Question 1

The results of the dividend growth model:

Accepted Answer

A) vary directly with the market rate of return. 
B) can only be applied to projects that have a growth rate equal to that of the current firm. 
C) are highly dependent upon the beta used in the model. 
D) are sensitive to the rate of dividend growth. 
E) are most reliable when the growth rate exceeds 10 percent.

Question 2

Great Lakes Packing has two bond issues outstanding.The first issue has a coupon rate of8 percent,matures in 6 years,has a total face value of $5 million,and is quoted at 101.2 percent of face value.The second issue has a 7.5 percent coupon,matures in 13 years,has a total face value of $18 million,and is quoted at 99 percent of face value.Both bonds pay interest semiannually.What is the firm's weighted average aftertax cost of debt if the tax rate is 34 percent?

Accepted Answer

A) 5.05 percent 
B) 5.12 percent 
C) 5.63 percent 
D) 5.95 percent 
E) 6.08 percent

Question 3

Titans has 7 percent bonds outstanding that mature in 16 years.The bonds pay interest semiannually and have a face value of $1,000.Currently,the bonds are selling for $1,015 each.What is the firm's pretax cost of debt?

Accepted Answer

A) 6.97 percent 
B) 6.84 percent 
C) 7.14 percent 
D) 7.31 percent 
E) 6.40 percent

Question 4

Rockingham Motors issued a 30-year,8 percent semiannual bond 3 years ago.The bond currently sells for 103.1 percent of its face value.The company's tax rate is 34 percent.What is the aftertax cost of debt?

Accepted Answer

A) 2.72 percent 
B) 5.10 percent 
C) 5.69 percent 
D) 5.72 percent 
E) 5.99 percent

Question 5

A firm that uses its weighted average cost of capital as the required return for all of its investments will:

Accepted Answer

A) maintain a constant value for its shareholders. 
B) increase the risk level of the firm over time. 
C) make the best possible accept and reject decisions related to those investments. 
D) find that its cost of capital declines over time. 
E) accept only the projects that add value to the firm's shareholders.

Question 6

Precision Cuts has a target debt-equity ratio of .48.Its cost of equity is 16.4 percent,and its pretax cost of debt is 8.2 percent.If the tax rate is 34 percent,what is the company's WACC?

Accepted Answer

A) 13.20 percent 
B) 11.72 percent 
C) 12.91 percent 
D) 11.28 percent 
E) 12.84 percent

Question 7

The Green Balloon just paid its first annual dividend of $.87 a share.The firm plans to increase the dividend by 3.2 percent per year indefinitely.What is the firm's cost of equity if the current stock price is $4.75 a share?

Accepted Answer

A) 20.35 percent 
B) 22.10 percent 
C) 24.42 percent 
D) 18.79 percent 
E) 19.98 percent

Question 8

Given the following information for Electric Transport,find the WACC.Assume the company's tax rate is 35 percent. Debt:
8,100,6.9 percent coupon bonds outstanding.$1,000 par value,17 years to maturity,selling for 101 percent of par,the bonds make semiannual payments.
Common stock:
175,000 shares outstanding,selling for $77 per share,beta is 1.32.
Preferred stock:
9,000 shares of $7.50 preferred stock outstanding,currently selling for $73 per share.
Market:
7)9 percent market risk premium and 3.6 percent risk-free rate.

Accepted Answer

A) 10.4 percent 
B) 12.0 percent 
C) 12.4 percent 
D) 11.1 percent 
E) 9.8 percent

Question 9

Piedmont Hotels is an all-equity firm with 48,000 shares of stock outstanding.The stock has a beta of 1.19 and a standard deviation of 14.8 percent.The market risk premium is 7.8 percent and the risk-free rate of return is 4.1 percent.The company is considering a project that it considers riskier than its current operations so has assigned an adjustment of 1.35 percent to the project's discount rate.What should the firm set as the required rate of return for the project?

Accepted Answer

A) 9.85 percent 
B) 10.92 percent 
C) 15.39 percent 
D) 14.73 percent 
E) 17.33 percent

Question 10

Trendsetters has a cost of equity of 14.6 percent.The market risk premium is 8.4 percent and the risk-free rate is 3.9 percent.The company is acquiring a competitor,which will increase the company's beta to 1.4.What effect,if any,will the acquisition have on the firm's cost of equity capital?

Accepted Answer

A) No effect 
B) Decrease of .62 percent 
C) Decrease of .84 percent 
D) Increase of 1.06 percent 
E) Increase of .13 percent

Question 11

The cost of preferred stock:

Accepted Answer

A) increases when a firm's tax rate decreases. 
B) is constant over time. 
C) is unaffected by changes in the market price of the stock. 
D) is equal to the stock's dividend yield. 
E) increases as the price of the stock increases.

Question 12

The Five and Dime Store has a cost of equity of 14.8 percent,a pretax cost of debt of 6.7 percent,and a tax rate of 34 percent.What is the firm's weighted average cost of capital if the debt-equity ratio is .46?

Accepted Answer

A) 10.18 percent 
B) 11.72 percent 
C) 11.53 percent 
D) 13.49 percent 
E) 14.93 percent

Question 13

Which one of the following statements concerning capital structure weights is correct?

Accepted Answer

A) Target capital structure rates for a firm are irrelevant to individual projects. 
B) The weights are unaffected when a bond issue matures. 
C) An increase in the debt-equity ratio will increase the weight of the common stock. 
D) The repurchase of preferred stock will increase the weight of debt. 
E) The issuance of additional shares of common stock will increase the weight of both the common and preferred stock

Question 14

Which statement is true?

Accepted Answer

A) An increase in the market value of preferred stock will increase a firm's weighted average cost of capital. 
B) The cost of preferred stock is unaffected by the issuer's tax rate. 
C) Preferred stock is generally the cheapest source of capital for a firm. 
D) The cost of preferred stock remains constant from year to year. 
E) Preferred stock is valued using the capital asset pricing model.

Question 15

Which statement is correct,all else held constant?

Accepted Answer

A) Beta is used to compute the return on equity and the standard deviation is used to compute the return on preferred. 
B) A decrease in a firm's WACC will increase the attractiveness of the firm's investment options. 
C) The aftertax cost of debt increases when the market price of a bond increases. 
D) If you have both the dividend growth and the security market line's costs of equity, you should use the higher of the two estimates when computing WACC. 
E) WACC is applicable only to firms that issue both common and preferred stock

Question 16

Which one of the following statements is correct? Assume the pretax cost of debt is less than the cost of equity.

Accepted Answer

A) A firm may change its capital structure if the government changes its tax policies. 
B) A decrease in the dividend growth rate increases the cost of equity. 
C) A decrease in the systematic risk of a firm will increase the firm's cost of capital. 
D) A decrease in a firm's debt-equity ratio will decrease the firm's cost of capital. 
E) The cost of preferred stock decreases when the tax rate increases.

Question 17

Stock in ABC Enterprises has a beta of 1.28.The market risk premium is 7.4 percent,and T-bills are currently yielding 3.6 percent.ABC's most recently paid dividend was $1.62 per share,and dividends are expected to grow at an annual rate of 2 percent indefinitely.If the stock sells for $38 a share,what is your best estimate of ABC's cost of equity?

Accepted Answer

A) 9.78 percent 
B) 7.82 percent 
C) 9.71 percent 
D) 9.41 percent 
E) 7.41 percent

Question 18

You want to use the pure play approach to assign a cost of capital to a proposed investment.Which one of the following characteristics should you most concentrate on as you search for an appropriate pure play firm?

Accepted Answer

A) Firm size 
B) Firm location 
C) Firm experience 
D) Firm operations 
E) Firm management

Question 19

Farmer's Supply is considering opening a clothing store,which would be a new line of business for the firm.Management has decided to use the cost of capital of a similar clothing store as the discount rate to evaluate this proposed expansion.Which one of the following terms describes this evaluation approach?

Accepted Answer

A) Equity approach 
B) Aftertax approach 
C) Subjective approach 
D) Market play 
E) Pure play approach

Question 20

Which one of the following is used as the pretax cost of debt?

Accepted Answer

A) Average coupon rate on the firm's outstanding bonds 
B) Coupon rate on the firm's latest bond issue 
C) Weighted average yield to maturity on the firm's outstanding debt 
D) Average current yield on the firm's outstanding debt 
E) Annual interest divided by the market price per bond for the latest bond issue

Exam 12: Cost of Capital