Question 1

The after-tax cost of debt 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 2

The cost of common stock equity may be estimated by using which of the following?

Accepted Answer

A)  Earnings curve 
B)  Dupont analysis 
C)  Capital asset pricing model 
D)  Price/Earnings ratio 
A)  Earnings curve 
B)  Dupont analysis 
C)  Capital asset pricing model 
D)  Price/Earnings ratio

Question 3

The optimal capital budget occurs at the point where two curves intersect. Which of the following is (are) one of those curves? 
I. Weighted marginal cost of capital curve
II. Investment opportunity curve

Accepted Answer

A)  Only statement I is correct. 
B)  Only statement II is correct. 
C)  Both statements I and II are correct. 
D)  Neither statement I nor II is correct. 
A)  Only statement I is correct. 
B)  Only statement II is correct. 
C)  Both statements I and II are correct. 
D)  Neither statement I nor II is correct.

Question 4

There are two primary ways that capital is raised. Which of the following statements is (are) correct? 
I. Capital is raised internally by using retained earnings.
II. Capital is raised externally by selling fixed assets.

Accepted Answer

A)  Only statement I is correct. 
B)  Only statement II is correct. 
C)  Both statements I and II are correct. 
D)  Neither statement I nor II is correct. 
A)  Only statement I is correct. 
B)  Only statement II is correct. 
C)  Both statements I and II are correct. 
D)  Neither statement I nor II is correct.

Question 5

The total return to stockholders, ke, is composed of the ____.

Accepted Answer

A)  opportunity cost plus a risk premium 
B)  dividend yield plus the price appreciation of the security 
C)  opportunity cost plus an inflation premium 
D)  dividend yield minus the risk premium 
A)  opportunity cost plus a risk premium 
B)  dividend yield plus the price appreciation of the security 
C)  opportunity cost plus an inflation premium 
D)  dividend yield minus the risk premium

Question 6

The most appropriate weights to use in calculating a firm's cost of capital are the proportions of the components in the firm's ____ capital structure.

Accepted Answer

A)  historical average 
B)  long-range target 
C)  current 
D)  industry average 
A)  historical average 
B)  long-range target 
C)  current 
D)  industry average

Question 7

Determine the (after-tax) percentage cost of a $50 million debt issue that the Mattingly Corporation is planning to place privately with a large insurance company. Assume that the company has a 40% marginal tax rate. This long-term debt issue will yield 12% to the insurance company.

Accepted Answer

A)  4.8% 
B)  7.2% 
C)  12.0% 
D)  10.6% 
A)  4.8% 
B)  7.2% 
C)  12.0% 
D)  10.6%

Question 8

In many instances, book value, rather than market value, may be used to determine the weighted average cost of capital. This is because of all of the following EXCEPT ____,

Accepted Answer

A)  market values change daily 
B)  the market prices of the various sources of capital are not easily estimated 
C)  many firms have several different issues of debt which may not be publicly held 
D)  book value is a more accurate value in determining the actual cost of capital 
A)  market values change daily 
B)  the market prices of the various sources of capital are not easily estimated 
C)  many firms have several different issues of debt which may not be publicly held 
D)  book value is a more accurate value in determining the actual cost of capital

Question 9

What is the cost of preferred stock for Foggy Futures Weather Forecasters? The firm is in the 40% tax bracket. The optimal capital structure is listed below: ? $$\begin{array} { | l | l | } 
\hline \text { Source of Capital } & \text { W eight } \
\hline \text { Long-Term Debt } & 25 \% \
\hline \text { Preferred Stock } & 20 \% \
\hline \text { Common Stock } & 55 \% \
\hline
\end{array}$$ ? $\begin{array}{|l|l|}
\hline \text { Debt: }&\begin{array}{ll}
\text {The firm can issue \( \$ 1,000 \mathrm{p} $ ar value, $ 8 \% $ coupon interest bonds with a 20 -year  }\\text {maturity date. The bond has an average discount of $ \$ 30 $ and flotation costs of }\\text {  $ \$ 30 $ per bond. The selling price is $ \$ 1,000 $.}
\end{array}\
\hline \text {Preferred Stock: }&\begin{array}{ll}
\text {The firm can sell preferred stock with a dividend that is $ 8 \% $ of the current price.  }\\text { The stock costs $ \$ 95 $. The cost of issuing and selling the stock is expected }\\text {to be $ \$ 5 $ per share. }
\end{array}\
\hline  \text {Common Stock: }&\begin{array}{ll}
\text {The firm's common stock is currently selling for $ \$ 90 $ per share.  }\\text {The firm's common stock is currently selling for $ \$ 90 $ per share. The firm expects to pay cash dividends  }\\text {  The dividends have been growing at $ 6 \% $. The stock must be discounted by $ \$ 7 $, }\\text {and flotation costs are expected to amount to $ \$ 5 $ per share. }
\end{array}\
\hline \text { Retained Earnings:}&\begin{array}{ll}
\text { The firm expects to have enough retained earnings in the coming year to be used}\\text { in place of any new stock being issued. }
\end{array}\
\hline 
\end{array}\)

Accepted Answer

A)  4.9% 
B)  11.55% 
C)  7.88% 
D)  8.44% 
A)  4.9% 
B)  11.55% 
C)  7.88% 
D)  8.44%

Question 10

Sharp's current capital structure of 60% equity, 35% debt, and 5% preferred stock is considered optimal. This year Sharp expects to have earnings after tax of $3.6 million and to pay out $600,000 in dividends. Sharp can also raise up to $2 million in long-term debt at a pretax interest rate of 10.6% (all debt over $2 million will cost 11.4% pretax), and sell preferred stock at a cost of 11.5%. Sharp's marginal tax rate is 40%. The current value of Sharp's common stock is $36 and a dividend of $2.15 is expected to be paid during the coming year. Dividends have been growing at an annual compound rate of 8% a year and are expected to continue growing at that rate. New shares can be sold to net the firm $34.50. Sharp has an opportunity to invest in the following capital projects. Which one(s) should be accepted? $\begin{array}{lllc}
\text { Project } & \text { Cost } & \text { Annual Cash Flow } & \text { Project Life } \
1 & \$ 3.0 \text { million } & \$ 552,893 & 10 \text { years } \
2 & \$ 2.5 \text { million } & \$ 693,481 & 5 \text { years } \
3 & \$ 2.0 \text { million } & \$ 345,220 & 10 \text { years }
\end{array}$

Accepted Answer

A)  1 and 2 only 
B)  1 and 3 only 
C)  1, 2, and 3 
D)  Cannot be determined from the information provided 
A)  1 and 2 only 
B)  1 and 3 only 
C)  1, 2, and 3 
D)  Cannot be determined from the information provided

Question 11

Surfin' Bubba Surfboard Shop is currently selling for $34.25 a share with a current dividend of $1.00. It is estimated that Surfin' Bubba will have a growth rate in earnings of 10% into the foreseeable future. If Surfin' Bubba plans to raise new capital for expansion, what is the cost of new equity if flotation costs are 8% of the price?

Accepted Answer

A)  13.49% 
B)  11.57% 
C)  12.21% 
D)  10.87% 
A)  13.49% 
B)  11.57% 
C)  12.21% 
D)  10.87%

Question 12

Calculate the weighted average cost of capital for Limp Linguini Noodle Makers Inc. under the following conditions: 
*The capital structure is 40% debt and 60% equity.
*The before-tax cost of debt (which includes flotation costs) is 20% and the firm is in the 40% tax bracket.
*The firm's beta is 1.7.
*The risk-free rate is 7% and the market risk premium is 6%.

Accepted Answer

A)  15.12% 
B)  18.7% 
C)  17.2% 
D)  12% 
A)  15.12% 
B)  18.7% 
C)  17.2% 
D)  12%

Question 13

Sadaplast has a target capital structure of 65% common equity, 30% debt, and 5% preferred stock. The cost of retained earnings is 14%, and the cost of new equity is 15.5%. Sadaplast expects to have a net income of $85 million in the coming year. If the firm sells bonds, up to $25 million can be sold at par value to yield an after-tax cost of 5.4%. An additional $20 million of debentures could be sold to yield an after-tax cost of 7.0%. The after-tax cost of preferred stock financing is estimated to be 11%. Sadaplast has a dividend payout ratio of 25%. What is Sadaplast's cost of capital between the first and second break points?

Accepted Answer

A)  12.25% 
B)  11.27% 
C)  11.75% 
D)  12.73% 
A)  12.25% 
B)  11.27% 
C)  11.75% 
D)  12.73%

Question 14

Which of the following statements is true concerning companies that do not pay dividends?

Accepted Answer

A)  The cost of equity capital can be estimated using the Capital Asset Pricing Model. 
B)  The cost of equity capital is equal to the growth short-term rate of earnings per share. 
C)  The dividend capitalization model can be used to determine an accurate cost of equity capital. 
D)  None of these are correct 
A)  The cost of equity capital can be estimated using the Capital Asset Pricing Model. 
B)  The cost of equity capital is equal to the growth short-term rate of earnings per share. 
C)  The dividend capitalization model can be used to determine an accurate cost of equity capital. 
D)  None of these are correct

Question 15

The cost of capital is ____.

Accepted Answer

A)  the rate of return required by investors in the firm's securities 
B)  the minimum rate of return required on new investments of high risk undertaken by the firm 
C)  approximately 10 percent for most firms 
D)  concerned with plant and equipment only 
A)  the rate of return required by investors in the firm's securities 
B)  the minimum rate of return required on new investments of high risk undertaken by the firm 
C)  approximately 10 percent for most firms 
D)  concerned with plant and equipment only

Question 16

Pluega Inc. issued a $100 million 8.27% coupon debenture bond due in the next 20 years. The bonds each sold for $996. If the bonds pay interest semi-annually, what is Pluega's after cash cost of debt? Assume 40% tax rate.

Accepted Answer

A)  4.96% 
B)  8.30% 
C)  4.99% 
D)  3.32% 
A)  4.96% 
B)  8.30% 
C)  4.99% 
D)  3.32%

Question 17

Studies analyzing the historical returns earned by common stock investors have found that the returns from average risk common stock investments over very long time periods have averaged approximately ____ percentage points ____ than holding period returns on corporate debt issues.

Accepted Answer

A)  7.5; higher 
B)  7.5; lower 
C)  5.7; lower 
D)  5.7; higher 
A)  7.5; higher 
B)  7.5; lower 
C)  5.7; lower 
D)  5.7; higher

Question 18

Easy Slider Inc. sold a 15-year $1,000 face value bond with a 10% coupon rate. Interest is paid annually. After flotation costs, Easy Slider received $928 per bond. Compute the after-tax cost of debt for these bonds if the firm's marginal tax rate is 40%.

Accepted Answer

A)  6.0% 
B)  7.2% 
C)  7.8% 
D)  6.6% 
A)  6.0% 
B)  7.2% 
C)  7.8% 
D)  6.6%

Question 19

If a preferred stock is callable, then the calculation of the cost of preferred stock financing is ____.

Accepted Answer

A)  similar to that for bonds 
B)  equal to Dp/Pn 
C)  equal to Dp less flotation costs 
D)  less than Dp/Pn 
A)  similar to that for bonds 
B)  equal to Dp/Pn 
C)  equal to Dp less flotation costs 
D)  less than Dp/Pn

Question 20

Rank in ascending order (lowest to highest) the relative riskiness of the various types of corporate and government securities.

Accepted Answer

A)  common stock, preferred stock, corporate debt, long-term government debt 
B)  corporate debt, long-term government debt, preferred stock, common stock 
C)  long-term government debt, corporate debt, preferred stock, common stock 
D)  corporate debt, preferred stock, long-term government debt, common stock 
A)  common stock, preferred stock, corporate debt, long-term government debt 
B)  corporate debt, long-term government debt, preferred stock, common stock 
C)  long-term government debt, corporate debt, preferred stock, common stock 
D)  corporate debt, preferred stock, long-term government debt, common stock

Exam 14: The Cost of Capital

The after-tax cost of debt is represented in financial formulas as ____.

The cost of common stock equity may be estimated by using which of the following?

The optimal capital budget occurs at the point where two curves intersect. Which of the following is (are) one of those curves? I. Weighted marginal cost of capital curve II. Investment opportunity curve

There are two primary ways that capital is raised. Which of the following statements is (are) correct? I. Capital is raised internally by using retained earnings. II. Capital is raised externally by selling fixed assets.

The total return to stockholders, ke, is composed of the ____.

The most appropriate weights to use in calculating a firm's cost of capital are the proportions of the components in the firm's ____ capital structure.

Determine the (after-tax) percentage cost of a $50 million debt issue that the Mattingly Corporation is planning to place privately with a large insurance company. Assume that the company has a 40% marginal tax rate. This long-term debt issue will yield 12% to the insurance company.

In many instances, book value, rather than market value, may be used to determine the weighted average cost of capital. This is because of all of the following EXCEPT ____,

Which of the following statements is true concerning companies that do not pay dividends?

The cost of capital is ____.

Pluega Inc. issued a $100 million 8.27% coupon debenture bond due in the next 20 years. The bonds each sold for $996. If the bonds pay interest semi-annually, what is Pluega's after cash cost of debt? Assume 40% tax rate.

Studies analyzing the historical returns earned by common stock investors have found that the returns from average risk common stock investments over very long time periods have averaged approximately ____ percentage points ____ than holding period returns on corporate debt issues.

Easy Slider Inc. sold a 15-year $1,000 face value bond with a 10% coupon rate. Interest is paid annually. After flotation costs, Easy Slider received $928 per bond. Compute the after-tax cost of debt for these bonds if the firm's marginal tax rate is 40%.

If a preferred stock is callable, then the calculation of the cost of preferred stock financing is ____.

Rank in ascending order (lowest to highest) the relative riskiness of the various types of corporate and government 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 total return to stockholders, k_e, is composed of the ____.

Studies analyzing the historical returns earned by common stock investors have found that the returns from average risk common stock investments over very long time periods have averaged approximately percentage points than holding period returns on corporate debt issues.