Exam 14: The Cost of Capital and Taxation Issues in Project Evaluation

Assume that Expansion Ltd is a diversified company that is considering an expansion project in a mining division.The company has a target debt-equity ratio of 1:2 and this ratio will not be affected by the new project.The company's manager has identified Dig-it-out Ltd as a company with the same business risk as the new project (equity beta of 1.5).Dig-it-out has a debt-equity ratio of 1:3.Estimate the project's cost of equity for Expansion if the risk-free rate of interest is 7 per cent and the risk premium of the market portfolio is 10 per cent.

If the preference shares are redeemable on a predetermined date,the calculation of the cost of preference shares is the same as the calculation of the:

During the year,Success Ltd shares have increased from $8 to $9 and shareholders received a final dividend of 50 cents per share,fully franked at the company tax rate of 30 per cent.Calculate the dividend yield after personal taxes for shareholders with a tax rate of 47 per cent (using the beginning of the year share price)on Success shares.

The cost of capital of a project should never be estimated based on another listed company,even if that company's sole operations are of the same systematic risk as the project being assessed.

If the cost of equity capital is 15% p.a. ,the market value of equity is $5 million,the company tax rate is 30%,the cost of debt is 12% p.a.and =0)60,what is the cost of capital?

From the estimates,calculate the return on equity (after tax)if Rf = 5%,E(Rm)= 13%,franking premium = 3%,beta = 1.5 and the corporate tax rate is 30 per cent.

For a diversified company,the use of the WACC is likely to result in incorrect investment decisions.

Under what conditions can a company's current capital structure be used to calculate the weights for each source of funds?

The weighted average cost of capital is calculated as: k' = ke [E/V] + kd (1 - te)[D/V]

From the following information,calculate the weighted average cost of debt:

Bank overdraft is not included in the calculation of the WACC.

The ____________________ requires that the definition of cash flows in the numerator should match the definition of the discount rate in the denominator of a NPV calculation.

Under which of the following conditions is it appropriate to estimate a project's cost of capital using the company's cost of capital?

When can the cost of capital for a company as a whole be a valid measure of the cost of capital for a particular project?

The cost of capital is an ____________ because capital suppliers require a projects rate of return to be at least as high as the return they can obtain on other investments of equivalent risk.

The certainty equivalent approach to project valuation may have an advantage over the risk-adjusted discount rate approach when:

The cost of capital of a project:

The shares of ABC Ltd have a market price of $4 and an annual dividend of 17.5 cents per share fully franked at the tax rate of 30 per cent.Calculate the dividend yield on the shares of ABC that would be reported in the financial press.

A problem with the dividend growth model is:

Calculate the cost of equity capital using CAPM if the risk-free rate of interest is 5 per cent,the return on the market portfolio is 12 per cent,beta is 0.8 and the franking premium is 2 per cent.