Question

TRUE OR FALSE

1. Ignoring taxes, if a firm issues debt at par, then the YTM cannot be computed.

2.Given the following: the risk-free rate is 8% and the market risk premium is 8.5%. Project III should be accepted if the firm's beta is 1.2.

Project	Beta	Expected return
I	0.65	12%
II	0.90	17%
III	1.40	19%

3. The cost of capital is also known as the appropriate discount rate

4. The weighted average cost of capital for a firm is dependent upon the firm's level of risk.

5. It is generally better to base estimates of the WACC on book value weights of debt and equity since market values, particularly those for equity, tend to fluctuate widely.

Answer 1

1. Answer: False.
YTM: It is the discount rate at which the present value of a bond’s
promised cash flows is equal to its market price is the bond.

2. Answer: True.
Capital Asset pricing model:

As per CAPM model:
Re= Rf+(Rm-Rf)B

Re= cost of capital.
Rf= Risk-free rate.
Rm =Market Risk Premium.
B = Beta, systematic risk.

Re= 8+(8.5-8)1.12
Re=8.6%

Since the cost of capital is less than the expected return of the project. It can be accepted.

3. Answer: True.
4. Answer: True
WACC = WEIGHTED AVERAGE COST OF CAPITAL.

It's the overall cost of raising funds for the firm. The ability to raise the Capital depends upon firms level of risk.

The weighted average cost of capital= (weight of equity x cost of equity)+(weight of debt x cost of debt)+(weight of preference x cost of preference)

5. Answer: False.
Market value weights show the real and appropriate level of the company. Book value weights are outdated.