Question 1

Which of the following statements regarding calculating a firm's cost of capital is correct?

Accepted Answer

A) The after-tax cost of debt is generally more expensive than the after-tax cost of preferred stock. 
B) Since retained earnings are readily available,the cost of retained earnings is generally lower than the cost of debt. 
C) If a company's beta increases,this will increase the cost of capital. 
D) The level of general economic conditions will determine whether a firm should utilize an arithmetic average cost of capital or a weighted average cost of capital. 
A) The after-tax cost of debt is generally more expensive than the after-tax cost of preferred stock. 
B) Since retained earnings are readily available,the cost of retained earnings is generally lower than the cost of debt. 
C) If a company's beta increases,this will increase the cost of capital. 
D) The level of general economic conditions will determine whether a firm should utilize an arithmetic average cost of capital or a weighted average cost of capital.

Question 2

Lott Bros Developers evaluates a great many small to medium size projects each year.Some are riskier than others.Lott Bros should probably:

Accepted Answer

A) allow individual project managers to estimate their own discount rates. 
B) try to identify the specific funding sources for each project. 
C) use the company's overall WACC for all projects. 
D) spend a great deal of time and money to estimate discount rates for each project. 
A) allow individual project managers to estimate their own discount rates. 
B) try to identify the specific funding sources for each project. 
C) use the company's overall WACC for all projects. 
D) spend a great deal of time and money to estimate discount rates for each project.

Question 3

Busing Manufacturing has a new bond issue that will net the firm $1,069,000.The bonds have a $1,000,000 par value,pay interest annually at a 12% coupon rate,and mature in 10 years.The firm has a marginal tax rate of 34%.The after-tax cost of the debt issue is:

Accepted Answer

A) 7.15%. 
B) 3.68%. 
C) 7.92%. 
D) 6.58%. 
A) 7.15%. 
B) 3.68%. 
C) 7.92%. 
D) 6.58%.

Question 4

The cost of debt is equal to one minus the marginal tax rate times the coupon rate of interest on the firm's outstanding debt.

Accepted Answer

A) True 
 B)False

Question 5

No adjustment is made in the cost of preferred stock for taxes since preferred stock dividends are not tax-deductible.

Accepted Answer

A) True 
 B)False

Question 6

In theory using the same discount rate to evaluate all projects can lead to:

Accepted Answer

A) rejection of low risk projects that should be accepted. 
B) acceptance of high risk projects that should be rejected. 
C) control of efforts by employees with a vested interested in a project to manipulate the discount rate. 
D) all of the above. 
A) rejection of low risk projects that should be accepted. 
B) acceptance of high risk projects that should be rejected. 
C) control of efforts by employees with a vested interested in a project to manipulate the discount rate. 
D) all of the above.

Question 7

XYZ Corporation is trying to determine the appropriate cost of preferred stock to use in determining the firm's cost of capital.This firm's preferred stock is currently selling for $29.89 and pays a perpetual annual dividend of $2.60 per share.Compute the cost of preferred stock for XYZ.

Accepted Answer

A) 7.2% 
B) 6.2% 
C) 8.7% 
D) 16.7% 
A) 7.2% 
B) 6.2% 
C) 8.7% 
D) 16.7%

Question 8

Using a firm's overall cost of capital to evaluate divisional projects can lead to the rejection of good investments in low-risk divisions and the acceptance of poor projects in high-risk divisions.

Accepted Answer

A) True 
 B)False

Question 9

The investor's required rate of return differs from the firm's cost of capital due to the:

Accepted Answer

A) firm's beta. 
B) tax deductibility of interest. 
C) CAPM. 
D) time value of money. 
A) firm's beta. 
B) tax deductibility of interest. 
C) CAPM. 
D) time value of money.

Question 10

Hoak Company's common stock is currently selling for $50.Last year's dividend was $1.83 per share.Investors expect dividends to grow at an annual rate of 9% into the future.
a.What is Hoak's cost of common equity?
b.Selling new common stock is expected to decrease the price of the stock by $5.00.What is the cost of new common stock? Dividends will remain the same.

Accepted Answer

a.K_r = [$1.83(1.09)/$

Question 11

All capital projects incur flotation costs,no matter how they are financed.

Accepted Answer

A) True 
 B)False

Question 12

Business risk reflects the added variability in earnings available to a firm's shareholders.

Accepted Answer

A) True 
 B)False

Question 13

If the before-tax cost of debt is 9% and the firm has a 34% marginal tax rate,the after-tax cost of debt is 5.94%.

Accepted Answer

A) True 
 B)False

Question 14

The cost of common equity is usually higher than the firm's WACC.

Accepted Answer

A) True 
 B)False

Question 15

The cost of common equity using the dividend-growth model is:

Accepted Answer

A) 11.00%. 
B) 11.32%. 
C) 11.50%. 
D) 11.72%. 
A) 11.00%. 
B) 11.32%. 
C) 11.50%. 
D) 11.72%.

Question 16

Tropical Fruit Drinks issued $10,000,000 in bonds to expand its production facilities.After issuing the bonds,the company was 60% debt financed and 40% common equity financed.Tropical intends to retire 20% of the bonds each year for the next 5 years and not to issue any new debt.

Accepted Answer

A) All things equal,we would expect Tropical Fruit Drinks cost of capital to decrease gradually over the next 5 years. 
B) All things equal,we would expect Tropical Fruit Drinks cost of capital to increase gradually over the next 5 years. 
C) All things equal,we would expect Tropical Fruit Drinks cost of capital to stay the same for the next 5 years,then decrease rapidly. 
D) All things equal,we would expect Tropical Fruit Drinks cost of capital to stay the same for the next five years,then increase rapidly. 
A) All things equal,we would expect Tropical Fruit Drinks cost of capital to decrease gradually over the next 5 years. 
B) All things equal,we would expect Tropical Fruit Drinks cost of capital to increase gradually over the next 5 years. 
C) All things equal,we would expect Tropical Fruit Drinks cost of capital to stay the same for the next 5 years,then decrease rapidly. 
D) All things equal,we would expect Tropical Fruit Drinks cost of capital to stay the same for the next five years,then increase rapidly.

Question 17

How frequently do most firms update their cost of capital?

Accepted Answer

A) Rarely,if ever 
B) At least once a year 
C) Daily 
D) Only when there are major changes in the firm's capital structure. 
A) Rarely,if ever 
B) At least once a year 
C) Daily 
D) Only when there are major changes in the firm's capital structure.

Question 18

The last paid dividend is $2 for a share of common stock that is currently selling for $20.What is the cost of common equity if the long-term growth rate in dividends for the firm is expected to be 8%?

Accepted Answer

A) 10.8% 
B) 12.8% 
C) 14.8% 
D) 16.8% 
E) 18.8% 
A) 10.8% 
B) 12.8% 
C) 14.8% 
D) 16.8% 
E) 18.8%

Question 19

The opportunity cost of securities issued by a firm is determined by:

Accepted Answer

A) the rate of return investors could earn on riskless securities. 
B) the rate of return on the firm's next best investment opportunity. 
C) the rate of return investors could obtain on similar securities. 
D) the weighted average rate of return on all securities issued by the firm. 
A) the rate of return investors could earn on riskless securities. 
B) the rate of return on the firm's next best investment opportunity. 
C) the rate of return investors could obtain on similar securities. 
D) the weighted average rate of return on all securities issued by the firm.

Question 20

Hill Town Motels has $5 million of debt outstanding with a coupon rate of 12%.Currently,the yield to maturity on these bonds is 14%.If the firm's tax rate is 40%,what is the after-tax cost of debt to Hill Town Motels?

Accepted Answer

A) 5.43% 
B) 11.2% 
C) 8.4% 
D) 5.6% 
A) 5.43% 
B) 11.2% 
C) 8.4% 
D) 5.6%

Which of the following statements regarding calculating a firm's cost of capital is correct?

Lott Bros Developers evaluates a great many small to medium size projects each year.Some are riskier than others.Lott Bros should probably:

Busing Manufacturing has a new bond issue that will net the firm $1,069,000.The bonds have a $1,000,000 par value,pay interest annually at a 12% coupon rate,and mature in 10 years.The firm has a marginal tax rate of 34%.The after-tax cost of the debt issue is:

The cost of debt is equal to one minus the marginal tax rate times the coupon rate of interest on the firm's outstanding debt.

No adjustment is made in the cost of preferred stock for taxes since preferred stock dividends are not tax-deductible.

In theory using the same discount rate to evaluate all projects can lead to:

XYZ Corporation is trying to determine the appropriate cost of preferred stock to use in determining the firm's cost of capital.This firm's preferred stock is currently selling for $29.89 and pays a perpetual annual dividend of $2.60 per share.Compute the cost of preferred stock for XYZ.

Using a firm's overall cost of capital to evaluate divisional projects can lead to the rejection of good investments in low-risk divisions and the acceptance of poor projects in high-risk divisions.

The investor's required rate of return differs from the firm's cost of capital due to the:

All capital projects incur flotation costs,no matter how they are financed.

Business risk reflects the added variability in earnings available to a firm's shareholders.

If the before-tax cost of debt is 9% and the firm has a 34% marginal tax rate,the after-tax cost of debt is 5.94%.

The cost of common equity is usually higher than the firm's WACC.

The cost of common equity using the dividend-growth model is:

Tropical Fruit Drinks issued $10,000,000 in bonds to expand its production facilities.After issuing the bonds,the company was 60% debt financed and 40% common equity financed.Tropical intends to retire 20% of the bonds each year for the next 5 years and not to issue any new debt.

How frequently do most firms update their cost of capital?

The last paid dividend is $2 for a share of common stock that is currently selling for $20.What is the cost of common equity if the long-term growth rate in dividends for the firm is expected to be 8%?

The opportunity cost of securities issued by a firm is determined by:

Hill Town Motels has $5 million of debt outstanding with a coupon rate of 12%.Currently,the yield to maturity on these bonds is 14%.If the firm's tax rate is 40%,what is the after-tax cost of debt to Hill Town Motels?

Getting Started-Principles of Finance

Firms and the Financial Market

Understanding Financial Statements, taxes, and Cash Flows

Financial Analysis-Sizing up Firm Performance

Time Value of Money-The Basics

The Time Value of Money-Annuities and Other Topics

An Introduction to Risk and Return-History of Financial Market Returns

Risk and Return-Capital Market Theory

Debt Valuation and Interest Rates

Stock Valuation

Investment Decision Criteria

Analyzing Project Cash Flows

Risk Analysis and Project Evaluation

Capital Structure Policy

Dividend Policy

Financial Forecasting and Planning

Working Capital Management

International Business Finance

Corporate Risk Management

Filters

Exam 14: The Cost of Capital

Which of the following statements regarding calculating a firm's cost of capital is correct?

Lott Bros Developers evaluates a great many small to medium size projects each year.Some are riskier than others.Lott Bros should probably:

Busing Manufacturing has a new bond issue that will net the firm $1,069,000.The bonds have a $1,000,000 par value,pay interest annually at a 12% coupon rate,and mature in 10 years.The firm has a marginal tax rate of 34%.The after-tax cost of the debt issue is:

The cost of debt is equal to one minus the marginal tax rate times the coupon rate of interest on the firm's outstanding debt.

No adjustment is made in the cost of preferred stock for taxes since preferred stock dividends are not tax-deductible.

In theory using the same discount rate to evaluate all projects can lead to:

XYZ Corporation is trying to determine the appropriate cost of preferred stock to use in determining the firm's cost of capital.This firm's preferred stock is currently selling for $29.89 and pays a perpetual annual dividend of $2.60 per share.Compute the cost of preferred stock for XYZ.

Using a firm's overall cost of capital to evaluate divisional projects can lead to the rejection of good investments in low-risk divisions and the acceptance of poor projects in high-risk divisions.

The investor's required rate of return differs from the firm's cost of capital due to the:

All capital projects incur flotation costs,no matter how they are financed.

Business risk reflects the added variability in earnings available to a firm's shareholders.

If the before-tax cost of debt is 9% and the firm has a 34% marginal tax rate,the after-tax cost of debt is 5.94%.

The cost of common equity is usually higher than the firm's WACC.

The cost of common equity using the dividend-growth model is:

Tropical Fruit Drinks issued $10,000,000 in bonds to expand its production facilities.After issuing the bonds,the company was 60% debt financed and 40% common equity financed.Tropical intends to retire 20% of the bonds each year for the next 5 years and not to issue any new debt.

How frequently do most firms update their cost of capital?

The last paid dividend is $2 for a share of common stock that is currently selling for $20.What is the cost of common equity if the long-term growth rate in dividends for the firm is expected to be 8%?

The opportunity cost of securities issued by a firm is determined by:

Hill Town Motels has $5 million of debt outstanding with a coupon rate of 12%.Currently,the yield to maturity on these bonds is 14%.If the firm's tax rate is 40%,what is the after-tax cost of debt to Hill Town Motels?

Getting Started-Principles of Finance

Firms and the Financial Market

Understanding Financial Statements, taxes, and Cash Flows

Financial Analysis-Sizing up Firm Performance

Time Value of Money-The Basics

The Time Value of Money-Annuities and Other Topics

An Introduction to Risk and Return-History of Financial Market Returns

Risk and Return-Capital Market Theory

Debt Valuation and Interest Rates

Stock Valuation

Investment Decision Criteria

Analyzing Project Cash Flows

Risk Analysis and Project Evaluation

Capital Structure Policy

Dividend Policy

Financial Forecasting and Planning

Working Capital Management

International Business Finance

Corporate Risk Management

Filters