FIN 5643 Questionnaire Week 4

A firm s WACC is it opportunity cost of capital.
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In calculating equity FCF we subtract the after-tax interest payments and payments of principal. We then add any proceeds of new debt issuedTrueWhen evaluating firms in the context of M&A, the entire firm is valuated.True Response Feedback - Private equity firms value equity directly. (p.106)The potential for estimation errors is probably greater for cash flows estimates than for the cost of capital.True Response Feedback - There is historical information to estimate the cost of capital. There are no anchors or boundaries to estimate cash flows. (p. 107)It is recommended that cost of capital be estimated using just one method to avoid multiple valuations.False Response Feedback - Use several methods. Each method is informative (p.107).In practice, capital structure weights are estimated using market values only for equity securities.True Response Feedback - It is difficult to get market prices of debt. In addition, some debt is private, meaning that there is no market price. p.108The estimated yield to maturity of a bond is used as its cost of debt.TrueIt is standard practice to estimate the cost of debt using the YTM on a portfolio of bonds with similar credit ratings, maturity and size as the firm s outstanding debt.FalsePromised and expected cash flows on debt (interest and principal) are the same for higher-rated debt.TrueThe YTM of convertible bonds overestimates their true cost.False Response Feedback - Because it doesn't consider the value of the convertible if debt is converted. (p.111)Compared to cost of debt and cost of preferred stock, estimating the cost of equity is difficult.True Response Feedback - The cost of common equity capital is the most difficult estimate we have to make in evaluating a firms cost of capital. (p.112)Estimation of the cost of preferred stock using its preferred dividend is upward biased.True Response Feedback - Because the company may delay the payments of the preferred dividend.The variability that contributes to the risk of a diversified portfolio is known as systematic risk.True Response Feedback - Systematic risk is also known as non-diversifiable risk. It is non-diversifiable because having more stocks in a portfolio lowers risk at to a point. Research shows that having 20 stocks in a portfolio is enough to get the benefits of diversification and risk reduction. Beyond 20, diversification doesn t help. We are then left with just systematic risk.Yields of 10-Year or 20-Year US Treasuries bonds are used as risk-free rates of interest?TrueThe Capital Assets Pricing Model (CAPM) is one of the methods used to estimate the cost of equity.True Response Feedback - The CAPM model is represented in equation 4.5 in p.114. It is commonly used to calculate the cost of equity. The CAPM model in one of the most important theorical models is finance. Correspondingly, equation 4.5 is one of the most important equations in finance as well. Beta represents the sensitivity of equity returns to variations in the rate of return on the overall market portfolio. (p.115)Beta is a measure of systemic risk.True Response Feedback - Systematic risk is the risk that cannot be diversified. Diversification occurs by forming a portfolio with a minimum of 20 stocks.Beta is estimated regressing stock returns on market returns.TrueWhen firms evaluate opportunities to acquire other firms, they calculate the WACC of the acquisition candidate.True Response Feedback - This is an important concept. It is not the WACC of the acquirer. (p.138)Historical rates of return for U.S. stocks show that geometric average returns are lower than arithmetic averages.TruePractitioners prefer geometric averages to estimate future market return premium.TrueIn practice, an equity risk premium of __ is used5%Cost of capital is the same as opportunity cost of capital.True