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Question;Managerial Finance ? Problem Review Set;? Cost of Capital ? with solutions;1);If a firm's marginal tax rate is;increased, this would, other things held constant, lower the cost of debt;used to calculate its WACC.;a.;True;b.;False;2);The lower the firm's tax rate, the;lower will be its after-tax cost of debt and WACC, other things held;constant.;a.;True;b.;False;3);If investors' aversion to risk;rose, causing the slope of the SML to increase, this would have a greater;impact on the required rate of return on equity, rs, than on the;interest rate on long-term debt, rd, for most firms. Other things held constant, this would lead;to an increase in the use of debt and a decrease in the use of equity. However, other things would not stay;constant if firms used a lot more debt, as that would increase the riskiness;of both debt and equity and thus limit the shift toward debt.;a.;True;b.;False;4);Jackson Inc. uses only equity capital;and it has 2 equally-sized divisions. Division A?s cost of capital is 10.0%;Division B?s cost is 14.0%, and the composite WACC is 12.0%. All of Division A?s projects have the same;risk, as do all of Division B's projects.;However, the projects in Division A have less risk than those in;Division B. Which of the following;projects should Jackson;accept?;a.;A Division B project with a 13%;return.;b.;A Division B project with a 12%;return.;c.;A Division A project with an 11%;return.;d.;A Division A project with a 9%;return.;e.;A Division B project with an 11%;return.;5);Vang Inc. estimates that its;average-risk projects have a WACC of 10%, its below-average risk projects;have a WACC of 8%, and its above-average risk projects have a WACC of;12%. Which of the following projects;(A, B, and C) should the company accept?;a.;Project B is of below-average risk;and has a return of 8.5%.;b.;Project C is of above-average risk;and has a return of 11%.;c.;Project A is of average risk and;has a return of 9%.;d.;None of the projects should be;accepted.;e.;All of the projects should be;accepted.;Divisional;risk Answer;c;6);Nelson Enterprises, an all-equity;firm, has a beta of 2.0. Nelson?s;chief financial officer is evaluating a project with an expected return of;21%, before any risk adjustment. The;risk-free rate is 7%, and the market risk premium is 6%. The project being evaluated is riskier than;Nelson?s average project, in terms of both its beta risk and its total;risk. Which of the following statements;is CORRECT?;a.;The project should definitely be;accepted because its expected return (before any risk adjustments) is greater;than its required return.;b.;The project should definitely be;rejected because its expected return (before risk adjustment) is less than;its required return.;c.;Riskier-than-average projects;should have their expected returns increased to reflect their higher;risk. Clearly, this would make the;project acceptable regardless of the amount of the adjustment.;d.;The accept/reject decision depends;on the firm's risk-adjustment policy.;If Nelson's policy is to increase the required return on a;riskier-than-average project to 3% over rS, then it should reject;the project.;e.;Capital budgeting projects should;be evaluated solely on the basis of their total risk. Thus, insufficient;information has been provided to make the accept/reject decision.;Pro.;7);Which of the following statements;is CORRECT?;a.;The WACC is calculated using;before-tax costs for all components.;b.;The after-tax cost of debt usually;exceeds the after-tax cost of equity.;c.;For a given firm, the after-tax;cost of debt is always more expensive than the after-tax cost of preferred;stock.;d.;Retained earnings that were;generated in the past and are reflected on the firm?s balance sheet are;generally available to finance the firm?s capital budget during the coming;year.;e.;The WACC that should be used in;capital budgeting is the firm?s marginal, after-tax cost of capital..;8);Assume that you are a consultant;to Magee Inc., and you have been provided with the following data: rRF;= 4.00%, RPM = 5.00%, and b = 1.15. What is the cost of equity from retained;earnings based on the CAPM approach?;a.;9.75%;b.;10.04%;c.;10.34%;d.;10.65%;e.;10.97%;Component


Paper#50999 | Written in 18-Jul-2015

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