Question 1

a typical firm, which of the following sequences is CORRECT? All rates are after taxes, and assume that the firm operates at its target capital structure.

Accepted Answer

A) rs > re > rd > WACC. 
B) re > rs > WACC > rd. 
C) WACC > re > rs > rd. 
D) rd > re > rs > WACC. 
E) WACC > rd > rs > re. 
A) rs > re > rd > WACC. 
B) re > rs > WACC > rd. 
C) WACC > re > rs > rd. 
D) rd > re > rs > WACC. 
E) WACC > rd > rs > re. B

Question 2

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  True

Question 3

general, firms should use their weighted average cost of capital (WACC) to evaluate capital budgeting projects because most projects are funded with general corporate funds, which come from a variety of sources.However, if the firm plans to use only debt or only equity to fund a particular project, it should use the after-tax cost of that specific type of capital to evaluate that project.

Accepted Answer

A) True 
 B)False  False

Question 4

estimating the cost of equity by use of the bond-yield-plus-risk-premium method, we can generally get a good idea of the interest rate on new long-term debt, but we cannot be sure that the risk premium we add is appropriate.This problem leaves us unsure of the true value of rs.

Accepted Answer

A) True 
 B)False

Question 5

Teall Development Company hired you as a consultant to help them estimate its cost of capital.You have been provided with the following data: D1 = $1.45; P0 = $22.50; and g = 6.50% Based on the DCF approach, what is the cost of common from retained 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 6

Assume that you are a consultant to Broske Inc., and you have been provided with the following data: D1 = $0.67; P0 = $27.50; and g = 8.00% What is the cost of common from retained earnings based on the DCF approach?

Accepted Answer

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

Question 7

estimating the cost of equity by use of the DCF method, the single biggest potential problem is to determine the growth rate that investors use when they estimate a stock's expected future rate of return.This problem leaves us unsure of the true value of rs.

Accepted Answer

A) True 
 B)False

Question 8

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 9

cost of external equity capital raised by issuing new common stock "

Accepted Answer

A) True 
 B)False

Question 10

O'Brien Inc.has the following data: rRF = 5.00%; RPM = 6.00%; and b = 1.05.What is the firm's cost of common from retained earnings based on the CAPM?

Accepted Answer

A) 11.30% 
B) 11.64% 
C) 11.99% 
D) 12.35% 
E) 12.72% 
A) 11.30% 
B) 11.64% 
C) 11.99% 
D) 12.35% 
E) 12.72%

Question 11

Norris Enterprises, an all-equity firm, has a beta of 2.0.The chief financial officer is evaluating a project with an expected return of 14%, before any risk adjustment.The risk-free rate is 5%, and the market risk premium is 4%.The project being evaluated is riskier than an average project, in terms of both its beta risk and its total risk.Which of the following statements is CORRECT?

Accepted Answer

A) The project should definitely be accepted because its expected return (before any risk adjustments) is greater than its required return. 
B) The project should definitely be rejected because its expected return (before risk adjustment) is less than its required return. 
C) Riskier-than-average projects should have their expected returns increased to reflect their higher risk.Clearly, this would make the project acceptable regardless of the amount of the adjustment. 
D) The accept/reject decision depends on the firm's risk-adjustment policy.If Norris' policy is to increase the required return on a riskier-than-average project to 3% over rS, then it should reject the project. 
E) Capital budgeting projects should be evaluated solely on the basis of their total risk.Thus, insufficient information has been provided to make the accept/reject decision. 
A) The project should definitely be accepted because its expected return (before any risk adjustments) is greater than its required return. 
B) The project should definitely be rejected because its expected return (before risk adjustment) is less than its required return. 
C) Riskier-than-average projects should have their expected returns increased to reflect their higher risk.Clearly, this would make the project acceptable regardless of the amount of the adjustment. 
D) The accept/reject decision depends on the firm's risk-adjustment policy.If Norris' policy is to increase the required return on a riskier-than-average project to 3% over rS, then it should reject the project. 
E) Capital budgeting projects should be evaluated solely on the basis of their total risk.Thus, insufficient information has been provided to make the accept/reject decision.

Question 12

Which of the following statements is CORRECT?

Accepted Answer

A) The WACC as used in capital budgeting is an estimate of a company's before-tax cost of capital. 
B) The percentage flotation cost associated with issuing new common equity is typically smaller than the flotation cost for new debt. 
C) 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. 
D) There is an "opportunity cost" associated with using retained earnings, hence they are not "free." 
E) 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. 
A) The WACC as used in capital budgeting is an estimate of a company's before-tax cost of capital. 
B) The percentage flotation cost associated with issuing new common equity is typically smaller than the flotation cost for new debt. 
C) 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. 
D) There is an "opportunity cost" associated with using retained earnings, hence they are not "free." 
E) 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.

Question 13

Since 70% of the preferred dividends received by a corporation are excluded from taxable income, the component cost of equity for a company that pays half of its earnings out as common dividends and half as preferred dividends should, theoretically, be
Cost of equity = rs

Accepted Answer

A) True 
 B)False

Question 14

Duval Inc.uses only equity capital, and it has two equally-sized divisions.Division A's cost of capital is 10.0%, Division B's cost is 14.0%, and the corporate (composite) WACC is 12.0%.All of Division A's projects are equally risky, as are all of Division B's projects.However, the projects of Division A are less risky than those of Division B.Which of the following projects should the firm accept?

Accepted Answer

A) A Division B project with a 13% return. 
B) A Division B project with a 12% return. 
C) A Division A project with an 11% return. 
D) A Division A project with a 9% return. 
E) A Division B project with an 11% return. 
A) A Division B project with a 13% return. 
B) A Division B project with a 12% return. 
C) A Division A project with an 11% return. 
D) A Division A project with a 9% return. 
E) A Division B project with an 11% return.

Question 15

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

Which of the following statements is CORRECT?

Accepted Answer

A) The WACC is calculated using before-tax costs for all components. 
B) The after-tax cost of debt usually exceeds the after-tax cost of equity. 
C) For a given firm, the after-tax cost of debt is always more expensive than the after-tax cost of non-convertible preferred stock. 
D) Retained earnings that were generated in the past and are reported on the firm's balance sheet are available to finance the firm's capital budget during the coming year. 
E) The WACC that should be used in capital budgeting is the firm's marginal, after-tax cost of capital. 
A) The WACC is calculated using before-tax costs for all components. 
B) The after-tax cost of debt usually exceeds the after-tax cost of equity. 
C) For a given firm, the after-tax cost of debt is always more expensive than the after-tax cost of non-convertible preferred stock. 
D) Retained earnings that were generated in the past and are reported on the firm's balance sheet are available to finance the firm's capital budget during the coming year. 
E) The WACC that should be used in capital budgeting is the firm's marginal, after-tax cost of capital.

Question 17

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%

Question 18

Which of the following statements is CORRECT?

Accepted Answer

A) 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. 
B) 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. 
C) 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. 
D) 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. 
E) The bond-yield-plus-risk-premium approach is the most sophisticated and objective method for estimating a firm's cost of equity capital. 
A) 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. 
B) 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. 
C) 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. 
D) 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. 
E) The bond-yield-plus-risk-premium approach is the most sophisticated and objective method for estimating a firm's cost of equity capital.

Question 19

a typical U.S.company correctly estimates its WACC at a given point in time and then uses that same cost of capital to evaluate all projects for the next 10 years, then the firm will most likely

Accepted Answer

A) become riskier over time, but its intrinsic value will be maximized. 
B) become less risky over time, and this will maximize its intrinsic value. 
C) accept too many low-risk projects and too few high-risk projects. 
D) become more risky and also have an increasing WACC.Its intrinsic value will not be maximized. 
E) continue as before, because there is no reason to expect its risk position or value to change over time as a result of its use of a single cost of capital. 
A) become riskier over time, but its intrinsic value will be maximized. 
B) become less risky over time, and this will maximize its intrinsic value. 
C) accept too many low-risk projects and too few high-risk projects. 
D) become more risky and also have an increasing WACC.Its intrinsic value will not be maximized. 
E) continue as before, because there is no reason to expect its risk position or value to change over time as a result of its use of a single cost of capital.

Question 20

cost of debt is equal to one minus the marginal tax rate multiplied by the interest rate on new debt.

Accepted Answer

A) True 
 B)False

a typical firm, which of the following sequences is CORRECT? All rates are after taxes, and assume that the firm operates at its target capital structure.

estimating the cost of equity by use of the bond-yield-plus-risk-premium method, we can generally get a good idea of the interest rate on new long-term debt, but we cannot be sure that the risk premium we add is appropriate.This problem leaves us unsure of the true value of rs.

Teall Development Company hired you as a consultant to help them estimate its cost of capital.You have been provided with the following data: D1 = $1.45; P0 = $22.50; and g = 6.50% Based on the DCF approach, what is the cost of common from retained earnings?

Assume that you are a consultant to Broske Inc., and you have been provided with the following data: D1 = $0.67; P0 = $27.50; and g = 8.00% What is the cost of common from retained earnings based on the DCF approach?

estimating the cost of equity by use of the DCF method, the single biggest potential problem is to determine the growth rate that investors use when they estimate a stock's expected future rate of return.This problem leaves us unsure of the true value of rs.

cost of external equity capital raised by issuing new common stock "

O'Brien Inc.has the following data: rRF = 5.00%; RPM = 6.00%; and b = 1.05.What is the firm's cost of common from retained earnings based on the CAPM?

Which of the following statements is CORRECT?

Since 70% of the preferred dividends received by a corporation are excluded from taxable income, the component cost of equity for a company that pays half of its earnings out as common dividends and half as preferred dividends should, theoretically, be Cost of equity = rs

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

Which of the following statements is CORRECT?

is the best estimate of the after-tax cost of debt?

Which of the following statements is CORRECT?

a typical U.S.company correctly estimates its WACC at a given point in time and then uses that same cost of capital to evaluate all projects for the next 10 years, then the firm will most likely

cost of debt is equal to one minus the marginal tax rate multiplied by the interest rate on new debt.

Overview

Statements, CF, Taxes

Financial Analysis

Time Value of Money

Bonds

Risk and Return

Stocks

Financial Options

Capital Budgeting

Cash Flow and Risk

Forecasting

Valuation, Governanc

Dividends

CAP Structure

Working Capital

Multinational

Filters

Exam 9: Cost of Capital

a typical firm, which of the following sequences is CORRECT? All rates are after taxes, and assume that the firm operates at its target capital structure.

estimating the cost of equity by use of the bond-yield-plus-risk-premium method, we can generally get a good idea of the interest rate on new long-term debt, but we cannot be sure that the risk premium we add is appropriate.This problem leaves us unsure of the true value of rs.

Teall Development Company hired you as a consultant to help them estimate its cost of capital.You have been provided with the following data: D1 = $1.45; P0 = $22.50; and g = 6.50% Based on the DCF approach, what is the cost of common from retained earnings?

Assume that you are a consultant to Broske Inc., and you have been provided with the following data: D1 = $0.67; P0 = $27.50; and g = 8.00% What is the cost of common from retained earnings based on the DCF approach?

estimating the cost of equity by use of the DCF method, the single biggest potential problem is to determine the growth rate that investors use when they estimate a stock's expected future rate of return.This problem leaves us unsure of the true value of rs.

cost of external equity capital raised by issuing new common stock "

O'Brien Inc.has the following data: rRF = 5.00%; RPM = 6.00%; and b = 1.05.What is the firm's cost of common from retained earnings based on the CAPM?

Which of the following statements is CORRECT?

Since 70% of the preferred dividends received by a corporation are excluded from taxable income, the component cost of equity for a company that pays half of its earnings out as common dividends and half as preferred dividends should, theoretically, be Cost of equity = rs

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

Which of the following statements is CORRECT?

is the best estimate of the after-tax cost of debt?

Which of the following statements is CORRECT?

a typical U.S.company correctly estimates its WACC at a given point in time and then uses that same cost of capital to evaluate all projects for the next 10 years, then the firm will most likely

cost of debt is equal to one minus the marginal tax rate multiplied by the interest rate on new debt.

Overview

Statements, CF, Taxes

Financial Analysis

Time Value of Money

Bonds

Risk and Return

Stocks

Financial Options

Capital Budgeting

Cash Flow and Risk

Forecasting

Valuation, Governanc

Dividends

CAP Structure

Working Capital

Multinational

Filters