Question 1

The interest tax shield generated by a project's actual equity financing is accounted for by using the after-tax cost of equity in the WACC.

Accepted Answer

A) True 
 B)False

Question 2

XYZ Company issues common stock that is expected to pay a dividend over the next year of $4 at a price of $25 per share.If its expected growth rate is 5%,what is XYZ's cost of common equity?

Accepted Answer

A)  9.0% 
B)  11.0% 
C)  16.0% 
D)  21.0%

Question 3

If a firm wishes to undertake a project with a different risk than its own,what is the best way by which to estimate the project's beta?

Accepted Answer

A)  a company in the same business as the firm. 
B)  a risk adjustment made to the firm's beta. 
C)  a company in the same business as the project. 
D)  management approximation.

Question 4

An implicit cost of increasing the proportion of debt in a firm's capital structure is that:

Accepted Answer

A)  the firm's asset beta will increase. 
B)  equity holders will demand a higher rate of return. 
C)  the tax shield will not apply to the added debt. 
D)  the equity-to-value ratio will decrease.

Question 5

Which of the following changes offer the greatest chance of changing a project's NPV from negative to positive?

Accepted Answer

A)  Substituting preferred stock for debt. 
B)  Selling the debt at less than par value. 
C)  A reduction in project risk. 
D)  A decrease in the marginal tax rate.

Question 6

What is the company cost of capital for a firm financed with 30% debt if the debt requires a 10% return and equity requires a 16% return?

Accepted Answer

A)  11.8% 
B)  13.3% 
C)  14.2% 
D)  14.8%

Question 7

Calculate a firm's required rates of return for both of its equity components: Its common stock sells for $50 per share and will pay a $6 dividend which is expected to grow at a constant 5% rate.Its preferred stock sells for $22.50 per share and pays $1.80 in dividends.What accounts for the difference in returns,given that these are both forms of equity?

Accepted Answer

The answer of Calculate a firm's required rates of return...

Question 8

Plasti-tech Inc.is financed 60% with equity and 40% with debt.Currently,its debt has a before-tax interest rate of 12%.Plasti-tech's common stock trades at $15 per share and its most recent dividend was $1.00.Future dividends are expected grow by 4%.If the tax rate is 34%,what is Plasti-tech's WACC?

Accepted Answer

A)  7.39% 
B)  9.57% 
C)  9.73% 
D)  11.20%

Question 9

The mix of a company's short-term financing is referred to as its capital structure.

Accepted Answer

A) True 
 B)False

Question 10

What dividend is paid on preferred stock if investors require a 9% rate of return and the stock has a market value of $54.00 per share and a book value of $50.00 per share?

Accepted Answer

A)  $2.92 
B)  $4.50 
C)  $4.68 
D)  $4.86

Question 11

With respect to the WACC:

Accepted Answer

A)  it is the proper discount rate for everything the company does. 
B)  it is used to value all new projects. 
C)  this benchmark discount rate is adjusted for the riskiness of the project. 
D)  no adjustments need to be made when using it as the discount rate.

Question 12

Why is it important to include the tax effect into cost of capital computations for firms with debt financing?

Accepted Answer

A)  firms pay taxes on the outstanding principal amount of the debt. 
B)  taxable income is reduced by the amount of the interest expense. 
C)  comparisons with equity financing would otherwise not be possible. 
D)  taxes are paid on interest but not on dividends.

Question 13

What is the expected growth rate in dividends for a firm in which shareholders require an 18% rate of return and the dividend yield is 10%?

Accepted Answer

A)  1.8% 
B)  5.2% 
C)  8.0% 
D)  28.0%

Question 14

A firm's cost of capital can be used in valuation of every new project they encounter,regardless of its risk.

Accepted Answer

A) True 
 B)False

Question 15

Free cash flow is defined as:

Accepted Answer

A)  debt at zero percent interest.. 
B)  cash flow that is not required for investing in fixed assets only. 
C)  cash flow that is not required for investing in working capital only. 
D)  cash flow that is not required for investing in either fixed assets or working capital.

Question 16

for purposes of computing the WACC,if the book value of equity exceeds the market value of equity,then:

Accepted Answer

A)  the book value of equity should be used. 
B)  the book value of equity less retained earnings should be used. 
C)  the market value of equity should be used. 
D)  the market value of equity less retained earnings should be used.

Question 17

What is the most difficult aspect in determining a firm's weighted average cost of capital?

Accepted Answer

A)  estimating the cost of equity. 
B)  estimating the cost of preferred stock. 
C)  estimating the cost of debt. 
D)  deriving weights for each cost.

Question 18

The difficulty in using the CAPM for determining the cost of equity lies in:

Accepted Answer

A)  the estimation of the firm's beta. 
B)  the estimation of the risk-free rate. 
C)  the estimation of the return on the market. 
D)  All of these choices are correct.

Question 19

The cost of capital must be based on the securities' book values.

Accepted Answer

A) True 
 B)False

Question 20

Capital structure in essence is a firm's mix of long-term financing.

Accepted Answer

A) True 
 B)False

Exam 13: The Weighted-Average Cost of Capital and Company Valuation

The interest tax shield generated by a project's actual equity financing is accounted for by using the after-tax cost of equity in the WACC.

XYZ Company issues common stock that is expected to pay a dividend over the next year of $4 at a price of $25 per share.If its expected growth rate is 5%,what is XYZ's cost of common equity?

If a firm wishes to undertake a project with a different risk than its own,what is the best way by which to estimate the project's beta?

An implicit cost of increasing the proportion of debt in a firm's capital structure is that:

Which of the following changes offer the greatest chance of changing a project's NPV from negative to positive?

What is the company cost of capital for a firm financed with 30% debt if the debt requires a 10% return and equity requires a 16% return?

The mix of a company's short-term financing is referred to as its capital structure.

What dividend is paid on preferred stock if investors require a 9% rate of return and the stock has a market value of $54.00 per share and a book value of $50.00 per share?

With respect to the WACC:

Why is it important to include the tax effect into cost of capital computations for firms with debt financing?

What is the expected growth rate in dividends for a firm in which shareholders require an 18% rate of return and the dividend yield is 10%?

A firm's cost of capital can be used in valuation of every new project they encounter,regardless of its risk.

Free cash flow is defined as:

for purposes of computing the WACC,if the book value of equity exceeds the market value of equity,then:

What is the most difficult aspect in determining a firm's weighted average cost of capital?

The difficulty in using the CAPM for determining the cost of equity lies in:

The cost of capital must be based on the securities' book values.

Capital structure in essence is a firm's mix of long-term financing.