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Homework answers / question archive / Bits n pieces Inc
Bits n pieces Inc. is in the process of evaluating an international shipping warehouse that spans several acres. Obviously, they need a discount rate for their NPV calculation and will use the company's WACC. Use the information below to calculate the weighted average cost of capital (WACC):
The company has 1,000,000 shares on issue.
The shares trade at $17.90 and have a Beta of 1.20.
The expected return on the market is 6% and the risk-free rate is 3%.
The company has 20,000 bonds on issue.
The bonds trade at $102 and have a yield to maturity of 5%.
The corporate taxation rate is 27.5%.
Select one:
a. 7.23%
b. 5.075%
c. 12.85%
d. 6.66%
e. 6.29%
2.
Agency cost is a type of incentive problem that arises from the conflict of interest between the principal and the agent. How can the misalignment of interests be managed between the principal and the agent of a firm?
Select one:
a. The principals are the managers, the agents are the owners. The agents can make the ownership of the firm part of the agent’s remuneration.
b. The principals are the owners of the firm, the agents are the managers. The principals can make ownership of the firm part of the agents’ remuneration.
c. The principals and the agents are always the same since every business owner manages their own business.
d. There is nothing anyone can do but to just make sure that they are aware they can be reported to the Corporate Governance committee of the company.
3.
What are the operating cash flows (OCF) of a firm which has sales of $291,800, COGS of $65,400, depreciation of $115,000 and taxes of $33,420?
Select one:
a. $190,100
b. $291,800
c. $192,980
d. $171,230
Answer (1)
~ Cost of Equity by CAPM method:
= Risk free rate + Beta (Expected market return - Risk free rate)
= 3% + 1.20 (6% - 3%)
= 6.60%
~ After Tax Cost of Debt :
= Yield to maturity (1 - tax)
= 5% (1 - 0.2750)
= 3.625%
~ Weights of Capital:
Capital | Market Value | % Weights |
Equity | $17.90 million (1 million shares x $17.90 each) | 0.8977 |
Debt | $2.04 (20,000 bonds x $102 each) | 0.1023 |
Total | $19.94 million | 1.0000 |
~ WACC:
= (Weight of Debt) (After tax cost of debt) + (Weight of Equity) (Cost of equity)
= (0.1023) (3.625) + (0.8977) (6.60%)
= 6.29%
Therefore, Answer = option e. = 6.29%
Answer (2)
Answer:
b. The principals are the owners of the firm, the agents are the managers. The principals can make ownership of the firm part of the agents’ remuneration.
Explanation:
~ In a principal-agent relationship, the agent manages the business of the principal on behalf of the principal.
~ Therefore, in a corporation form of business, the owners are the principal, and the managers are the agents who manage the business on behalf of the owners, and for the best interest of owners.
~ However, sometimes the managers (agents) do not act in the best interest of owners, because they are just the managers of business and do not get ownership benefits, hence their interests differ from owners' interests. Therefore arises agency problem.
~ To manage this misalignment, if the owners give some profit sharing (ownership benefit) to the managers as a part of their remuneration, then they will also have the same interest as the principals to run the business with best practices.
Answer (3)
~ For calculating operating cash flow, depreciation is not deducted as a cash outflow, because it is a non-cash expense.
~ Operating Cash Flow :
= Sales - COGS - Taxes
= $291,800 - $65,400 - $33,420
= $192,980
Therefore, Answer = c. $192,980