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Question 69 interest tax shield, capital structure, leverage, WACC

Which statement about risk, required return and capital structure is the most correct?

(a) The before-tax cost of debt is less than the before-tax cost of equity. Therefore debt is a cheaper form of financing than equity so companies should try to finance their projects with debt only.

(b) Debt makes a firm's equity more risky. Therefore the higher the amount of debt, the higher the cost of equity.

(c) The more debt a firm has, the higher its tax shields. Therefore firms should seek to have as much debt and as little equity as possible.

(d) The more debt, the lower the firm's after tax WACC. The after tax WACC is the discount rate that discounts the firm's cash flows, so the lower it is the more the firm is worth. Therefore firms should try to make their after tax WACC as low as possible by using as much debt as possible.

(e) The less debt, the lower the chance of bankruptcy. Therefore firms should try to pay off all of their debt so that they are financed by equity only.

Question 176 CFFA

Why is Capital Expenditure (CapEx) subtracted in the Cash Flow From Assets (CFFA) formula?

###CFFA=NI+Depr-CapEx - \Delta NWC+IntExp###

Question 182 NPV, IRR, pay back period

A project's NPV is positive. Select the most correct statement:

Question 260 DDM

A share just paid its semi-annual dividend of $5. The dividend is expected to grow at 1% every 6 months forever. This 1% growth rate is an effective 6 month rate.

Therefore the next dividend will be $5.05 in six months. The required return of the stock 8% pa, given as an effective annual rate.

What is the price of the share now?

Question 272 NPV

Suppose you had $100 in a savings account and the interest rate was 2% per year.

After 5 years, how much do you think you would have in the account if you left the money to grow?

Question 285 covariance, portfolio risk

Two risky stocks A and B comprise an equal-weighted portfolio. The correlation between the stocks' returns is 70%.

If the variance of stock A's returns increases but the:

Prices and expected returns of each stock stays the same,
Variance of stock B's returns stays the same,
Correlation of returns between the stocks stays the same.

Which of the following statements is NOT correct?

Question 377 leverage, capital structure

Question 527 income and capital returns

Total cash flows can be broken into income and capital cash flows.

What is the name given to the cash flow generated from selling shares at a higher price than they were bought?

Question 546 income and capital returns, interest only loan, no explanation

Which of the following statements about the capital and income returns of an interest-only loan is correct?

Assume that the yield curve (which shows total returns over different maturities) is flat and is not expected to change.

An interest-only loan's expected:

Question 684 future, arbitrage, no explanation

An equity index stands at 100 points and the one year equity futures price is 102.

The equity index is expected to have a dividend yield of 4% pa. Assume that investors are risk-neutral so their total required return on the shares is the same as the risk free Treasury bond yield which is 10% pa. Both are given as discrete effective annual rates.

Assuming that the equity index is fairly priced, an arbitrageur would recognise that the equity futures are: