Question 1

The firm's cost of external equity raised by issuing new stock is the same as the required rate of return on the firm's outstanding common stock.

Accepted Answer

A) True 
 B)False

Question 2

When estimating the cost of equity by use of the CAPM,three potential problems are (1)whether to use long-term or short-term rates for rRF, (2)whether or not the historical beta is the beta that investors use when evaluating the stock,and (3)how to measure the market risk premium,RPM.These problems leave us unsure of the true value of rs.

Accepted Answer

A) True 
 B)False

Question 3

For capital budgeting and cost of capital purposes,the firm should assume that each dollar of capital is obtained in accordance with its target capital structure,which for many firms means partly as debt,partly as preferred stock,and partly common equity.

Accepted Answer

A) True 
 B)False

Question 4

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. 
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.

Question 5

Trahern Baking Co.common stock sells for $32.50 per share.It expects to earn $3.50 per share during the current year,its expected dividend payout ratio is 65%,and its expected constant dividend growth rate is 6.0%.New stock can be sold to the public at the current price,but a flotation cost of 5% would be incurred.What would be the cost of equity from new common stock?

Accepted Answer

A)  12.70% 
B)  13.37% 
C)  14.04% 
D)  14.74% 
E)  15.48% 
A)  12.70% 
B)  13.37% 
C)  14.04% 
D)  14.74% 
E)  15.48%

Question 6

Which of the following statements is CORRECT?

Accepted Answer

A)  WACC calculations should be based on the before-tax costs of all the individual capital components. 
B)  Flotation costs associated with issuing new common stock normally reduce the WACC. 
C)  If a company's tax rate increases, then, all else equal, its weighted average cost of capital will decline. 
D)  An increase in the risk-free rate will normally lower the marginal costs of both debt and equity financing. 
E)  A change in a company's target capital structure cannot affect its WACC. 
A)  WACC calculations should be based on the before-tax costs of all the individual capital components. 
B)  Flotation costs associated with issuing new common stock normally reduce the WACC. 
C)  If a company's tax rate increases, then, all else equal, its weighted average cost of capital will decline. 
D)  An increase in the risk-free rate will normally lower the marginal costs of both debt and equity financing. 
E)  A change in a company's target capital structure cannot affect its WACC.

Question 7

Firms raise capital at the total corporate level by retaining earnings and by obtaining funds in the capital markets.They then provide funds to their different divisions for investment in capital projects.The divisions may vary in risk,and the projects within the divisions may also vary in risk.Therefore,it is conceptually correct to use different risk-adjusted costs of capital for different capital budgeting projects.

Accepted Answer

A) True 
 B)False

Question 8

Which of the following is NOT a capital component when calculating the weighted average cost of capital (WACC)for use in capital budgeting?

Accepted Answer

A)  Accounts payable. 
B)  Common stock "raised" by reinvesting earnings. 
C)  Common stock raised by new issues. 
D)  Preferred stock. 
E)  Long-term debt. 
A)  Accounts payable. 
B)  Common stock "raised" by reinvesting earnings. 
C)  Common stock raised by new issues. 
D)  Preferred stock. 
E)  Long-term debt.

Question 9

To help them estimate the company's cost of capital,Smithco has hired you as a consultant.You have been provided with the following data: D1 = $1.45; P0 = $22.50; and g = 6.50% (constant).Based on the DCF approach,what is the cost of common from reinvested earnings?

Accepted Answer

A)  11.10% 
B)  11.68% 
C)  12.30% 
D)  12.94% 
E)  13.59% 
A)  11.10% 
B)  11.68% 
C)  12.30% 
D)  12.94% 
E)  13.59%

Question 10

The text identifies three methods for estimating the cost of common stock from reinvested earnings (not newly issued stock): the CAPM method,the DCF method,and the bond-yield-plus-risk-premium method.Since we cannot be sure that the estimate obtained with any of these methods is correct,it is often appropriate to use all three methods,then consider all three estimates,and end up using a judgmental estimate when calculating the WACC.

Accepted Answer

A) True 
 B)False

Question 11

The lower the firm's tax rate,the lower will be its after-tax cost of debt and also its WACC,other things held constant.

Accepted Answer

A) True 
 B)False

Question 12

Exhibit 9.1
The Collins Group, a leading producer of custom automobile accessories, has hired you to estimate the firm's weighted average cost of capital. The balance sheet and some other information are provided below.
   
The stock is currently selling for $15.25 per share, and its noncallable $1,000 par value, 20-year, 7.25% bonds with semiannual payments are selling for $875.00. The beta is 1.25, the yield on a 6-month Treasury bill is 3.50%, and the yield on a 20-year Treasury bond is 5.50%. The required return on the stock market is 11.50%, but the market has had an average annual return of 14.50% during the past 5 years. The firm's tax rate is 40%.
-Refer to Exhibit 9.1.What is the best estimate of the after-tax cost of debt?

Accepted Answer

A)  4.64% 
B)  4.88% 
C)  5.14% 
D)  5.40% 
E)  5.67% 
A)  4.64% 
B)  4.88% 
C)  5.14% 
D)  5.40% 
E)  5.67%

The firm's cost of external equity raised by issuing new stock is the same as the required rate of return on the firm's outstanding common stock.

For capital budgeting and cost of capital purposes,the firm should assume that each dollar of capital is obtained in accordance with its target capital structure,which for many firms means partly as debt,partly as preferred stock,and partly common equity.

Which of the following statements is CORRECT?

Which of the following statements is CORRECT?

Which of the following is NOT a capital component when calculating the weighted average cost of capital (WACC)for use in capital budgeting?

To help them estimate the company's cost of capital,Smithco has hired you as a consultant.You have been provided with the following data: D₁ = $1.45; P₀ = $22.50; and g = 6.50% (constant).Based on the DCF approach,what is the cost of common from reinvested earnings?

The lower the firm's tax rate,the lower will be its after-tax cost of debt and also its WACC,other things held constant.

An Overview of Financial Management and the Financial Environment

Financial Statements, cash Flow, and Taxes

Analysis of Financial Statements

Time Value of Money

Bonds, bond Valuation, and Interest Rates

Risk and Return

Valuation of Stocks and Corporations

Financial Options and Applications in Corporate Finance

The Basics of Capital Budgeting: Evaluating Cash Flows

Cash Flow Estimation and Risk Analysis

Corporate Valuation and Financial Planning

Agency Conflicts and Corporate Governance

Distributions to Shareholders: Dividends and Repurchases

Capital Structure Decisions

Supply Chains and Working Capital Management

Multinational Financial Management

Public and Private Financing: Initial Offerings, seasoned Offerings, and Investment Banks

Extension 18 A: Rights Offerings

Lease Financing

Hybrid Financing: Preferred Stock, warrants, and Convertibles

Dynamic Capital Structures

Mergers and Corporate Control

Enterprise Risk Management

Bankruptcy, reorganization, and Liquidation

Portfolio Theory and Asset Pricing Models

Real Options

Providing and Obtaining Credit

Advanced Issues in Cash Management and Inventory Control

Pension Plan Management

Financial Management in Not For Profit Businesses

Filters

Exam 9: The Cost of Capital

The firm's cost of external equity raised by issuing new stock is the same as the required rate of return on the firm's outstanding common stock.

For capital budgeting and cost of capital purposes,the firm should assume that each dollar of capital is obtained in accordance with its target capital structure,which for many firms means partly as debt,partly as preferred stock,and partly common equity.

Which of the following statements is CORRECT?

Which of the following statements is CORRECT?

Which of the following is NOT a capital component when calculating the weighted average cost of capital (WACC)for use in capital budgeting?

To help them estimate the company's cost of capital,Smithco has hired you as a consultant.You have been provided with the following data: D1 = $1.45; P0 = $22.50; and g = 6.50% (constant).Based on the DCF approach,what is the cost of common from reinvested earnings?

The lower the firm's tax rate,the lower will be its after-tax cost of debt and also its WACC,other things held constant.

An Overview of Financial Management and the Financial Environment

Financial Statements, cash Flow, and Taxes

Analysis of Financial Statements

Time Value of Money

Bonds, bond Valuation, and Interest Rates

Risk and Return

Valuation of Stocks and Corporations

Financial Options and Applications in Corporate Finance

The Basics of Capital Budgeting: Evaluating Cash Flows

Cash Flow Estimation and Risk Analysis

Corporate Valuation and Financial Planning

Agency Conflicts and Corporate Governance

Distributions to Shareholders: Dividends and Repurchases

Capital Structure Decisions

Supply Chains and Working Capital Management

Multinational Financial Management

Public and Private Financing: Initial Offerings, seasoned Offerings, and Investment Banks

Extension 18 A: Rights Offerings

Lease Financing

Hybrid Financing: Preferred Stock, warrants, and Convertibles

Dynamic Capital Structures

Mergers and Corporate Control

Enterprise Risk Management

Bankruptcy, reorganization, and Liquidation

Portfolio Theory and Asset Pricing Models

Real Options

Providing and Obtaining Credit

Advanced Issues in Cash Management and Inventory Control

Pension Plan Management

Financial Management in Not For Profit Businesses

Filters

To help them estimate the company's cost of capital,Smithco has hired you as a consultant.You have been provided with the following data: D₁ = $1.45; P₀ = $22.50; and g = 6.50% (constant).Based on the DCF approach,what is the cost of common from reinvested earnings?