Question 1

Which of the following statements is CORRECT?

Accepted Answer

A)  WACC calculations should be based on the before-tax costs of all the individual capital components. 
B)  Flotation costs associated with issuing new common stock normally reduce the WACC. 
C)  If a company's tax rate increases,then,all else equal,its weighted average cost of capital will decline. 
D)  An increase in the risk-free rate will normally lower the marginal costs of both debt and equity financing. 
E)  A change in a company's target capital structure cannot affect its WACC. 
A)  WACC calculations should be based on the before-tax costs of all the individual capital components. 
B)  Flotation costs associated with issuing new common stock normally reduce the WACC. 
C)  If a company's tax rate increases,then,all else equal,its weighted average cost of capital will decline. 
D)  An increase in the risk-free rate will normally lower the marginal costs of both debt and equity financing. 
E)  A change in a company's target capital structure cannot affect its WACC.

Question 2

Which of the following statements is CORRECT?

Accepted Answer

A)  The WACC is calculated using a before-tax cost for debt that is equal to the interest rate that must be paid on new debt,along with the after-tax costs for common stock and for preferred stock if it is used. 
B)  An increase in the risk-free rate is likely to reduce the marginal costs of both debt and equity. 
C)  The relevant WACC can change depending on the amount of funds a firm raises during a given year.Moreover,the WACC at each level of funds raised is a weighted average of the marginal costs of each capital component,with the weights based on the firm's target capital structure. 
D)  Beta measures market risk,which is generally the most relevant risk measure for a publicly-owned firm that seeks to maximize its intrinsic value.However,this is not true unless all of the firm's stockholders are well diversified. 
E)  The bond-yield-plus-risk-premium approach to estimating the cost of common equity involves adding a risk premium to the interest rate on the company's own long-term bonds.The size of the risk premium for bonds with different ratings is published daily in The Wall Street Journal. 
A)  The WACC is calculated using a before-tax cost for debt that is equal to the interest rate that must be paid on new debt,along with the after-tax costs for common stock and for preferred stock if it is used. 
B)  An increase in the risk-free rate is likely to reduce the marginal costs of both debt and equity. 
C)  The relevant WACC can change depending on the amount of funds a firm raises during a given year.Moreover,the WACC at each level of funds raised is a weighted average of the marginal costs of each capital component,with the weights based on the firm's target capital structure. 
D)  Beta measures market risk,which is generally the most relevant risk measure for a publicly-owned firm that seeks to maximize its intrinsic value.However,this is not true unless all of the firm's stockholders are well diversified. 
E)  The bond-yield-plus-risk-premium approach to estimating the cost of common equity involves adding a risk premium to the interest rate on the company's own long-term bonds.The size of the risk premium for bonds with different ratings is published daily in The Wall Street Journal.

Question 3

Refer to the data for the Collins Group.Which of the following is the best estimate for the weight of debt for use in calculating the firm's WACC?

Accepted Answer

A)  18.67% 
B)  19.60% 
C)  20.58% 
D)  21.61% 
E)  22.69% 
A)  18.67% 
B)  19.60% 
C)  20.58% 
D)  21.61% 
E)  22.69%

Question 4

Taylor Inc.estimates 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 5

When estimating the cost of equity by use of the bond-yield-plus-risk-premium method,we can generally get a good idea of the interest rate on new long-term debt,but we cannot be sure that the risk premium we add is appropriate.This problem leaves us unsure of the true value of rs.

Accepted Answer

A) True 
 B)False

Question 6

Bloom and Co.has 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 7

The before-tax cost of debt,which is lower than the after-tax cost,is used as the component cost of debt for purposes of developing the firm's WACC.

Accepted Answer

A) True 
 B)False

Question 8

When 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 9

You have been hired by the CFO of Lugones Industries to help estimate its cost of common equity.You have obtained the following data: (1)rd = yield on the firm's bonds = 7.00% and the risk premium over its own debt cost = 4.00%.(2)rRF = 5.00%,RPM = 6.00%,and b = 1.25.(3)D1 = $1.20,P0 = $35.00,and gL = 8.00% (constant).You were asked to estimate the cost of common based on the three most commonly used methods and then to indicate the difference between the highest and lowest of these estimates.What is that difference?

Accepted Answer

A)  1.13% 
B)  1.50% 
C)  1.88% 
D)  2.34% 
E)  2.58% 
A)  1.13% 
B)  1.50% 
C)  1.88% 
D)  2.34% 
E)  2.58%

Question 10

You are a finance intern at Chambers and Sons and they have asked you to help estimate the company's cost of common equity.You obtained the following data: D1 = $1.25;P0 = $27.50;gL = 5.00% (constant);and F = 6.00%.What is the cost of equity raised by selling new common stock?

Accepted Answer

A)  9.06% 
B)  9.44% 
C)  9.84% 
D)  10.23% 
E)  10.64% 
A)  9.06% 
B)  9.44% 
C)  9.84% 
D)  10.23% 
E)  10.64%

Question 11

Suppose you are the president of a small,publicly-traded corporation.Since you believe that your firm's stock price is temporarily depressed,all additional capital funds required during the current year will be raised using debt.In this case,the appropriate marginal cost of capital for use in capital budgeting during the current year is the after-tax cost of debt.

Accepted Answer

A) True 
 B)False

Which of the following statements is CORRECT?

Which of the following statements is CORRECT?

Refer to the data for the Collins Group.Which of the following is the best estimate for the weight of debt for use in calculating the firm's WACC?

Taylor Inc.estimates 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?

When estimating the cost of equity by use of the bond-yield-plus-risk-premium method,we can generally get a good idea of the interest rate on new long-term debt,but we cannot be sure that the risk premium we add is appropriate.This problem leaves us unsure of the true value of r_s.

The before-tax cost of debt,which is lower than the after-tax cost,is used as the component cost of debt for purposes of developing the firm's WACC.

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

You are a finance intern at Chambers and Sons and they have asked you to help estimate the company's cost of common equity.You obtained the following data: D₁ = $1.25;P₀ = $27.50;g_L = 5.00% (constant);and F = 6.00%.What is the cost of equity raised by selling new common stock?

An Overview of Financial Management and the Financial Environment

Financial Statements, Cash Flow, and Taxes

Analysis of Financial Statements

Time Value of Money

Bonds, Bond Valuation, and Interest Rates

Risk and Return

Corporate Valuation and Stock Valuation

Financial Options and Applications in Corporate Finance

The Basics of Capital Budgeting: Evaluating Cash Flows

Cash Flow Estimation and Risk Analysis

Financial Planning and Applications to Corporate Valuation

Corporate Governance

Distributions to Shareholders: Dividends and Repurchases

Capital Structure Decisions

Supply Chains and Working Capital Management

Multinational Financial Management

Public and Private Financing: Initial Offerings, Seasoned Offerings, and Investment Banks

Lease Financing

Hybrid Financing: Preferred Stock, Warrants, and Convertibles

Dynamic Capital Structures and Corporate Valuation

Mergers and Corporate Control

Enterprise Risk Management

Bankruptcy, Reorganization, and Liquidation

Portfolio Theory and Asset Pricing Models

Real Options

Providing and Obtaining Credit

Advanced Issues in Cash Management and Inventory Control

Pension Plan Management

Financial Management in Not-For-Profit Businesses

Filters

Exam 9: The Cost of Capital

Which of the following statements is CORRECT?

Which of the following statements is CORRECT?

Refer to the data for the Collins Group.Which of the following is the best estimate for the weight of debt for use in calculating the firm's WACC?

Taylor Inc.estimates 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?

When estimating the cost of equity by use of the bond-yield-plus-risk-premium method,we can generally get a good idea of the interest rate on new long-term debt,but we cannot be sure that the risk premium we add is appropriate.This problem leaves us unsure of the true value of rs.

The before-tax cost of debt,which is lower than the after-tax cost,is used as the component cost of debt for purposes of developing the firm's WACC.

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

You are a finance intern at Chambers and Sons and they have asked you to help estimate the company's cost of common equity.You obtained the following data: D1 = $1.25;P0 = $27.50;gL = 5.00% (constant);and F = 6.00%.What is the cost of equity raised by selling new common stock?

An Overview of Financial Management and the Financial Environment

Financial Statements, Cash Flow, and Taxes

Analysis of Financial Statements

Time Value of Money

Bonds, Bond Valuation, and Interest Rates

Risk and Return

Corporate Valuation and Stock Valuation

Financial Options and Applications in Corporate Finance

The Basics of Capital Budgeting: Evaluating Cash Flows

Cash Flow Estimation and Risk Analysis

Financial Planning and Applications to Corporate Valuation

Corporate Governance

Distributions to Shareholders: Dividends and Repurchases

Capital Structure Decisions

Supply Chains and Working Capital Management

Multinational Financial Management

Public and Private Financing: Initial Offerings, Seasoned Offerings, and Investment Banks

Lease Financing

Hybrid Financing: Preferred Stock, Warrants, and Convertibles

Dynamic Capital Structures and Corporate Valuation

Mergers and Corporate Control

Enterprise Risk Management

Bankruptcy, Reorganization, and Liquidation

Portfolio Theory and Asset Pricing Models

Real Options

Providing and Obtaining Credit

Advanced Issues in Cash Management and Inventory Control

Pension Plan Management

Financial Management in Not-For-Profit Businesses

Filters

When estimating the cost of equity by use of the bond-yield-plus-risk-premium method,we can generally get a good idea of the interest rate on new long-term debt,but we cannot be sure that the risk premium we add is appropriate.This problem leaves us unsure of the true value of r_s.

You are a finance intern at Chambers and Sons and they have asked you to help estimate the company's cost of common equity.You obtained the following data: D₁ = $1.25;P₀ = $27.50;g_L = 5.00% (constant);and F = 6.00%.What is the cost of equity raised by selling new common stock?