Question

1. Which of the following statements are correct (there can be several correct answers)?

a)      A project whose expected return is greater than the company's WACC is worth pursuing

b)      WACC represents the required return by the company's shareholders

c)      When a project shows a negative NPV, this means its expected return is lower than the company's WACC

d)      When making an investment decision, calculating IRR is not relevant

2. Which of the following statements are correct (there can be several correct answers)?

a)      The WACC is based on the fact that cost of equity and the cost of debt can be different

b)      The notion of “tax shield” is extremely important when calculating the cost of debt

c)      The capital structure of a company is taken into account when calculating the WACC

d)      Everything being equal, a company with a more volatile stock price has a lower WACC

e)      It would be probably irrelevant to use the WACC for a company with no debt

3. Under perfect capital markets conditions, what happens when a company takes on new debt? Note that several answers may be correct.

a)      It reduces its cost of capital

b)      It does not affect its cost of capital

c)      It increases its cost of capital

d)      It increases its cost of equity

e)      It decreases its cost of equity

Answer 1

1]

(a) is correct - A project with expected return higher than WACC is worth pursuing because the NPV is likely to be positive, and it will create value for investors

(b) is incorrect - WACC is the required return of all investors, including common stockholders, preferred stockholders and debtholders

(c) is correct - A project with negative NPV will have a required return lower than WACC

(d) is incorrect - Calculating IRR is relevant as it is an important capital budgeting tool along with NPV