Corporate Finance

Brendan P. Sehgal 10/28/15

Quiz 6: WACC

QUESTION 1

A firm has a capital structure with $100 million in equity and $100 million of debt. The cost of equity capital is 14% and the pretax cost of debt is 8%. If the marginal tax rate of the firm is 30%, compute the weighted average cost of capital of the firm.

A. 11.1%

B. 10.3%

C. 11.7%

D. 9.8%

EXPLANATION: WACC = weight in equity × cost of equity + weight in debt × cost of debt × (1-tax rate) WACC = 100 / (100 + 100) × 0.14 + 100 / (100 + 100) × 0.08 × (1 - 0.30) = 9.8%

QUESTION 2

A firm incurs $50,000 in interest expenses each year. If the tax rate of the firm is 30%, what is the effective after-tax interest rate expense for the firm?

A. $29,000

B. $27,000

C. $32,000

D. $35,000

EXPLANATION: Effective after-tax interest expense = Interest expense × (1 - Tax Rate)

Effective after-tax interest expense = $50,000 × (1 - 0.3) = $35,000

QUESTION 3

Epiphany is an all-equity firm with an estimated market value of $400,000. The firm sells $300,000 of debt and uses the proceeds to purchase outstanding equity. Compute the weight in equity and the weight in debt after the proposed financing and repurchase of equity.

A. 0.2, 0.8

B. 0.5, 0.5

C. 0.25, 0.75

D. 0.4, 0.6

EXPLANATION: Weight in debt = Debt raised / Market value of firm;

Weight in equity = 1 - Weight in debt Weight in debt = $300,000 / $400,000 = 0.75; Weight in equity = 1 - 0.75 = 0.25

QUESTION 4

Epiphany is an all-equity firm with an estimated market value of $500,000. The firm sells $200,000 of debt and uses the proceeds to invest in new projects. Compute the weight in equity and the weight in debt after the proposed financing.

A. 0.28, 0.72

B. 0.4, 0.6

C. 0.6, 0.4

D. 0.72, 0.28

EXPLANATION: Weight in debt = Debt raised / Market value of firm; Weight in equity = 1 - Weight in debt Weight in debt = $200,000 / $500,000 = 0.4; Weight in equity = 1 – 0.4 =...