Required rates of return are estimated based on debt ratio

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Reference no: EM132025537

1. Assume that the firm’s optimal debt ratio is 40%. The following required rates of return are estimated based on this debt ratio:

Cost of debt: .05

Cost of equity: .12

If the tax rate is 40%, what is the firm's weighted average cost of capital, WACCcomp?

a. 8.4%

b. 9.2%

c. 8%

d. 8.8%

2. The firm has a debt obligation of 100 due at t=1. The current asset value is 97; that is, the firm is under financial distress. The management believes that the asset value is most likely to remain at 97 at t=1 and the firm would go under. The firm has an investment project at the present time that requires 10 as initial investment. The value of the project has a 90% chance to become 12 (that is, a gain of 2) and a 10% chance to become 9 (that is, a loss of 1). The WACC for the project is 10 percent. What is the expected cash flow at t=1 for debt-holders if the firm undertakes the project?

a. $100

b. $98.0

c. $99.3

d. $-4

e. $98.7

Reference no: EM132025537

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