Bigby Corp. Balance Sheet 1 Looking at Bigby's depreciation expense in 2014, what depreciation rate was used to calculate it? Open attachment for this question Answer. 10.0% Why is this the correct answer? 2. You've been asked to calculate the pre-tax cost of BB-rated corporate debt using the Treasury yield plus historical spread method as an estimate for non-recourse debt on a project. You expect treasury yields to remain relatively constant. However, between now and the time your project will need to secure financing, you expect the spread between treasuries and BB-rated bonds to become significantly wider than the historical average spread. How might you adjust your cost calculation to compensate? Answer. Increase cost calculation relative to the cost implied by historical spread. Why is this the correct answer? 3. If investors become greedier and less fearful, driving down the market risk premium, then this will cause the security market line to move in what way? Remember, the SML is a graphical represenation of the CAPM. Answer. It will become flatter. Why is this the correct answer? 4. You're a project manager and you've been instructed to evaluate any potential projects using a project-specific WACC of 10% or opportunity cost, whichever is greater. You're considering two projects. Project A has an IRR of 9% and Project B has an IRR of 12%. Project A would be approved if: Answer. Project A would not be approved. Why is this the correct answer? Use the following info to answer this question Capital Market Assumptions Risk-Free Security: 4% Inflation: 2% Expected return on market: 10% Expected GDP growth rate: 2.5% Style premium for ABC: 0.25% Size Premium for ABC: 0.15% Liquidity Premium for ABC: -0.10% ABC Corp. Assumptions Levered Beta: 1.20 Debt/Equity: 0.50 Tax Rate: 40% Return on equity: 15% Payout ratio: 45% Current Stock Price: $55 Current dividend yield: 2.10% 5. Using the CAPM, re-calculate ABC corps cost of equity accounting for a 50% increase in debt Answer. 12%. Why is this the correct answer? 6. In general, a capital structure consisting of 100% equity will have a lower cost of capital than a capital structure with even a modest amount of debt. This is because bankruptcy risk increases as debt is added to the capital structure, resulting in an increase in both the equity and debt component costs of capital and therefore the weighted-average cost of capital. Answer. False. Why is this the correct answer? 7. You're analyzing a project with large cash flows occurring early in its life. It's later cash flows are relatively small by comparison. Compared to a project with equal cash flows each period, how does this project's NPV profile compare? Answer. It is flatter. Why is this the correct answer? 8. The project financing method of calculating WACC relies on the component costs of the parent firm, but it uses the project's own capital structure weightings. The corporate financing method relies on the component costs of the parent firm and uses debt capacity to determine capital structure weightings. Answer. False. Why is this the correct answer? 9. Snappy Gator Corp. is a company with multiple operating divisions, each with different risk and return characteristics. Within each operating division, projects can vary significantly with respect to their own risk and return characteristics. Influence costs are considered to be negligible at Snappy Gator. Given this information, it would be most appropriate for Snappy Gator to use: Answer. Project-specific WACC. Why is this the correct answer? 10. In essence, the cost of equity described the constant growth model is really just the combination of the current yield and a capital gains (growth rate) rate. Answer. False. Why is this the correct answer? 11. In essence, the cost of equity described by the CAPM is really just the combination of the risk-free rate, a business risk premium, and a financial risk premium. Answer. True. Why is this the correct answer? 12. Clear Water inc. has two operating division, high and low. If Clear Water has a firm WACC of 10%, then there is risk that management will inappropriately approved a low-risk project with a projected return of, say 8%. To combat this risk, Clear Water could implement a divisional WACC, which would more appropriately account for the risk and return profiles of projects within each division. Answer. False. Why is this the correct answer? 13. Consider the below series of cash flows. Assuming a discount rate of 5%, the net present value of this cash flow series is greater than $50. T0: -500 T1: $100 T2: $200 T3: $75 T4: $150 T5: $75 Answer. False. Why is this the correct answer? 14. What is the internal rate of return for the series of cash flows in the question above? Answer. 6.79%. Why is this the correct answer? For a series of normal, equal cash flows with an IRR of 12% and a WACC of 8%, the MIRR will be Answer. Less than the IRR. Why is this the correct answer? 15. When comparing competing projects that are significantly different in terms of magnitude (for example a $1 billion project versus a $1 million project), IRR is a more useful measure than NPV, because it states the result in terms of a percentage. This makes the results "common sized" and allows for a better apples-to-apples comparison. Answer. False. Why is this the correct answer? 15. You're attempting to calculate cost of equity for a project using project financing. You've analyzed a series of comparable firms and determined an average unlevered equity beta of 0.67 across those firms. You've further determined than an appropriate risk free rate is 4% and an appropriate market risk premium is 7%. If the project you're analyzing has a capital structure of 40% debt and 60% equity, what is the cost of equity for the project? Assume a tax rate of 40%. Answer. 10.6% Why is this the correct answer? For all of these questions, can you please explain to me why that's the answer.