Question 1

Rivoli Inc.hired you as a consultant to help estimate its cost of capital.You have been provided with the following data: D0 = $0.80;P0 = $57.50;and g = 8.00% (constant) .Based on the DCF approach,what is the cost of equity from retained earnings? Do not round your intermediate calculations.

Accepted Answer

A)   11.02%
B)   10.17%
C)   9.50%
D)   10.07%
E)   7.98%F) A) and D)
G) A) and E)

Question 2

Cranberry Corp.has two divisions of equal size: a computer manufacturing division and a data processing division.Its CFO believes that stand-alone data processor companies typically have a WACC of 8%,while stand-alone computer manufacturers typically have a 12% WACC.He also believes that the data processing and manufacturing divisions have the same risk as their typical peers.Consequently,he estimates that the composite,or corporate,WACC is 10%.A consultant has suggested using an 8% hurdle rate for the data processing division and a 12% hurdle rate for the manufacturing division.However,the CFO disagrees,and he has assigned a 10% WACC to all projects in both divisions.Which of the following statements is CORRECT?

Accepted Answer

A)   While the decision to use just one WACC will result in its accepting more projects in the manufacturing division and fewer projects in its data processing division than if it followed the consultant's recommendation,this should not affect the firm's intrinsic value.
B)   The decision not to adjust for risk means,in effect,that it is favoring the data processing division.Therefore,that division is likely to become a larger part of the consolidated company over time.
C)   The decision not to adjust for risk means that the company will accept too many projects in the manufacturing division and too few in the data processing division.This will lead to a reduction in the firm's intrinsic value over time.
D)   The decision not to risk adjust means that the company will accept too many projects in the data processing business and too few projects in the manufacturing business.This will lead to a reduction in its intrinsic value over time.
E)   The decision not to risk adjust means that the company will accept too many projects in the manufacturing business and too few projects in the data processing business.This may affect the firm's capital structure but it will not affect its intrinsic value.F) C) and E)
G) A) and D)

Question 3

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 4

Bolster Foods' (BF) balance sheet shows a total of $25 million long-term debt with a coupon rate of 8.50%.The yield to maturity on this debt is 8.00%,and the debt has a total current market value of $27 million.The balance sheet also shows that the company has 10 million shares of stock,and the stock has a book value per share of $5.00.The current stock price is $20.00 per share,and stockholders' required rate of return,rs,is 12.00%.The company recently decided that its target capital structure should have 35% debt,with the balance being common equity.The tax rate is 40%.Calculate WACCs based on book,market,and target capital structures,and then find the sum of these three WACCs.Do not round your intermediate calculations.

Accepted Answer

A)   27.81%
B)   26.60%
C)   36.27%
D)   24.78%
E)   30.22%F) A) and E)
G) B) and D)

Question 5

Which of the following statements is CORRECT?

Accepted Answer

A)   The discounted cash flow method of estimating the cost of equity cannot be used unless the growth rate,g,is expected to be constant forever.
B)   If the calculated beta underestimates the firm's true investment risk-i.e. ,if the forward-looking beta that investors think exists exceeds the historical beta-then the CAPM method based on the historical beta will produce an estimate of rs and thus WACC that is too high.
C)   Beta measures market risk,which is,theoretically,the most relevant risk measure for a publicly-owned firm that seeks to maximize its intrinsic value.This is true even if not all of the firm's stockholders are well diversified.
D)   An advantage shared by both the DCF and CAPM methods when they are used to estimate the cost of equity is that they are both "objective" as opposed to "subjective," hence little or no judgment is required.
E)   The specific risk premium used in the CAPM is the same as the risk premium used in the bond-yield-plus-risk-premium approach.F) A) and E)
G) A) and B)

Question 6

The MacMillen Company has equal amounts of low-risk,average-risk,and high-risk projects.The firm's overall WACC is 12%.The CFO believes that this is the correct WACC for the company's average-risk projects,but that a lower rate should be used for lower-risk projects and a higher rate for higher-risk projects.The CEO disagrees,on the grounds that even though projects have different risks,the WACC used to evaluate each project should be the same because the company obtains capital for all projects from the same sources.If the CEO's position is accepted,what is likely to happen over time?

Accepted Answer

A)   The company will take on too many high-risk projects and reject too many low-risk projects.
B)   The company will take on too many low-risk projects and reject too many high-risk projects.
C)   Things will generally even out over time,and,therefore,the firm's risk should remain constant over time.
D)   The company's overall WACC should decrease over time because its stock price should be increasing.
E)   The CEO's recommendation would maximize the firm's intrinsic value.F) A) and B)
G) C) and D)

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 DCF method is widely used in practice.

Accepted Answer

A) True 
 B)False

Question 8

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) C) and D)
G) D) and E)

Question 9

Several years ago the Jakob Company sold a $1,000 par value,noncallable bond that now has 20 years to maturity and a 7.00% annual coupon that is paid semiannually.The bond currently sells for $875,and the company's tax rate is 40%.What is the component cost of debt for use in the WACC calculation? Do not round your intermediate calculations.

Accepted Answer

A)   4.58%
B)   4.97%
C)   3.78%
D)   4.92%
E)   5.87%F) A) and C)
G) All of the above

Question 10

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 11

Scanlon Inc.'s CFO hired you as a consultant to help her estimate the cost of capital.You have been provided with the following data: rRF = 4.10%;RPM = 5.25%;and b = 0.70.Based on the CAPM approach,what is the cost of equity from retained earnings?

Accepted Answer

A)   9.25%
B)   7.00%
C)   8.47%
D)   7.08%
E)   7.78%F) B) and D)
G) A) and B)

Question 12

Which of the following statements is CORRECT?

Accepted Answer

A)   Although some methods used to estimate the cost of equity are subject to severe limitations,the CAPM is a simple,straightforward,and reliable model that consistently produces accurate cost of equity estimates.In particular,academics and corporate finance people generally agree that its key inputs-beta,the risk-free rate,and the market risk premium-can be estimated with little error.
B)   The DCF model is generally preferred by academics and financial executives over other models for estimating the cost of equity.This is because of the DCF model's logical appeal and also because accurate estimates for its key inputs,the dividend yield and the growth rate,are easy to obtain.
C)   The bond-yield-plus-risk-premium approach to estimating the cost of equity may not always be accurate,but it has the advantage that its two key inputs,the firm's own cost of debt and its risk premium,can be found by using standardized and objective procedures.
D)   Surveys indicate that the CAPM is the most widely used method for estimating the cost of equity.However,other methods are also used because CAPM estimates may be subject to error,and people like to use different methods as checks on one another.If all of the methods produce similar results,this increases the decision maker's confidence in the estimated cost of equity.
E)   The DCF model is preferred by academics and finance practitioners over other cost of capital models because it correctly recognizes that the expected return on a stock consists of a dividend yield plus an expected capital gains yield.F) None of the above
G) A) and E)

Question 13

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 = $47.50;and g = 7.00% (constant) .Based on the DCF approach,what is the cost of equity from retained earnings? Do not round your intermediate calculations.

Accepted Answer

A)   8.85%
B)   10.38%
C)   10.02%
D)   8.03%
E)   9.03%F) A) and B)
G) A) and C)

Question 14

For capital budgeting and cost of capital purposes,the firm should always consider retained earnings as the first source of capital (i.e. ,use these funds first)because retained earnings have no cost to the firm.

Accepted Answer

A) True 
 B)False

Question 15

Exhibit 10.1
Assume that you have been hired as a consultant by CGT,a major producer of chemicals and plastics,including plastic grocery bags,styrofoam cups,and fertilizers,to estimate the firm's weighted average cost of capital.The balance sheet and some other information are provided below.
Assets   Current assets $38,000,000 Net plant, property, and equipment $101,000,000 Total assets $139,000,000\begin{array}{lr}	ext { Current assets } & \$ 38,000,000 \	ext { Net plant, property, and equipment } & \$ 101,000,000 \	ext { Total assets } & \$ 139,000,000\end{array} Current assets  Net plant, property, and equipment  Total assets ​$38,000,000$101,000,000$139,000,000​  ​
Liabilities and Equity   Accounts payable $10,000,000 Accruals $9,000,000 Current liabilities $19,000,000 Long-term debt ( 40,000 bonds, $1,000 par value)  $40,000,000 Total liabilities $59,000,000 Common stock ( 10,000,000 shares)  $30,000,000 Retained earnings $50,000,000 Total shareholders’ equity $80,000,000 Total liabilities and sharehol ders’ equity $139,000,000\begin{array}{lr}	ext { Accounts payable } & \$ 10,000,000 \	ext { Accruals } & \$ 9,000,000 \	ext { Current liabilities } & \$ 19,000,000 \	ext { Long-term debt ( } 40,000 	ext { bonds, } \$ 1,000 	ext { par value)  } & \$ 40,000,000 \	ext { Total liabilities } & \$ 59,000,000 \	ext { Common stock ( } 10,000,000 	ext { shares)  } & \$ 30,000,000 \	ext { Retained earnings } & \$ 50,000,000 \	ext { Total shareholders&#x27; equity } & \$ 80,000,000 \	ext { Total liabilities and sharehol ders&#x27; equity } & \$ 139,000,000 \\hline\end{array} Accounts payable  Accruals  Current liabilities  Long-term debt ( 40,000 bonds, $1,000 par value)   Total liabilities  Common stock ( 10,000,000 shares)   Retained earnings  Total shareholders’ equity  Total liabilities and sharehol ders’ equity ​$10,000,000$9,000,000$19,000,000$40,000,000$59,000,000$30,000,000$50,000,000$80,000,000$139,000,000​​  The stock is currently selling for $17.75 per share,and its noncallable $3,319.97 par value,20-year,1.70% bonds with semiannual payments are selling for $881.00.The beta is 1.29,the yield on a 6-month Treasury bill is 3.50%,and the yield on a 20-year Treasury bond is 5.50%.The required return on the stock market is 11.50%,but the market has had an average annual return of 14.50% during the past 5 years.The firm's tax rate is 40%.
-Refer to Exhibit 10.1.Which of the following is the best estimate for the weight of debt for use in calculating the WACC? Do not round your intermediate calculations.

Accepted Answer

A)   16.56%
B)   17.23%
C)   17.57%
D)   17.92%
E)   18.64% F) B) and D)
G) A) and C)

Question 16

You were hired as a consultant to Quigley Company,whose target capital structure is 35% debt,10% preferred,and 55% common equity.The interest rate on new debt is 6.50%,the yield on the preferred is 6.00%,the cost of retained earnings is 14.75%,and the tax rate is 40%.The firm will not be issuing any new stock.What is Quigley's WACC? Round final answer to two decimal places.Do not round your intermediate calculations.

Accepted Answer

A)   12.19%
B)   8.36%
C)   9.17%
D)   10.08%
E)   8.87%F) B) and C)
G) A) and D)

Question 17

Which of the following statements is CORRECT?

Accepted Answer

A)   In the WACC calculation,we must adjust the cost of preferred stock (the market yield) to reflect the fact that 70% of the dividends received by corporate investors are excluded from their taxable income.
B)   We should use historical measures of the component costs from prior financings that are still outstanding when estimating a company's WACC for capital budgeting purposes.
C)   The cost of new equity (re) could possibly be lower than the cost of retained earnings (rs) if the market risk premium,risk-free rate,and the company's beta all decline by a sufficiently large amount.
D)   Its cost of retained earnings is the rate of return stockholders require on a firm's common stock.
E)   The component cost of preferred stock is expressed as rp(1 - T) ,because preferred stock dividends are treated as fixed charges,similar to the treatment of interest on debt.F) A) and E)
G) A) and D)

Question 18

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.Since we cannot be sure that the estimate obtained with any of these methods is correct,it is often appropriate to use all three methods,then consider all three estimates,and end up using a judgmental estimate when calculating the WACC.

Accepted Answer

A) True 
 B)False

Question 19

Which of the following statements is CORRECT?

Accepted Answer

A)   The component cost of preferred stock is expressed as rp(1 - T) .This follows because preferred stock dividends are treated as fixed charges,and as such they can be deducted by the issuer for tax purposes.
B)   A cost should be assigned to retained earnings due to the opportunity cost principle,which refers to the fact that the firm's stockholders would themselves expect to earn a return on earnings that were paid out rather than retained and reinvested.
C)   No cost should be assigned to retained earnings because the firm does not have to pay anything to raise them.They are generated as cash flows by operating assets that were raised in the past,hence they are "free."
D)   Suppose a firm has been losing money and thus is not paying taxes,and this situation is expected to persist into the foreseeable future.In this case,the firm's before-tax and after-tax costs of debt for purposes of calculating the WACC will both be equal to the interest rate on the firm's currently outstanding debt,provided that debt was issued during the past 5 years.
E)   If a firm has enough retained earnings to fund its capital budget for the coming year,then there is no need to estimate either a cost of equity or a WACC.F) B) and C)
G) C) and D)

Question 20

Which of the following statements is CORRECT?

Accepted Answer

A)   The "break point" as discussed in the text refers to the point where the firm's tax rate increases.
B)   The "break point" as discussed in the text refers to the point where the firm has raised so much capital that it is simply unable to borrow any more money.
C)   The "break point" as discussed in the text refers to the point where the firm is taking on investments that are so risky the firm is in serious danger of going bankrupt if things do not go exactly as planned.
D)   The "break point" as discussed in the text refers to the point where the firm has raised so much capital that it has exhausted its supply of additions to retained earnings and thus must raise equity by issuing stock.
E)   The "break point" as discussed in the text refers to the point where the firm has exhausted its supply of additions to retained earnings and thus must begin to finance with preferred stock.F) D) and E)
G) B) and D)

Exam 10: The Cost of Capital

Which of the following statements is CORRECT?

Correct Answer
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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
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Correct Answer
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Correct Answer
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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 DCF method is widely used in practice.

Correct Answer
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Correct Answer
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Which of the following statements is CORRECT?

Correct Answer
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Which of the following statements is CORRECT?

Correct Answer
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Which of the following statements is CORRECT?

Correct Answer
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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 = $47.50;and g = 7.00% (constant) .Based on the DCF approach,what is the cost of equity from retained earnings? Do not round your intermediate calculations.

Correct Answer
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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
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Correct Answer
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Which of the following statements is CORRECT?

Correct Answer
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Correct Answer
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Rivoli Inc.hired you as a consultant to help estimate its cost of capital.You have been provided with the following data: D₀ = $0.80;P₀ = $57.50;and g = 8.00% (constant) .Based on the DCF approach,what is the cost of equity from retained earnings? Do not round your intermediate calculations.

Correct Answer
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Correct Answer
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Scanlon Inc.'s CFO hired you as a consultant to help her estimate the cost of capital.You have been provided with the following data: r_RF = 4.10%;RP_M = 5.25%;and b = 0.70.Based on the CAPM approach,what is the cost of equity from retained earnings?

Correct Answer
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Correct Answer
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Which of the following statements is CORRECT?

Correct Answer
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For capital budgeting and cost of capital purposes,the firm should always consider retained earnings as the first source of capital (i.e. ,use these funds first)because retained earnings have no cost to the firm.

Correct Answer
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Exam 10: The Cost of Capital

Which of the following statements is CORRECT?

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

Correct AnswerverifiedShow Answer

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 DCF method is widely used in practice.

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Which of the following statements is CORRECT?

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 = $47.50;and g = 7.00% (constant) .Based on the DCF approach,what is the cost of equity from retained earnings? Do not round your intermediate calculations.

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

Correct AnswerverifiedShow Answer

Which of the following statements is CORRECT?

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Rivoli Inc.hired you as a consultant to help estimate its cost of capital.You have been provided with the following data: D0 = $0.80;P0 = $57.50;and g = 8.00% (constant) .Based on the DCF approach,what is the cost of equity from retained earnings? Do not round your intermediate calculations.

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Scanlon Inc.'s CFO hired you as a consultant to help her estimate the cost of capital.You have been provided with the following data: rRF = 4.10%;RPM = 5.25%;and b = 0.70.Based on the CAPM approach,what is the cost of equity from retained earnings?

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Which of the following statements is CORRECT?

Correct AnswerverifiedShow Answer

For capital budgeting and cost of capital purposes,the firm should always consider retained earnings as the first source of capital (i.e. ,use these funds first)because retained earnings have no cost to the firm.

Correct AnswerverifiedShow Answer

Correct Answer
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Correct Answer
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Correct Answer
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Correct Answer
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Correct Answer
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Correct Answer
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Correct Answer
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Correct Answer
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Correct Answer
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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 = $47.50;and g = 7.00% (constant) .Based on the DCF approach,what is the cost of equity from retained earnings? Do not round your intermediate calculations.

Correct Answer
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Correct Answer
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Correct Answer
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Correct Answer
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Correct Answer
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Rivoli Inc.hired you as a consultant to help estimate its cost of capital.You have been provided with the following data: D₀ = $0.80;P₀ = $57.50;and g = 8.00% (constant) .Based on the DCF approach,what is the cost of equity from retained earnings? Do not round your intermediate calculations.

Correct Answer
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Correct Answer
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Scanlon Inc.'s CFO hired you as a consultant to help her estimate the cost of capital.You have been provided with the following data: r_RF = 4.10%;RP_M = 5.25%;and b = 0.70.Based on the CAPM approach,what is the cost of equity from retained earnings?

Correct Answer
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Correct Answer
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Correct Answer
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Correct Answer
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