"Corporate Finance": Systematic risk of the project
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Questions 1:
A company’s data are provided in the following
The weighted average cost of capital (WACC) is closest to:
A 、 14.0%.
B、 11.5%.
C、 13.0%.
Questions 2:
When estimating the NPV for a project with a risk level higher than the company’saverage risk level, an analyst will most likely discount the project’s cash flows by a rate that is:
A 、determined by the firm’s target capital structure.
B、 below the WACC.
C 、above the WACC.
C is correct. Convert the D/E to determine the weights of debt and equity as follows:
A is incorrect because the debt is not tax adjusted when determining the WACC. WACC = 33.3% × 10% + 66.7% × 16% = 14.0%
B is incorrect because the D/E is used as the weight for debt and equity. WACC = 50% × 10% × (1 – 30%) + 50% × 16% = 11.5%
C is correct. If the systematic risk of the project is above average relative to the company’s current portfolio of projects, an upward adjustment is made to the company’s MCC or WACC.
A is incorrect. The firm’s target capital structure is used to determine WACC, but in this case we need more adjustment in the company’s WACC.
B is incorrect. If the systematic risk of the project is above average relative to the company’s current portfolio of projects, an upward adjustment is made to the company’s MCC or WACC.
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