1. Which of the following is true of the change in the weighted average cost of capital of a firm? a. A decrease in the weighted average cost of the capital increases the value of the firm. b. An increase in the weighted average cost of the capital increases the value of the firm. c. A decrease in the weighted average cost of the capital decreases the value of the firm. d. A decrease in the weighted average cost of the capital increases the cash flow generated by the investments. e. Any change in the weighted average cost of capital results in no change in the value of the firm.
2. The cost of debt to the firm is adjusted for _____. a. marginal revenue generated b. taxes c. interest rate d. internal rate of return e. return to investors
3. The firm's cost of external equity capital is the same as the required rate of return on the firm's outstanding common stock. a. True b. False
4. The target capital structure of a firm is the capital structure that: a. minimizes the operating risk of the firm's assets. b. maximizes the tax shield created by debt. c. minimizes the default risk of long-term debt. d. maximizes the price of the firm's stock. e. minimizes the risk premium paid on long-term debt.
5. The correct discount rate for a firm to use in capital budgeting, assuming that new investments are as risky as the firm's existing assets, is its marginal cost of capital. a. True b. False
6. The component costs of capital are market-determined variables in as much as they are based on investors' required returns. a. True b. False
7. The rates of return, or costs, that a firm must pay to raise funds to invest in capital budgeting projects are determined by: a. the marginal revenue generated by investment in the new projects. b. the investors who purchase the firm's stocks and bonds. c. the internal rate of return of the firm. d. the cash flow generated by the investment in the additional projects. e. the dividend payout ratio fixed by the firm.
8. The marginal cost of capital _____ as more capital is raised during a given period. a. remains the same b. decreases c. increases d. changes in an unpredictable way e. approaches zero 10. The firm's cost of capital represents the maximum rate of return that a firm can earn from its capital budgeting projects to ensure that the value of the firm increases. a. True b. False
12. Omega Inc. has a history of abnormally high growth due to general economic fluctuations. Estimating the cost of common equity using the discounted cash flow approach is difficult because: a. the dividend yield is extremely difficult to estimate. b. the proper growth rate is difficult to establish. c. the market price of the common equity is very volatile. d. the firm grows at a constant rate in perpetuity. e. the firm's historical data of dividend yield is unavailable.
13. The cost of debt is equal to one minus the marginal tax rate multiplied by the coupon rate on outstanding debt. a. True b. False
14. Bouchard Company's stock sells for $20 per share, its last dividend (D0) was $1.00, its growth rate is a constant 6 percent, and the company would incur a flotation cost of 20 percent if it sold new common stock. Which of the following is the cost of issuing new common stock? (Round off the answer to two decimal places.) a. 11.96 percent b. 12.25 percent c. 12.63 percent d. 10.24 percent e. 11.42 percent
15. Which of the following is a capital component for the purpose of calculating the weighted average cost of capital in capital budgeting? a. The after-tax cost of long-term debt b. The after-tax cost of common stock c. The after-tax cost of preferred stock d. The after-tax cost of retained earnings e. The after-tax cost of new equity
16. Which of the following statements is true of the impact of tax on the cost of capital of a firm? a. All else being equal, an increase in the corporate tax rate results in a decrease in the weighted average cost of capital. b. The before-tax cost of debt is the cheapest component of the cost of capital since the tax paid is a deductible expense. c. The before-tax cost of debt is always less than the after-tax cost of debt of a firm. d. The tax paid on dividends of preferred stock reduces the amount of funds that the firm can use for financing capital budgeting projects. e. All else being equal, an increase in the equity capital that a firm raises by retaining earnings results in in the increase in the tax rate applicable to the firm.
18. A firm's weighted average cost of capital (WACC) is: a. set by the board of directors of the firm because it is the benchmark they use to evaluate upper management. b. regulated by the Internal Revenue Service (IRS) because tax-deductible debt is included in the computation. c. determined by the financial markets because investors provide the funds used by firms and these funds have costs, which are the returns demanded by investors. d. the same as the firm's internal rate of return (IRR). e. the total net present value (NPV) of all the capital budgeting projects in which the firm invests in any year.
19. Everything else equal, an asset's value is directly related to: a. the cost of raising additional capital. b. the rate of return investors require to invest in that asset. c. the risk associated with the investment in that asset. d. the cash flow the asset is expected to generate. e. the rate of return that the firm must earn to satisfy investors' demands.
24. If a project's _____ exceeds the firm's cost of capital, its NPV will be positive. a. marginal cost of capital b. cash flow c. rate of return expected by investors d. internal rate of return (IRR) e. discount rate
25. The cost of equity raised by retaining earnings can be less than, equal to, or greater than the cost of equity raised by selling new issues of common stock, depending on tax rates, flotation costs, the attitude of investors, and other factors. a. True b. False
26. The before-tax cost of debt, rd, is the same as the: a. average yield to maturity (YTM) associated with the firm's bonds. b. dividend yield associated with the firm's common stock. c. average coupon rate of the firm's bonds. d. return on equity if the firm has no preferred stock. e. the firm's marginal tax rate.
29. As per the Bond-Yield-Plus-Risk-Premium Approach, analysts estimate the cost of common equity by adding a risk premium of 3 to 5 percentage points to: a. the cost of preferred stock of the firm. b. the risk free rate of the common equity of the firm. c. the interest rate on the long term debt of the firm. d. the return on the firm's investment in municipal bonds. e. the growth rate of the firm.
30. The marginal cost of capital (MCC) is the cost of the last dollar of new capital that the firm raises, and the marginal cost declines as more and more of a specific type of capital is raised during a given period. a. True b. False
31. Which of the following statements is true of flotation costs? a. Flotation costs decrease the cost of preferred stock to the issuing firm. b. Flotation costs are added to the issue price of preferred stock to compute the cost of preferred stock. c. Floatation costs are added to the cost of debt to compute the weighted average cost of capital of a firm. d. Floatation costs result in higher funds available from the issue of preferred stock to the firm. e. Floatation costs increase the rate the issuing firm must earn to pay the preferred dividend.
34. Under normal circumstances, the weighted average cost of capital is used as the firm's required rate of return because: a. as long as the firm's investments earn returns greater than the cost of capital, the value of the firm will not decrease. b. returns below the cost of capital will cover all the fixed costs associated with the capital and provide excess returns to the firm's stockholders. c. it is comparable to the average of all the interest rates on debt that currently prevail in the financial markets. d. it is an indication of the return the firm is expecting to earn in future from all of its expansion plans. e. the weighted average cost of capital remains unchanged if the components costs of capital changes.
36. The cost of issuing preferred stock by a corporation must be adjusted to an after-tax figure because of the 70 percent dividend exclusion provision for corporations holding other corporations' preferred stock. a. True b. False
38. The after-tax cost of debt is used to calculate the weighted average cost of capital since we are concerned with the after-tax cash flows of the firm. a. True b. False
39. Beige Inc. plans to issue preferred stock that pays an $11.50 dividend per share and sells for $120 per share in the market. It will cost 4 percent, or $4.80 per share, to issue the new preferred stock, so Beige will net $115.20 per share. Which of the following is Beige's cost of preferred stock? (Round off the answer to two decimal places.) a. 8.89 percent b. 12.25 percent c. 11.50 percent d. 15.20 percent e. 9.98 percent
40. The Jackson Company has just paid a dividend of $3.00 per share on its common stock, and it expects this dividend to grow by 10 percent per year, indefinitely. The firm has a beta of 1.50; the risk-free rate is 10 percent; and the expected return on the market is 14 percent. Which of the following is the required rate of return as per the capital asset pricing model (CAPM) approach? a. 9 percent b. 12 percent c. 7 percent d. 16 percent e. 18 percent
41. J. Ross and Sons Inc. has a target capital structure that calls for 40 percent debt, 10 percent preferred stock, and 50 percent common equity. Ross' common stock currently sells for $40 per share. The firm recently paid a dividend of $2 per share on its common stock, and investors expect the dividend to grow indefinitely at a constant rate of 10 percent per year. Which of the following is the firm's cost of retained earnings? (Round off the answer to two decimal places.) a. 16.34 percent b. 10.42 percent c. 15.50 percent d. 12.20 percent e. 13.25 percent
42. Omega Inc.'s net income is expected to be $600,000 and the firm's payout ratio is 60 percent. The firm's common stock ratio is 30 percent and it has no preferred stock outstanding. Which of the following is the retained earnings break point for Omega Inc.? a. $400,000 b. $250,000 c. $375,000 d. $100,000 e. $800,000
43. Marigold Inc.'s common stock currently sells for $40 per share, but the firm will net only $34 per share from the sale of new common stock. The firm recently paid a dividend of $2 per share on its common stock, and investors expect the dividend to grow indefinitely at a constant rate of 10 percent per year. Which of the following is the cost of newly issued common stock? (Round off the answer to two decimal places.) a. 12.24 percent b. 13.56 percent c. 14.12 percent d. 16.47 percent e. 17.53 percent
44. Super Solutions Inc. is a constant growth firm, which just paid a dividend of $3.00, sells for $33.00 per share, and has a growth rate of 6 percent. Which of the following is the cost of retained earnings using the discounted cash flow (DCF) approach? (Round off the answer to two decimal places.) a. 12.55 percent b. 15.64 percent c. 16.25 percent d. 13.35 percent e. 12.40 percent
45. The _____ is equal to the average rate of return that investors require to provide funds to the firm in the form of debt. a. Coupon rate b. Yield to maturity (YTM) c. Maturity value d. Discount rate e. Internal rate of return
46. Oval Inc. has just paid a dividend of $1.50 per share on its common stock, and it expects this dividend to grow by 4 percent per year, indefinitely. The firm plans to issue common stock at $16. The firm's investment bankers believe that new issues of common stock would have a flotation cost equal to 4 percent of the current market price. Which of the following is the cost of newly issued common stock? (Round off the answer to two decimal places.) a. 14.16 percent b. 10.15 percent c. 15.36 percent d. 13.80 percent e. 16.92 percent
47. Diggin Tools just issued new preferred stock, which sold for $85 in the stock markets. Holders of the stock will receive an annual dividend equal to $9.35. The flotation costs associated with the new issue were 6 percent and Diggin's marginal tax rate is 30 percent. Which of the following is the component cost of preferred stock, rps? (Round off the answer to two decimal places.) a. 10.75 percent b. 10.52 percent c. 12.25 percent d. 11.70 percent e. 11.05 percent
48. Rollins Corporation is constructing its MCC schedule. Its target capital structure is 20 percent debt, 20 percent preferred stock, and 60 percent common equity. Its bonds have a 12 percent coupon, paid semiannually, a current maturity of 20 years, and sell for $1,000. The firm's marginal tax rate is 40 percent. Which of the following is Rollins' component cost of debt? (Round off the answer to one decimal place.) a. 8.4 percent b. 7.2 percent c. 6.8 percent d. 5.3 percent e. 9.5 percent
50. Coral Inc.'s preferred stock currently sells for $90 a share and pays a dividend of $10 per share; however, the firm will net only $80 per share from the sale of new preferred stock. What is the firm's cost of newly issued preferred stock? (Round off the answer to two decimal places.) a. 11.15 percent b. 12.50 percent c. 16.45 percent d. 10.52 percent e. 13.46 percent
