Question 1

cost of debt is equal to one minus the marginal tax rate multiplied by the average coupon rate on all outstanding debt.

Accepted Answer

A) True 
 B)False

Question 2

Adams Inchas 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 3

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 4

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 5

cost of external equity capital raised by issuing new common stock (re) is defined as follows, in words: "The cost of external equity equals the cost of equity capital from retaining earnings (rs), divided by one minus the percentage flotation cost required to sell the new stock, (1 - F)."

Accepted Answer

A) True 
 B)False

Question 6

Westbrook's Painting Coplans to issue a $1,000 par value, 20-year noncallable bond with a 7.00% annual coupon, paid semiannually The company's marginal tax rate is 40.00%, but Congress is considering a change in the corporate tax rate to 30.00% By how much would the component cost of debt used to calculate the WACC change if the new tax rate was adopted?

Accepted Answer

A)  0.57% 
B)  0.63% 
C)  0.70% 
D)  0.77% 
E)  0.85% 
A)  0.57% 
B)  0.63% 
C)  0.70% 
D)  0.77% 
E)  0.85%

Question 7

consultant firm has been hired by Eco Brothers Incto help them estimate the cost of common equity The yield on the firm's bonds is 8.75%, and your firm's economists believe that the cost of common can be estimated using a risk premium of 3.85% over a firm's own cost of debt What is an estimate of the firm's cost of common from retained earnings?

Accepted Answer

A)  12.60% 
B)  13.10% 
C)  13.63% 
D)  14.17% 
E)  14.74% 
A)  12.60% 
B)  13.10% 
C)  13.63% 
D)  14.17% 
E)  14.74%

Question 8

Tierney Group has two divisions of equal size: an office furniture manufacturing division and a data processing division Its CFO believes that stand-alone data processor companies typically have a WACC of 9%, while stand-alone furniture manufacturers typically have a 13% WACC She also believes that the data processing and manufacturing divisions have the same risk as their typical peers Consequently, she estimates that the composite, or corporate, WACC is 11% A consultant has suggested using a 9% hurdle rate for the data processing division and a 13% hurdle rate for the manufacturing division However, the CFO disagrees, and she has assigned an 11% WACC to all projects in both divisions Which of the following statements is CORRECT?

Accepted Answer

A)  The decision not to adjust for risk means, in effect, that it is favoring the data processing division. Therefore, that division is likely to become a larger part of the consolidated company over time. 
B)  The decision not to adjust for risk means that the company will accept too many projects in the manufacturing division and too few in the data processing division. This will lead to a reduction in the firm's intrinsic value over time. 
C)  The decision not to risk-adjust means that the company will accept too many projects in the data processing business and too few projects in the manufacturing business. This will lead to a reduction in its intrinsic value over time. 
D)  The decision not to risk adjust means that the company will accept too many projects in the manufacturing business and too few projects in the data processing business. This may affect the firm's capital structure but it will not affect its intrinsic value. 
E)  While the decision to use just one WACC will result in its accepting more projects in the manufacturing division and fewer projects in its data processing division than if it followed the consultant's recommendation, this should not affect the firm's intrinsic value. 
A)  The decision not to adjust for risk means, in effect, that it is favoring the data processing division. Therefore, that division is likely to become a larger part of the consolidated company over time. 
B)  The decision not to adjust for risk means that the company will accept too many projects in the manufacturing division and too few in the data processing division. This will lead to a reduction in the firm's intrinsic value over time. 
C)  The decision not to risk-adjust means that the company will accept too many projects in the data processing business and too few projects in the manufacturing business. This will lead to a reduction in its intrinsic value over time. 
D)  The decision not to risk adjust means that the company will accept too many projects in the manufacturing business and too few projects in the data processing business. This may affect the firm's capital structure but it will not affect its intrinsic value. 
E)  While the decision to use just one WACC will result in its accepting more projects in the manufacturing division and fewer projects in its data processing division than if it followed the consultant's recommendation, this should not affect the firm's intrinsic value.

Question 9

were recently hired by Garrett Design, Incto estimate its cost of common equity You obtained the following data: D1 = $1.75; P0 = $42.50; g = 7.00% (constant); and F = 5.00% What is the cost of equity raised by selling new common stock?

Accepted Answer

A)  10.77% 
B)  11.33% 
C)  11.90% 
D)  12.50% 
E)  13.12% 
A)  10.77% 
B)  11.33% 
C)  11.90% 
D)  12.50% 
E)  13.12%

Question 10

Taylor Incestimates that its average-risk projects have a WACC of 10%, its below-average risk projects have a WACC of 8%, and its above-average risk projects have a WACC of 12% Which of the following projects (A, B, and C) should the company accept?

Accepted Answer

A)  Project C, which is of above-average risk and has a return of 11%. 
B)  Project A, which is of average risk and has a return of 9%. 
C)  None of the projects should be accepted. 
D)  All of the projects should be accepted. 
E)  Project B, which is of below-average risk and has a return of 8.5%. 
A)  Project C, which is of above-average risk and has a return of 11%. 
B)  Project A, which is of average risk and has a return of 9%. 
C)  None of the projects should be accepted. 
D)  All of the projects should be accepted. 
E)  Project B, which is of below-average risk and has a return of 8.5%.

Question 11

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 12

reason why retained 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 retained earnings is based on the opportunity cost principle.

Accepted Answer

A) True 
 B)False

Question 13

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 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 14

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 15

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

Question 16

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

Question 17

working with the CAPM, which of the following factors can be determined with the most precision?

Accepted Answer

A)  The beta coefficient, bi, of a relatively safe stock. 
B)  The most appropriate risk-free rate, rRF. 
C)  The expected rate of return on the market, rM. 
D)  The beta coefficient of "the market," which is the same as the beta of an average stock. 
E)  The market risk premium (RPM). 
A)  The beta coefficient, bi, of a relatively safe stock. 
B)  The most appropriate risk-free rate, rRF. 
C)  The expected rate of return on the market, rM. 
D)  The beta coefficient of "the market," which is the same as the beta of an average stock. 
E)  The market risk premium (RPM).

Question 18

higher the firm's flotation cost for new common equity, the more likely the firm is to use preferred stock, which has no flotation cost, and retained earnings, whose cost is the average return on the assets that are acquired.

Accepted Answer

A) True 
 B)False

Question 19

Bloom and Cohas no debt or preferred stock-it uses only equity capital, and has two equally-sized divisions Division X's cost of capital is 10.0%, Division Y's cost is 14.0%, and the corporate (composite) WACC is 12.0% All of Division X's projects are equally risky, as are all of Division Y's projects However, the projects of Division X are less risky than those of Division Y Which of the following projects should the firm accept?

Accepted Answer

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

Question 20

"Capital" is sometimes defined as funds supplied to a firm by investors.

Accepted Answer

A) True 
 B)False

cost of debt is equal to one minus the marginal tax rate multiplied by the average coupon rate on all outstanding debt.

Adams Inchas 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?

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

cost of external equity capital raised by issuing new common stock (re) is defined as follows, in words: "The cost of external equity equals the cost of equity capital from retaining earnings (rs), divided by one minus the percentage flotation cost required to sell the new stock, (1 - F)."

were recently hired by Garrett Design, Incto estimate its cost of common equity You obtained the following data: D1 = $1.75; P0 = $42.50; g = 7.00% (constant); and F = 5.00% What is the cost of equity raised by selling new common stock?

Taylor Incestimates that its average-risk projects have a WACC of 10%, its below-average risk projects have a WACC of 8%, and its above-average risk projects have a WACC of 12% Which of the following projects (A, B, and C) should the company accept?

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.

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 retained earnings?

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

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

working with the CAPM, which of the following factors can be determined with the most precision?

higher the firm's flotation cost for new common equity, the more likely the firm is to use preferred stock, which has no flotation cost, and retained earnings, whose cost is the average return on the assets that are acquired.

"Capital" is sometimes defined as funds supplied to a firm by investors.

Overview

Risk and Return: Part I

Risk and Return: Part II

Bonds

Stocks

Financial Options

Financial Analysis

Forecasting

Corporate Valuation

Capital Budgeting

Cash Flows and Risk

Real Options

Cap Structure

Cap Structure II

Dividends

Ipos, Invsmt Banking

Leasing

Hybrids

Working Capital

Derivatives

Bankruptcy, Reorganization, and Liquidation

Mergers

Filters

Exam 10: Cost of Capital

cost of debt is equal to one minus the marginal tax rate multiplied by the average coupon rate on all outstanding debt.

Adams Inchas 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?

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

cost of external equity capital raised by issuing new common stock (re) is defined as follows, in words: "The cost of external equity equals the cost of equity capital from retaining earnings (rs), divided by one minus the percentage flotation cost required to sell the new stock, (1 - F)."

were recently hired by Garrett Design, Incto estimate its cost of common equity You obtained the following data: D1 = $1.75; P0 = $42.50; g = 7.00% (constant); and F = 5.00% What is the cost of equity raised by selling new common stock?

Taylor Incestimates that its average-risk projects have a WACC of 10%, its below-average risk projects have a WACC of 8%, and its above-average risk projects have a WACC of 12% Which of the following projects (A, B, and C) should the company accept?

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.

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 retained earnings?

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

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

working with the CAPM, which of the following factors can be determined with the most precision?

higher the firm's flotation cost for new common equity, the more likely the firm is to use preferred stock, which has no flotation cost, and retained earnings, whose cost is the average return on the assets that are acquired.

"Capital" is sometimes defined as funds supplied to a firm by investors.

Overview

Risk and Return: Part I

Risk and Return: Part II

Bonds

Stocks

Financial Options

Financial Analysis

Forecasting

Corporate Valuation

Capital Budgeting

Cash Flows and Risk

Real Options

Cap Structure

Cap Structure II

Dividends

Ipos, Invsmt Banking

Leasing

Hybrids

Working Capital

Derivatives

Bankruptcy, Reorganization, and Liquidation

Mergers

Filters