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?
What types of firms need to estimate industry asset betas? How would such a firm make the estimate? Describe the process step by step.
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.
Suppose that the expected variable costs of Otobai's project are ¥33 billion a year and that fixed costs are zero. How does this change the degree of operating leverage (DOL)? Now recompute the operating leverage assuming that the entire ¥33 billion of costs are fixed.
Answers Corporate Finance Questions on Cost of Capital, Asset Betas, Capital Budgeting, Leverage using Excel.
Capital Budgeting and Portfolio Beta
See the attached file.
e. Suppose you are managing a stock portfolio consisting a mixture of high and low beta
stocks. You have information which leads you to believe that the stock market is likely to
be very strong in the immediate future, i.e., you are confident that the market is about to
rise sharply. If you want to take advantage of the situation to maximize the value of your
portfolio, what would you do now? Explain your answer.
a) Project X has an internal rate of return of 20 percent. Project Y has an internal rate of return of 15 percent. Both projects have a positive net present value. Does this mean Project X has a shorter payback than Project Y? Explain your answer.
i) In capital budgeting, why is the focus on cash flows rather than net income? Should interest payments be considered in capital budgeting? How about the changes in net operating working capital? Provide the arguments to support your answers.
1- What would be the effect if a company increases its debt ratio, but leaves its operating
income (EBIT) and total assets unchanged?