Question 1

Alio e Olio has restaurants throughout the United States,Canada,and Western Europe.It is considering a proposal to open several restaurants in major cities of India and China.

Accepted Answer

A) Alio e Olio should use the company's overall WACC to evaluate all proposals. 
B) Alio e Olio should use a lower discount rate for new ventures to be sure it does not miss out on opportunities. 
C) Alio e Olio should evaluate projects in different regions at discount rates that reflect the risk inherent in those projects. 
D) Alio e Olio should adjust the discount rate for specific regions to reflect the specific sources of funding used.

Question 2

Which of the following is a valid issue in implementing the dividend growth model? The model:

Accepted Answer

A) is too complex to be used to estimate value. 
B) does not require an accurate estimate of the rate of growth in future dividends. 
C) is based upon the assumption that dividends are expected to grow at a constant rate forever. 
D) both A and C.

Question 3

The average cost of capital is the appropriate rate to use when evaluating new investments,even though the new investments might be in a higher risk class.

Accepted Answer

A) True 
 B)False

Question 4

Paramount,Inc.just paid a dividend of $2.05 per share,and the firm is expected to experience constant growth of 12.50% over the foreseeable future.The common stock is currently selling for $65.90 per share.What is Paramount's cost of retained earnings using the Dividend Growth Model approach?

Accepted Answer

A) 12.50% 
B) 17.90% 
C) 16.00% 
D) 14.55%

Question 5

Which of the following is a correct formula for calculating the cost of capital?

Accepted Answer

A) WACC = weighted after-tax cost of debt + weighted cost of preferred stock + weighted cost of common stock 
B) WACC = weighted after-tax cost of debt + weighted after-tax cost of preferred stock + weighted after-tax cost of common stock 
C) WACC = (after-tax cost of debt + cost of preferred stock + cost of common stock )/3 
D) WACC = weighted cost of debt + weighted cost of preferred stock + weighted cost of common stock

Question 6

The weights used to determine the relative importance of the firm's sources of capital should reflect:

Accepted Answer

A) book values in accord with generally accepted accounting principles. 
B) current market values for bonds,common stock,and preferred stock and book values for retained earnings. 
C) current market values. 
D) subjective adjustments for firm risk.

Question 7

The cost of common equity using the CAPM is:

Accepted Answer

A) 11.00%. 
B) 11.20%. 
C) 11.50%. 
D) 11.72%.

Question 8

The weighted cost of capital assumes that the company maintains a constant debt to equity ratio.

Accepted Answer

A) True 
 B)False

Question 9

14.2 Determining the Firm's Capital Structure Weights
Use the following information to answer the following question(s).
The following data concerning Grafton Computer Peripherals' capital structure is available.
 
-The total capital that should be used in computing the weights for Grafton's WACC is:

Accepted Answer

A) $800. 
B) $525. 
C) $750. 
D) $425.

Question 10

Larger issues of new common stock can cause ________ to increase.

Accepted Answer

A) flotation costs 
B) the investor's required rate of return 
C) the stock price 
D) the tax rate

Question 11

Large firms are most likely to adjust for differences in the risk levels of investments taken on by different parts of the firm:

Accepted Answer

A) by subjectively adjusting the company's WACC up or down. 
B) by estimating individual costs of capital for each individual project. 
C) by estimating individual costs of capital for each division or unit of the company. 
D) by identifying the specific sources of funding used by each division or unit.

Question 12

Pilgrim's WACC is 12%.It has one opportunity to invest in a high risk project with an expected rate of return of 25%.It has another opportunity to lease a building to a government agency.The expected rate of return on the lease is 10%.

Accepted Answer

A) Pilgrim should definitely accept the high risk project and reject the leasing arrangement. 
B) Ideally,Pilgrim would discount the cash flows from each project at a rate appropriate to its risk. 
C) Pilgrim should definitely accept both projects. 
D) Pilgrim should finance the lease with all debt and the high risk project with all equity.

Question 13

Most firms use Treasury securities with maturities of ________ to determine the appropriate risk-free rate to use in the CAPM.

Accepted Answer

A) 90 days 
B) 180 days 
C) 10 years 
D) 30 years

Question 14

The firm should continue to invest in new projects up to the point where the marginal rate of return earned on a new investment equals the marginal cost of new capital.

Accepted Answer

A) True 
 B)False

Question 15

The firm's weighted average cost of capital is:

Accepted Answer

A) 10.47%. 
B) 9.29%. 
C) 8.63%. 
D) 7.71%.

Question 16

Which of the following reasons causes bonds to be a less expensive form of capital for a public firm than the issuance of common stock? Bondholders:

Accepted Answer

A) bear less risk than common stockholders bear. 
B) have prior voting rights over common stockholders. 
C) receive greater returns than common stockholders. 
D) investors pay a lower tax rate on bond interest

Question 17

Many corporate finance professionals favor the CAPM for determining the cost of equity.Which of the following is a reason for this preference?

Accepted Answer

A) The data is less expensive. 
B) The variables in the model that apply to public corporations are readily available from public sources. 
C) Because the CAPM gives better treatment to flotation costs. 
D) The CAPM uses data from the firm's financial statements.

Question 18

Which of the following statements is true?

Accepted Answer

A) 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. 
B) A firm should utilize a weighted average cost of capital for evaluating investment decisions rather than an arithmetic average cost of capital. 
C) For an average firm that is capitalized with 65% equity,usage of an arithmetic average cost of capital will usually overstate the true cost of capital. 
D) All of the above are true. 
E) None of the above are true.

Question 19

The after-tax cost of debt is:

Accepted Answer

A) 6.20%. 
B) 5.40%. 
C) 4.60%. 
D) 3.80%.

Question 20

In calculating the cost of capital for an average firm,which of the following statements is true?

Accepted Answer

A) The cost of a firm's bonds is greater than the cost of its common stock. 
B) The cost of a firm's preferred stock is greater than the cost of its common stock. 
C) The cost of a firm's retained earnings is less than the cost of its bonds. 
D) The cost of a firm's common stock is greater than the cost of its bonds.

Exam 14: The Cost of Capital

Alio e Olio has restaurants throughout the United States,Canada,and Western Europe.It is considering a proposal to open several restaurants in major cities of India and China.

Which of the following is a valid issue in implementing the dividend growth model? The model:

The average cost of capital is the appropriate rate to use when evaluating new investments,even though the new investments might be in a higher risk class.

Paramount,Inc.just paid a dividend of $2.05 per share,and the firm is expected to experience constant growth of 12.50% over the foreseeable future.The common stock is currently selling for $65.90 per share.What is Paramount's cost of retained earnings using the Dividend Growth Model approach?

Which of the following is a correct formula for calculating the cost of capital?

The weights used to determine the relative importance of the firm's sources of capital should reflect:

The cost of common equity using the CAPM is:

The weighted cost of capital assumes that the company maintains a constant debt to equity ratio.

14.2 Determining the Firm's Capital Structure Weights Use the following information to answer the following question(s) . The following data concerning Grafton Computer Peripherals' capital structure is available. -The total capital that should be used in computing the weights for Grafton's WACC is:

Larger issues of new common stock can cause ________ to increase.

Large firms are most likely to adjust for differences in the risk levels of investments taken on by different parts of the firm:

Pilgrim's WACC is 12%.It has one opportunity to invest in a high risk project with an expected rate of return of 25%.It has another opportunity to lease a building to a government agency.The expected rate of return on the lease is 10%.

Most firms use Treasury securities with maturities of ________ to determine the appropriate risk-free rate to use in the CAPM.

The firm should continue to invest in new projects up to the point where the marginal rate of return earned on a new investment equals the marginal cost of new capital.

The firm's weighted average cost of capital is:

Which of the following reasons causes bonds to be a less expensive form of capital for a public firm than the issuance of common stock? Bondholders:

Many corporate finance professionals favor the CAPM for determining the cost of equity.Which of the following is a reason for this preference?

Which of the following statements is true?

The after-tax cost of debt is:

In calculating the cost of capital for an average firm,which of the following statements is true?