Using the Modigliani-Miller (MM) theory in a perfect market, you want to evaluate a proiect and how to finance it. The project has free cash flows in one year (vear 1) of $90 in a weak economy or $120 in a strong economy. There is 75% chance that the economy is strong. The initial investment required for the project is $80, and the project's cost of capital is 10%. The risk free interest rate is 5%. Suppose that to raise the funds for the initial investment, you can both raise some amount of levered equity and borrow $80 at the risk free interest rate. For the cost of the levered equity and the cost of capital (WACC), which of the following statements is correct? A. The cost of the levered equity is 56.32% and the cost of capital is 10.00% B. The cost of the levered equity is 27.96% and the cost of capital is 10.0096 C. The cost of the levered equity is 27.96% and the cost of capital is 15.00% D. The cost of the levered equity is 56.32% and the cost of capital is 15.00% Wyatt Oil has a bond issue outstanding with seven years to maturity, a yield to maturity of 7.0%, and a BBB rating. The bondholders' expected loss rate in the event of default is 70%. You are also given the following information for corporate bonds. Assuming the economy is in normal conditions, the expected return on Wyatt Oil's debt is closest to: AAA AA A BBB BB CCC Rating Average Default Rate Recession Default Rate 0.096 0.196 0.296 0.596 2.296 5.5% 12.296 0.0% 1.096 3.096 3.096 8.096 16.096 48.096 Average Beta 0.05 0.05 0.05 0.10 0.17 0.26 0.31 A. 8.15% OB.6.6596 OC. 6.7196 OD. 7.0196 Rearden Metal currently has no debt and an equity cost of capital of 14%. Suppose that Rearden decides to increase its leverage and maintain a debt to equity ratio of 1 and its cost of debt will be 89. The corporate tax rate is 40%. Assuming that Rearden's pre-tax cost of capital (Pretax WACC) remains constant, then with the addition of leverage, Rearden's effective after-tax cost of capital (WACC) will be closest to: A. 10.896 OB. 13.496 OC. 12.8% OD. 12.496 Using the Modigliani-Miller (MM) theory in a perfect market, you want to evaluate a proiect and how to finance it. The project has free cash flows in one year (vear 1) of $90 in a weak economy or $120 in a strong economy. There is 75% chance that the economy is strong. The initial investment required for the project is $80, and the project's cost of capital is 10%. The risk free interest rate is 5%. Suppose that to raise the funds for the initial investment, you can both raise some amount of levered equity and borrow $80 at the risk free interest rate. For the cost of the levered equity and the cost of capital (WACC), which of the following statements is correct? A. The cost of the levered equity is 56.32% and the cost of capital is 10.00% B. The cost of the levered equity is 27.96% and the cost of capital is 10.0096 C. The cost of the levered equity is 27.96% and the cost of capital is 15.00% D. The cost of the levered equity is 56.32% and the cost of capital is 15.00% Wyatt Oil has a bond issue outstanding with seven years to maturity, a yield to maturity of 7.0%, and a BBB rating. The bondholders' expected loss rate in the event of default is 70%. You are also given the following information for corporate bonds. Assuming the economy is in normal conditions, the expected return on Wyatt Oil's debt is closest to: AAA AA A BBB BB CCC Rating Average Default Rate Recession Default Rate 0.096 0.196 0.296 0.596 2.296 5.5% 12.296 0.0% 1.096 3.096 3.096 8.096 16.096 48.096 Average Beta 0.05 0.05 0.05 0.10 0.17 0.26 0.31 A. 8.15% OB.6.6596 OC. 6.7196 OD. 7.0196 Rearden Metal currently has no debt and an equity cost of capital of 14%. Suppose that Rearden decides to increase its leverage and maintain a debt to equity ratio of 1 and its cost of debt will be 89. The corporate tax rate is 40%. Assuming that Rearden's pre-tax cost of capital (Pretax WACC) remains constant, then with the addition of leverage, Rearden's effective after-tax cost of capital (WACC) will be closest to: A. 10.896 OB. 13.496 OC. 12.8% OD. 12.496
