Question 3: Which of the following statements is correct? (6 points) A) When cal

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Question 3: Which of the following statements is correct? (6 points) A) When calculating the cost of debt, a company needs to adjust for taxes, because interest payment s are deductible by the paying corporation. (B) When calculating the cost of preferred stock, companies must adjust for taxes, because dividends paid on preferred stock are deductible by the paying corporation. C) Because of tax effects, an increase in the risk-free rate will have a greater effect on the after-tax cost of debt than on the cost of common stock as measured by the CAPM (D) If a company's beta increases, this will increase the cost of equity used to calculate the WACC, but only if the company does not have enough retained earnings to take care of its gquityfinancing and hence must issue new stock E) Higher flotation costs reduce investors' expected returns, and that leads to a reduction in a company's WACC Question 4: Which of the following statements is CORRECT? Assume that the project being considered has normal cash flows, with one outflow followed by a series of inflows. (6 points) A) A project's NPV is found by compounding the cash inflows at the IRR to find the terminal value (TV), then discounting the TV at the WACC (B) The lower the WACC used to calculate it, the lower the calculated NPV will be. [C) If a project's NPV is less than zero, then its IRR must be less than the WACC. (D) If a project's NPV is greater than zero, then its IRR must be less than zero. E) The NPV of a relatively low-risk project should be found using a relatively high WACC

Explanation / Answer

Question 3:

A is correct as debt has to be adjusted as interest is tax deductible
B is incorrect because preferred stock are not tax deductible
C is incorrect because risk free rate increase will have a larger effect on equity than debt
D is incorrect because cost of equity will increase nevetheless
E is incorrect because higher floatation cost will lead to a higher WACC


Question 4:

A is incorrect because NPV is calculated using WACC and not IRR
B is incorrect because lower wacc will lead to a higher NPV
C is correct option
D is incorrect becuase a positive IRR below WACC will make NPV negative
E is incorrect because low risk project should have a lower WACC

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