This fourth quiz will test your understanding of the issues discussed in session 4 of the ‘Corporate Finance Essentials’ course. Before attempting to answer the questions below, make sure you review the issues discussed in this session, and that you read all the required material.
(The following information applies to questions 1 through 6.) Consider Rhye, amid-size pharmaceutical company. Rhye’s equity has a book value of $2.8 billion and a market value of $19.4 billion. Rhye’s debt, on the other hand, has a book value of $500 million and a market value of $600 million; the debt’s annual interest rate and yield to maturity are 6% and 5%, respectively. Currently, Rhye has a beta of 1.2 and faces a corporate tax rate of 35%. Also currently, the yield to maturity on 10-year U.S. Treasury Notes is 2.5%. The market risk premium remains around its historical average of 5.5%.
Estimating the Cost of Capital - An Application
Quiz 4
1.
What is Rhye’s required return on debt, or cost of debt?
5%
7%
4%
3%
6%
1
point
2.
What is Rhye’s after-tax required return on debt, or after-tax cost of debt?
3.25%
5.75%
7.50%
6.25%
4.50%
1
point
3.
What is Rhye’s required return on equity, or cost of equity?
8.0%
5.4%
4.1%
6.8%
9.1%
1
point
4.
What is Rhye’s debt ratio, or the proportion of debt relative to the company’s total capital, the latter defined as the sum of debt and equity?
5%
7%
9%
3%
11%
1
point
5.
What is Rhye’s equity ratio, or the proportion of equity relative to the company’s total capital, the latter defined as the sum of debt and equity?
100%
90%
81%
97%
87%
1
point
6.
What is Rhye’s weighted-average cost of capital?
4.1%
10.2%
12.0%
8.9%
6.6%
1
point
7.
Of the five options below, select the one that correctly completes the following sentence: “When estimating a company’s cost of capital …
the cost of debt is typically given by a bond’s interest rate.”
the cost of debt is typically estimated with the CAPM.”
the weights of debt and equity are typically considered at book value.”
the weights of debt and equity are typically considered at market value.”
corporate taxes are irrelevant and play no role in its determination.”
1
point
8.
Of the five options below, select the one that correctly completes the following sentence: “If a company’s cost of capital is 8% …
it should invest in a project from which it expects a 5% return.”
the company’s cost of equity must be 4% and its cost of debt 12%.”
it should invest in a project from which it expects a 10% return.”
the company’s cost of equity must be 12% and its cost of debt 4%.”
all its divisions must always use 8% as the appropriate hurdle rate.”
