Corporate Finance - Corporate Finance Section 2

>>>>>>>>Corporate Finance Section 2

 Current (\$) ) Target (\$) Book Value of Debt 62 62 Market Value of Debt 59 63 Book Value of Shareholder’s Equity 78 88 Market Value of Shareholder’s Equity 230 240

• Option : B
• Explanation : Use the market values of debt and equity to calculate their weights. wd = \$63 / (\$63 + \$240) = 0.208 we = \$240 / (\$63 + \$240) = 0.792.

• Option : C
• Explanation : When making adjustments from the asset beta, derived from the comparables, to calculate the equity beta of the new product, the correct approach is to use the debt-to-equity ratio of the new product line.

• Option : C
• Explanation : An optimal capital budget occurs when the marginal cost of capital intersects the investment opportunity schedule.

• Option : B
• Explanation : The point at which the marginal cost of capital intersects the investment opportunity schedule is the optimal capital.

 Source of capital Capital structure proportion Marginal after-tax cost Long-term debt 30% 12% Preferred stock 5% 15% Common equity 65% 20%

• Option : B
• Explanation : The WACC of the company is calculated as follows: 0.3(12%) + 0.05(15%) + 0.65(20%) = 17.35%. To have a positive NPV, a project must have an IRR greater than the WACC used to calculate the NPV. Only the storage project has a NPV greater than \$0 (at the company’s WACC of 17.35%), therefore only the storage project has an IRR that exceeds 17.35%.