Question 1

The market value weights are preferred when calculating a firm's weighted average cost of capital.

Accepted Answer

A) True 
 B)False

Question 2

Triplin Corporation's marginal tax rate is 35%.It can issue 10-year bonds with an annual coupon rate of 7% and a par value of $1,000.After $12 per bond flotation costs,new bonds will net the company $966 in proceeds.Determine the appropriate after-tax cost of new debt for Triplin to use in a capital budgeting analysis.

Accepted Answer

A)  2.62% 
B)  4.87% 
C)  7.50% 
D)  7.8% 
A)  2.62% 
B)  4.87% 
C)  7.50% 
D)  7.8%

Question 3

The firm's cost of capital may also be referred to as the firm's opportunity cost of capital.

Accepted Answer

A) True 
 B)False

Question 4

The Capital Asset Pricing Model may be used to estimate the cost of retained earnings.

Accepted Answer

A) True 
 B)False

Question 5

Last year Gator Getters,Inc.had $50 million in total assets.Management desires to increase its plant and equipment during the coming year by $12 million.The company plans to finance 40 percent of the expansion with debt and the remaining 60 percent with equity capital.Bond financing will be at a 9 percent rate and will be sold at its par value.Common stock is currently selling for $50 per share,and flotation costs for new common stock will amount to $5 per share.The expected dividend next year for Gator is $2.50.Furthermore,dividends are expected to grow at a 6 percent rate far into the future.The marginal corporate tax rate is 34 percent.Internal funding available from additions to retained earnings is $4,000,000.
a.What amount of new common stock must be sold if the existing capital structure is to be maintained?
b.Calculate the weighted marginal cost of capital at an investment level of $12 million.

Accepted Answer

a.
Equity needed = $12 million × 0.6 = $

Question 6

Atlas Corporation wishes to estimate its cost of retained earnings.The firm's beta is 1.3.The rate on 6-month T-bills is 2%,and the return on the S&P 500 index is 15%.What is the appropriate cost for retained earnings in determining the firm's cost of capital?

Accepted Answer

A)  17.0% 
B)  19.5% 
C)  18.9% 
D)  22.1% 
A)  17.0% 
B)  19.5% 
C)  18.9% 
D)  22.1%

Question 7

The interest rate parity theorem suggests that differences in observed nominal rates of interest in two countries should equal

Accepted Answer

A)  differences in the expected rates of inflation between the two countries. 
B)  differences in the risk free rates of return between the two countries. 
C)  differences in the federal funds rates between the two countries. 
D)  differences in currency exchange rates between the two countries. 
A)  differences in the expected rates of inflation between the two countries. 
B)  differences in the risk free rates of return between the two countries. 
C)  differences in the federal funds rates between the two countries. 
D)  differences in currency exchange rates between the two countries.

Question 8

The cost of capital is the rate that must be earned on an investment project if the project is to increase the value of the common shareholders' investment.

Accepted Answer

A) True 
 B)False

Question 9

The cost of external equity capital is greater than the cost of retained earnings because of:

Accepted Answer

A)  flotation costs on new equity. 
B)  increasing marginal tax rates. 
C)  higher dividends. 
D)  greater risk for shareholders. 
A)  flotation costs on new equity. 
B)  increasing marginal tax rates. 
C)  higher dividends. 
D)  greater risk for shareholders.

Question 10

The best financial structure is determined by finding the debt and equity mix that maximizes the firm's cost of capital.

Accepted Answer

A) True 
 B)False

Question 11

A firm's weighted average cost of capital is a function of (1)the individual costs of capital,(2)the capital structure mix,and (3)the level of financing necessary to make the investment.

Accepted Answer

A) True 
 B)False

Question 12

Gibson Industries is issuing a $1,000 par value bond with an 8% annual interest coupon rate that matures in 11 years.Investors are willing to pay $972,and flotation costs will be 9%.Gibson is in the 34% tax bracket.What will be the after-tax cost of new debt for the bond?

Accepted Answer

9.76% × (1

Question 13

A reasonable estimate of the market risk premium based on historical data and expert opinion is between 5% and 7%.

Accepted Answer

A) True 
 B)False

Question 14

The market risk premium remains constant over time because the risk free rate of return moves inversely with beta.

Accepted Answer

A) True 
 B)False

Question 15

General Bill's will issue preferred stock to finance a new artillery line.The firm's existing preferred stock pays a dividend of $4.00 per share and is selling for $40 per share.Investment bankers have advised General Bill that flotation costs on the new preferred issue would be 5% of the selling price.The General's marginal tax rate is 30%.What is the relevant cost of new preferred stock?

Accepted Answer

A)  7.00% 
B)  7.37% 
C)  10.00% 
D)  10.53% 
E)  15.00% 
A)  7.00% 
B)  7.37% 
C)  10.00% 
D)  10.53% 
E)  15.00%

Question 16

Jiffy Co.expects to pay a dividend of $3.00 per share in one year.The current price of Jiffy common stock is $60 per share.Flotation costs are $3.00 per share when Jiffy issues new stock.What is the cost of internal common equity (retained earnings)if the long-term growth in dividends is projected to be 8 percent indefinitely?

Accepted Answer

A)  13 percent 
B)  14 percent 
C)  15 percent 
D)  16 percent 
A)  13 percent 
B)  14 percent 
C)  15 percent 
D)  16 percent

Question 17

Milton Parker has a capital structure that consists of $7 million of debt,$2 million of preferred stock,and $11 million of common equity,based upon current market values.Parker's yield to maturity on its bonds is 7.4%,and investors require an 8% return on Parker's preferred and a 14% return on Parker's common stock.If the tax rate is 35%,what is Parker's WACC?

Accepted Answer

A)  7.21% 
B)  8.12% 
C)  10.18% 
D)  12.25% 
A)  7.21% 
B)  8.12% 
C)  10.18% 
D)  12.25%

Question 18

The required return of a preferred stockholder,rps,is higher than the cost of preferred stock for the corporation because stockholder's must pay federal taxes on their dividend income.

Accepted Answer

A) True 
 B)False

Question 19

Because investors like dividends,the higher the company's dividend growth rate,the lower the company's cost of common equity.

Accepted Answer

A) True 
 B)False

Question 20

Which of the following causes a firm's cost of capital (WACC)to differ from an investor's required rate of return on the company's common stock?

Accepted Answer

A)  The fact that the risk free rate of interest has increased. 
B)  The incurrence of flotation costs when new securities are issued. 
C)  The market risk premium exceeds 12%. 
D)  None of the above - the WACC and required return are the same 
A)  The fact that the risk free rate of interest has increased. 
B)  The incurrence of flotation costs when new securities are issued. 
C)  The market risk premium exceeds 12%. 
D)  None of the above - the WACC and required return are the same

The market value weights are preferred when calculating a firm's weighted average cost of capital.

The firm's cost of capital may also be referred to as the firm's opportunity cost of capital.

The Capital Asset Pricing Model may be used to estimate the cost of retained earnings.

Atlas Corporation wishes to estimate its cost of retained earnings.The firm's beta is 1.3.The rate on 6-month T-bills is 2%,and the return on the S&P 500 index is 15%.What is the appropriate cost for retained earnings in determining the firm's cost of capital?

The interest rate parity theorem suggests that differences in observed nominal rates of interest in two countries should equal

The cost of capital is the rate that must be earned on an investment project if the project is to increase the value of the common shareholders' investment.

The cost of external equity capital is greater than the cost of retained earnings because of:

The best financial structure is determined by finding the debt and equity mix that maximizes the firm's cost of capital.

A firm's weighted average cost of capital is a function of (1)the individual costs of capital,(2)the capital structure mix,and (3)the level of financing necessary to make the investment.

Gibson Industries is issuing a $1,000 par value bond with an 8% annual interest coupon rate that matures in 11 years.Investors are willing to pay $972,and flotation costs will be 9%.Gibson is in the 34% tax bracket.What will be the after-tax cost of new debt for the bond?

A reasonable estimate of the market risk premium based on historical data and expert opinion is between 5% and 7%.

The market risk premium remains constant over time because the risk free rate of return moves inversely with beta.

The required return of a preferred stockholder,r_ps,is higher than the cost of preferred stock for the corporation because stockholder's must pay federal taxes on their dividend income.

Because investors like dividends,the higher the company's dividend growth rate,the lower the company's cost of common equity.

Which of the following causes a firm's cost of capital (WACC)to differ from an investor's required rate of return on the company's common stock?

An Introduction to the Foundations of Financial Management

The Financial Markets and Interest Rates

Understanding Financial Statements and Cash Flows

Evaluating a Firms Financial Performance

The Time Value of Money

The Meaning and Measurement of Risk and Return

The Valuation and Characteristics of Bonds

The Valuation and Characteristics of Stock

Capital-Budgeting Techniques and Practice

Cash Flows and Other Topics in Capital Budgeting

Determining the Financing Mix

Dividend Policy and Internal Financing

Short-Term Financial Planning

Working-Capital Management

Current Asset Management

International Business Finance

Filters

Exam 9: The Cost of Capital

The market value weights are preferred when calculating a firm's weighted average cost of capital.

The firm's cost of capital may also be referred to as the firm's opportunity cost of capital.

The Capital Asset Pricing Model may be used to estimate the cost of retained earnings.

Atlas Corporation wishes to estimate its cost of retained earnings.The firm's beta is 1.3.The rate on 6-month T-bills is 2%,and the return on the S&P 500 index is 15%.What is the appropriate cost for retained earnings in determining the firm's cost of capital?

The interest rate parity theorem suggests that differences in observed nominal rates of interest in two countries should equal

The cost of capital is the rate that must be earned on an investment project if the project is to increase the value of the common shareholders' investment.

The cost of external equity capital is greater than the cost of retained earnings because of:

The best financial structure is determined by finding the debt and equity mix that maximizes the firm's cost of capital.

A firm's weighted average cost of capital is a function of (1)the individual costs of capital,(2)the capital structure mix,and (3)the level of financing necessary to make the investment.

Gibson Industries is issuing a $1,000 par value bond with an 8% annual interest coupon rate that matures in 11 years.Investors are willing to pay $972,and flotation costs will be 9%.Gibson is in the 34% tax bracket.What will be the after-tax cost of new debt for the bond?

A reasonable estimate of the market risk premium based on historical data and expert opinion is between 5% and 7%.

The market risk premium remains constant over time because the risk free rate of return moves inversely with beta.

The required return of a preferred stockholder,rps,is higher than the cost of preferred stock for the corporation because stockholder's must pay federal taxes on their dividend income.

Because investors like dividends,the higher the company's dividend growth rate,the lower the company's cost of common equity.

Which of the following causes a firm's cost of capital (WACC)to differ from an investor's required rate of return on the company's common stock?

An Introduction to the Foundations of Financial Management

The Financial Markets and Interest Rates

Understanding Financial Statements and Cash Flows

Evaluating a Firms Financial Performance

The Time Value of Money

The Meaning and Measurement of Risk and Return

The Valuation and Characteristics of Bonds

The Valuation and Characteristics of Stock

Capital-Budgeting Techniques and Practice

Cash Flows and Other Topics in Capital Budgeting

Determining the Financing Mix

Dividend Policy and Internal Financing

Short-Term Financial Planning

Working-Capital Management

Current Asset Management

International Business Finance

Filters

The required return of a preferred stockholder,r_ps,is higher than the cost of preferred stock for the corporation because stockholder's must pay federal taxes on their dividend income.