Question 1

The major components that determine the risk premium on a specific security at any point in time include all of the following except

Accepted Answer

A)  business risk 
B)  financial risk 
C)  interest rate risk 
D)  real rate of return risk

Question 2

Heleveton Industries is 100% equity financed. Its current beta is 1.1. The expected market risk premium is 8.5% and the risk-free rate is 4.2%. If Heleveton changes its capital structure to 25% debt, it estimates its beta will increase to 1.2. If the after-tax cost of debt will be 6%, should Heleveton make the capital structure change?

Accepted Answer

A)  Yes, cost of capital decreases by 2.52% 
B)  Yes, cost of capital decreases 1.67%. 
C)  No, stock price would decrease due to increased risk 
D)  No, cost of capital increases by 0.85%.

Question 3

The cost of capital is

Accepted Answer

A)  the rate of return required by investors in the firm's securities 
B)  the minimum rate of return required on new investments of high risk undertaken by the firm 
C)  approximately 10 percent for most firms 
D)  concerned with plant and equipment only

Question 4

Haulsee Inc. pays no dividend currently but is expected to start paying a small dividend next year. The 5-year old firm has a beta of 1.25 and current earnings of $0.90 per share. The current Treasury bill rate is 6.10% and the market risk premium is 8.8%. Determine Haulsee's cost of equity if the firm's tax rate is 40%.

Accepted Answer

A)  9.48% 
B)  17.1% 
C)  14.9% 
D)  cannot determined from the information provided

Question 5

What is the weighted average cost of capital for Mud Bug Corporation?

Accepted Answer

A)  6.9% 
B)  8.5% 
C)  10.2% 
D)  9.8%

Question 6

For a company that is not planning to change its target capital structure, the proportions of debt and equity used in calculating the weighted cost of capital should be based on the current ____ weights of the individual components.

Accepted Answer

A)  book value 
B)  market value 
C)  replacement value 
D)  accounting value

Question 7

Which of the following statements (if any) is (are) true concerning companies that do not pay dividends?

Accepted Answer

A)  The cost of equity capital can be estimated using the Capital Asset Pricing Model. 
B)  The cost of equity capital is equal to the growth short-term rate of earnings per share. 
C)  The dividend capitalization model can be used to determine an accurate cost of equity capital. 
D)  The cost of equity capital cannot be determined by using the CAPM, the risk premium on debt approach, or by estimating ke for comparable dividend-paying stocks in their industry.

Question 8

Witin's stock price is currently $34.25 and the current quarterly dividend is $0.25. Consensus estimates for Witin indicate a growth rate in earnings of 10% into the foreseeable future. If Witin plans to sell 1 million shares to raise new capital for expansion, what is the cost of new equity if the issuance costs are 8%?

Accepted Answer

A)  13.49% 
B)  10.87% 
C)  13.21% 
D)  13.17%

Question 9

The required rate of return on any security consists of a

Accepted Answer

A)  risk premium plus an expected inflation rate 
B)  risk free rate plus a risk premium 
C)  inflation rate plus a marketability premium 
D)  risk free rate plus an inflation premium

Question 10

Sources of debt capital to small firms is limited. Generally, what are the sources of funds for the small firm?

Accepted Answer

The answer of Sources of debt capital to small firms...

Question 11

American Dental Laser is selling a 10 year $1,000 face value bond with a 8% coupon rate. Interest is paid annually. The price to the public is $820 and the issue costs per bond are $10 each. Compute the pretax cost of debt for these bonds.

Accepted Answer

A)  11.1% 
B)  11.3% 
C)  11.5% 
D)  11.8%

Question 12

____ refers to the variability in the firm's operating earnings.

Accepted Answer

A)  Business risk 
B)  Financial risk 
C)  Marketability risk 
D)  Interest rate risk

Question 13

Firms can raise capital in two ways. Why is it that internal funding does not have a zero cost?

Accepted Answer

The answer of Firms can raise capital in two ways....

Question 14

What would be the weighted average cost of capital for Limp Linguini Noodle Makers, Inc. under the following conditions:
*The capital structure is 40% debt and 60% equity
*The before-tax cost of debt (which includes flotation costs) is 20% and the firm is in the 40% tax bracket.
*The firm's beta is 1.7
*The risk-free rate is 7% and the market risk premium is 6%

Accepted Answer

A)  15.12% 
B)  18.7% 
C)  17.2% 
D)  12%

Question 15

Alpha Products maintains a capital structure of 40 percent debt and 60 percent common equity. To finance its capital budget for next year, the firm will sell $50 million of 11 percent debentures at par and finance the balance of its $125 million capital budget with retained earnings. Next year Alpha expects net income to grow 7 percent to $140 million, and dividends also are expected to increase 7 percent to $1.40 per share and to continue growing at that rate for the foreseeable future. The current market value of Alpha's stock is $30. If the firm has a marginal tax rate of 40 percent, what is its weighted cost of capital for the coming year?

Accepted Answer

A)  9.64% 
B)  8.63% 
C)  9.84% 
D)  11.67%

Question 16

What is the investment opportunity curve and how is it accomplished?

Accepted Answer

The answer of What is the investment opportunity curve and...

Question 17

Zappin' Skeeters Corporation needs to know its cost of retained earnings. Based on the following information, compute the cost of retained earnings: The stock sells for $25, flotation costs are $3 and the firm is in the 35% tax bracket.

Accepted Answer

A)  15.71% 
B)  9.11% 
C)  12.56% 
D)  10.72%

Question 18

Wellington Gas has a target capital structure of 50 percent common equity, 40 percent debt, and 10 percent preferred stock. The cost of retained earnings is 16 percent, and the cost of new equity (external) is 16.7 percent. Wellington can sell debentures that will have an after-tax cost of 8.3 percent and the after-tax cost of preferred stock will be 11.9 percent. What is the marginal cost of capital before and after the break point?

Accepted Answer

A)  12.51% and 12.86% 
B)  11.18% and 11.53% 
C)  14.23% and 14.68% 
D)  12.51% and 11.53%

Question 19

The total return to stockholders, ke, is composed of the

Accepted Answer

A)  opportunity cost plus a risk premium 
B)  dividend yield plus the price appreciation of the security 
C)  opportunity cost plus an inflation premium 
D)  dividend yield minus the risk premium

Question 20

Which of the following is not a typical source of debt funds for a small firm?

Accepted Answer

A)  investment banking firms 
B)  commercial finance companies 
C)  Small Business Administration 
D)  leasing companies

Exam 12: The Cost of Capital