Question 1

Your estimate of the market risk premium is 7%. The risk-free rate of return is 4% and General Motors has a beta of 1.6. What is General Motors' cost of equity capital?

Accepted Answer

A) 15.2% 
B) 14.4% 
C) 16.0% 
D) 13.7% 
A) 15.2% 
B) 14.4% 
C) 16.0% 
D) 13.7% A

Question 2

The relative proportion of debt, equity, and other securities that a firm has outstanding constitute its ________.

Accepted Answer

A) asset ratio 
B) current ratio 
C) capital structure 
D) retained earnings 
A) asset ratio 
B) current ratio 
C) capital structure 
D) retained earnings C

Question 3

The outstanding debt of Berstin Corp. has five years to maturity, a current yield of 6%, and a price of $95. What is the pretax cost of debt if the tax rate is 30%.

Accepted Answer

A) 4.2% 
B) 4.8% 
C) 6.9% 
D) more information needed 
A) 4.2% 
B) 4.8% 
C) 6.9% 
D) more information needed C

Question 4

Assume the market value of Fords' equity, preferred stock and debt are $7 billion, $4 billion and $10 billion respectively. Ford has a beta of 1.4, the market risk premium is 6% and the risk-free rate of interest is 4%. Ford's preferred stock pays a dividend of $3 each year and trades at a price of $25 per share. Ford's debt trades with a yield to maturity of 8.5%. What is Ford's weighted average cost of capital if its tax rate is 35%?

Accepted Answer

A) 7.69% 
B) 8.15% 
C) 8.60% 
D) 9.05% 
A) 7.69% 
B) 8.15% 
C) 8.60% 
D) 9.05%

Question 5

Assume Ford Motors expects a new hybrid-engine project to produce incremental cash flows of $50 million each year, and expects these to grow at 4% each year. The upfront project costs are $420 million and Ford's weighted average cost of capital is 9%. If the issuance costs for external finances are $20 million, what is the net present value (NPV)of the project?

Accepted Answer

A) $504 million 
B) $560 million 
C) $588 million 
D) $616 million 
A) $504 million 
B) $560 million 
C) $588 million 
D) $616 million

Question 6

As a firm increases its level of debt relative to its level of equity, the firm is ________.

Accepted Answer

A) increasing the fraction of its equity 
B) decreasing the fraction of its debt 
C) decreasing its leverage 
D) increasing its leverage 
A) increasing the fraction of its equity 
B) decreasing the fraction of its debt 
C) decreasing its leverage 
D) increasing its leverage

Question 7

The after-tax cost of debt ________ the before-tax cost of debt for a firm that has a positive marginal tax rate.

Accepted Answer

A) is always greater than 
B) is always equal to 
C) is always less than 
D) may be greater than or less than 
A) is always greater than 
B) is always equal to 
C) is always less than 
D) may be greater than or less than

Question 8

An all-equity firm had a dividend expense of $45,000 last year. The market value of the firm is $800,000 and the dividend is expected to increase at 7% each year. What is the cost of equity for this firm?

Accepted Answer

A) 11.72% 
B) 12.37% 
C) 13.02% 
D) 14.32% 
A) 11.72% 
B) 12.37% 
C) 13.02% 
D) 14.32%

Question 9

A firm's overall cost of capital that is a blend of the costs of the different sources of capital is known as the firm's ________.

Accepted Answer

A) weighted average cost of capital 
B) cost of equity infusion 
C) cost of debt 
D) cost of preferred stock 
A) weighted average cost of capital 
B) cost of equity infusion 
C) cost of debt 
D) cost of preferred stock

Question 10

To attract capital from outside investors, a firm must offer potential investors an expected return that is commensurate with the level of risk that they can bear.

Accepted Answer

A) True 
 B)False

Question 11

Which of the following statements is FALSE?

Accepted Answer

A) Issuance costs increase the WACC. 
B) External equity is less expensive than retained earnings. 
C) A project that can be financed with internal funds will be less costly than the same project if it were financed with external funds. 
D) Issuance costs should be treated as cash outflows in NPV analysis. 
A) Issuance costs increase the WACC. 
B) External equity is less expensive than retained earnings. 
C) A project that can be financed with internal funds will be less costly than the same project if it were financed with external funds. 
D) Issuance costs should be treated as cash outflows in NPV analysis.

Question 12

A firm has a capital structure with $75 million in equity and $45 million of debt. The cost of equity capital is 10% and the pretax cost of debt is 7%. If the marginal tax rate of the firm is 40%, compute the weighted average cost of capital of the firm.

Accepted Answer

A) 6.7% 
B) 7.0% 
C) 7.8% 
D) 8.6% 
A) 6.7% 
B) 7.0% 
C) 7.8% 
D) 8.6%

Question 13

Assume IBM just paid a dividend of $4.50 and expects these dividends to grow at 8% a year. The price of IBM is $100 per share. What is IBM's cost of equity capital?

Accepted Answer

A) 3.86% 
B) 8% 
C) 12.22% 
D) 12.86% 
A) 3.86% 
B) 8% 
C) 12.22% 
D) 12.86%

Question 14

Assume Time Warner shares have a market capitalization of $40 billion. The company is expected to pay a dividend of $0.25 per share and each share trades for $40. The growth rate in dividends is expected to be 7% per year. Also, Time Warner has $20 billion of debt that trades with a yield to maturity of 9%. If the firm's tax rate is 40%, what is the WACC?

Accepted Answer

A) 5.85% 
B) 6.54% 
C) 6.88% 
D) 7.57% 
A) 5.85% 
B) 6.54% 
C) 6.88% 
D) 7.57%

Question 15

Epiphany is an all-equity firm with an estimated market value of $400,000. The firm sells $225,000 of debt and uses the proceeds to purchase outstanding equity. Compute the weight in equity and the weight in debt after the proposed financing and repurchase of equity.

Accepted Answer

A) 0.28, 0.72 
B) 0.44, 0.56 
C) 0.39, 0.61 
D) 0.56, 0.44 
A) 0.28, 0.72 
B) 0.44, 0.56 
C) 0.39, 0.61 
D) 0.56, 0.44

Question 16

When calculating the WACC, it is a standard practice to subtract ________ to compute the net debt outstanding.

Accepted Answer

A) equity 
B) dividends 
C) cash and risk-free securities 
D) coupons 
A) equity 
B) dividends 
C) cash and risk-free securities 
D) coupons

Question 17

What type of adjustment to debt is in practice?

Accepted Answer

Most practitioners use net deb

Question 18

Outstanding debt of Home Depot trades with a yield to maturity of 7%. The tax rate of Home Depot is 35%. What is the effective cost of debt of Home Depot?

Accepted Answer

A) 4.55% 
B) 5.01% 
C) 5.46% 
D) 5.69% 
A) 4.55% 
B) 5.01% 
C) 5.46% 
D) 5.69%

Question 19

A firm's sources of financing, which usually consists of debt and equity, represent its ________.

Accepted Answer

A) total assets 
B) capital 
C) total liabilities 
D) current liabilities 
A) total assets 
B) capital 
C) total liabilities 
D) current liabilities

Question 20

Divisional costs of capital are more appropriate when evaluating a project for a line of business when the types of business in a firm are ________.

Accepted Answer

A) mature businesses 
B) similar 
C) new businesses 
D) different 
A) mature businesses 
B) similar 
C) new businesses 
D) different

Exam 13: The Cost of Capital

Your estimate of the market risk premium is 7%. The risk-free rate of return is 4% and General Motors has a beta of 1.6. What is General Motors' cost of equity capital?

The relative proportion of debt, equity, and other securities that a firm has outstanding constitute its ________.

The outstanding debt of Berstin Corp. has five years to maturity, a current yield of 6%, and a price of $95. What is the pretax cost of debt if the tax rate is 30%.

As a firm increases its level of debt relative to its level of equity, the firm is ________.

The after-tax cost of debt ________ the before-tax cost of debt for a firm that has a positive marginal tax rate.

An all-equity firm had a dividend expense of $45,000 last year. The market value of the firm is $800,000 and the dividend is expected to increase at 7% each year. What is the cost of equity for this firm?

A firm's overall cost of capital that is a blend of the costs of the different sources of capital is known as the firm's ________.

To attract capital from outside investors, a firm must offer potential investors an expected return that is commensurate with the level of risk that they can bear.

Which of the following statements is FALSE?

A firm has a capital structure with $75 million in equity and $45 million of debt. The cost of equity capital is 10% and the pretax cost of debt is 7%. If the marginal tax rate of the firm is 40%, compute the weighted average cost of capital of the firm.

Assume IBM just paid a dividend of $4.50 and expects these dividends to grow at 8% a year. The price of IBM is $100 per share. What is IBM's cost of equity capital?

Epiphany is an all-equity firm with an estimated market value of $400,000. The firm sells $225,000 of debt and uses the proceeds to purchase outstanding equity. Compute the weight in equity and the weight in debt after the proposed financing and repurchase of equity.

When calculating the WACC, it is a standard practice to subtract ________ to compute the net debt outstanding.

What type of adjustment to debt is in practice?

Outstanding debt of Home Depot trades with a yield to maturity of 7%. The tax rate of Home Depot is 35%. What is the effective cost of debt of Home Depot?

A firm's sources of financing, which usually consists of debt and equity, represent its ________.

Divisional costs of capital are more appropriate when evaluating a project for a line of business when the types of business in a firm are ________.

Corporate Finance and the Financial Manager

Introduction to Financial Statement Analysis

Time Value of Money: an Introduction

Time Value of Money: Valuing Cash Flow Streams

Interest Rates

Bonds

Stock Valuation

Investment Decision Rules

Fundamentals of Capital Budgeting

Stock Valuation: a Second Look

Risk and Return in Capital Markets

Systematic Risk and the Equity Risk Premium

Raising Equity Capital

Debt Financing

Capital Structure

Payout Policy

Financial Modeling and Pro Forma Analysis

Working Capital Management

Short-Term Financial Planning

Option Applications and Corporate Finance

Mergers and Acquisitions

International Corporate Finance

Leasing

Insurance and Risk Management

Corporate Governance

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