Corporate Finance MCQ - Corporate Finance Section 2

21 Gaven Warren at California Investment Advisors wants to estimate the cost of capital for Semiactive Conductors as well as projected cash flows for two of their projects to determine the effect of these new projects on the value of Semiactive Conductors. Warren has gathered following information on Semiactive Conductors:

	Current ($) )	Target ($)
Book Value of Debt	62	62
Market Value of Debt	59	63
Book Value of Shareholder’s Equity	78	88
Market Value of Shareholder’s Equity	230	240

Weights that should be applied to estimating the cost of debt and equity capital for Semiactive Conductors respectively are:

Use the market values of debt and equity to calculate their weights. wd = $63 / ($63 + $240) = 0.208 we = $240 / ($63 + $240) = 0.792.

22 In collecting information to conduct financial analysis on Budweiser’s new product line of sparkling water, Simon Hayes found that Budweiser currently has a debt-to-equity ratio of 0.55 and the new product line would be financed with $45 million of debt and $65 million of equity. Hayes has estimated the equity beta and asset beta of comparable companies to determine the valuation impact of the new product line on Budweiser’s value. Which of the following statements for calculating the equity beta for this new line of product is most accurate?

When making adjustments from the asset beta, derived from the comparables, to calculate the equity beta of the new product, the correct approach is to use the debt-to-equity ratio of the new product line.

23 An optimal capital budget occurs when the marginal cost of capital:

An optimal capital budget occurs when the marginal cost of capital intersects the investment opportunity schedule.

24 Analyst 1: A company’s optimal capital budget occurs at the intersection of the net present value and the internal rate of return profiles. Analyst 2: A company’s optimal capital budget occurs at the intersection of the marginal cost of capital and the investment opportunity schedule. Which analyst’s statements is most likely correct?

The point at which the marginal cost of capital intersects the investment opportunity schedule is the optimal capital.

25 Information about a company is provided below. It is expected that the company will fund its capital budget without issuing any additional shares of common stock:

Source of capital	Capital structure proportion	Marginal after-tax cost
Long-term debt	30%	12%
Preferred stock	5%	15%
Common equity	65%	20%

Net present values of three independent projects:
Storage project: $348 Upgrade project: $0
Production line improvement project: -$231 If no significant size or timing differences exist among the projects and the projects all have the same risk as the company, which project has an internal rate of return that exceeds 17.35 percent?

The WACC of the company is calculated as follows: 0.3(12%) + 0.05(15%) + 0.65(20%) = 17.35%. To have a positive NPV, a project must have an IRR greater than the WACC used to calculate the NPV. Only the storage project has a NPV greater than $0 (at the company’s WACC of 17.35%), therefore only the storage project has an IRR that exceeds 17.35%.