Corporate Finance & Investment Flashcards

A company has an after-tax cost of debt of 4%, a cost of equity of 10%, and a debt-to-equity ratio of 1:1. What is the WACC?

Answer: 7%

With equal proportions (50% each), WACC = 0.5×4% + 0.5×10% = 7%.

Which of the following best describes the 'pecking order theory' of capital structure?

Answer: Firms prefer internal financing first, then debt, then equity as a last resort

The pecking order theory states firms favor retained earnings, then debt, and issue new equity only as a last resort due to information asymmetry costs.

A bond with a face value of $1,000, a coupon rate of 6%, and 5 years to maturity is trading at $950. Is the yield to maturity (YTM) higher or lower than 6%?

Answer: Higher than 6%

When a bond trades below par (at a discount), the YTM is higher than the coupon rate.

Which investment appraisal technique explicitly accounts for the time value of money by discounting future cash flows?

Answer: Net Present Value (NPV)

NPV discounts all future cash flows back to their present value using the cost of capital.

A project has an NPV of $0 at a discount rate of 12%. What does this imply?

Answer: The project's IRR equals 12%

The IRR is the discount rate at which NPV equals zero, so IRR = 12% in this case.

Under the dividend growth model (Gordon Growth Model), if a share pays a dividend of $2, the required return is 8%, and dividends grow at 4%, what is the share's intrinsic value?

Answer: $50

Value = D1 / (r − g) = $2 / (0.08 − 0.04) = $2 / 0.04 = $50.

Which of the following is a NON-CASH item that reduces taxable profit but does not affect operating cash flow directly?

Answer: Depreciation

Depreciation reduces accounting profit but is added back in cash flow statements as it involves no cash outflow.