Exam 11: The Cost of Capital

Allison Engines Corporation has established a target capital structure of 40 percent debt and 60 percent common equity. The firm expects to earn $150,000 in after-tax income during the coming year, and it will retain 30 percent of those earnings. What is the break point of retained earnings?

The annual growth of Omega Inc's operations fluctuates substantially. As a result, using the dividend discount model (DDM) to estimate Omega's cost of retained earnings, r_s, is difficult because:

Which of the following is true of a break point on a firm's marginal cost of capital (MCC) schedule?

The before-tax cost of debt, rd, is the same as the:

The Jackson Company just paid a dividend equal to $3.00 per share on its common stock, and it expects this dividend to grow by 7 percent per year indefinitely. The firm has a beta coefficient equal to 1.50, the risk-free rate is 10 percent, and the expected return on the market is 14 percent. According to the capital asset pricing model, what is Jackson's cost of retained earnings, r_s?

The rates of return, or costs, that a firm must pay to raise funds to invest in capital budgeting projects are determined by the:

The marginal cost of capital (MCC) schedule generally rises, which implies that the weighted average cost of capital:

Tangerine Inc.'s target capital structure is 20 percent debt, 20 percent preferred stock, and 60 percent common equity. Its bonds have a 12 percent coupon rate, semiannual interest payments, a current maturity of 20 years, and a market value equal to their par value of $1,000. The firm's marginal tax rate is 40 percent. The firm's policy is to use a risk premium of 4 percentage points when using the bond-yield-plus-risk-premium method to determine its cost of retained earnings. What is Tangerine's component cost of retained earnings?

Even if a firm obtains all of its common equity financing from retained earnings, its marginal cost of capital (MCC) schedule could still increase if very large amounts of new capital are raised. 

Which of the following is the correct relationship between different capital components of a firm? r_d = before-tax cost of debt; r_s = cost of retained earnings; re = cost of new common equity

A firm should continue to invest in capital budgeting projects to the point where the marginal cost of capital (MCC) equals the marginal return (internal rate of return, IRR) generated by the last project that is purchased. 

The investment opportunity schedule (IOS) shows the:

To determine the actual cost of using debt, a firm must adjust its bonds' average yield to maturity for the fact that _____. 

The cost of issuing preferred stock must be adjusted for taxes because preferred stock dividend payments represent a tax-deductible expense for the firm. 

The _____ on a bond is the cost to the firm for using bondholders' funds. 

A firm's cost of capital (WACC) represents the maximum rate of return that a firm can earn from its capital budgeting projects to ensure that the value of the firm does not decrease. 

The marginal cost of capital generally _____ as more capital is raised during a given period. 

Oval Inc. just paid a dividend equal to $1.50 per share on its common stock, and it expects this dividend to grow by 4 percent per year indefinitely. The firm plans to issue common stock, which has a $16 per share market price, to raise funds to support operations. Oval's investment bankers estimate that the flotation costs for new issues of common stock will be equal to 8 percent of the issue (market) price. What is Oval's cost of new common equity, r_e?

Which of the following mathematical expressions is used to calculate the after-tax cost of debt, r_dT?

Which of the following cost of capital measures must be adjusted to account for tax savings?