hi i attempt this qns on qbank: A firm is considering a $5,000 project that will generate an annual cash flow of $1,000 for the next 8 years. The firm has the following financial data: Debt/equity ratio is 50%. Cost of equity capital is 15%. Cost of new debt is 9%. Tax rate is 33%. Determine the project’s net present value (NPV) and whether or not to accept it. NPV Accept / Reject A) +$33 Accept B) +$4,968 Accept C) -$33 Reject Below is the ans from the qbank. First, calculate the weights for debt and equity d + we = 1 d = 0.50We e + We = 1 d = 0.333, we = 0.667 Second, calculate WACC WACC = (wd × kd) × (1 - t) + (we × ke) = (0.333 × 0.09 × 0.67) + (0.667 × 0.15) = 0.020 + 0.100 = 0.120 Third, calculate the PV of the project cash flows N = 8, PMT = -1,000, FV = 0, I/Y = 12, CPT PV = 4,967 And finally, calculate the project NPV by subtracting out the initial cash flow NPV = $4,967 - $5,000 = -$33 ================================================================= My QNs is since the debt equity ratio is 50% as stated in the qns, why debt is not 50% and equity is not 50%? Instead the debt is 0.333 and equity is 0.667? Thanks
Vitalstrike82, Debt-to-Equity (D/E) = 50% = 0.50 means that D/E = 0.5/1 which implies that Debt is half the amount of Equity and since firm’s capital structure comprise of Debt and Equity only, Assets will be financed by just Debt and Equity. So, Assets = Debt + Equity = 0.5 + 1 = 1.5 It means % of Debt = 0.5/1.5 = 0.333 = 33.33% and, % of Equity = 1/1.5 = 0.6667 = 66.67% I hope u get it know! In case of any problem feel free to ask! Cheers!
oh i see. Thanks for the guidance.
Vitalstrike: Do you fine the QBank helpful? I’m currently trying to decide if I should order it or not. Thanks!
It is helful due to the huge amount of questions it contains, but not as much helpful as one first could think because of its excessively quantitative nature. You may find yourself losing much time performing pointless calculations. CFAI questions are much more conceptual. Still, if the cost doesn’t hurt you and you save time also for EOCQ, I’d say go for it. Just skip the questions regarding calculation of variances and all that stuff.
Ops… i know the reply is late cos i just happen to view if this qns whether qbank is useful while i’m doing my revision back on this debt equity qns… From my point of view, due to the overwhelming text CFA level 1 has provide, its hard to gauge how much i have understand after studying. The best thing with qbank is at least i know which areas i’m weak at and that will be the areas i need tp put more effort in.
Which qbank is this?