Question

1. A firm has a debt-equity ratio of 4. The market value of the firm’s debt and equity is £5m. What is the value of the firm’s debt?

A: £4.0m
B: £3.8m
C: £4.5m
D: £2.6m

2. A firm has a debt-equity ratio of 4. The cost of debt capital is 8% and the cost of equity capital is 12%. What is the weighted average cost of capital for the firm (WACC)?

A: 10.1%
B: 8.8%
C: 9.5%
D: 9.2%

3. Suppose Modigliani-Miller irrelevance of borrowing holds, and assume the firm has a weighted average cost of capital of 7%. If the debt-equity ratio is 2 and the cost of debt capital is 5%, what is the cost of equity capital?

A: 12%
B: 10%
C: 11%
D: 9%

4. Data about the earnings flow of a firm are given in the table below. What is the value per share of the firm?

Expected earnings next year	£1m
Payout policy	100% of earnings is distributed to the shareholders every year
Expected earnings growth	0
Debt-equity ratio	0
Weighted average cost of capital	7%
Number of shares	15m

A: £1.62
B: 95p
C: 81p
D: £1.56

5. Use the data given in question 14. What is the dividend per share of the firm?

A: 5.1p
B: 2.5p
C: 3.9p
D: 6.7p

6. Use the data given in question 14. Suppose the firm changes its payout policy to 70%, such that 30% is reinvested in the firm, earnings a return equal to 7%. What is next year’s expected dividend per share?

A: 4.7p

B: 5.2p

C: 3.1p

D: 2.6p

7. Consider the payout policy given in question 16. What is the dividend and earnings growth for the firm?

A: 0.5%
B: 3.6%
C: 2.1%
D: 4.6%

8. The data in the table shows the earnings data as well as data on the coupon and capital payments on the firm’s debt. The corporate and investor tax rate is zero. What is the debt-equity ratio of the firm?

Earnings before interest payments and depreciation	£15m
Earnings growth	0
Face value debt	£100m
Maturity data (at which the face value is repaid)	10 years
Annual coupon rate	5%
Yield to maturity debt	5%
Weighted average cost of capital	8%

A: 4.20
B: 2.36
C: 1.14
D: 3.10

9. A firm has annual dividend yield 3.5% and expected growth in dividends of 2% per year. You should assume the growth in dividends is sustainable for the foreseeable future. What is the firm’s cost of capital?

A: 8.2%
B: 5.5%
C: 7.1%
D: 10.5%

10. Suppose the firm’s weighted average cost of capital is 12%, the cost of debt capital is 7%, and the cost of equity capital is 15%. What is the debt-equity ratio of the firm?

A: 1.5
B: 4.8
C: 0.6
D: 2.3

Answer 1

1.Given the debt:equity ratio being 4:1, we can deduce the market value of the firm comrpising of both debt and equity would be split in the ratio of 4:1 correspondingly. Thus thereby we get the value of the firm's debt by the following formula:

Total Value of the firm/Total value of ratio*debt ratio value

i.e 5/(4+1)*4=4

Answer: A

2. WACC can be computed by the following formula:

Weight of equity*cost of equity + weight of debt*cost of debt

i.e 1/5*12% + 4/5*8%(1-t) .... (where t is the tax benefit of interest we get in the form of tax deduction which reduces the effective cost of debt. However in the absence of the tax rate, we would presume it to 0)

2.4%+6.4%=8.8%

Answer: B

3. One of the basic Modigliani & Miller propositions is based on the following key assumptions:

• No taxes

Thus we have no tax rate.

So the weighted average cost of the capital can be computed as follows:

Weight of equity*cost of equity + weight of debt*cost of debt

i.e 1/3*x + 2/3*5=7

Therefore, solving above equation we get x=11%

Answer: C

4. Given the data, we will use Dividend growth model for cost of equity (CoE) to find out the value per share.

CoE=Dividend per share/value per share+Growth

7=(1/15)/x +0

x=0.009524

Answer: B

5. Dividend per share is given by

Total Dividend / No of shares

1/15=0.0067

Answer: D