Question

In: Finance

Each of the following factors affects the weighted average cost of capital (WACC) equation. Which are...

Each of the following factors affects the weighted average cost of capital (WACC) equation. Which are factors that a firm can control? Check all that apply.

The firm’s capital structure

Tax rates

The firm’s dividend payout ratio

The firm’s capital budgeting decision rules

The impact of cost of capital on managerial decisions

Consider the following case:

International Imports (I2) has two divisions, L and H. Division L is the company’s low-risk division and would have a weighted average cost of capital of 8% if it was operated as an independent company. Division H is the company’s high-risk division and would have a weighted average cost of capital of 14% if it was operated as an independent company. Because the two divisions are the same size, the company has a composite weighted average cost of capital of 11%. Division H is considering a project with an expected return of 12%.

Should International Imports (I2) accept or reject the project?

Reject the project

Accept the project

On what grounds do you base your accept–reject decision?

Division H’s project should be accepted, as its return is greater than the risk-based cost of capital for the division.

Division H’s project should be rejected since its return is less than the risk-based cost of capital for the division.

Expert Solution

The firm's capital structure affects the weighted average cost of capital since the different types of share capital is financed at different rates and thus, the firm's capital structure will affect the WACC.

Tax rates also affect the weighted average cost of capital since it is required to calculate the after tax cost of debt.

The dividend payout ratio also affects the WACC because it affects the growth rate which is used in the Dividend Discount Model to find the cost of equity and therefore, it affects the WACC.

The firm's capital budgeting decision rules does not affect the weighted average cost of capital because the WACC is used to discount the cash flows to find out the NPV

The impact of cost of capital on managerial decisions does not affect the WACC because it used to make decisions and is not factored in the WACC

CASE

International Imports(I2) should accept the project.

Division H’s project should be accepted, as its return is greater than the risk-based cost of capital for the division. For example, the cash inflow would be 100, expected return is 12% and the cost of capital is 11% , the present value of this inflow is 100*12/11 would be 109.10

jeff jeffy answered 1 year ago

Each of the following factors affects the weighted average cost of capital (WACC) equation. Which of...

Each of the following factors affects the weighted average cost of capital (WACC) equation. Which of the following factors are outside a firm’s control? Check all that apply. The general level of stock prices The effect of the tax rate on the cost of debt in the weighted average cost of capital equation The firm’s capital budgeting decision rules Edinburgh Exports has two divisions, L and H. Division L is the company’s low-risk division and would have a weighted average...

9. Factors that affect the WACC equation Each of the following factors affects the weighted average...

9. Factors that affect the WACC equation Each of the following factors affects the weighted average cost of capital (WACC) equation. Which are factors that a firm can control? Check all that apply. The firm's capital structure Interest rates in the economy The firm 's dividend payout ratio The general level of stock prices The impact of cost of capital on managerial decisions Consider the following case: Marston Manufacturing Company has two divisions, L and H. Division L is the...

The weighted average cost of capital (WACC) is calculated as the weighted average of cost of...

The weighted average cost of capital (WACC) is calculated as the weighted average of cost of component capital, including debt, preferred stock and common equity. In general, debt is less expensive than equity because it is less risky to the investors. Some managers may intend to increase the usage of debt, therefore increase the weight on debt (Wd). Do you think by increasing the weight on debt (Wd) will reduce the WACC infinitely? What are the benefits and costs of...

What is Weighted Average Cost of Capital (WACC)?

Charlotte's Crochet Shoppe has 14,300 shares of common stock outstanding at a price per share of $75 and a rate of return of 11.61%. The company also has 280 bonds outstanding, with a par value of $2000 per bond. The pre-tax cost of debt is 6.13% and the bonds sell for 97.2% of the par. What is the weighted average cost of capital (WACC), if the tax rate is 40%?

Define each of the following terms: a. Weighted average cost of capital, WACC; after-tax cost of...

Define each of the following terms: a. Weighted average cost of capital, WACC; after-tax cost of debt, rd 1 T ; after-tax cost of short-term debt, rstd 1 T b. Cost of preferred stock, rps; cost of common equity (or cost of common stock), rs c. Target capital structure d. Flotation cost, F; cost of new external common equity, re

Which one of the following statements is correct concerning the weighted average cost of capital? (WACC)?...

Which one of the following statements is correct concerning the weighted average cost of capital? (WACC)? A. The pre?tax rate of return on the debt is the rate that is relevant to the computation of the WACC.?? B. When computing the? WACC, the weight assigned to the preferred stock is equal to the coupon rate multiplied by the par value assigned to the preferred stock.?? C. The weight of the common stock used in the computation of the WACC is...

20. Weighted Average Cost of Capital (WACC) primarily focused on: A.definition of “Weighted Average Cost of...

20. Weighted Average Cost of Capital (WACC) primarily focused on: A.definition of “Weighted Average Cost of Capital“ (WACC) and concept of costs of equity B.and debt, method of calculation C.WACC use in corporate financial management D. factors that affect the cost of equity and debs E. nature of costs of equity and debt calculation using the CAPM model 21. Business risks and their typology with focus on: A.risk classification criteria and their categorization according to the industry of the enterprise...

1. The Weighted Average Cost of Capital (WACC) is a. the rate at which a company’s future...

1. The Weighted Average Cost of Capital (WACC) is a. the rate at which a company’s future cash flows need to be discounted b. to arrive at a present value for the business. c. all of the above reflect the WACC d. the value of a company equals the present value of its future cash flows 2. Flotation Cost is a. the cost for servicing equity capital b. the cost for using debt capital c. the cost for using retained earnings d....

Does the Weighted Average Cost of Capital (WACC) account for demand?

17 Given the following data, compute the weighted average cost of capital (WACC). Components of capital...

17 Given the following data, compute the weighted average cost of capital (WACC). Components of capital structure After Tax Cost Debt $65 million 6.5% Preferred Stock 35 million 10.5% Common Equity 60 million 12.75% Total 160 million If the return on assets of the corporation is 13% on an annual basis, calculate its profitability and economic value added, EVA.