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CORPORATE FINANCE FINAL STUDY GUIDE QUESTIONS AND ANSWERS WITH SOLUTIONS 2024
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CORPORATE FINANCE FINAL STUDY GUIDE QUESTIONS AND ANSWERS WITH SOLUTIONS 2024
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CORPORATE FINANCE FINAL STUDYGUIDE QUESTIONS AND ANSWERS
WITH SOLUTIONS 2024
TheDWACCDaccountsDforDinterestDtaxDshieldsDbyDusingDthe:D-DANSWERDafter-taxDcostDofDdebt
WhenDshouldDmanagersDuseDcautionDwhenDapplyingDtheDWACCDformula?D-DANSWERD-
DWhenDaDprojectDisDlessDriskyDthanDaverage
-DWhenDaDprojectDwouldDincreaseDtheDfirm'sDtargetDdebtDratio
-DWhenDaDprojectDisDriskierDthanDaverage
-DWhenDaDprojectDwouldDdecreaseDtheDfirm'sDtargetDdebtDratio
SupposeDthatDaDfirmDhasDaDcapitalDstructureDofD40%DdebtDandD60%Dequity.DTheDcostDofDdebtDisD7.5%DandDt
heDcostDofDequityDisD18%.DTheDfirmDisDtaxedDatDtheD35%DmarginalDtaxDrate.DCalculateDtheDafter-taxDWACC.D-
DANSWERDCostDofDdebtDafter-tax=8*(1-taxDrate)
=8*(1-0.35)=5.2%
WACC=RespectiveDcost*RespectiveDweight
=(0.4*5.2)+(0.6*18)
whichDisDequalDto
=12.75%
SupposeDthatDaDlargeDautoDmanufacturerDisDconsideringDtheDadditionDofDaDnewDplantDtoDmanufactureDpart
s.DTheyDhaveDalreadyDdeterminedDthatDtheDproject'sDNPVDisD0.DTheyDhaveDestimatedDafter-
taxDyearlyDcashDflowDatD$1.975DmillionDinDperpetuity.DTheDcostDofDdebtDisD5%DandDtheDcostDofDequityDisD11
%.DTheyDareDtaxedDatDaDmarginalDtaxDrateDofD35%.DTheDcompany'sDdebtDratioDisD40%DandDitsDequityDratioDis
D60%.DWhatDmustDbeDtheDmarketDvalueDofDtheDasset?D-DANSWERDWACCD=D5%(1-
.35)(0.4)+11%(.6)=7.9%;D1.975/7.9%=25
InDorderDforDaDcompanyDtoDcorrectlyDuseDtheDWACCDtoDvalueDaDproject,DtheDfollowingDrequirementsDmustD
beDmet:D-DANSWERD-DTheDriskDlevelDofDtheDprojectDmustDmatchDtheDriskDlevelDofDtheDfirm'sDotherDassets
-DTheDprojectDmustDnotDalterDtheDfirm'sDexistingDdebtDratio
,HowDdoesDtheDWACCDformulaDaccountDforDtheDvalueDofDinterestDtaxDshields?D-
DANSWERDByDusingDtheDafter-taxDcostDofDdebt
UsingDanDindustryDWACCDforDaDcompanyDwithinDthatDindustryDassumesDthat:D-DANSWERD-
DtheDcompanyDandDindustryDhaveDaboutDtheDsameDriskDlevel
-DtheDcompanyDandDtheDindustryDhaveDaboutDtheDsameDfinancingDterms
TheDWACCDformulaDshouldDbeDusedDforDprojectsDthatDoffer:D-
DANSWERDaverageDriskDtoDtheDfirm'sDexistingDassets
IdentifyDsomeDofDtheDcommonDconsiderationsDthatDmanagersDmakeDwhenDusingDtheDWACCDtoDvalueDaDco
mpany.D-DANSWERD-DHowDfinancingDcostsDareDdetermined
-DHowDotherDcurrentDliabilitiesDaffectDnetDworkingDcapitalDcalculations
-DThatDthereDmayDbeDmultipleDsourcesDofDfinancing
-DTheDWACCDofDcomparableDcompanies
TheDafter-taxDweightedDaverageDcostDofDcapitalDisDdeterminedDby:D-
DANSWERDaddingDtheDweightedDaverageDafter-taxDcostDofDdebtDtoDtheDweightedDaverageDcostDofDequity
ADproject'sDcostDofDequityDwillDequalDitsDexpectedDreturnDwhen:D-DANSWERDitDhasDaDNPVDofDzero
WhatDisDtheDrelationshipDbetweenDtheDWACC,DtheDcostDofDequity,DandDtheDopportunityDcostDofDcapitalDifDaD
companyDorDprojectDisDfinancedDsolelyDbyDequity?D-
DANSWERDTheDWACC,DtheDcostDofDequity,DandDtheDopportunityDcostDofDcapitalDwillDallDbeDequal
AllisonDandDSaraDKimDareDtwinDsistersDwhoDrunDaDcompanyDthatDoperatesDthreeDsuccessfulDKoreanDBBQDre
staurantsDinDLA'sDKoreatown.DTheyDareDconsideringDmovingDtoDBoise,DIdahoDtoDbeDcloserDtoDtheirDfamilyDa
ndDwouldDlikeDtoDopenDaDKoreanDBBQDthere.DTheDnewDventureDholdsDaDhigherDlevelDofDriskDthanDtheirDexist
ingDcompanyDprofileDbecauseDtheDrestaurantDwouldDbeDtheDfirstDofDitsDkindDinDBoise.DInDaddition,DtheDtwin
sDwouldDfinanceDtheDnewDrestaurantDmostlyDwithDdebt,DwhereasDtheDcurrentDcompanyDhasDlittleDdebtDonDi
tsDbooks.DWhatDareDsomeDofDtheDproblemsDwithDusingDtheDWACCDinDthisDsituation?D-DANSWERD-
DTheDdebtDincurredDforDtheDnewDrestaurantDisDunrelatedDtoDtheDproject'sDhurdleDrate
-DTheDexpectedDreturnDrequiredDbyDinvestorsDandDtheDborrowingDrateDwouldDbothDrise
, -DTheDriskDprofilesDofDtheDcurrentDcompanyDandDtheDnewDventureDdiffer
WhichDofDtheDfollowingDstatementsDcharacterizesDtheDweightedDaverageDcostDofDcapitalDformula?D-
DANSWERDItDassumesDtheDprojectDisDaDcarbonDcopyDofDtheDfirm
AsDtheDratioDofDdebtDtoDequityDincreases,DwhatDhappensDtoDtheDcostDofDequityDandDtheDWACC?D-
DANSWERDTheDcostDofDequityDincreasesDandDtheDWACCDdecreases
TellDComputers,DaDlargeDmakerDofDPCs,DisDconsideringDtheDpurchaseDofDLeapDSystems,DaDsmallDtechnologyD
companyDwhoseDcapitalDstructureDdiffersDfromDTell's.DTell'sDdebtDbetaDisD.2DandDitsDequityDbetaDisD1.1.DTheD
riskDfreeDinterestDrateDisD4%DandDtheDmarketDriskDpremiumDisD8%.DTell'sDdebt-
equityDratioDisD50/50,DwhereasDLeap'sDdebt-
equityDratioDisD40/60.DWhatDisDtheDrecalculatedDcostDofDequity?D(Hint:DRecalculateDtheDequityDbetaDfirst).D-
DANSWERDStepD1:DCalculateDtheDassetDbeta.D(.2DxD.5)D+D(1.1DxD.5)D=D.65.DStepD2:DRecalculateDtheDequityDbet
a.D.65D+D(.65D-
D.2)DxD.6667D=D.95.DRecallDthatDD/ED=D.4/.6D=D.6667.DStepD3:DRecalculateDtheDcostDofDequity.D.04D+D.08D(.95)D
=D.116DorD11.6%.
AsDtheDdebtDratioDincreases,DtheDcostDofDequityDincreases,DbutDtheDWACCDdeclines.DThisDisDbecauseDof:D-
DANSWERDinterestDtaxDshields
SupposeDthatDH20DResourcesDhasDanDequityDbetaDofD.9.DTheDcurrentDriskDfreeDrateDofDinterestDisD2%DandDth
eDmarketDriskDpremiumDisD6%.DWhatDisDtheDcompany'sDcostDofDequity?D-
DANSWERD=.02D+D(.06).9D=D.074DorD7.4%
SupposeDthatDaDcorporationDhasDaDcostDofDdebtDofD8%DwhenDitDhasD40%DofDitsDvalueDtiedDupDinDdebt.DItsDco
stDofDequityDisD11%DwhenD60%DofDitsDvalueDisDinDequity.DIfDtheDcorporateDtaxDrateDisD35%,DwhatDisDtheDcorp
oration'sDWACC?D-DANSWERD.08DxD(1-.35)DxD.4D+D.11DxD.6D=D8.68%
AsDtheDdebtDratioDincreases,DwhyDdoesDtheDweightedDaverageDcostDofDcapitalDdecrease?D-
DANSWERDTheDexistenceDofDtaxDshieldsDonDdebtDinterestDpayments
ThoughtDPodDComputers,DaDlargeDmakerDofDlaptopDPCs,DisDconsideringDtheDpurchaseDofDJumperDSystems,Da
DsmallDtechnologyDcompanyDwhoseDcapitalDstructureDdiffersDfromDThoughtDPod's.DThoughtDPod'sDdebtDbet
aDisD.2DandDitsDequityDbetaDisD1.2.DTheDriskDfreeDinterestDrateDisD4%DandDtheDmarketDriskDpremiumDisD8%.DTh
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