4%

The cost of preferred equity capital for the firm is closest to:

• 3.33%

• 5.00%

• 6.00%

• 10.00%

Calculate the cost of equity capital (ke) using the Capital Asset Pricing Model (CAPM) given a risk-free rate (rf) of 2.00%, a beta (β) of .9 and an expected return on the market e(rM) of 10.5%.

• 7.65%

• 9.65%

• 10.50%

• 11.45%

Calculate the cost of equity capital (ke) using the appropriate variant of the dividend discount model (DDM) given: market price of the common stock (P0) of $72/share, a current year dividend (D0) of $3.00/share, a constant dividend growth rate (g) of 5%, a risk-free rate (rf) of 4% and a 5-year average return on equity of 20.8% The company’s cost of equity capital would be closest to:

• 8.38%

• 9.17%

• 9.38%

• 9.87%

Calculate a firm’s weighted average cost of capital (WACC) given its cost of equity capital (ke) is 11.50%, debt capital (kd) is 6.5%, faces a marginal tax rate of 25% and has a capital structure is comprised of 40% equity and 60% debt.

• 7.53%

• 8.19%

• 8.85%

• 9.50%