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Rob's e2700 Notes

✏️ WACC Practice

Some warmup multiple choice practice questions.

✏️ Bookworm Publishing has debt outstanding with a market value of $10 million. The company’s common stock has a book value of $20 million and a market value of $30 million. What weight for equity should Bookworm use in its WACC calculation?

  1. 25%
  2. 50%
  3. 66%
  4. 75%
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d

✏️ Which of the following should be used as the firm’s cost of debt?

  1. The coupon rate on existing debt outstanding.
  2. The U.S. Treasury bill rate plus the coupon rate on existing debt outstanding.
  3. The coupon rate on existing debt outstanding minus the U.S. Treasury Bill rate.
  4. The yield to maturity on the existing debt outstanding.
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d

✏️ The effective cost of debt is

  1. the return paid to the debt holders.
  2. more than the return paid to the debt holders because of the tax consequences of the interest paid on debt.
  3. less than the return paid to the debt holders because of the tax deductibility of the interest expense.
  4. is equal to the firm’s beta multiplied by the return paid to the debt holders.
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c

✏️ To use the CAPM to estimate the cost of equity, you need to know

  1. the equity beta.
  2. the risk-free rate.
  3. the market risk premium.
  4. All of the above.
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d

✏️ Which of the following do you NOT need to know to use the CDGM to estimate the cost of equity?

  1. Current stock price.
  2. Risk-free rate.
  3. Expected dividend next year.
  4. Future dividend growth rate.
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b

✏️ The stock of Fratelli Branca is currently trading at $45 a share and the equity beta of the company is estimated to be 1.3. The company is expected to pay a dividend of $1.50 a share next year, and this dividend is expected to grow at a rate of 4% a year. The rate on the 10-year U.S. Treasury bond is 4% and you estimate the market risk premium to be 5%. Using the CAPM, what is the company’s cost of equity?

  1. 5.6%
  2. 7.3%
  3. 10.5%
  4. 12.9%
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c
E(rS) = rF + β(E(rM) - rF) = 4% + 1.3(5%) = 10.5%

✏️ Using the information in the previous question for Fratelli Branca, what is the company’s cost of equity using the CDGM?

  1. 5.6%
  2. 7.3%
  3. 10.5%
  4. 12.9%
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b
$1.50/$45 + 4% = 7.3%

✏️ Net debt equals

  1. total debt outstanding minus the value of the firm’s assets.
  2. total debt outstanding minus the value of the company’s equity.
  3. total debt outstanding minus any interest payments due.
  4. total debt outstanding minus any cash balances.
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d

✏️ The debt issued by Trekker Cycling has a coupon rate of 5% and a yield-to-maturity of 6.2%. The company is in the 25% tax bracket. Trekker’s effective cost of debt is:

  1. 3.75%
  2. 4.65%
  3. 8.40%
  4. 9.00%
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b