Capital Budgeting Paper 25

1

Assume that two companies, Company X and Company Y, are alike in all respects, except the market value of the outstanding common shares of Company X is greater than the market value of Company Y shares. This may indicate that






2

Which of the following methods explicitly recognizes a firm’s risk when determining the estimated cost of equity?






3

Assume a firm is expected to pay a dividend of $5.00 per share this year. The firm along with the dividend is expected to grow at a rate of 6%. If the current market price of the stock is $60 per share, what is the estimated cost of equity?






4

The bond-yield-plus approach to estimating the cost of common equity involves adding a risk premium of 3% to 5% to the firm’s






5

In practice, dividends






6

DQZ Telecom is considering a project for the coming year that will cost $50 million. DQZ plans to use the following combination of debt and equity to finance the investment.
• Issue $15 million of 20-year bonds at a price of 101, with a coupon rate of 8%, and flotation costs of 2% of par.
• Use $35 million of funds generated from earnings.
The equity market is expected to earn 12%. US Treasury bonds are currently yielding 5%. The beta coefficient for DQZ is esti-mated to be .60. DQZ is subject to an effective corporate income tax rate of 40%. Assume that the after-tax costs of debt is 7% and the cost of equity is 12%. Determine the weighted-average cost of capital.






7

DQZ Telecom is considering a project for the coming year that will cost $50 million. DQZ plans to use the following combination of debt and equity to finance the investment.
• Issue $15 million of 20-year bonds at a price of 101, with a coupon rate of 8%, and flotation costs of 2% of par.
• Use $35 million of funds generated from earnings.
The equity market is expected to earn 12%. US Treasury bonds are currently yielding 5%. The beta coefficient for DQZ is esti-mated to be .60. DQZ is subject to an effective corporate income tax rate of 40%. The Capital Asset Pricing Model (CAPM) computes the expected return on a security by adding the risk-free rate of return to the incremental yield of the expected market return that is adjusted by the company’s beta. Compute DQZ’s expected rate of return.






8

When calculating the cost of capital, the cost assigned to retained earnings should be






9

According to the Capital Asset Pricing Model (CAPM), the relevant risk of a security is its






10

Hi-Tech Inc. has determined that it can minimize its weighted-average cost of capital (WACC) by using a debt/equity ratio of 2/3. If the firm’s cost of debt is 9% before taxes, the cost of equity is estimated to be 12% before taxes, and the tax rate is 40%, what is the firm’s WACC?






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