[jeff]

Post by Another71.

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Jeff Elliott, CPA (KS) | Another71 | NINJA CPA | NINJA CMA | NINJA CPE

[Anonymous]

My advice for those using both Becker and NINJA, use NINJA as a comprehensive review. If you are struggling with a particular topic, use Becker and then set NINJA to only pull questions from that weak area.

When I took BEC, I was trending right around 80% and about 70% into the adaptve learning phase (I just kept getting the same questions over and over and over again). I'll let you know on Tuesday what that translates into on the actual exam.

[Mjganier]

Datacomp Industries, which has no current debt and has a beta of .95 for its common stock. Management is considering a change in the capital structure to 30% debt and 70% equity. This change would increase the beta on the stock to 1.05, and the after-tax cost of debt will be 7.5%. The expected return on equity is 16%, and the risk-free rate is 6%. Should Datacomp's management proceed with the capital structure change?

Incorrect A.

No, because the cost of equity capital will increase

B.

Yes, because the cost of equity capital will decrease

C.

Yes, because the weighted average cost of capital will decrease

D.

No, because the weighted average cost of capital will increase

Answer C.

In the current situation, the weighted average cost of capital (WACC) is equal to the cost of equity due to the fact that no debt exists in the capital structure; therefore, the WACC is 16% (the expected return on equity).

If the capital structure changes to 30% debt with an after-tax cost of debt of 7.5%, then the WACC will decrease even if there is a small increase in the cost of equity due to an increase in the beta associated with the stock of the firm, since 30% of the financing of the company now has a 7.5% cost. Management's focus should be to finance the company for the lowest cost on average. The cost of one element of the capital structure (debt, preferred stock, or common stock) is not significant in the decision-making process. Management's focus needs to be on the WACC.

A key to this problem from a mathematical point of view is understanding the use of the capital asset pricing model (CAPM), whose formula is shown below:

Required rate of return for equity = Risk-free rate + beta(LT average risk premium for the market – Risk-free rate)

Step 1: In this problem, the following original facts are known:

Expected return for equity = 16%

Risk-free rate = 6%

beta = .95

Substituting the known items in the CAPM equation, the LT average risk premium for the market can be determined:

Required rate of return for equity = Risk-free rate + beta(LT average risk premium for the market – Risk-free rate)

16% = 6% + .95(LT average risk premium for the market – 6%)

LT average risk premium for the market = 16.5%

Step 2: The proposed change to 30% debt and 70% equity provides the following known information:

LT average risk premium for the market = 16.5%

Risk-free rate = 6%

beta = 1.05

The new required rate of return for equity can now be calculated as:

Required rate of return for equity = Risk-free rate + beta(LT average risk premium for the market – Risk-free rate)

Required rate of return for equity = 6% +1.05(16.5% – 6%)

Required rate of return for equity = 17.0%

Step 3: The WACC of capital under the proposed capital structure can then be calculated as:

Proposed WACC = Weighted cost of debt + Weighted cost of equity

= (30% x 7.5%) + (70% x 17.0%)

= 2.3% + 11.9%

= 14.2%

Comparison of the current structure and the proposed structure:

Current Proposed

Structure Structure

---

---

Cost of debt 7.5%

Cost of equity 16.0% 17.0%

WACC 16.0% 14.2%

Where is the 7.5% coming from??

FAR 8/18/2014--87
AUD 10/18/2014--78
REG 11/24/2014--76
BEC 2/28/2015--76

"If you can't explain it simply, you don't understand it well enough"-Albert Einstein

Study Mats: Cpaexcel study text and EQ, Ninja MCQ, Ninja notes

[highlightnumb]

@Mjganier I may be reading your question incorrectly but if you are asking where the after tax cost of debt of 7.5% is coming from, its given in the question/fact pattern.

FAR. Feb 2014 76
REG. Jan 2015 79 half way there!!
BEC. Feb 2015 79 thank you God!!
AUD. Apr 20, 2015 and will be done. Hold that thought 65, 7/14/15 85!
Ok where was I? Oh thats right now I'm Done!!!!!!!!!
Ethics 92!!

"You down wit SEC?, yeah you know me!!!"

Cali Candidate

All Becker Materials, Wiley Test Bank, Ninja audio, Ninja MCQ, Ninja Notes

[Mjganier]

…I guess I need a break…thanks for the response Highlight

FAR 8/18/2014--87
AUD 10/18/2014--78
REG 11/24/2014--76
BEC 2/28/2015--76

"If you can't explain it simply, you don't understand it well enough"-Albert Einstein

Study Mats: Cpaexcel study text and EQ, Ninja MCQ, Ninja notes

[highlightnumb]

no worries. happens to me all the time lol

FAR. Feb 2014 76
REG. Jan 2015 79 half way there!!
BEC. Feb 2015 79 thank you God!!
AUD. Apr 20, 2015 and will be done. Hold that thought 65, 7/14/15 85!
Ok where was I? Oh thats right now I'm Done!!!!!!!!!
Ethics 92!!

"You down wit SEC?, yeah you know me!!!"

Cali Candidate

All Becker Materials, Wiley Test Bank, Ninja audio, Ninja MCQ, Ninja Notes

[highlightnumb]

@Mjganier in relation to your question that you posted, does CAPM formula only relate to equity and not debt? In other words, I would use the CAPM formula to calculate required return on equity and not debt?

FAR. Feb 2014 76
REG. Jan 2015 79 half way there!!
BEC. Feb 2015 79 thank you God!!
AUD. Apr 20, 2015 and will be done. Hold that thought 65, 7/14/15 85!
Ok where was I? Oh thats right now I'm Done!!!!!!!!!
Ethics 92!!

"You down wit SEC?, yeah you know me!!!"

Cali Candidate

All Becker Materials, Wiley Test Bank, Ninja audio, Ninja MCQ, Ninja Notes

[Mjganier]

Honestly, Highlight, I have no earthly idea. Most of the concepts in financial management completely elude me…this section will be the death of me as I may as well be deciphering latin. I'm going through the ninja questions and getting highly frustrated since what the questions are asking makes no sense to me and cpaexcel has not done a great job in putting in the necessary material.

FAR 8/18/2014--87
AUD 10/18/2014--78
REG 11/24/2014--76
BEC 2/28/2015--76

"If you can't explain it simply, you don't understand it well enough"-Albert Einstein

Study Mats: Cpaexcel study text and EQ, Ninja MCQ, Ninja notes

[highlightnumb]

Lol dont you just love this stuff?? Well lets keep up the good fight and be done with this. If im able to answer my own question, ill keep you posted. When are you taking bec?

FAR. Feb 2014 76
REG. Jan 2015 79 half way there!!
BEC. Feb 2015 79 thank you God!!
AUD. Apr 20, 2015 and will be done. Hold that thought 65, 7/14/15 85!
Ok where was I? Oh thats right now I'm Done!!!!!!!!!
Ethics 92!!

"You down wit SEC?, yeah you know me!!!"

Cali Candidate

All Becker Materials, Wiley Test Bank, Ninja audio, Ninja MCQ, Ninja Notes

[Anonymous]

@Mjganier AMEN! I feel the same way. I read the question then I'm like WTF then sit their and stare at the 4 choices and eventually just guess. Even after reading the explanation sometimes I still don't understand. I'm going back and re-doing the Becker questions and it's making more sense the second time around.

@Angelwatch I don't know how you reached the 80s in ninja mcq. But your passing for sure!

[highlightnumb]

@Mjganier btw that deciphering latin…lmao!

FAR. Feb 2014 76
REG. Jan 2015 79 half way there!!
BEC. Feb 2015 79 thank you God!!
AUD. Apr 20, 2015 and will be done. Hold that thought 65, 7/14/15 85!
Ok where was I? Oh thats right now I'm Done!!!!!!!!!
Ethics 92!!

"You down wit SEC?, yeah you know me!!!"

Cali Candidate

All Becker Materials, Wiley Test Bank, Ninja audio, Ninja MCQ, Ninja Notes

[Anonymous]

I believe CAPM is used when your trying to figure out the cost of retained earnings. From the practice questions it would appear that you're given all the components and you just have to know the formula to calculate the answer.

CAPM= Risk free rate + Beta(Market return- Risk free rate)

[highlightnumb]

@aspiringcpa2014…That sounds just about right. So far all of the problems that I have worked have asked to calculate the cost or RE or Equity using CAPM. So I will just ride that wave for now. Thanks.

FAR. Feb 2014 76
REG. Jan 2015 79 half way there!!
BEC. Feb 2015 79 thank you God!!
AUD. Apr 20, 2015 and will be done. Hold that thought 65, 7/14/15 85!
Ok where was I? Oh thats right now I'm Done!!!!!!!!!
Ethics 92!!

"You down wit SEC?, yeah you know me!!!"

Cali Candidate

All Becker Materials, Wiley Test Bank, Ninja audio, Ninja MCQ, Ninja Notes

[highlightnumb]

You know I can totally understand preparing for war just to walk into a pillow fight, but some of these questions in becker material are just way too much. It's clear as day that you won't see long drawn out questions that require about 10 mins of calculation on the exam but looking at it can be very discouraging. I'm not going to lie there are some questions that I'll take a stab at and then look at the explanation, I'm like forget it, see ya later, Next. Just venting out loud. I'm getting so sick of doing questions!!!!!

FAR. Feb 2014 76
REG. Jan 2015 79 half way there!!
BEC. Feb 2015 79 thank you God!!
AUD. Apr 20, 2015 and will be done. Hold that thought 65, 7/14/15 85!
Ok where was I? Oh thats right now I'm Done!!!!!!!!!
Ethics 92!!

"You down wit SEC?, yeah you know me!!!"

Cali Candidate

All Becker Materials, Wiley Test Bank, Ninja audio, Ninja MCQ, Ninja Notes

[fightingforsanity]

@highlightnumb Preach. I'm right there with ya. I have my exam in a week and I feel like this is the most unprepared I have ever felt for an exam. I feel like my brain is refusing to cooperate and won't let me retain any more information. I'm going to need a miracle. #Endrant. Good luck to all!

FAR - ✓
AUD - ✓
REG - ✓
BEC - ✓

Don't give up!

[highlightnumb]

Lol i hear you sanity. My exam is in 5 days and i am definitely going to need a miracle. Well tomorrow is another day. people say this BEC exam is the easiest but I actually think it's the most pain in the butt studying for. I think there are more calculations than FAR

FAR. Feb 2014 76
REG. Jan 2015 79 half way there!!
BEC. Feb 2015 79 thank you God!!
AUD. Apr 20, 2015 and will be done. Hold that thought 65, 7/14/15 85!
Ok where was I? Oh thats right now I'm Done!!!!!!!!!
Ethics 92!!

"You down wit SEC?, yeah you know me!!!"

Cali Candidate

All Becker Materials, Wiley Test Bank, Ninja audio, Ninja MCQ, Ninja Notes

[Author]

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