Question 1

If a firm's marginal tax rate is increased,this would,other things held constant,lower the cost of debt used to calculate its WACC.

Accepted Answer

A) True 
 B)False

Question 2

Which of the following statements is CORRECT?

Accepted Answer

A)   All else equal,an increase in a company's stock price will increase its marginal cost of reinvested earnings (not newly issued stock) ,rs.
B)   All else equal,an increase in a company's stock price will increase its marginal cost of new common equity,re.
C)   Since the money is readily available,the after-tax cost of reinvested earnings (not newly issued stock) is usually much lower than the after-tax cost of debt.
D)   If a company's tax rate increases but the YTM on its noncallable bonds remains the same,the after-tax cost of its debt will fall.
E)   When calculating the cost of preferred stock,a company needs to adjust for taxes,because preferred stock dividends are deductible by the paying corporation.F) C) and D)
G) B) and C)

Question 3

Burnham Brothers Inc.has no retained earnings since it has always paid out all of its earnings as dividends.This same situation is expected to persist in the future.The company uses the CAPM to calculate its cost of equity,and its target capital structure consists of common stock,preferred stock,and debt.Which of the following events would REDUCE its WACC?

Accepted Answer

A)   The flotation costs associated with issuing new common stock increase.
B)   The company's beta increases.
C)   Expected inflation increases.
D)   The flotation costs associated with issuing preferred stock increase.
E)   The market risk premium declines.F) A) and E)
G) All of the above

Question 4

The text identifies three methods for estimating the cost of common stock from reinvested earnings (not newly issued stock): the CAPM method,the dividend growth method,and the bond-yield-plus-risk-premium method.However,only the dividend growth method is widely used in practice.

Accepted Answer

A) True 
 B)False

Question 5

The cost of preferred stock to a firm must be adjusted to an after-tax figure because 70% of dividends received by a corporation may be excluded from the receiving corporation's taxable income.

Accepted Answer

A) True 
 B)False

Question 6

If investors' aversion to risk rose,causing the slope of the SML to increase,this would have a greater impact on the required rate of return on equity,rs,than on the interest rate on long-term debt,rd,for most firms.Other things held constant,this would lead to an increase in the use of debt and a decrease in the use of equity.However,other things would not stay constant if firms used a lot more debt,as that would increase the riskiness of both debt and equity and thus limit the shift toward debt.

Accepted Answer

A) True 
 B)False

Question 7

A company's perpetual preferred stock currently sells for $92.50 per share,and it pays an $8.00 annual dividend.If the company were to sell a new preferred issue,it would incur a flotation cost of 5.00% of the issue price.What is the firm's cost of preferred stock?

Accepted Answer

A)   7.81%
B)   8.22%
C)   8.65%
D)   9.10%
E)   9.56%F) A) and E)
G) D) and E)

Question 8

Which of the following statements is CORRECT?

Accepted Answer

A)   The after-tax cost of debt that should be used as the component cost when calculating the WACC is the average after-tax cost of all the firm's outstanding debt.
B)   Suppose some of a publicly-traded firm's stockholders are not diversified;they hold only the one firm's stock.In this case,the CAPM approach will result in an estimated cost of equity that is too low in the sense that if it is used in capital budgeting,projects will be accepted that will reduce the firm's intrinsic value.
C)   The cost of equity is generally harder to measure than the cost of debt because there is no stated,contractual cost number on which to base the cost of equity.
D)   The bond-yield-plus-risk-premium approach is the most sophisticated and objective method for estimating a firm's cost of equity capital.
E)   The cost of capital used to evaluate a project should be the cost of the specific type of financing used to fund that project,i.e. ,it is the after-tax cost of debt if debt is to be used to finance the project or the cost of equity if the project will be financed with equity.F) A) and E)
G) A) and B)

Question 9

Refer to the data for the Collins Group.What is the best estimate of the firm's WACC?

Accepted Answer

A)   10.85%
B)   11.19%
C)   11.53%
D)   11.88%
E)   12.24%F) A) and E)
G) B) and C)

Question 10

Funds acquired by the firm through retaining earnings have no cost because there are no dividend or interest payments associated with them,and no flotation costs are required to raise them,but capital raised by selling new stock or bonds does have a cost.

Accepted Answer

A) True 
 B)False

Question 11

Refer to the data for the Collins Group.Based on the CAPM,what is the firm's cost of common stock?

Accepted Answer

A)   11.15%
B)   11.73%
C)   12.35%
D)   13.00%
E)   13.65%F) A) and B)
G) A) and C)

Question 12

Which of the following statements is CORRECT? Assume a company's target capital structure is 50% debt and 50% common equity.

Accepted Answer

A)   The WACC is calculated on a before-tax basis.
B)   The WACC exceeds the cost of equity.
C)   The cost of equity is always equal to or greater than the cost of debt.
D)   The cost of reinvested earnings typically exceeds the cost of new common stock.
E)   The interest rate used to calculate the WACC is the average after-tax cost of all the company's outstanding debt as shown on its balance sheet.F) B) and E)
G) C) and D)

Question 13

The cost of debt,rd,is normally less than rs,so rd(1 − T)will normally be much less than rs.Therefore,as long as the firm is not completely debt financed,the weighted average cost of capital (WACC)will normally be greater than rd(1 − T).

Accepted Answer

A) True 
 B)False

Question 14

Which of the following statements is CORRECT?

Accepted Answer

A)   The percentage flotation cost associated with issuing new common equity is typically smaller than the flotation cost for new debt.
B)   The WACC as used in capital budgeting is an estimate of the cost of all the capital a company has raised to acquire its assets.
C)   There is an "opportunity cost" associated with using reinvested earnings,hence they are not "free."
D)   The WACC as used in capital budgeting would be simply the after-tax cost of debt if the firm plans to use only debt to finance its capital budget during the coming year.
E)   The WACC as used in capital budgeting is an estimate of a company's before-tax cost of capital.F) C) and E)
G) A) and B)

Question 15

The component costs of capital are market-determined variables in the sense that they are based on investors' required returns.

Accepted Answer

A) True 
 B)False

Question 16

The reason why reinvested earnings have a cost equal to rs is because investors think they can (i.e. ,expect to)earn rs on investments with the same risk as the firm's common stock,and if the firm does not think that it can earn rs on the earnings that it retains,it should distribute those earnings to its investors.Thus,the cost of reinvested earnings is based on the opportunity cost principle.

Accepted Answer

A) True 
 B)False

Question 17

As a consultant to Basso Inc. ,you have been provided with the following data: D1 = $0.67;P0 = $27.50;and gL = 8.00% (constant) .What is the cost of common from reinvested earnings based on the dividend growth approach?

Accepted Answer

A)   9.42%
B)   9.91%
C)   10.44%
D)   10.96%
E)   11.51%F) C) and E)
G) A) and D)

Question 18

Which of the following statements is CORRECT? Assume that the firm is a publicly-owned corporation and is seeking to maximize shareholder wealth.

Accepted Answer

A)   If a firm's managers want to maximize the value of their firm's stock,they should,in theory,concentrate on project risk as measured by the standard deviation of the project's expected future cash flows.
B)   If a firm evaluates all projects using the same cost of capital,and the CAPM is used to help determine that cost,then its risk as measured by beta will probably decline over time.
C)   Projects with above-average risk typically have higher than average expected returns.Therefore,to maximize a firm's intrinsic value,its managers should favor high-beta projects over those with lower betas.
D)   Project A has a standard deviation of expected returns of 20%,while Project B's standard deviation is only 10%.A's returns are negatively correlated with both the firm's other assets and the returns on most stocks in the economy,while B's returns are positively correlated.Therefore,Project A is less risky to a firm and should be evaluated with a lower cost of capital.
E)   If a firm has a beta that is less than 1.0,say 0.9,this would suggest that the expected returns on its assets are negatively correlated with the returns on most other firms' assets.F) A) and D)
G) C) and D)

Question 19

The president and CFO of Spellman Transportation are having a disagreement about whether to use market value or book value weights in calculating the WACC.Spellman's balance sheet shows a total of noncallable $45 million long-term debt with a coupon rate of 7.00% and a yield to maturity of 6.00%.This debt currently has a market value of $50 million.The company has 10 million shares of common stock,and the book value of the common equity (common stock plus retained earnings) is $65 million.The current stock price is $22.50 per share;stockholders' required return,rs,is 14.00%;and the firm's tax rate is 40%.The CFO thinks the WACC should be based on market value weights,but the president thinks book weights are more appropriate.What is the difference between these two WACCs?

Accepted Answer

A)   1.55%
B)   1.72%
C)   1.91%
D)   2.13%
E)   2.36%F) A) and B)
G) A) and C)

Question 20

Which of the following statements is CORRECT?

Accepted Answer

A)   The tax-adjusted cost of debt is always greater than the interest rate on debt,provided the company does in fact pay taxes.
B)   If a company assigns the same cost of capital to all of its projects regardless of each project's risk,then the company is likely to reject some safe projects that it actually should accept and to accept some risky projects that it should reject.
C)   Because no flotation costs are required to obtain capital as reinvested earnings,the cost of reinvested earnings is generally lower than the after-tax cost of debt.
D)   Higher flotation costs tend to reduce the cost of equity capital.
E)   Since debt capital can cause a company to go bankrupt but equity capital cannot,debt is riskier than equity,and thus the after-tax cost of debt is always greater than the cost of equity.F) A) and C)
G) A) and B)

Exam 9: The Cost of Capital

Correct Answer
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Refer to the data for the Collins Group.Based on the CAPM,what is the firm's cost of common stock?

Correct Answer
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Correct Answer
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The cost of preferred stock to a firm must be adjusted to an after-tax figure because 70% of dividends received by a corporation may be excluded from the receiving corporation's taxable income.

Correct Answer
verified

Which of the following statements is CORRECT? Assume that the firm is a publicly-owned corporation and is seeking to maximize shareholder wealth.

Correct Answer
verified

Correct Answer
verified

Correct Answer
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The cost of debt,r_d,is normally less than r_s,so r_d(1 − T)will normally be much less than r_s.Therefore,as long as the firm is not completely debt financed,the weighted average cost of capital (WACC)will normally be greater than r_d(1 − T).

Correct Answer
verified

As a consultant to Basso Inc. ,you have been provided with the following data: D₁ = $0.67;P₀ = $27.50;and g_L = 8.00% (constant) .What is the cost of common from reinvested earnings based on the dividend growth approach?

Correct Answer
verified

Which of the following statements is CORRECT?

Correct Answer
verified

Which of the following statements is CORRECT?

Correct Answer
verified

Refer to the data for the Collins Group.What is the best estimate of the firm's WACC?

Correct Answer
verified

If a firm's marginal tax rate is increased,this would,other things held constant,lower the cost of debt used to calculate its WACC.

Correct Answer
verified

The component costs of capital are market-determined variables in the sense that they are based on investors' required returns.

Correct Answer
verified

Which of the following statements is CORRECT?

Correct Answer
verified

The text identifies three methods for estimating the cost of common stock from reinvested earnings (not newly issued stock): the CAPM method,the dividend growth method,and the bond-yield-plus-risk-premium method.However,only the dividend growth method is widely used in practice.

Correct Answer
verified

Funds acquired by the firm through retaining earnings have no cost because there are no dividend or interest payments associated with them,and no flotation costs are required to raise them,but capital raised by selling new stock or bonds does have a cost.

Correct Answer
verified

Which of the following statements is CORRECT?

Correct Answer
verified

Which of the following statements is CORRECT? Assume a company's target capital structure is 50% debt and 50% common equity.

Correct Answer
verified

A company's perpetual preferred stock currently sells for $92.50 per share,and it pays an $8.00 annual dividend.If the company were to sell a new preferred issue,it would incur a flotation cost of 5.00% of the issue price.What is the firm's cost of preferred stock?

Correct Answer
verified

Exam 9: The Cost of Capital

Correct AnswerverifiedShow Answer

Refer to the data for the Collins Group.Based on the CAPM,what is the firm's cost of common stock?

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

The cost of preferred stock to a firm must be adjusted to an after-tax figure because 70% of dividends received by a corporation may be excluded from the receiving corporation's taxable income.

Correct AnswerverifiedShow Answer

Which of the following statements is CORRECT? Assume that the firm is a publicly-owned corporation and is seeking to maximize shareholder wealth.

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

The cost of debt,rd,is normally less than rs,so rd(1 − T)will normally be much less than rs.Therefore,as long as the firm is not completely debt financed,the weighted average cost of capital (WACC)will normally be greater than rd(1 − T).

Correct AnswerverifiedShow Answer

As a consultant to Basso Inc. ,you have been provided with the following data: D1 = $0.67;P0 = $27.50;and gL = 8.00% (constant) .What is the cost of common from reinvested earnings based on the dividend growth approach?

Correct AnswerverifiedShow Answer

Which of the following statements is CORRECT?

Correct AnswerverifiedShow Answer

Which of the following statements is CORRECT?

Correct AnswerverifiedShow Answer

Refer to the data for the Collins Group.What is the best estimate of the firm's WACC?

Correct AnswerverifiedShow Answer

If a firm's marginal tax rate is increased,this would,other things held constant,lower the cost of debt used to calculate its WACC.

Correct AnswerverifiedShow Answer

The component costs of capital are market-determined variables in the sense that they are based on investors' required returns.

Correct AnswerverifiedShow Answer

Which of the following statements is CORRECT?

Correct AnswerverifiedShow Answer

The text identifies three methods for estimating the cost of common stock from reinvested earnings (not newly issued stock): the CAPM method,the dividend growth method,and the bond-yield-plus-risk-premium method.However,only the dividend growth method is widely used in practice.

Correct AnswerverifiedShow Answer

Funds acquired by the firm through retaining earnings have no cost because there are no dividend or interest payments associated with them,and no flotation costs are required to raise them,but capital raised by selling new stock or bonds does have a cost.

Correct AnswerverifiedShow Answer

Which of the following statements is CORRECT?

Correct AnswerverifiedShow Answer

Which of the following statements is CORRECT? Assume a company's target capital structure is 50% debt and 50% common equity.

Correct AnswerverifiedShow Answer

A company's perpetual preferred stock currently sells for $92.50 per share,and it pays an $8.00 annual dividend.If the company were to sell a new preferred issue,it would incur a flotation cost of 5.00% of the issue price.What is the firm's cost of preferred stock?

Correct AnswerverifiedShow Answer

Correct Answer
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Correct Answer
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Correct Answer
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Correct Answer
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Correct Answer
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Correct Answer
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Correct Answer
verified

The cost of debt,r_d,is normally less than r_s,so r_d(1 − T)will normally be much less than r_s.Therefore,as long as the firm is not completely debt financed,the weighted average cost of capital (WACC)will normally be greater than r_d(1 − T).

Correct Answer
verified

As a consultant to Basso Inc. ,you have been provided with the following data: D₁ = $0.67;P₀ = $27.50;and g_L = 8.00% (constant) .What is the cost of common from reinvested earnings based on the dividend growth approach?

Correct Answer
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Correct Answer
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Correct Answer
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Correct Answer
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Correct Answer
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Correct Answer
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Correct Answer
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Correct Answer
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Correct Answer
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Correct Answer
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Correct Answer
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