Finance Weighted Average Cost of Capital and Market Risk...

Cost of Capital questions and practice problems Questions 1. What does the WACC measure? 2. Which is easier to calculate directly, the expected rate of return on the assets of a firm or the expected rate of return on the firm’s debt and equity? Assume you are an outsider to the firm. 3. Why are market-based weights important? 4. Why is the coupon rate of existing debt irrelevant for finding the cost of debt capital? 5. Under what assumptions can the WACC be used to value a project? 6. How should you value a project in a line of business with risk that is different than the average risk of your firm’s projects? 7. Maltese Falcone, has not checked its weighted average cost of capital for†¦show more content†¦If Dot.com’s marginal tax rate is 38%, what is its after-tax cost of debt? 7. Reactive Industries has a market value of debt of $20 million, with a rate of return of 6%, a market value of preferred stock of $10 million, with a rate of return of 8% and a market value of common stock of $50 million, with a rate of return of 12%. Its tax marginal tax rate is 35%. What is its WACC? 8. The common stock of BCCI has a beta of 0.90. The T-bill rate is 4% and the market risk premium is estimated at 8%. BCCI’s capital structure is 30% debt, having a 5% YTM, and 70% equity. What is BCCI’s cost of equity capital? It WACC? BCCI pays tax at 40%. 9. RiverRocks is considering a project with the following projected free cash flows: |0 |1 |2 |3 |4 | |-50 |10 |20 |20 |15 | The firm believes that, given the risk of this project, the WACC method is the appropriate approach to valuing the project. RiverRock’s WACC is 12%. Should it take on this project? Why or why not? 10. RiverRocks (whose WACC is 12%) is considering an acquisition of Raft Adventures (whose WACC is 15%). What is the appropriateShow MoreRelatedFinance 1001185 Words   |  5 Pagesreturn. Systematic risk is risk that influences a large number of assets called market risk. Where as unsystematic risk is a risk that influences a single company of a small group of companies, also called unique risk. Unsystematic risk is eliminated by diversification, so a portfolio with man assets has almost no unsystematic risk. Unsystematic risk is also called diversifiable risk. Systematic risk is called non diversifiable risk. Diversification eliminates unsystematic risk but does not eliminateRead MoreBest Practices in Estimating the Cost of Capital: Survey and Synthesis1254 Words   |  6 PagesOverview This case study focuses on where financial theory ends and practical application of the weighted average cost of capital (WACC) begins. It presents evidence on how some of the most financially complex companies and financial advisors estimated capital costs and focuses on the gaps found between theory and application. The approach taken in the paper differed from their predecessors in several various respects. Prior published information was solely based on written, closed-end surveys sentRead MoreCost of Capital1479 Words   |  6 PagesCost of Capital Definition: cost of capital is the rate of return that a company must earn on its project investments to maintain its market value and attract funds. The cost of capital to a company is the minimum rate of return that is must earn on its investments in order to satisfy the various categories of investors, who have made investments in the form of shares , debentures and loans. The cost of capital in operational terms refers to the discount rate that would be used in determining theRead MoreBoeings Strategy1485 Words   |  6 PagesThe Capital Assets Price Model (CAPM), is a model for pricing an individual security or a portfolio. Its basic function is to describe the relationship between risk and expected return, which is often used to estimate a cost of equity (Wikipedia, 2009). It serves as a model for determining the discount rate which is used in calculating net present value. The CAPM says that the expected return of a security or a portfolio equals the rate on a risk-free secu rity plus a risk premium. The formula is: Read MoreSouthwest Winglets Case Essays858 Words   |  4 PagesTopping, Director of Finance DATE: March 31, 2009 SUBJECT: Blended Winglet Project In order to calculate Southwest’s expected future cash flows from the Blended Winglet project we made specific decisions in setting the cash flows. First, we assumed that the cost of a Winglet is $700,000 per pair. Additionally, we assumed initial costs of: installation downtown per plane of $5,000, an installation cost of $56,000, and a facility modification cost of $1,200. Since costs were expected to riseRead MoreDisney Cost of Capital1059 Words   |  5 PagesFINAN 6121 – Corporate Finance Cost of Capital – The Walt Disney Company Team Titans B (Doug Horne, Shaun Hoggan, James Thackeray, Jeff Burg) The purpose of this project is to determine the weighted-average cost of capital (WACC) for The Walt Disney Company. According to The Walt Disney Company’s Form 10-K filing for the fiscal year ended September 29, 2012, â€Å"The Walt Disney Company, together with its subsidiaries, is a diversified worldwide entertainment company with operations in five businessRead MoreCapital Asset Pricing Model ( Capm )1310 Words   |  6 Pagesprojects to be invested in or finance in to increase the value of the company. However, to increase the value of the company, firm need to choose the worth pursuing project. In this case, firm need to evaluate the projects which the evaluation of a project can be done by cash flow method. The paper depicts how weight average of cost capital is used as a source of a discount rates for capital budgeting. In this paper, the discount rate in the weight average of cost capital (WACC) will be used in theRead MoreThe Weighted Average Cost Of Capital1987 Words   |  8 Pagesthe Weighted Average Cost of Capital of AGL Energy Ltd and gearing, as well as analysing the capital structure of the company. Through this, recommendations can be given to the firm to increase and better manage capital and how it is used. The Weighted Average Cost of Capital (WACC) is a calculation of a firm s cost of capital. It is the average costs of debt and equity financing, each of which is weighted by its proportional use. Body Weighted Average Cost of Capital The Weighted Average CostRead MoreMba 520 Module Six Forecasting Model Questions Essay1379 Words   |  6 Pagesbest way to minimize the weighted average cost of capital? Weighted Average Cost of Capital (WACC) is the combined rate at which a company repays borrowed capital and comes from debit financing and equity capital. WACC can be reduced by cutting debt financing costs, lowering equity costs, and capital restructuring. In order to minimize WACC, companies can issue bonds by lowering the interest rate they offer to investors as well as, cutting down on the costs it takes to finance debts, reviewing and modifyingRead MoreThe problems to estimate the cost of capital1051 Words   |  5 Pagesestimate the cost of capital Before starting to describe the problems associated to the estimation of the cost of capital, it is extremely relevant to describe its meaning: according to Investopedia, it is â€Å"the cost of funds used for financing a business†. In order to carry out this process, the companies can only be financed through equity; only through debt; or using a â€Å"combination of debt and equity† - in this particular case it is a â€Å"overall cost of capital derived from a weighted average of all