Question

1. A company is financed 60% by debt and 40% by equity. The pre-tax cost of debt is currently 10%. The Finance Director has stated that the weighted average cost of capital for the company is 9.6%. What is the cost of equity? Assume the tax rate is 40%.

2. What weakness does the NPV method have that is not present in the payback method?

Group of answer choices:

a Initial cash flows are ignored.

b The NPV method is easier to understand.

c It takes into account the time value of money.

d It requires estimating the cost of capital.

3. You are contemplating the purchase of a TV with a retail price of $2,100. The retailer is offering interest-free terms that require a cash payment of $700 now, another $700 in six months, and a final payment of $700 one year (12 months) from now. If your borrowing rate is 1% per month, what is the most you would want to pay for the purchase today (rounded to the nearest dollar)?

Group of answer choices:

a $1,974.

b $1,980.

c $2,100.

d $1,983.

4. When calculating net present value we use cash flows for various reasons. Which of the following is FALSE?

Group of answer choices:

a. Projects have a beginning and an end so we should use cash for the duration of that project.

b. All of the other options are TRUE.

c. We should use accrual accounting for net present value calculations.

d. Capital expenditure is usually in cash and therefore the possible future benefits of that cash outlay should be measured in cash.

5. Why might management prefer equity financing to debt financing?

Group of answer choices

Debt has to be repaid.

Equity financing is usually cheaper.

A company is more successful if they only have equity financing.

Dividend payments are tax deductible.

Answer 1

Let the cost of Equity be x

WACC = After tax cost of debt*weight of debt + cost of equity*weight of Equity

9.6% = 10%*(1-40%)*60% + x*40%

x = 15%

Hence, cost of Equity = 15%

2. d It requires estimating the cost of capital.

Which is not required in payback method as it does not consider time value of money

3.Most to be paid today is equal to present value of payments in future

= 700 + 700/(1.01)^6 + 700/((1.01)^12

= $1,980.65

i.e. b

4. c. We should use accrual accounting for net present value calculations.

5. Debt has to be repaid.