Exam 11: The Cost of Capital

Because the value of a firm's stock depends on the after-tax cash flows it generates during its life, after-tax component costs of capital (i.e., the after-tax cost of debt) are used when computing a firm's weighted average cost of capital (WACC). 

Coral Inc.'s preferred stock currently sells for $90 a share and pays a dividend of $10 per share. However, the firm will net only $80 per share if it issues new preferred stock. What is Coral's cost of preferred stock? Coral's marginal tax rate is 35 percent. 

Which of the following is a major assumption that is embedded in the capital asset pricing model (CAPM), which is often used to estimate the cost of retained earnings, r_s?

The value of any asset-real or financial-is based on the _____ and the _____. 

Byron Corporation forecasts that its income will be $21,000 next year. The firm pays out 30 percent of earnings as dividends to common stockholders. Its target capital structure is 40 percent debt and 60 percent common equity. What Byron's retained earnings break point?

Alpha Inc.'s beta coefficient is 1.2, the risk-free rate is 10 percent, and the market risk premium is 5 percent. Based on the capital asset pricing model (CAPM), what should be Alpha's cost of retained earnings?

If a project's _____ exceeds the firm's weighted average cost of capital (WACC), its net present value (NPV) will be positive. 

Under normal circumstances, the weighted average cost of capital (WACC) is used as the firm's required rate of return because:

Beige Inc. is evaluating three capital budgeting projects whose internal rates of return (IRRs) are greater than the firm's marginal cost of capital (MCC). Beige should choose:

Bouchard Company's stock sells for $20 per share, its last dividend (D0) was $1.00, its growth rate is a constant 6 percent, and the company must pay flotation cost equal to 20 percent when it issues new common stock. What is Bouchard's cost of issuing new common stock?

According to the bond-yield-plus-risk-premium approach, a firm's cost of retained earnings, r_s, can be estimated by adding a risk premium of 3 to 5 percentage points to:

The target capital structure of a firm is the capital structure that:

Which of the following statements about the marginal cost of capital is correct? Assume everything else is equal. 

Which of the following statements is correct about using the capital asset pricing model (CAPM) to determine a firm's component costs of capital?

SW Inc.'s preferred stock, which pays a $5.25 dividend each year, currently sells for $62.50. The company's marginal tax rate is 40 percent. When it issues preferred stock, SW normally incurs flotation costs equal to 8 percent. What is the cost of preferred stock, r_ps, that should be included in the computation of the SW Inc.'s weighted average cost of capital (WACC)?

The weighted average cost of capital of a firm represents the:

The marginal cost of capital (MCC) is the weighted average cost of the last dollar of new capital that the firm raises. The MCC generally declines as greater amounts of a specific type of capital are raised during a given period. 

Diggin Tools plans to issue new preferred stock, which has a market value of $85 per share. Holders of the stock will receive an annual dividend equal to $9.35. The flotation costs associated with the new issue were 6 percent and Diggin's marginal tax rate is 30 percent. What Diggin's component cost of preferred stock, r_ps?

Everything else equal, an asset's value is:

A firm should continue to invest in capital budgeting projects until its marginal cost of capital is equal to the: