Question 1

Retained earnings are a cheaper source of funds than the sale of new equity because ____.

Accepted Answer

A)  retention defers the payment of taxable dividends to shareholders 
B)  there are no flotation costs 
C)  new shares are usually priced below current market price 
D)  All of these are correct 
A)  retention defers the payment of taxable dividends to shareholders 
B)  there are no flotation costs 
C)  new shares are usually priced below current market price 
D)  All of these are correct

Question 2

The following financial information is available on Rawls Manufacturing Company: $$\begin{array} { l r } 
\text { Current per share market price } & \$ 48.00 \
\text { Current per share dividend } & \$ 3.50 \
\text { Current per share earnings } & \$ 6.00 \
\text { Beta } & 12.0 \% \
\text { Expected rate of return on market } & 6.0 \% \
\text { Risk-free rate } & 5.0 \%
\end{array}$$ ? Rawls can issue new common stock to net the company $44 per share. Determine the cost of external equity capital using the dividend capitalization model approach. (Compute answer to the nearest 0.1%.)

Accepted Answer

A)  12.7% 
B)  14.4% 
C)  12.6% 
D)  13.4% 
A)  12.7% 
B)  14.4% 
C)  12.6% 
D)  13.4%

Question 3

A firm has a beta of 1.2. The return in the market is 14%, and the risk-free rate is 6%. The estimated cost of common stock equity is ____.

Accepted Answer

A)  6% 
B)  7.2% 
C)  15.6% 
D)  14% 
A)  6% 
B)  7.2% 
C)  15.6% 
D)  14%

Question 4

During the 1980s, the cost of capital for U.S. firms averaged about 3.3 percentage points higher than Japanese firms. During 1990 this disadvantage may have disappeared due to ____.

Accepted Answer

A)  higher exports to the United States 
B)  higher real interest rates in Japan 
C)  larger shareholder interest 
D)  higher Japanese stock market 
A)  higher exports to the United States 
B)  higher real interest rates in Japan 
C)  larger shareholder interest 
D)  higher Japanese stock market

Question 5

Columbia Gas Company's (CG) current capital structure is 35% debt and 65% equity. This year CG has earnings after tax of $5.31 million and is paying $1.6 million in dividends. To finance a transmission pipe line, CG can borrow $2 million at a cost of 10%, the same rate that CG is currently paying on a total of $15 million long-term debt. CG has 1,000,000 shares outstanding, and its current market price is $31. If CG's long-term growth rate of dividends is expected to be 8%, what is the weighted cost of capital for the firm? Assume a marginal tax rate of 40%.

Accepted Answer

A)  10.9% 
B)  13.6% 
C)  19.6% 
D)  16.9% 
A)  10.9% 
B)  13.6% 
C)  19.6% 
D)  16.9%

Question 6

Crickentree has a target capital structure of 30% debt and 70% equity. If the firm expects to have a net income of $1.7 million and a dividend payout ratio of 40%, what will be its equity break point?

Accepted Answer

A)  $2,428,571 
B)  $1,457,143 
C)  $3,400,000 
D)  $971,429 
A)  $2,428,571 
B)  $1,457,143 
C)  $3,400,000 
D)  $971,429

Question 7

California Best (CB), a sports shoes store, expects an operating income of $2.3 million this year. CB has no long-term debt. The firm is considering as expansion project. The current risk-free rate of return is 7%, and the current market risk premium is 8.3%. If CB's beta is 20% greater than the overall market, what is the firm's cost of capital? Assume that CB has a marginal tax rate of 40%.

Accepted Answer

A)  8.3% 
B)  16.96% 
C)  9.96% 
D)  15.3% 
A)  8.3% 
B)  16.96% 
C)  9.96% 
D)  15.3%

Question 8

Zappin' Skeeters Corporation needs to know its cost of retained earnings. Based on the following information, compute the cost of retained earnings: The stock sells for $25, flotation costs are $3, and the firm is in the 35% tax bracket. $$\begin{array} { l l } 
\text { Year } & \text { Dividend } \
2014 & \$ 1.55 \
2013 & \$ 1.40 \
2012 & \$ 1.35 \
2011 & \$ 1.32
\end{array}$$

Accepted Answer

A)  15.71% 
B)  9.11% 
C)  12.56% 
D)  10.72% 
A)  15.71% 
B)  9.11% 
C)  12.56% 
D)  10.72%

Question 9

A firm with a 40% marginal tax rate has a capital structure of $60,000,000 in debt and $140,000,000 in equity. What is the firm's weighted cost of capital if the marginal pretax cost of debt is 12%, the firm's average pretax cost of debt outstanding is 8%, and the cost of equity is 14.5%?

Accepted Answer

A)  13.75% 
B)  11.59% 
C)  12.31% 
D)  10.45% 
A)  13.75% 
B)  11.59% 
C)  12.31% 
D)  10.45%

Question 10

Groves Inc. pays an annual dividend of $1.22. This dividend is expected to continue growing at a rate of about 5% each year. The firm is in a fairly risky business and has a beta of 1.45. The expected market rate of return is 13.5%, and the risk-free rate is 9.3%. What is the cost of equity for Groves?

Accepted Answer

A)  19.6% 
B)  13.5% 
C)  15.4% 
D)  6.1% 
A)  19.6% 
B)  13.5% 
C)  15.4% 
D)  6.1%

Question 11

Bay State Technology has determined that its cost of equity is 15% and its after-tax cost of debt is 7.2%. Bay State expects to earn $14 million after taxes next year and, as a new firm, does not pay any dividends. The stock sells for $24. Bonds are currently selling at par value. Compute Bay State's weighted cost of capital. A partial balance sheet is shown below: $$\begin{array} { l r } 
\text { Current liabilities } & \$ 300,000 \
\text { Long-term debt } & \$ 1,000,000 \
\text { Common stock at } \$ 1 \text { par } & \$ 100,000 \
\text { Paid in capital } & \$ 900,000 \
\text { Retained earnings } & \$ 3,000,000 \
\text { Total liabilities and stockholders' equity } & \$ 5,300,000
\end{array}$$

Accepted Answer

A)  13.4% 
B)  13.1% 
C)  11.6% 
D)  12.7% 
A)  13.4% 
B)  13.1% 
C)  11.6% 
D)  12.7%

Question 12

Northeast Airlines (NA) has a current dividend of $1.80. Dividends are expected to grow at a rate of 7% a year into the foreseeable future. What is NA's cost of external equity if its stock can be sold to net $46 a share?

Accepted Answer

A)  10.9% 
B)  11.2% 
C)  7.2% 
D)  21.0% 
A)  10.9% 
B)  11.2% 
C)  7.2% 
D)  21.0%

Question 13

The CAPM assumes that the only risk of concern to the investor is ____, which is measured by ____.

Accepted Answer

A)  unsystematic risk; beta 
B)  systematic risk; the return to the market portfolio 
C)  systematic risk; beta 
D)  unsystematic risk; the return to the market portfolio 
A)  unsystematic risk; beta 
B)  systematic risk; the return to the market portfolio 
C)  systematic risk; beta 
D)  unsystematic risk; the return to the market portfolio

Question 14

Mahlo is planning to diversify into the bakery industry. As a result, its beta should drop from 1.4 to 1.2 and the expected long-term growth rate of dividends will drop from 12% to 9%. The risk-free rate is 4%, the expected market risk premium is 9%, and the current dividend per share paid by Mahlo is $2.10. Should Mahlo complete the diversification into the bakery industry?

Accepted Answer

A)  No, stock price drops about $11.70 
B)  Yes, stock price increases about $9.40 
C)  Yes, stock price increases about $1.80 
D)  No, stock price drops about $9.40 
A)  No, stock price drops about $11.70 
B)  Yes, stock price increases about $9.40 
C)  Yes, stock price increases about $1.80 
D)  No, stock price drops about $9.40

Question 15

If a firm is losing money then the after-tax cost of debt is ____.

Accepted Answer

A)  equal to kd(1 - T) 
B)  found by trial and error 
C)  equal to the pretax cost of debt 
D)  equal to the yield to first call date 
A)  equal to kd(1 - T) 
B)  found by trial and error 
C)  equal to the pretax cost of debt 
D)  equal to the yield to first call date

Question 16

The cost of external common equity is represented in financial formulas as ____.

Accepted Answer

A)  ki 
B)  kd 
C)  k'e 
D)  ke 
A)  ki 
B)  kd 
C)  k'e 
D)  ke

Question 17

The cost of debt must account for all of the following inputs EXCEPT ____.

Accepted Answer

A)  bond ratings 
B)  issuance costs 
C)  flotation costs 
D)  the tax rate 
A)  bond ratings 
B)  issuance costs 
C)  flotation costs 
D)  the tax rate

Question 18

What does the optimal capital budget maximize? How is it determined?

Accepted Answer

The optimal capital budget max

Question 19

The Allegheny Valley Power Company common stock has a beta of 0.80. Assume the current risk-free rate is 6.5% and the expected return on the stock market as a whole is 16%, determine the cost of equity capital for the firm (using the CAPM).

Accepted Answer

A)  14.1% 
B)  7.6% 
C)  6.5% 
D)  13.0% 
A)  14.1% 
B)  7.6% 
C)  6.5% 
D)  13.0%

Question 20

Rank in ascending order (lowest to highest) investors' required rates of return on the various types of corporate securities.

Accepted Answer

A)  preferred stock, corporate debt, common stock 
B)  common stock, preferred stock, corporate debt 
C)  preferred stock, common stock, corporate debt 
D)  corporate debt, preferred stock, common stock 
A)  preferred stock, corporate debt, common stock 
B)  common stock, preferred stock, corporate debt 
C)  preferred stock, common stock, corporate debt 
D)  corporate debt, preferred stock, common stock

Exam 14: The Cost of Capital

Retained earnings are a cheaper source of funds than the sale of new equity because ____.

A firm has a beta of 1.2. The return in the market is 14%, and the risk-free rate is 6%. The estimated cost of common stock equity is ____.

During the 1980s, the cost of capital for U.S. firms averaged about 3.3 percentage points higher than Japanese firms. During 1990 this disadvantage may have disappeared due to ____.

Crickentree has a target capital structure of 30% debt and 70% equity. If the firm expects to have a net income of $1.7 million and a dividend payout ratio of 40%, what will be its equity break point?

Zappin' Skeeters Corporation needs to know its cost of retained earnings. Based on the following information, compute the cost of retained earnings: The stock sells for $25, flotation costs are $3, and the firm is in the 35% tax bracket. Year Dividend 2014 \ 1.55 2013 \ 1.40 2012 \ 1.35 2011 \ 1.32

A firm with a 40% marginal tax rate has a capital structure of $60,000,000 in debt and $140,000,000 in equity. What is the firm's weighted cost of capital if the marginal pretax cost of debt is 12%, the firm's average pretax cost of debt outstanding is 8%, and the cost of equity is 14.5%?

Northeast Airlines (NA) has a current dividend of $1.80. Dividends are expected to grow at a rate of 7% a year into the foreseeable future. What is NA's cost of external equity if its stock can be sold to net $46 a share?

The CAPM assumes that the only risk of concern to the investor is ____, which is measured by ____.

If a firm is losing money then the after-tax cost of debt is ____.

The cost of external common equity is represented in financial formulas as ____.

The cost of debt must account for all of the following inputs EXCEPT ____.

What does the optimal capital budget maximize? How is it determined?

The Allegheny Valley Power Company common stock has a beta of 0.80. Assume the current risk-free rate is 6.5% and the expected return on the stock market as a whole is 16%, determine the cost of equity capital for the firm (using the CAPM).

Rank in ascending order (lowest to highest) investors' required rates of return on the various types of corporate securities.

The Role and Objective of Financial Management

The Domestic and International Financial Marketplace

Evaluation of Financial Performance

Financial Planning and Forecasting

The Time Value of Money

Continuous Compounding and Discounting

Fixed Income Securities: Characteristics and Valuation

Common Stock: Characteristics, Valuation, and Issuance

Analysis of Risk and Return

Capital Budgeting and Cash Flow Analysis

Mutually Exclusive Investments Having Unequal Lives

Capital Budgeting: Decision Criteria and Real Option Considerations

Capital Budgeting and Risk

Capital Structure Concepts

Breakeven Analysis

Capital Structure Management in Practice

Dividend Policy

Working Capital Policy and Short-Term Financing

The Management of Cash and Marketable Securities

The Management of Accounts Receivable and Inventories

Lease and Intermediate Term Financing

Financing With Derivatives

Bond Refunding Analysis

Risk Management

International Financial Management

Corporate Restructuring

Filters

The CAPM assumes that the only risk of concern to the investor is , which is measured by .