Question 1

Which of the following statements is CORRECT? Assume that the firm is a publicly-owned corporation and is seeking to maximize shareholder wealth.

Accepted Answer

A)   If a firm has a beta that is less than 1.0,say 0.9,this would suggest that the expected returns on its assets are negatively correlated with the returns on most other firms' assets.
B)   If a firm's managers want to maximize the value of the stock,they should,in theory,concentrate on project risk as measured by the standard deviation of the project's expected future cash flows.
C)   If a firm evaluates all projects using the same cost of capital,and the CAPM is used to help determine that cost,then its risk as measured by beta will probably decline over time.
D)   Projects with above-average risk typically have higher-than-average expected returns.Therefore,to maximize a firm's intrinsic value,its managers should favor high-beta projects over those with lower betas.
E)   Project A has a standard deviation of expected returns of 20%,while Project B's standard deviation is only 10%.A's returns are negatively correlated with both the firm's other assets and the returns on most stocks in the economy,while B's returns are positively correlated.Therefore,Project A is less risky to a firm and should be evaluated with a lower cost of capital.F) A) and B)
G) A) and C)

Question 2

Which of the following statements is CORRECT?

Accepted Answer

A)   The WACC as used in capital budgeting is an estimate of a company's before-tax cost of capital.
B)   The percentage flotation cost associated with issuing new common equity is typically smaller than the flotation cost for new debt.
C)   The WACC as used in capital budgeting is an estimate of the cost of all the capital a company has raised to acquire its assets.
D)   There is an "opportunity cost" associated with using retained earnings,hence they are not "free."
E)   The WACC as used in capital budgeting would be simply the before-tax cost of debt if the firm plans to use only debt to finance its capital budget during the coming year.F) A) and B)
G) C) and E)

Question 3

Which of the following is NOT a capital component when calculating the weighted average cost of capital (WACC) for use in capital budgeting?

Accepted Answer

A)   Long-term debt.
B)   Accounts payable.
C)   Retained earnings.
D)   Common stock.
E)   Preferred stock.F) B) and E)
G) None of the above

Question 4

S.Bouchard and Company hired you as a consultant to help estimate its cost of capital.You have obtained the following data: D0 = $0.85;P0 = $22.00;and g = 6.00% (constant) .The CEO thinks,however,that the stock price is temporarily depressed,and that it will soon rise to $34.00.Based on the DCF approach,by how much would the cost of equity from retained earnings change if the stock price changes as the CEO expects? Do not round your intermediate calculations.

Accepted Answer

A)   -1.45%
B)   -1.72%
C)   -1.11%
D)   -1.40%
E)   -1.36%F) A) and D)
G) A) and C)

Question 5

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 or is available online.
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) A) and E)
G) All of the above

Question 6

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 = $19.00;and g = 6.50% (constant) .Based on the DCF approach,what is the cost of equity from retained earnings?

Accepted Answer

A)   10.88%
B)   15.26%
C)   14.41%
D)   13.00%
E)   14.13%F) A) and C)
G) C) and E)

Question 7

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 $37.50 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? Do not round your intermediate calculations.

Accepted Answer

A)   9.41%
B)   8.72%
C)   7.58%
D)   9.94%
E)   8.80%F) B) and E)
G) C) and D)

Question 8

In general,firms should use their weighted average cost of capital (WACC)to evaluate capital budgeting projects because most projects are funded with general corporate funds,which come from a variety of sources.However,if the firm plans to use only debt or only equity to fund a particular project,it should use the after-tax cost of that specific type of capital to evaluate that project.

Accepted Answer

A) True 
 B)False

Question 9

Vang Enterprises,which is debt-free and finances only with equity from retained earnings,is considering 7 equal-sized capital budgeting projects.Its CFO hired you to assist in deciding whether none,some,or all of the projects should be accepted.You have the following information: rRF = 4.50%;RPM = 5.50%;and b = 0.98.The company adds or subtracts a specified percentage to the corporate WACC when it evaluates projects that have above- or below-average risk.Data on the 7 projects are shown below.If these are the only projects under consideration,how large should the capital budget be?   Project  Risk  Risk factor  Expected  return  Cost (millions)  1 Very low −2.00%7.60%$252 Low −1.00%9.15%$253 Average 0.00%10.10%$254 High 1.00%10.40%$255 Very high 2.00%10.80%$256 Very high 2.00%10.90%$257 Very high 2.00%13.00%$25\begin{array} { l l l l l } 	ext { Project } & 	ext { Risk } & 	ext { Risk factor } & \begin{array} { l } 	ext { Expected } \	ext { return }\end{array} & 	ext { Cost (millions)  } \\hline 1 & 	ext { Very low } & - 2.00 \% & 7.60 \% & \$ 25 \2 & 	ext { Low } & - 1.00 \% & 9.15 \% & \$ 25 \3 & 	ext { Average } & 0.00 \% & 10.10 \% & \$ 25 \4 & 	ext { High } & 1.00 \% & 10.40 \% & \$ 25 \5 & 	ext { Very high } & 2.00 \% & 10.80 \% & \$ 25 \6 & 	ext { Very high } & 2.00 \% & 10.90 \% & \$ 25 \7 & 	ext { Very high } & 2.00 \% & 13.00 \% & \$ 25\end{array} Project 1234567​ Risk  Very low  Low  Average  High  Very high  Very high  Very high ​ Risk factor −2.00%−1.00%0.00%1.00%2.00%2.00%2.00%​ Expected  return ​7.60%9.15%10.10%10.40%10.80%10.90%13.00%​ Cost (millions)  $25$25$25$25$25$25$25​​ 
?

Accepted Answer

A)   $100 million
B)   $125 million
C)   $25 million
D)   $50 million
E)   $75 million F) A) and B)
G) A) and C)

Question 10

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 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

Which of the following statements is CORRECT?

Accepted Answer

A)   Since the costs of internal and external equity are related,an increase in the flotation cost required to sell a new issue of stock will increase the cost of retained earnings.
B)   Since its stockholders are not directly responsible for paying a corporation's income taxes,corporations should focus on before-tax cash flows when calculating the WACC.
C)   An increase in a firm's tax rate will increase the component cost of debt,provided the YTM on the firm's bonds is not affected by the change in the tax rate.
D)   When the WACC is calculated,it should reflect the costs of new common stock,retained earnings,preferred stock,long-term debt,short-term bank loans if the firm normally finances with bank debt,and accounts payable if the firm normally has accounts payable on its balance sheet.
E)   If a firm has been suffering accounting losses that are expected to continue into the foreseeable future,and therefore its tax rate is zero,then it is possible for the after-tax cost of preferred stock to be less than the after-tax cost of debt.F) B) and C)
G) A) and D)

Question 13

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 14

When estimating the cost of equity by use of the bond-yield-plus-risk-premium method,we can generally get a good idea of the interest rate on new long-term debt,but we cannot be sure that the risk premium we add is appropriate.This problem leaves us unsure of the true value of rs.

Accepted Answer

A) True 
 B)False

Question 15

The before-tax cost of debt,which is lower than the after-tax cost,is used as the component cost of debt for purposes of developing the firm's WACC.

Accepted Answer

A) True 
 B)False

Question 16

Sapp Trucking's balance sheet shows a total of noncallable $45 million long-term debt with a coupon rate of 7.00% and a yield to maturity of 6.00%.This debt currently has a market value of $50 million.The balance sheet also shows that the company has 10 million shares of common stock,and the book value of the common equity (common stock plus retained earnings) is $65 million.The current stock price is $22.50 per share;stockholders' required return,rs,is 14.00%;and the firm's tax rate is 40%.The CFO thinks the WACC should be based on market value weights,but the president thinks book weights are more appropriate.What is the difference between these two WACCs?

Accepted Answer

A)   2.48%
B)   2.25%
C)   2.36%
D)   2.95%
E)   1.77%F) A) and B)
G) A) and C)

Question 17

If expectations for long-term inflation rose,but the slope of the SML remained constant,this would have a greater impact on the required rate of return on equity,rs,than on the interest rate on long-term debt,rd,for most firms.Therefore,the percentage point increase in the cost of equity would be greater than the increase in the interest rate on long-term debt.

Accepted Answer

A) True 
 B)False

Question 18

Norris Enterprises,an all-equity firm,has a beta of 2.0.The chief financial officer is evaluating a project with an expected return of 14%,before any risk adjustment.The risk-free rate is 5%,and the market risk premium is 4%.The project being evaluated is riskier than the firm's average project,in terms of both its beta risk and its total risk.Which of the following statements is CORRECT?

Accepted Answer

A)   The project should definitely be accepted because its expected return (before any risk adjustments) is greater than its required return.
B)   The project should definitely be rejected because its expected return (before risk adjustment) is less than its required return.
C)   Riskier-than-average projects should have their expected returns increased to reflect their higher risk.Clearly,this would make the project acceptable regardless of the amount of the adjustment.
D)   The accept/reject decision depends on the firm's risk-adjustment policy.If Norris' policy is to increase the required return on a riskier-than-average project to 3% over rs,then it should reject the project.
E)   Capital budgeting projects should be evaluated solely on the basis of their total risk.Thus,insufficient information has been provided to make the accept/reject decision.F) A) and B)
G) C) and D)

Question 19

Duval Inc.uses only equity capital,and it has two equally-sized divisions.Division A's cost of capital is 10.0%,Division B's cost is 14.0%,and the corporate (composite) WACC is 12.0%.All of Division A's projects are equally risky,as are all of Division B's projects.However,the projects of Division A are less risky than those of Division B.Which of the following projects should the firm accept?

Accepted Answer

A)   A Division B project with a 13% return.
B)   A Division B project with a 12% return.
C)   A Division A project with an 11% return.
D)   A Division A project with a 9% return.
E)   A Division B project with an 11% return.F) A) and B)
G) A) and C)

Question 20

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.What is the best estimate of the firm's WACC? Do not round your intermediate calculations.

Accepted Answer

A)   11.26%
B)   11.74%
C)   12.11%
D)   12.59%
E)   12.97% F) A) and E)
G) A) and B)

Exam 10: The Cost of Capital

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 NOT a capital component when calculating the weighted average cost of capital (WACC) for use in capital budgeting?

Correct Answer
verified

Correct Answer
verified

When estimating the cost of equity by use of the bond-yield-plus-risk-premium method,we can generally get a good idea of the interest rate on new long-term debt,but we cannot be sure that the risk premium we add is appropriate.This problem leaves us unsure of the true value of r_s.

Correct Answer
verified

The before-tax cost of debt,which is lower than the after-tax cost,is used as the component cost of debt for purposes of developing the firm's WACC.

Correct Answer
verified

Which of the following statements is CORRECT?

Correct Answer
verified

Which of the following statements is CORRECT? Assume that the firm is a publicly-owned corporation and is seeking to maximize shareholder wealth.

Correct Answer
verified

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

Correct Answer
verified

Correct Answer
verified

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

Correct Answer
verified

Which of the following statements is CORRECT?

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Which of the following statements is CORRECT?

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 = $19.00;and g = 6.50% (constant) .Based on the DCF approach,what is the cost of equity from retained earnings?

Correct Answer
verified

Exam 10: The Cost of Capital

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 NOT a capital component when calculating the weighted average cost of capital (WACC) for use in capital budgeting?

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

When estimating the cost of equity by use of the bond-yield-plus-risk-premium method,we can generally get a good idea of the interest rate on new long-term debt,but we cannot be sure that the risk premium we add is appropriate.This problem leaves us unsure of the true value of rs.

Correct AnswerverifiedShow Answer

The before-tax cost of debt,which is lower than the after-tax cost,is used as the component cost of debt for purposes of developing the firm's WACC.

Correct AnswerverifiedShow Answer

Which of the following statements is CORRECT?

Correct AnswerverifiedShow Answer

Which of the following statements is CORRECT? Assume that the firm is a publicly-owned corporation and is seeking to maximize shareholder wealth.

Correct AnswerverifiedShow Answer

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

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

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

Correct AnswerverifiedShow Answer

Which of the following statements is CORRECT?

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Which of the following statements is CORRECT?

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 = $19.00;and g = 6.50% (constant) .Based on the DCF approach,what is the cost of equity from retained earnings?

Correct AnswerverifiedShow Answer

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

When estimating the cost of equity by use of the bond-yield-plus-risk-premium method,we can generally get a good idea of the interest rate on new long-term debt,but we cannot be sure that the risk premium we add is appropriate.This problem leaves us unsure of the true value of r_s.

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

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 = $19.00;and g = 6.50% (constant) .Based on the DCF approach,what is the cost of equity from retained earnings?

Correct Answer
verified