Question

-Why might hurdle rate for a project within a firm vary considerably from its overall hurdle rate?

	Project may be a new venture with an unproven outcome.
	Project may be in a different geographic region or country.
	Project may be in a business unit whose economic performance is above or below average.
	All of the above.

-You are seeking to estimate the operating leverage for a company. Over the past year sales have increased by 10% while operating income (EBIT) has risen by 15%. What is the operating leverage?

	0.67X
	1.50X
	1.67X
	1.85X

-You are analyzing a public company with a Beta of 1.20x. The firm has $100 million in debt and a market value of equity of $300 million. What is the unlevered Beta?

	0.85x
	0.89x
	0.92x
	1.20x

-You are seeking to determine the weighted average cost of capital for a company. Its book value of equity is $400 million and the market value of equity is $800 million. The book and market value of debt is $200 million. If tax rate is 20%, pre-tax cost of debt is 6% and cost of equity is 12%, what is the market weighted average cost of capital?

	9.36%
	10.56%
	11.35%
	12.00%

-Which of the following would not be a source of project risk?

	Technology risk
	Legal risk
	Commodity risk
	Market risk

Answer 1

Solution:

Q1.

Hurdle rate for a project is not always the same as the overall hurdle rate for an organization and this can arise due to following reasons

• All the projects have different risk and situations associated with it
• Outcomes of the projects can be different
• Location factor
• Economic outcome factor

So the correct option is D all of the above

Q2.

Operating leverage formula is

Operating leverage = Change in Operating income / Change in sales

Operating leverage = 15% / 10% = 1.5X

Option B is correct

Q3.

Levered Beta = 1.20

Debt = 100, Equity = 300 Debt/ equity = 100/300 =1/3

Formula for levered beta

Levered beta = Unlevered beta * ( 1 + Debt / Equity)

1.2 = Unlevered beta * ( 1 + 1/3 )

Unlevered beta = 1.2 * 3 /4 = 0.90

Closest answer is 0.89X

Option B is correct

Q4.

Market Value of equity = $800 million

The market value of debt = $200 million

Total value of the firm = 1000 million

Debt weigtage = Debt / Total value = 200/1000 = 0.2

Equity weightage = Equity /Total value = 800/1000 = 0.8

Pretax cost of debt = 6%, tax rate = 20%, After tax cost of debt = Pre-tax cost of debt * (1- tax) = 6%* (1-20%) = 6%*0.8 = 4.8%

Cost of equity = 12%
WACC = Cost of debt * weight of debt + cost of equity * weight of equity = 4.8% * 0.2 + 12% *0.8

= 0.96 % + 9.6% = 10.56%

Option B is correct

Q5.

Technological, market and legal risks are associated with project risk

Technological: It is kind of strategy risk. The project can be on risk if technology changes

Market Risk: under this, we have competition, foreign exchange risk etc

Legal: A project always faces legal risk like regulations etc

So the correct answer should be commodity risk : Not a source of project risk