Question 1

Among the two models Constant Dividend Growth Model (CDGM) and Capital Asset Pricing Model (CAPM), which is a better method for computation of the cost of equity?

Accepted Answer

The Capital Asset Pricing Model (CAPM) is more popular for estimating the cost of equity because of the difficulties in estimating the dividend growth rate required for the Constant Dividend Growth Model (CDGM).

Question 2

Assume preferred stock of Ford Motors pays a dividend of $3.00 each year and trades at a price of $20. What is the cost of preferred stock capital for Ford?

Accepted Answer

A)  12.0% 
B)  13.5% 
C)  15.0% 
D)  16.5% 
A)  12.0% 
B)  13.5% 
C)  15.0% 
D)  16.5% C

Question 3

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

Accepted Answer

A)  expensed 
B)  margined 
C)  refinanced 
D)  capitalized 
A)  expensed 
B)  margined 
C)  refinanced 
D)  capitalized A

Question 4

For an unlevered firm, the cost of capital can be determined by using the ________.

Accepted Answer

A)  yield on the traded debt 
B)  Capital Asset Pricing Model 
C)  dividend yield 
D)  preferred stock yield 
A)  yield on the traded debt 
B)  Capital Asset Pricing Model 
C)  dividend yield 
D)  preferred stock yield

Question 5

The outstanding debt of Berstin Corp. has eight years to maturity, a current yield of 7%, and a price of $85. What is the pretax cost of debt if the tax rate is 40%?

Accepted Answer

A)  5.1% 
B)  5.9% 
C)  8.5% 
D)  more information needed 
A)  5.1% 
B)  5.9% 
C)  8.5% 
D)  more information needed

Question 6

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 7

Should a firm with high retained earnings have a lower cost of equity?

Accepted Answer

Cost of equity is the return t

Question 8

A firm has a capital structure with $75 million in equity and $75 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 35%, compute the weighted average cost of capital of the firm.

Accepted Answer

A)  7.3% 
B)  7.6% 
C)  8.0% 
D)  8.4% 
A)  7.3% 
B)  7.6% 
C)  8.0% 
D)  8.4%

Question 9

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 10

Assume the market value of Fords' equity, preferred stock and debt are $6 billion, $3 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 $2.50 each year and trades at a price of $30 per share. Ford's debt trades with a yield to maturity of 9.5%. What is Ford's weighted average cost of capital if its tax rate is 35%?

Accepted Answer

A)  9.78% 
B)  10.24% 
C)  9.31% 
D)  11.18% 
A)  9.78% 
B)  10.24% 
C)  9.31% 
D)  11.18%

Question 11

A firm is considering investing in a new project with an upfront cost of $400 million. The project will generate an incremental free cash flow of $50 million in the first year and this cash flow is expected to grow at an annual rate of 3% forever. If the firm's WACC is 12%, what is the value of this project?

Accepted Answer

A)  $155.6 million 
B)  $555.6 million 
C)  $583.3 million 
D)  $183.3 million 
A)  $155.6 million 
B)  $555.6 million 
C)  $583.3 million 
D)  $183.3 million

Question 12

Different divisions with differing lines of business use different costs of capital because their cost of ________ could be different.

Accepted Answer

A)  debt 
B)  equity 
C)  capital 
D)  assets 
A)  debt 
B)  equity 
C)  capital 
D)  assets

Question 13

SAP Inc. received a $1.5 million grant under its Small Business Innovation program. SAP invested the grant money and developed a system to remove metal contaminants from storm water in shipyards. The firm estimates that each shipyard spends $500,000 a year on storm water clean-up efforts. If SAP is able to sign up and retain four shipyards in the first year onwards, what is the present value (PV) of the project (net of investment) if the cost of capital for SAP is 14% per year? Assume a cost of operations and other costs for SAP equal 50% of revenue.

Accepted Answer

A)  $4.51 million 
B)  $4.80 million 
C)  $5.93 million 
D)  $5.64 million 
A)  $4.51 million 
B)  $4.80 million 
C)  $5.93 million 
D)  $5.64 million

Question 14

Firms that have many divisions with different lines of business do not use a companywide WACC to evaluate projects.

Accepted Answer

A) True 
 B)False

Question 15

One should use accounting-based book values rather than market values of debt and equity to determine the weights for the different sources of capital.

Accepted Answer

A) True 
 B)False

Question 16

Your estimate of the market risk premium is 9%. The risk-free rate of return is 4.1% and General Motors has a beta of 1.8. What is General Motors' cost of equity capital?

Accepted Answer

A)  20.3% 
B)  18.3% 
C)  19.3% 
D)  21.3% 
A)  20.3% 
B)  18.3% 
C)  19.3% 
D)  21.3%

Question 17

Internal financing is more costly than external financing because of issuance costs.

Accepted Answer

A) True 
 B)False

Question 18

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

Question 19

Anheuser Busch, a manufacturer of beverages, is planning to purchase Six Flags theme parks. Anheuser Busch should use the ________ to evaluate the business of Six Flags.

Accepted Answer

A)  WACC of Anheuser Busch 
B)  WACC of Six Flags 
C)  average market return 
D)  divisional cost of capital 
A)  WACC of Anheuser Busch 
B)  WACC of Six Flags 
C)  average market return 
D)  divisional cost of capital

Question 20

Is it incorrect to use the coupon rate of debt toward cost of debt?

Accepted Answer

Yes, it is inaccurate to use t

Exam 13: The Cost of Capital

Among the two models Constant Dividend Growth Model (CDGM) and Capital Asset Pricing Model (CAPM), which is a better method for computation of the cost of equity?

Assume preferred stock of Ford Motors pays a dividend of $3.00 each year and trades at a price of $20. What is the cost of preferred stock capital for Ford?

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

For an unlevered firm, the cost of capital can be determined by using the ________.

The outstanding debt of Berstin Corp. has eight years to maturity, a current yield of 7%, and a price of $85. What is the pretax cost of debt if the tax rate is 40%?

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?

Should a firm with high retained earnings have a lower cost of equity?

A firm has a capital structure with $75 million in equity and $75 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 35%, compute the weighted average cost of capital of the firm.

Different divisions with differing lines of business use different costs of capital because their cost of ________ could be different.

Firms that have many divisions with different lines of business do not use a companywide WACC to evaluate projects.

One should use accounting-based book values rather than market values of debt and equity to determine the weights for the different sources of capital.

Your estimate of the market risk premium is 9%. The risk-free rate of return is 4.1% and General Motors has a beta of 1.8. What is General Motors' cost of equity capital?

Internal financing is more costly than external financing because of issuance costs.

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%.

Anheuser Busch, a manufacturer of beverages, is planning to purchase Six Flags theme parks. Anheuser Busch should use the ________ to evaluate the business of Six Flags.

Is it incorrect to use the coupon rate of debt toward cost of debt?

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

Filters