Exam 13: The Cost of Capital

Why do we use leverage if it increases the risk of a firm?

When we compute the cost of equity capital for a project we assume that the ________ of the project is equivalent to the average market risk of the firm's investments.

Why do we use market values rather than book values in calculation of WACC?

A firm has a pre-tax cost of debt of 9.0%. If the firm has a marginal tax rate of 35%, what is its effective cost of debt?

The fact that the after-tax cost of debt is lower than the pretax cost of debt implicitly assumes that interest expense can be ________.

Assume preferred stock of Ford Motors pays a dividend of $3.50 each year and trades at a price of $30. What is the cost of preferred stock capital for Ford?

The fact that the interest paid on debt is a tax-deductible expense increases the cost of debt financing.

SIROM Scientific Solutions has $5 million of outstanding equity and $5 million of bank debt. The bank debt costs 4% per year. The estimated equity beta is 2. If the market risk premium is 8% and the risk-free rate is 4%, compute the weighted average cost of capital if the firm's tax rate is 35%.

Assume the market value of Fords' equity, preferred stock, and debt are$6 billion, $2 billion, and $13 billion, respectively. Ford has a beta of 1.7, the market risk premium is 8%, and the risk-free rate of interest is 3%. Ford's preferred stock pays a dividend of $4 each year and trades at a price of $30 per share. Ford's debt trades with a yield to maturity of 8.0%. What is Ford's weighted average cost of capital if its tax rate is 30%?

When we use the WACC to assess a project, we assume that the ________ ratio does not change.