Cost of Capital

Question 1

Question

The cost of capital is the rate of return a firm must earn on investments in order to leave share price unchanged.

Answer

True
False

Question 2

Question

If risk is unchanged, the undertaking of projects with a rate of return above the cost of capital will decrease the value of the firm.

Answer

True
False

Question 3

Question

The specific cost of each source of financing is viewed on a before tax basis.

Answer

True
False

Question 4

Question

The net proceeds used in calculation of the cost of long-term debt are funds actually received from the sale after paying flotation costs.

Answer

True
False

Question 5

Question

When the net proceeds from the sale of a bond equal its par value, the coupon interest rate will be the bond's before tax cost of capital.

Answer

True
False

Question 6

Question

The cost of preferred stock is typically lower than the cost of long-term debt because dividends paid on preferred stock are tax deductible.

Answer

True
False

Question 7

Question

The cost of common stock equity may be measured using either zero growth valuation model or the CAPM.

Answer

True
False

Question 8

Question

The cost of retained earnings is always lower than the cost of a new issue of common stock due to the absence of flotation costs.

Answer

True
False

Question 9

Question

The CAPM describes the relationship between the required return and the non systematic risk of the firm as measured by the beta coefficient.

Answer

True
False

Question 10

Question

Larger volumes of new financing are associated with greater risk and lead to higher financial costs.

Answer

True
False

Question 11

Question

Since preferred stock is a form of ownership, the stock will never mature.

Answer

True
False

Question 12

Question

The weighted marginal cost of capital is the firm's weighted average cost of capital associated with its next dollar of total financing.

Answer

True
False

Question 13

Question

A firm's investment opportunities schedule is a ranking of investment possibilities for worse (lowest return) to best (highest return).

Answer

True
False

Question 14

Question

As cumulative amount of money invested in a firm's capital project increases, its returns on the projects will increase.

Answer

True
False

Question 15

Question

According to the firm's owner wealth maximization goal, the firm should accept projects up to the point where the marginal return on its investment equals its weighted marginal cost of capital.

Answer

True
False

Question 16

Question

The component cost of capital are market-determined variables in as much as they are based on investor's required returns.

Answer

True
False

Question 17

Question

The cost of issuing preferred stock by a corporation must be adjusted to an after-tax figure because of the 70% dividend exclusion provision for corporations holding other corporations' preferred stock.

Answer

True
False

Question 18

Question

The weighted average cost of capital increases if the total funds required call for an amount of equity in excess of what can be obtained as retained earnings.

Answer

True
False

Question 19

Question

In capital budgeting and cost of capital analyses, the firm should always consider retained earnings as the first source of capital, since this is a free source of funding to the firm.

Answer

True
False

Question 20

Question

The cost of capital should reflect the average cost of the various sources of long-term funds a firm uses to support its assets.

Answer

True
False

Question 21

Question

The _____ is the rate of return a firm must earn on its investment in order to maintain the market value of its stock.

Answer

gross profit margin
internal rate of return
net present value
cost of capital

Question 22

Question

_____ refers to the risk of the firm being unable to cover its operation costs.

Answer

Financial risk
Total risk
Business risk
Nonsystematic

Question 23

Question

The cost of capital reflects the cost of funds _____.

Answer

over the short run
at current book value
at historical values
over the long run

Question 24

Question

The firm's optimal mix of debt and equity is called _____.

Answer

target capital structure
maximum wealth ratio
optimal mix
debt to equity ratio

Question 25

Question

The specific cost of each source of long-term financing is based on _____ and _____ costs.

Answer

before-tax; current
after-tax; historical
after-tax; current
before-tax; historical

Question 26

Question

A tax adjustment must be made in determining the cost of _____.

Answer

common stock
long-term debt
retained earnings
preferred stock

Question 27

Question

A firm has issued 8% preferred stock, which sold for $100 per share par value. The flotation costs of the stock equaled $3 and the firm's marginal tax rate is 40%. The cost of the preferred stock is

Answer

8.25%
7.5%
7.35%
9.85%

Question 28

Question

The approximate before-tax cost of debt for a 20 year, 9%, $1000 par value bond selling at $950 is

Answer

10.63%
11.39%
7.45%
9.49%

Question 29

Question

The cost of common stock equity may be estimated by using the

Answer

IRR
NPV
Constant growth valuation model
MIRR model

Question 30

Question

The cost of retained earnings is equal t

Answer

the cost of long-term debt
the cost of common stock equity
zero
the marginal cost of capital

Question 31

Question

The firm has a beta of .90. The market return equals 12% and the risk free rate of return equals 4%. The estimated cost of common stock equity is _____

Answer

11.2%
9.8%
10.4%
12.6%

Question 32

Question

One major expense associated with issuing new shares of common stock is

Answer

legal fees
underwriting fees
registration fees
underpricing

Question 33

Question

A firm has common stock with a market price of $45 per share and an expert dividend of $3 per share at the end of the coming year. The growth rate in dividends has been 4%. The cost of the firm's common stock equity is

Answer

9.75%
10.67%
8.42%
11.25%

Question 34

Question

Generally the least expensive form of long-term capital is _____

Answer

short-term debt
retained earnings
long-term debt
common stock

Question 35

Question

A firm has determined its cost of each source of capital and optimal capital structure, which is composed of the following sources: Source of capital proportion after-tax cost long-term debt 45% 7% preferred stock 15% 10% common stock equity 40% 14% the weighted average cost of capital is _____

Answer

10.25%
11.45%
9.75%
8.35%

Question 36

Question

A firm's before-tax cost of long-term debt 10.45%. what is the firm's after tax cost of long-term debt if the firm has a 40% corporate tax rate?

Answer

8.48%
6.27%
5.32%
9.75%

Question 37

Question

In calculating the cost of common stock equity, the model having the stronger theoretical foundation is the _____.

Answer

Gordon model
variable growth model
zero growth model
CAPM

Question 38

Question

A firm has discovered that its retained earnings of $400,000 will soon be exhausted. What is the point at which th firm will non longer be able to sustain the retained earnings cost of 6% if the historical weight of debt in the firm's WACC is 40%.

Answer

$750,000
$160,000
$1,000,000
$100,000

Question 39

Question

When determining the after-tax cost of a bond, the face value of the bond must be adjusted to the net proceeds amount by considering _____.

Answer

risk
flotation cost
taxes
returns

Question 40

Question

When the face value of a bond equals its selling price, the firm's cost of the bond will be equal to

Answer

the coupon interest rate
the firm's WACC
the risk free rate
the firm's WMCC

Question 41

Question

Which of the following statements is most correct?

Answer

Under normal conditions, the CAPM approach to estimating a firm's cost of retained earnings gives a better estimate than other approaches.
The risk premium used in the bond-yield-plus-risk-premiun methods is the same as the one used in the CAPM method.
The CAPM approach is typically used to estimate a firm's flotation cost adjustment factor, and this factor is added to the DCF cost estimate.
The above statements are all false.

Question 42

Question

Micro Corp's common stock is currently selling sfor $50 per share. Current dividends is $2 per share. If dividends are expected to grow 6% per year and its flotation costs are 10%, then what is the firm's cost of retained earnings and cost of new common stock?

Answer

10.71%; 10.24%
10.24%; 10.71%
10.24%; 11.38%
11.38%; 10.71%

Question 43

Question

Project A has a cost of $200 million and a rate of return of 13%, while project B has a cost of $125 million and a rate of return of 10%. All of the company's potential projects are equally risky. Which of the following may be true concerning debt and equity?

Answer

Cost of debt of firm A > Cost of equity of firm A
Cost of debt of firm A > Cost of equity of firm B
the cost of internally generated equity for firm A > cost of externally generated equity funds of firm A
the cost of internally generated equity for firm A < cost of debt for firm A

	Created by lseyer436 about 9 years ago

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