Lecture 8 - cost of capital

What does the unlevered cost of capital represent?

• The cost of debt financing only

• The cost of capital for a company with no debt

• The cost of capital including effect of taxes

• The dividend payout ratio

Which of the following statements best describes the term 'credit spread"

• The difference between the purchase price and selling price of a security

• he spread between the highest and lowest quoted price of a security in a day

• The difference in yield between a U.S Treasury bill and corporate bond of the same maturity

• The spread between the interest rates on short-term and long-term loans offered by a bank

Which method is commonly used to estimate the cost of capital for a new project when the project is not a publicly traded security?

• Using the company's overall WACC

• Using the historical returns of the company's stock

• Using the cost of capital of similar, publicly traded companies in the same industry

• Using the current interest rate on the company's bank loans

True of False: WACC is used to discount the to evaluate an investment as it provides a benchmark return that a company should earn on its existing assets.

• True

• False

How does WACC account for risk assessment?

• By providing the lowest possible cost of capital.

• By incorporating the relative proportion of cost of equity and debt, providing a risk-adjusted rate

• By considering only the market risk premium

• By excluding the cost of equity to minimise risk

Why is the equity beta (levered beta) often higher than the asset beta (unlevered beta) in leveraged firms?

• Because the company's debt increases the risk of its equity

• Because the company's equity is less risky that its debt

• because the company's assets are less risky than its debt

• Because the company's debt increases the risk of its assets

Which of the following is the correct application of the unlevered cost of capital (pre-tax WACC)?

• It is used to evaluate the expected return of a firm's equity shares.

• It is used to calculate the after-tax cost of a firm's debt

• It is used to evaluate the cash flows of an all-equity financed project with the same risk as the firm

• It is used to evaluate the expected return of a firm's debt holders.

What statement is true regarding the risk profiles of different sources of capital?

• Debt is riskier than equity

• Equity is riskier than debt

• Both equity and debt have the same risk profile

• The risk profile of capital source is irrelevant to WACC

What does the cost of capital represent in the context of financial management

• The profits of a company needs to make to stay in business

• The returns expected by investors who provide funds to a firm

• The total amount of debt a company has accrued

• The revenue a company generates from its business operations

How does a lower weighted average cost of capital (WACC) potentially impact a firm's value?

• It decreases the firm's value as it signifies higher risk to investors

• It increases the firm's value by enabling more investment in positive NPV projects

• It has not impact on a firm's value because WACC only relates to the firm's financial decisions

• It decreases the firm's value as it implies lower return for investors