Question 1

Assume that Kish Inc. hired you as a consultant to help estimate its cost of capital. You have obtained the following data: D0 = $0.90; P0 = $27.50; and g = 7.00% (constant) . Based on the DCF approach, what is the cost of equity from retained earnings?

Accepted Answer

A)   9.29%
B)   9.68%
C)   10.08%
D)   10.50%
E)   10.92%F) A) and B)
G) C) and D)

Question 2

LaPango Inc. estimates that its average-risk projects have a WACC of 10%, its below-average risk projects have a WACC of 8%, and its above-average risk projects have a WACC of 12%. Which of the following projects (A, B, and C)  should the company accept?

Accepted Answer

A)   Project B, which is of below-average risk and has a return of 8.5%.
B)   Project C, which is of above-average risk and has a return of 11%.
C)   Project A, which is of average risk and has a return of 9%.
D)   None of the projects should be accepted.
E)   All of the projects should be accepted.F) B) and D)
G) None of the above

Question 3

Butcher Timber Company hired your consulting firm to help them estimate the cost of equity. The yield on the firm's bonds is 8.75%, and your firm's economists believe that the cost of equity can be estimated using a risk premium of 3.85% over a firm's own cost of debt. What is an estimate of the firm's cost of equity from retained earnings?

Accepted Answer

A)   12.60%
B)   13.10%
C)   13.63%
D)   14.17%
E)   14.74%F) A) and B)
G) A) and C)

Question 4

If the expected dividend growth rate is zero, then the cost of external equity capital raised by issuing new common stock If the expected growth rate is not zero, then the cost of external equity must be found using a different formula.

Accepted Answer

A) True 
 B)False

Question 5

Sorensen Systems Inc. is expected to pay a $2.50 dividend at year end (D1 = $2.50) , the dividend is expected to grow at a constant rate of 5.50% a year, and the common stock currently sells for $52.50 a share. The before-tax cost of debt is 7.50%, and the tax rate is 40%. The target capital structure consists of 45% debt and 55% common equity. What is the company's WACC if all the equity used is from retained earnings?

Accepted Answer

A)   7.07%
B)   7.36%
C)   7.67%
D)   7.98%
E)   8.29%F) B) and E)
G) All of the above

Question 6

"Capital" is sometimes defined as funds supplied to a firm by investors.

Accepted Answer

A) True 
 B)False

Question 7

The text identifies three methods for estimating the cost of common stock from retained earnings: the CAPM method, the DCF method, and the bond-yield-plus-risk-premium method. However, only the CAPM method always provides an accurate and reliable estimate.

Accepted Answer

A) True 
 B)False

Question 8

The lower the firm's tax rate, the lower will be its after-tax cost of debt and also its WACC, other things held constant.

Accepted Answer

A) True 
 B)False

Question 9

If a typical U.S. company correctly estimates its WACC at a given point in time and then uses that same cost of capital to evaluate all projects for the next 10 years, then the firm will most likely

Accepted Answer

A)   become riskier over time, but its intrinsic value will be maximized.
B)   become less risky over time, and this will maximize its intrinsic value.
C)   accept too many low-risk projects and too few high-risk projects.
D)   become more risky and also have an increasing WACC. Its intrinsic value will not be maximized.
E)   continue as before, because there is no reason to expect its risk position or value to change over time as a result of its use of a single cost of capital.F) A) and C)
G) A) and B)

Question 10

The higher the firm's flotation cost for new common equity, the more likely the firm is to use preferred stock, which has no flotation cost, and retained earnings, whose cost is the average return on the assets that are acquired.

Accepted Answer

A) True 
 B)False

Question 11

Funds acquired by the firm through retaining earnings have no cost because there are no dividend or interest payments associated with them, and no flotation costs are required to raise them, but capital raised by selling new stock or bonds does have a cost.

Accepted Answer

A) True 
 B)False

Question 12

For capital budgeting and cost of capital purposes, the firm should assume that each dollar of capital is obtained in accordance with its target capital structure, which for many firms means partly as debt, partly as preferred stock, and partly common equity.

Accepted Answer

A) True 
 B)False

Question 13

The cost of capital used in capital budgeting should reflect the average cost of the various sources of investor-supplied funds a firm uses to acquire assets.

Accepted Answer

A) True 
 B)False

Question 14

Which of the following statements is CORRECT?

Accepted Answer

A)   A change in a company's target capital structure cannot affect its WACC.
B)   WACC calculations should be based on the before-tax costs of all the individual capital components.
C)   Flotation costs associated with issuing new common stock normally reduce the WACC.
D)   If a company's tax rate increases, then, all else equal, its weighted average cost of capital will decline.
E)   An increase in the risk-free rate will normally lower the marginal costs of both debt and equity financing.F) B) and C)
G) A) and E)

Question 15

Suppose the debt ratio (D/TA) is 50%, the interest rate on new debt is 8%, the current cost of equity is 16%, and the tax rate is 40%. An increase in the debt ratio to 60% would have to decrease the weighted average cost of capital (WACC).

Accepted Answer

A) True 
 B)False

Question 16

The cost of preferred stock to a firm must be adjusted to an after-tax figure because 70% of dividends received by a corporation may be excluded from the receiving corporation's taxable income.

Accepted Answer

A) True 
 B)False

Question 17

Which of the following statements is CORRECT?

Accepted Answer

A)   Since debt capital can cause a company to go bankrupt but equity capital cannot, debt is riskier than equity, and thus the after-tax cost of debt is always greater than the cost of equity.
B)   The tax-adjusted cost of debt is always greater than the interest rate on debt, provided the company does in fact pay taxes.
C)   If a company assigns the same cost of capital to all of its projects regardless of each project's risk, then the company is likely to reject some safe projects that it actually should accept and to accept some risky projects that it should reject.
D)   Because no flotation costs are required to obtain capital as retained earnings, the cost of retained earnings is generally lower than the after-tax cost of debt.
E)   Higher flotation costs tend to reduce the cost of equity capital.F) A) and E)
G) None of the above

Question 18

Teall Development Company hired you as a consultant to help them estimate its cost of capital. You have been provided with the following data: D1 = $1.45; P0 = $22.50; and g = 6.50% (constant) . Based on the DCF approach, what is the cost of equity from retained earnings?

Accepted Answer

A)   11.10%
B)   11.68%
C)   12.30%
D)   12.94%
E)   13.59%F) A) and D)
G) C) and D)

Question 19

Which of the following is the best estimate for the weight of debt for use in calculating the WACC?

Accepted Answer

A)   18.67%
B)   19.60%
C)   20.58%
D)   21.61%
E)   22.69%F) A) and C)
G) A) and B)

Question 20

Which of the following statements is CORRECT?

Accepted Answer

A)   The bond-yield-plus-risk-premium approach to estimating the cost of common equity involves adding a risk premium to the interest rate on the company's own long-term bonds. The size of the risk premium for bonds with different ratings is published daily in The Wall Street Journal.
B)   The WACC is calculated using a before-tax cost for debt that is equal to the interest rate that must be paid on new debt, along with the after-tax costs for common stock and for preferred stock if it is used.
C)   An increase in the risk-free rate is likely to reduce the marginal costs of both debt and equity.
D)   The relevant WACC can change depending on the amount of funds a firm raises during a given year. Moreover, the WACC at each level of funds raised is a weighted average of the marginal costs of each capital component, with the weights based on the firm's target capital structure.
E)   Beta measures market risk, which is generally the most relevant risk measure for a publicly-owned firm that seeks to maximize its intrinsic value. However, this is not true unless all of the firm's stockholders are well diversified.F) C) and E)
G) All of the above

Exam 11: Cost of Capital

For capital budgeting and cost of capital purposes, the firm should assume that each dollar of capital is obtained in accordance with its target capital structure, which for many firms means partly as debt, partly as preferred stock, and partly common equity.

Correct Answer
verified

If the expected dividend growth rate is zero, then the cost of external equity capital raised by issuing new common stock If the expected growth rate is not zero, then the cost of external equity must be found using a different formula.

Correct Answer
verified

LaPango Inc. estimates that its average-risk projects have a WACC of 10%, its below-average risk projects have a WACC of 8%, and its above-average risk projects have a WACC of 12%. Which of the following projects (A, B, and C) should the company accept?

Correct Answer
verified

The cost of preferred stock to a firm must be adjusted to an after-tax figure because 70% of dividends received by a corporation may be excluded from the receiving corporation's taxable income.

Correct Answer
verified

Suppose the debt ratio (D/TA) is 50%, the interest rate on new debt is 8%, the current cost of equity is 16%, and the tax rate is 40%. An increase in the debt ratio to 60% would have to decrease the weighted average cost of capital (WACC).

Correct Answer
verified

Which of the following statements is CORRECT?

Correct Answer
verified

If a typical U.S. company correctly estimates its WACC at a given point in time and then uses that same cost of capital to evaluate all projects for the next 10 years, then the firm will most likely

Correct Answer
verified

"Capital" is sometimes defined as funds supplied to a firm by investors.

Correct Answer
verified

Teall Development Company hired you as a consultant to help them estimate its cost of capital. You have been provided with the following data: D1 = $1.45; P0 = $22.50; and g = 6.50% (constant) . Based on the DCF approach, what is the cost of equity from retained earnings?

Correct Answer
verified

The lower the firm's tax rate, the lower will be its after-tax cost of debt and also its WACC, other things held constant.

Correct Answer
verified

The text identifies three methods for estimating the cost of common stock from retained earnings: the CAPM method, the DCF method, and the bond-yield-plus-risk-premium method. However, only the CAPM method always provides an accurate and reliable estimate.

Correct Answer
verified

The cost of capital used in capital budgeting should reflect the average cost of the various sources of investor-supplied funds a firm uses to acquire assets.

Correct Answer
verified

Which of the following statements is CORRECT?

Correct Answer
verified

Which of the following statements is CORRECT?

Correct Answer
verified

Assume that Kish Inc. hired you as a consultant to help estimate its cost of capital. You have obtained the following data: D0 = $0.90; P0 = $27.50; and g = 7.00% (constant) . Based on the DCF approach, what is the cost of equity from retained earnings?

Correct Answer
verified

The higher the firm's flotation cost for new common equity, the more likely the firm is to use preferred stock, which has no flotation cost, and retained earnings, whose cost is the average return on the assets that are acquired.

Correct Answer
verified

Funds acquired by the firm through retaining earnings have no cost because there are no dividend or interest payments associated with them, and no flotation costs are required to raise them, but capital raised by selling new stock or bonds does have a cost.

Correct Answer
verified

Which of the following is the best estimate for the weight of debt for use in calculating the WACC?

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Exam 11: Cost of Capital

For capital budgeting and cost of capital purposes, the firm should assume that each dollar of capital is obtained in accordance with its target capital structure, which for many firms means partly as debt, partly as preferred stock, and partly common equity.

Correct AnswerverifiedShow Answer

If the expected dividend growth rate is zero, then the cost of external equity capital raised by issuing new common stock If the expected growth rate is not zero, then the cost of external equity must be found using a different formula.

Correct AnswerverifiedShow Answer

LaPango Inc. estimates that its average-risk projects have a WACC of 10%, its below-average risk projects have a WACC of 8%, and its above-average risk projects have a WACC of 12%. Which of the following projects (A, B, and C) should the company accept?

Correct AnswerverifiedShow Answer

The cost of preferred stock to a firm must be adjusted to an after-tax figure because 70% of dividends received by a corporation may be excluded from the receiving corporation's taxable income.

Correct AnswerverifiedShow Answer

Suppose the debt ratio (D/TA) is 50%, the interest rate on new debt is 8%, the current cost of equity is 16%, and the tax rate is 40%. An increase in the debt ratio to 60% would have to decrease the weighted average cost of capital (WACC).

Correct AnswerverifiedShow Answer

Which of the following statements is CORRECT?

Correct AnswerverifiedShow Answer

If a typical U.S. company correctly estimates its WACC at a given point in time and then uses that same cost of capital to evaluate all projects for the next 10 years, then the firm will most likely

Correct AnswerverifiedShow Answer

"Capital" is sometimes defined as funds supplied to a firm by investors.

Correct AnswerverifiedShow Answer

Teall Development Company hired you as a consultant to help them estimate its cost of capital. You have been provided with the following data: D1 = $1.45; P0 = $22.50; and g = 6.50% (constant) . Based on the DCF approach, what is the cost of equity from retained earnings?

Correct AnswerverifiedShow Answer

The lower the firm's tax rate, the lower will be its after-tax cost of debt and also its WACC, other things held constant.

Correct AnswerverifiedShow Answer

The text identifies three methods for estimating the cost of common stock from retained earnings: the CAPM method, the DCF method, and the bond-yield-plus-risk-premium method. However, only the CAPM method always provides an accurate and reliable estimate.

Correct AnswerverifiedShow Answer

The cost of capital used in capital budgeting should reflect the average cost of the various sources of investor-supplied funds a firm uses to acquire assets.

Correct AnswerverifiedShow Answer

Which of the following statements is CORRECT?

Correct AnswerverifiedShow Answer

Which of the following statements is CORRECT?

Correct AnswerverifiedShow Answer

Assume that Kish Inc. hired you as a consultant to help estimate its cost of capital. You have obtained the following data: D0 = $0.90; P0 = $27.50; and g = 7.00% (constant) . Based on the DCF approach, what is the cost of equity from retained earnings?

Correct AnswerverifiedShow Answer

The higher the firm's flotation cost for new common equity, the more likely the firm is to use preferred stock, which has no flotation cost, and retained earnings, whose cost is the average return on the assets that are acquired.

Correct AnswerverifiedShow Answer

Funds acquired by the firm through retaining earnings have no cost because there are no dividend or interest payments associated with them, and no flotation costs are required to raise them, but capital raised by selling new stock or bonds does have a cost.

Correct AnswerverifiedShow Answer

Which of the following is the best estimate for the weight of debt for use in calculating the WACC?

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

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