Question

The unlevered cost of capital is ____________

Select one:

a.
the cost of capital for a firm with no debt in its capital structure.

b.
the cost of capital for a firm with no equity in its capital structure.

c.
the cost of preferred stock for a firm with equal parts debt and common stock in its capital structure.

d.
the interest tax shield times pretax net income.

e.
equal to the profit margin for a firm with some debt in its capital structure.

Dalilah Santana needs to decide between buying or leasing a computer equipment with a cost of $12.5 million. The equipment would be depreciated straight-line to zero over 5 years. The tax rate is 34%. The annual depreciation is $2. 5 million. The after-tax lease payments are $2 million per year for 5 years. The after tax cost of debt is 5.5%. Given this information the incremental cash flow of leasing instead of buying for year 0 is ___ and for years 1 to 5 is ______.

Select one:

a. $12.5 million; -$2.85 million

b. $0 million; -$2 million

c. -$12.5 million; $2.85 million

d. $0 million; -$1.32 million

The beta is a good measure of risk for an individual stock when held in a well-diversified portfolio.

Select one:

True

False

Answer 1

1]

The unlevered cost of capital is the cost of capital for a firm with no debt in its capital structure.

The answer is (a)

2]

incremental cash flow of leasing instead of buying = Cash flow with leasing - cash flow with buying.

Buying :

Cash outflow in year 0 = cost of equipment.

Cash inflow in each year = annual depreciation * tax rate = $2,500,000 * 34% = $850,000

Leasing :

Net cash outflow with leasing = after tax lease payment = $2,000,000

The answer is (a)

3]

True.

Total risk = systematic risk + unsystematic risk

For a well-diversified portfolio, systematic risk (beta) is close to 1, and the unsystematic risk is diversified away. Therefore, beta is the appropriate risk measure