Corporate Finance MCQ - Corporate Finance Section 2

26 If we use the company’s marginal cost of capital in the calculation of the NPV of a project, we are least likely assuming that:

Statement B is not an assumption we make when using the company’s marginal cost of capital to calculate the NPV of a project.

27 Which of the following is the least appropriate method for an external analyst to estimate a company’s cost of debt?

Bond yield plus risk premium is used to calculate cost of equity not cost of debt. The other two are approaches to calculate cost of debt.

28 If the debt rating approach is used to determine the cost of debt, then:

The debt rating approach depends on knowledge of the company’s rating and can be compared with yields on bonds in the public market.

29 A company is considering issuing a 5-year option-free, 8 percent coupon bond, paid semi-annually. The bond is expected to sell at 98 percent of par value (USD1,000). If the company’s marginal tax rate is 35 percent, then the after-tax cost of debt is closest to:

Using the financial calculator, determine the yield.
N = 10, PV = -980, PMT = 80/2 = 40, FV = 1000, CPT I/Y = 4.25 semiannual Annual yield = 4.25 * 2 = 8.50 before tax
After-tax cost of debt: 8.50% (1 – 35%) = 5.525 ~ 5.53%.

30 A company issued $20 million in long-term bonds at par value three years ago with a coupon rate of 10 percent. The company has decided to issue an additional $20 million in bonds and expects the new issue to be priced at par value with a coupon rate of 8 percent. There is no other outstanding debt. The applicable tax rate is 35 percent. The appropriate after-tax cost of debt in order the compute the weighted average cost of capital is closest to:

The appropriate cost is the marginal cost of debt. The before-tax cost of debt can be calculated by the yield to maturity on a comparable outstanding. After adjusting for tax, the after-tax cost of debt is 8(1 – 0.35) = 8(0.65) = 5.2%.