Question 1

The cost of retained earnings differs from the cost of new equity due to:

Accepted Answer

A)  flotation costs.
B)  dividends.
C)  capital gains yields.
D)  Both a & c
E)  All of the above

Question 2

With a combined federal and state corporate tax rate of 40% and a market yield of 8% on long-term debt, the after-tax cost of debt is 3.20%.

Accepted Answer

A) True 
 B)False

Question 3

Which of the following is a reason why calculating the capital structure based on market prices is considered tedious?

Accepted Answer

A)  Accurate market prices can never be determined.
B)  Dividend payout ratios on stocks are usually unpredictable.
C)  The market-based structure is constantly changing.
D)  The implied error in market-based structures is large.

Question 4

Which is incorrect in regard to the firm's cost of capital?

Accepted Answer

A)  It is the risk adjusted discount rate that is appropriate for all projects under consideration by the firm.
B)  It is the average rate for using the firm's funds.
C)  It is the opportunity cost of using the firm's funds.
D)  It is the minimum rate of return a project must generate to warrant consideration by management.

Question 5

An increase in a firm's operating risk will have no impact on its cost of capital.

Accepted Answer

A) True 
 B)False

Question 6

Using the Gordon Model, estimate the cost of retained earnings for a firm whose stock is currently selling for $40, paid a dividend of $.75 last year, and whose growth is expected to be 6% indefinitely.

Accepted Answer

A)  7.25%
B)  7.99%
C)  10.62%
D)  4/80%

Question 7

The marginal cost of capital (MCC)is the cost of the next dollar of capital to be raised.

Accepted Answer

A) True 
 B)False

Question 8

Although the money paid to investors is both the firm's cost and the investors return:

Accepted Answer

A)  certain adjustments prevent the effective cost and return from being the same.
B)  adjustments must be made to keep the effective cost and return equal.
C)  adjustments keep the costs of common and preferred equity equal but debt's cost is usually higher.
D)  a and c

Question 9

Different securities issued by the same company have different levels of risk so that:

Accepted Answer

A)  equity (stock) has the highest risk, debt (bonds) the lowest, and preferred stock is in between.
B)  equity (stock) has the lowest risk, debt (bonds) the highest, and preferred stock is in between.
C)  Preferred stock has the highest risk because it's an unusual security that doesn't interest many investors, equity (stock) and debt (bonds) are about the same.
D)  debt is the riskiest security because companies often default on bonds before failing entirely; preferred stock is a little safer than common stock, that's why it's called preferred.

Question 10

The only reason for the difference between the effective cost of capital and investors' returns is the tax effect of interest payments, which reduces the firm's cost of debt.

Accepted Answer

A) True 
 B)False

Question 11

The capital structure is industry specific and not firm specific. That is, all firms in a particular industry will have the same capital structure.

Accepted Answer

A) True 
 B)False

Question 12

Capital structure and component costs should be calculated using:

Accepted Answer

A)  book values for structure and market values for costs.
B)  market values for structure and book values for costs.
C)  book values for both structure and costs.
D)  market values for both structure and costs.

Question 13

The component cost of a firm's preferred stock consists of:

Accepted Answer

A)  the current dividend yield.
B)  the expected growth rate of dividends.
C)  dividends expressed as a percent of par value.
D)  a and b

Question 14

A firm's target capital structure is 30% debt and 70% equity and retained earnings are planned at $1.4 million. The first breakpoint in the MCC is at $2 million.

Accepted Answer

A) True 
 B)False

Question 15

The cost of capital can be described best as the:

Accepted Answer

A)  rate a firm pays for the use of invested funds.
B)  the minimum return required of capital budgeting projects that are about as risky as the firm.
C)  Either of the above
D)  None of the above

Question 16

All of the following represent adjustments to the cost of capital components except:

Accepted Answer

A)  the tax effect on debt.
B)  the tax effect on equity.
C)  floatation costs when issuing preferred stock.
D)  floatation costs when issuing common stock.
E)  All of the above could represent adjustments to the cost of capital components.

Question 17

The most recent dividend was $2.50, the anticipated constant growth rate is 4%, the selling price today is $28 per share, and flotation costs are 18%. What is the cost of retained earnings ?

Accepted Answer

A)  15.3%
B)  14.9%
C)  12.9%
D)  13.3%

Question 18

It is appropriate that the WACC reflect historic costs of capital as the best estimate of what capital will cost during the coming period.

Accepted Answer

A) True 
 B)False

Question 19

The weighted-average cost of capital:

Accepted Answer

A)  blends the returns required by all suppliers of funds.
B)  incorporates the firm's capital structure in its calculation.
C)  is virtually never lower than the cost of debt nor higher than the cost of equity.
D)  All of the above

Question 20

The cost of capital is used primarily in:

Accepted Answer

A)  negotiations with banks because it reflects the company's overall borrowing power.
B)  setting the firm's basic risk level.
C)  capital budgeting because it reflects what the firm pays for the money it invests.
D)  negotiations with investment bankers because it establishes an overall return on which the market can base prices for the firm's securities.

Exam 13: Cost of Capital

All of the following represent adjustments to the cost of capital components except:

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The weighted-average cost of capital:

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The component cost of a firm's preferred stock consists of:

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Although the money paid to investors is both the firm's cost and the investors return:

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With a combined federal and state corporate tax rate of 40% and a market yield of 8% on long-term debt, the after-tax cost of debt is 3.20%.

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The only reason for the difference between the effective cost of capital and investors' returns is the tax effect of interest payments, which reduces the firm's cost of debt.

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Different securities issued by the same company have different levels of risk so that:

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The cost of retained earnings differs from the cost of new equity due to:

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Using the Gordon Model, estimate the cost of retained earnings for a firm whose stock is currently selling for $40, paid a dividend of $.75 last year, and whose growth is expected to be 6% indefinitely.

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It is appropriate that the WACC reflect historic costs of capital as the best estimate of what capital will cost during the coming period.

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The capital structure is industry specific and not firm specific. That is, all firms in a particular industry will have the same capital structure.

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The marginal cost of capital (MCC)is the cost of the next dollar of capital to be raised.

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A firm's target capital structure is 30% debt and 70% equity and retained earnings are planned at $1.4 million. The first breakpoint in the MCC is at $2 million.

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The most recent dividend was $2.50, the anticipated constant growth rate is 4%, the selling price today is $28 per share, and flotation costs are 18%. What is the cost of retained earnings ?

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The cost of capital is used primarily in:

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Capital structure and component costs should be calculated using:

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Which of the following is a reason why calculating the capital structure based on market prices is considered tedious?

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An increase in a firm's operating risk will have no impact on its cost of capital.

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Which is incorrect in regard to the firm's cost of capital?

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The cost of capital can be described best as the:

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