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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 97 WACC, no explanation

A company has:

10 million common shares outstanding, each trading at a price of $90.
1 million preferred shares which have a face (or par) value of $100 and pay a constant dividend of 9% of par. They currently trade at a price of $120 each.
Debentures that have a total face value of $60,000,000 and a yield to maturity of 6% per annum. They are publicly traded and their market price is equal to 90% of their face value.
The risk-free rate is 5% and the market return is 10%.
Market analysts estimate that the company's common stock has a beta of 1.2. The corporate tax rate is 30%.

What is the company's after-tax Weighted Average Cost of Capital (WACC)? Assume a classical tax system.

Question 235 SML, NPV, CAPM, risk

The security market line (SML) shows the relationship between beta and expected return.

Investment projects that plot on the SML would have:

Question 312 foreign exchange rate, American and European terms

If the current AUD exchange rate is USD 0.9686 = AUD 1, what is the American terms quote of the AUD against the USD?

Question 326 CAPM

A fairly priced stock has an expected return equal to the market's. Treasury bonds yield 5% pa and the market portfolio's expected return is 10% pa. What is the stock's beta?

Question 413 CFFA, interest tax shield, depreciation tax shield

There are many ways to calculate a firm's free cash flow (FFCF), also called cash flow from assets (CFFA).

One method is to use the following formulas to transform net income (NI) into FFCF including interest and depreciation tax shields:

###FFCF=NI + Depr - CapEx -ΔNWC + IntExp###

###NI=(Rev - COGS - Depr - FC - IntExp).(1-t_c )###

Another popular method is to use EBITDA rather than net income. EBITDA is defined as:

###EBITDA=Rev - COGS - FC###

One of the below formulas correctly calculates FFCF from EBITDA, including interest and depreciation tax shields, giving an identical answer to that above. Which formula is correct?

Question 472 quick ratio, accounting ratio

A firm has current assets totaling $1.5b of which cash is $0.25b and inventories is $0.5b. Current liabilities total $2b of which accounts payable is $1b.

What is the firm's quick ratio, also known as the acid test ratio?

Question 623 market efficiency

The efficient markets hypothesis (EMH) and no-arbitrage pricing theory are most closely related to which of the following concepts?

Question 767 idiom, corporate financial decision theory, no explanation

The sayings "Don't cry over spilt milk", "Don't regret the things that you can't change" and "What's done is done" are most closely related to which financial concept?

Question 830 option, delta, gamma, no explanation

Below are some statements about European-style options on non-dividend paying stocks. Assume that the risk free rate is always positive. Which of these statements is NOT correct?