Exam (elaborations)
FIN4801 EXAM PACK 2023
- Institution
- University Of South Africa
QUESTIONS AND ANSWERS
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FIN4801EXAM
PACK 2023
, lOMoARcPSD|24668432
SOLUTIONS
Practice questions
Multiple Choice
1. XYZ has $25,000 of debt outstanding and a book value of equity of $25,000. The company has
10,000 shares outstanding and a stock price of $10. If the unlevered beta is 0.75 and the marginal
tax rate is 20%, what is XYZ's levered beta?
a. 0.75
b. 0.8
c. 0.85
D. 0.9
Market value of equity = 10,000 x $10 = $100,000; β L = 0.75[1+(1-0.2)($25,000/$100,000)]
2. The Collection Co. has a current beta of 1.6. The market risk premium is 7 percent and the risk-
free rate of return is 3 percent. By how much will the cost of equity increase if the company
expands their operations such that their company beta rises to 1.9?
a. 0.30 percent
b. 0.90 percent
c. 1.50 percent
D. 2.10 percent
e. 2.70 percent
Current cost of equity = 3+1.6(7) = 14.2%
New cost of equity = 3+1.9(7) = 16.3%
Change in cost of equity = 16.3 – 14.2 = 2.1
3. Blue Ribbon, Inc. wants to have a weighted average cost of capital of 10 percent. The firm has an
aftertax cost of debt of 4 percent and a cost of equity of 12 percent. What debt-equity ratio is
needed for the firm to achieve their targeted weighted average cost of capital?
a. .25
B. .33
c. .50
d. .67
e. .75
.10 = [W e .12] + [(1 W e) .04)
.10 = .12W e + .04 .04W e
.06 = .08W e
W e =.75
Wd = 1 We = 1 .75 = .25
Debt-equity ratio = .25 / .75 = .33
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, lOMoARcPSD|24668432
SOLUTIONS
4. If a firm uses its WACC as the discount rate for all of the projects it undertakes then the firm will
tend to:
I. reject some positive net present value projects.
II. accept some negative net present value projects.
III. favor high risk projects over low risk projects.
IV. maintain its current level of risk.
a. I and III only
b. III and IV only
C. I, II, and III only
d. I, II, and IV only
e. I, II, III, and IV
5. Wayne's of New York specializes in clothing for female executives living and working in the
financial district of New York City. Allen's of PA. specializes in clothing for women who live
and work in the rural areas of Western Pennsylvania. Both firms are currently considering
expanding their clothing line to encompass working women in the rural upstate region of New
York state. Wayne's currently has a cost of capital of 11 percent while Allen's cost of capital is 9
percent. The expansion project has a projected net present value of $36,900 at a 9 percent
discount rate and a net present value of $13,200 at an 11 percent discount rate. Which firm or
firms should expand into rural New York state?
a. Wayne's only
b. Allen's only
C. both Wayne's and Allen's
d. neither Wayne's nor Allen's
e. cannot be determined from the information provided
6. You are considering a project that will generate sales of $89,000, costs of $56,000, and annual
depreciation of $26,000. What is the value of the operating cash flow if the tax rate is 34
percent?
a. $28,380
b. $30,620
C. $47,780
d. $59,000
OCF = [($89,000 − $56,000) × (1 − .34)] + 26,000 = $47,780
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