FIN 302 Lecture Notes - Lecture 11: Capital Structure, Opti Inc., Corporate Tax

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erinjackal368

22 Jun 2016

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Wacc = the sum of the weighted (aftertax) cost of each source of capital. If a firm changes its financial leverage (capital structure), its cost of capital will also change accordingly: cost of debt. Is the effective yield to maturity (or interest rate) earned by its bondholders. Two adjustments must be made to the yield: tax and flotation costs. Preferred stock: has a fixed dividend (similar to debt) has no maturity date dividends are not tax deductible to the firm and are expected to be perpetual or infinite. Common stock equity is available through retained earnings (r/e) or by issuing new common stock: The cost of new common stock is higher than the cost of retained earnings because of flotation costs. Note: this becomes cost of common equity as it represents opportunity cost for common shareholders. The optimum (best) situation is associated with the minimum overall cost of capital (wacc):

Related Questions

Please guys answer all the questions. I have to turn this in 6 hours. Thanks in Advance.

1)A firm should never undertake an investment if accepting it would increase the firmâs cost of capital.

A)True

B)False

2)If a investment under consideration has beta of zero, its purchase will not affect the firmâs market risk.

A)True

B)Fase

3) A particular project might have highly volatile forecasted cash flows, yet not have high market risk.

A)True

B)False

4)If a firm is considering purchasing an asset (with normal cash flows) whose beta is greater than the current beta of the firm, it should evaluate it using a discount rate greater than the firmâs current cost of capital.

A)True

B)False

5)If a company uses the same discount rate to evaluate all projects,

A)it will become riskier over time, and its value will decline.

B)it will become riskier over time, and its value will rise.

C)it will become less risky over time, and its value will rise.

D)it will become less risky over time, and its value will decline.

E)there is no reason to expect its risk position or value to change.

6)Tropicaliâs overall average cost of capital is 10%. Its frozen foods division is riskier than the firm as a whole, its fresh produce division has risk similar to the firmâs, and its institutional foods division has less risk. Tropicali adjusts for both divisional and project risk by adding/subtracting 2 percentage points to/from its corporate cost of capital. The hurdle rate for a low-risk project in the frozen foods division is:

a. 6%.

b. 8%.

c. 10%.

d. 12%.

e. 14%.

salmoncamel471

Please refer to previous question I posted.

What is an appropriate required rate of return (hurdle rate) for Food Products and Instruments? How did you get it? (Hints: you may want to use the capital asset pricing model (CAPM) to estimate the cost of equity This was the answer is was given. The required rate of return or hurdle rate for Food Products and Instruments or any division or firm is the minimum rate that the firm is expected to earn while taking the project, It can generally be determined through the CAPM model: Cost of Equity = Risk free rate + Beta * Risk Premium WACC (Hurdle Rate) = D/D+E * Cost of after tax debt + E/D+E * Cost of Equity D/E Ratios can be calculated by dividing debt to equity. The values can be taken by the firm's annual sheet or management discussions only. The value for this is available at various financial sites as well. Hurdle Rate for food products = D/D+E * Cost of after tax debt + E/D+E * Cost of Equity = 0.6 * 2.2 + 0.4 * 4.8 = 1.32 + 1.92 = 3.24 Hurdle Rate for Instruments = D/D+E * Cost of after tax debt + E/D+E * Cost of Equity = 0.4 * 2.2 + 0.46* 9.4 = 0.88 + 5.64 = 6.52 please explain how these numbers came to be. I have worked them every way possible in my notes.

byzantiumsnail1

8.1 Is each of the following statements true or false? Explain your answers briefly.

a. Using the same risk-adjusted discount rate to discount all future cash flows ignores the fact that the more distant cash flows are often riskier than cash flows occurring sooner.

b. The cost of capital, or WACC, is not the correct discount rate to use for all projects undertaken by a firm.

c. If you can borrow all of the money you need for a project at 6 percent, the cost of capital for this project is 6 percent.

d. The best way to estimate the cost of debt capital for a firm is to di- vide the interest expense on the income statement by the interest-bearing debt on the balance sheet.

e. One reliable estimate of a privately held firmâs equity beta is the average of the equity betas of several publicly held competitors.

FIN 302 Lecture Notes - Lecture 11: Capital Structure, Opti Inc., Corporate Tax

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