Project #29651 - Week 4

 

Hi, I will include the Excel worksheet and the link to the text I'm using (Ch 9, 10). Thank you

 

Brealey, R. A., Myers, S. C. & Allen, F. (2011). Principles of Corporate Finance, Concise Edition, (2nd ed.). New York, NY: McGraw-Hill Irwin.

 

 

 

 

 

 

Problem 9-2

       
         

A company is 40% financed by risk-free debt. The interest rate is 10%, the expected market risk premium is 8%, and the beta of the company’s common stock is .5.

 

 

 

 

 

Risk Free Debt

Interest Rate

Market Risk Premium

Beta

Taxes

40%

10%

8%

0.5

35%

 

 

 

 

 

a.      What is the company cost of capital?

 

 

b.      What is the after-tax WACC, assuming that the company pays tax at a 35% rate?

         

Answers:

       
         

Step 1:

       

r(d)=

F

     

r(e)=

C

     

D/V

C

 

TIP: D + E = V

 

E/V

C

     
         

Step 2:

       

a.

 

Formula (in words)

Calculation

 

 

Cost of Capital

T

C

 
         

b.

WACC

T

C

 

 

 

 

Problem 9-16

                 
                   
                   

What types of firms need to estimate industry asset betas? How would such a firm make the estimate? Describe the process step by step.

 
 
 
                   
                   

Answer:

                 
                   

What types of firms need to estimate industry asset betas?

         

 T

 
 
 
 
 
 
 
 
 
 
 
 
 
 
                   

How would such a firm make the estimate? Describe the process step by step.

     

T

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

 

 

 

 

 

Problem 10-2

                 
                   
                   

Explain how each of the following actions or problems can distort or disrupt the capital budgeting process.                                                                                                                                                                                             a. Overoptimism by project sponsors.
b. Inconsistent forecasts of industry and macroeconomic variables.
c. Capital budgeting organized solely as a bottom-up process.

 
 
 
 
 
 
                   
                   

Answer:

                 
                   

a.

T

 
   
   
   
   
   
   
   
   
   
                   

b.

T

 
   
   
   
   
   
   
   
   
   
                   

c.

T

 
   
   
   
   
   
   
   
   
   
   

 

 

 

 

 

Problem 10-14

           
               

Suppose that the expected variable costs of Otobai’s project are ¥33 billion a year and that fixed costs are zero.                                                                                                                                                       a. How does this change the degree of operating leverage (DOL)?                                                                                b. Now recompute the operating leverage assuming that the entire ¥33 billion of costs are fixed.

 
 
 
 
               

Answers:

           
 

See page 243, Table 10.1,  of textbook for additional information. Copy is also provided below.

   
               

 

DOL Formula

Fixed Costs

Calculation

     

a.

1+(Fixed cost + depreciation)/ operating profit

 F

C

     

 

     

b.

1+(Fixed cost + depreciation)/ operating profit

 F

C

     
               
               
 

Table 10.1.jpg

       
         
         
         
         
         
         
         
         
         
         
         
         
         
         
               

 

 

 

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