Deck 9: The Cost of Capital

Question 1

When determining the after-tax cost of a bond, the face value of the issue must be adjusted to the net proceeds amount by considering

A) the taxes.
B) the approximate returns.
C) the risk.
D) the flotation costs.

Answer 1

the flotation costs.

Question 2

The investment opportunity schedule combined with the weighted marginal cost of capitalindicates

A) those projects that a firm should select.
B) those projects that will result in the highest cash flows.
C) which combination of projects will fit within the firm's capital budget.
D) which projects are acceptable given the firm's cost of capital.

Answer 2

which projects are acceptable given the firm's cost of capital.

Question 3

The investment opportunity schedule (IOS) is

A) an internal rate of return ranking of capital projects from best to worst.
B) a set of decision criteria for determining the acceptability of capital projects.
C) a determination of the weighted average cost of capital at various increments of financing.
D) a list of investment opportunities available to the firm.

Answer 3

an internal rate of return ranking of capital projects from best to worst.

Question 4

The cost utilized in making capital budgeting decisions given an investment opportunity scheduleis

A) the weighted average cost of all bonds issued that are related to the capital budget.
B) the weighted average cost of all needed financing for funding.
C) the weighted average cost of the last incremental amount of financing.
D) the simple average of the cost of the last incremental amount of financing.

Question 5

The cost of retained earnings is

A) equal to the cost of common stock equity.
B) zero.
C) equal to the cost of a new issue of common stock.
D) irrelevant to the investment/financing decision.

Question 6

According to the investment opportunity schedule (IOS), as the cumulative amount of moneyinvested in a project increases, the return on the projects will

A) decrease.
B) remain unchanged.
C) increase.
D) not be a factor.

Question 7

The cost of capital reflects the cost of funds

A) at a given point in time.
B) over a long-run time period.
C) at current book values.
D) over a short-run time period.

Question 8

The Titanic Company has just gone public. Under a firm commitment agreement, Titanic received$14 for each of the 2 million shares sold. The initial offering price was $15 per share, and the stockrose to $16.40 per share in the first few minutes of trading. Titanic paid $500,000 in administrative costs. The total floatation costs for the new issue are

A) $2,000,000.
B) $4,800,000.
C) $2,800,000.
D) $5,300,000.

Question 9

Which of the following companies would have the greatest business risk?

A) Manitoba Telephone System
B) Royal Bank of Canada
C) Canada Safeway
D) Air Canada

Question 10

The cost of common stock equity may be estimated by using the

A) yield curve.
B) DuPont analysis.
C) Gordon model.
D) net present value method.

Question 11

The cost of common stock equity may be estimated by using the

A) internal rate of return.
B) yield curve.
C) capital asset pricing model.
D) DuPont analysis.

Question 12

Since retained earnings are viewed as a fully subscribed issue of additional common stock, the cost of retained earnings is

A) greater than the cost of new common stock equity.
B) less than the cost of new common stock equity.
C) not related to the cost of new common stock equity.
D) equal to the cost of new common stock equity.

Question 13

A firm has determined it can issue preferred stock at $115 per share par value. The stock will pay a$12 annual dividend. The cost of issuing and selling the stock is $3 per share. The cost of thepreferred stock is

A) 10.4 percent.
B) 10.7 percent.
C) 12 percent.
D) 6.4 percent.

Question 14

The cost of equity for a firm is 12% and its cost of debt is 6%. Ignoring taxes, what is the firm'sWACC if its debt-to-equity ratio is 1.0?

A) 12%
B) 9%
C) 18%
D) 15%

Question 15

In calculating the cost of common stock equity, the model having the stronger theoretical foundation is

A) the constant growth model.
B) the capital asset pricing model.
C) the variable growth model.
D) the Gordon model.

Question 16

The___________ is a weighted average of the cost of funds which reflects the interrelationship of financing decisions.

A) risk premium
B) nominal cost
C) risk-free rate
D) cost of capital

Question 17

Generally the least expensive source of long-term capital is

A) short-term debt.
B) long-term debt.
C) preferred stock.
D) retained earnings.

Question 18

A firm has issued 10 percent preferred stock, which sold for $100 per share par value. The cost ofissuing and selling the stock was $2 per share. The firm's marginal tax rate is 40 percent. The costof the preferred stock is

A) 9.8 percent.
B) 6.1 percent.
C) 10.2 percent.
D) 3.9 percent.

Question 19

One major expense associated with issuing new shares of common stock is

A) underwriting fees.
B) legal fees.
C) underpricing.
D) registration fees.

Question 20

Given that the cost of common stock is 18 percent, dividends are $1.50 per share, and the price ofthe stock is $12.50 per share, what is the annual growth rate of dividends?

A) 6 percent
B) 5 percent
C) 4 percent
D) 8 percent

Question 21

When discussing weighing schemes for calculating the weighted average cost of capital, the preferences can be stated as

A) book value weights are preferred over market value weights and target weights are preferred over historic weights.
B) market value weights are preferred over book value weights and target weights are preferred over historic weights.
C) book value weights are preferred over market value weights and historic weights are preferred over target weights.
D) market value weights are preferred over book value weights and historic weights are preferred over target weights.

Question 22

What is the dividend on an 8 percent preferred stock that currently sells for $45 and has a face value of $50 per share?

A) $5.00
B) $4.00
C) $3.60
D) $3.33

Question 23

A firm has determined its optimal structure which is composed of the following sources and target market value proportions.
$$\begin{array} { l c } \text { Source of capital } & \begin{array} { c } \text { Target market } \\\text { Proportions }\end{array} \\\hline \text { Long-term debt } & 60 \% \\\text { Common stock equity } & 40\end{array}$$
DEBT: The firm can sell a 15-year, $1,000 par value, 8 percent bond for $1,050. A flotation cost of 2 percent of the face value would be required in addition to the premium of $50.
COMMON STOCK: A firm's common stock is currently selling for $75 per share. The dividend expected to be paid at the end of the coming year is $5. Its dividend payments have been growing at a constant rate for the last five years. Five years ago, the dividend was $3.10. It is expected that to sell, a new common stock issue must be underpriced $2 per share and the firm must pay $1 per share in flotation costs. Additionally, the firm has a marginal tax rate of 40 percent.


-The firm's cost of a new issue of common stock is

A) 14.3 percent.
B) 10.2 percent.
C) 16.7 percent.
D) 17.0 percent.

Question 24

The specific cost of each source of long-term financing is based on_________and_________costs.

A) after-tax; historical
B) before-tax; book value
C) after-tax; current
D) before-tax; historical

Question 25

A firm has determined its optimal structure which is composed of the following sources and target market value proportions.
$$\begin{array} { l c } \text { Source of capital } & \begin{array} { c } \text { Target market } \\\text { Proportions }\end{array} \\\hline \text { Long-term debt } & 60 \% \\\text { Common stock equity } & 40\end{array}$$
DEBT: The firm can sell a 15-year, $1,000 par value, 8 percent bond for $1,050. A flotation cost of 2 percent of the face value would be required in addition to the premium of $50.
COMMON STOCK: A firm's common stock is currently selling for $75 per share. The dividend expected to be paid at the end of the coming year is $5. Its dividend payments have been growing at a constant rate for the last five years. Five years ago, the dividend was $3.10. It is expected that to sell, a new common stock issue must be underpriced $2 per share and the firm must pay $1 per share in flotation costs. Additionally, the firm has a marginal tax rate of 40 percent.


-The weighted average cost of capital up to the point when retained earnings are exhausted is

A) 9.5 percent.
B) 11.3 percent.
C) 7.7 percent.
D) 6.8 percent.

Question 26

A firm has determined its optimal capital structure which is composed of the following sources and target market value proportions.
$$\begin{array} { l c } \text { Source of capital } & \begin{array} { c } \text { Target market } \\\text { proportions }\end{array} \\\hline \text { Long-term debt } & 20 \% \\\text { Preferred stock } & 10 \\\text { Common stock equity } & 70\end{array}$$ DEBT: The firm can sell a 12-year, $1,000 par value, 7 percent bond for $960. A flotation cost of 2 percent of the face value would be required in addition to the discount of $40.
PREFERRED STOCK: The firm has determined it can issue preferred stock at $75 per share par value. The stock will pay a
$10 annual dividend. The cost of issuing and selling the stock is $3 per share.
COMMON STOCK: A firm's common stock is currently selling for $18 per share. The dividend expected to be paid at the
end of the coming year is $1.74. Its dividend payments have been growing at a constant rate for the last five years. Five years ago, the dividend was $1.50. It is expected that to sell, a new common stock issue must be underpriced $1 per share in
floatation costs. Additionally, the firm's marginal tax rate is 40 percent.


-The firm's cost of a new issue of common stock is

A) 14.4 percent.
B) 7 percent.
C) 9.08 percent.
D) 13.2 percent.

Question 27

A firm has determined its optimal structure which is composed of the following sources and target market value proportions.
$$\begin{array} { l c } \text { Source of capital } & \begin{array} { c } \text { Target market } \\\text { Proportions }\end{array} \\\hline \text { Long-term debt } & 60 \% \\\text { Common stock equity } & 40\end{array}$$
DEBT: The firm can sell a 15-year, $1,000 par value, 8 percent bond for $1,050. A flotation cost of 2 percent of the face value would be required in addition to the premium of $50.
COMMON STOCK: A firm's common stock is currently selling for $75 per share. The dividend expected to be paid at the end of the coming year is $5. Its dividend payments have been growing at a constant rate for the last five years. Five years ago, the dividend was $3.10. It is expected that to sell, a new common stock issue must be underpriced $2 per share and the firm must pay $1 per share in flotation costs. Additionally, the firm has a marginal tax rate of 40 percent.


-Assuming the firm plans to pay out all of its earnings as dividends, the weighted average cost of capital is

A) 10.9 percent.
B) 11.6 percent.
C) 9.6 percent.
D) 12.1 percent.

Question 28

The cost of common stock equity is

A) the cost of the guaranteed stated dividend.
B) the aftertax cost of the interest obligations.
C) the historical cost of floating the stock issue.
D) the rate at which investors discount the expected dividends of the firm.

Question 29

A firm has determined its optimal capital structure which is composed of the following sources and target market value proportions.
$$\begin{array} { l c } \text { Source of capital } & \begin{array} { c } \text { Target market } \\\text { proportions }\end{array} \\\text { Long-term debt } & 20 \% \\\text { Preferred stock } & 10 \\\text { Common stock equity } & 70\end{array}$$
DEBT: The firm can sell a 12-year, $1,000 par value, 7 percent bond for $960. A flotation cost of 2 percent of the face value would be required in addition to the discount of $40.
PREFERRED STOCK: The firm has determined it can issue preferred stock at $75 per share par value. The stock will pay a
$10 annual dividend. The cost of issuing and selling the stock is $3 per share.
COMMON STOCK: A firm's common stock is currently selling for $18 per share. The dividend expected to be paid at the
end of the coming year is $1.74. Its dividend payments have been growing at a constant rate for the last five years. Five years ago, the dividend was $1.50. It is expected that to sell, a new common stock issue must be underpriced $1 per share in
floatation costs. Additionally, the firm's marginal tax rate is 40 percent.


-The firm's aftertax cost of debt is

A) 8.13 percent.
B) 4.5 percent.
C) 8 percent.
D) 3.25 percent.

Question 30

Generally, market risk premiums go up when

A) the average asset in the market becomes less risky.
B) the threat of terrorism goes down.
C) investors develop confidence in the market.
D) none of the above.

Question 31

A firm has determined its optimal capital structure which is composed of the following sources and target market value proportions.
$$\begin{array} { l c } \text { Source of capital } & \begin{array} { c } \text { Target market } \\\text { proportions }\end{array} \\\text { Long-term debt } & 20 \% \\\text { Preferred stock } & 10 \\\text { Common stock equity } & 70\end{array}$$
DEBT: The firm can sell a 12-year, $1,000 par value, 7 percent bond for $960. A flotation cost of 2 percent of the face value would be required in addition to the discount of $40.
PREFERRED STOCK: The firm has determined it can issue preferred stock at $75 per share par value. The stock will pay a
$10 annual dividend. The cost of issuing and selling the stock is $3 per share.
COMMON STOCK: A firm's common stock is currently selling for $18 per share. The dividend expected to be paid at the
end of the coming year is $1.74. Its dividend payments have been growing at a constant rate for the last five years. Five years ago, the dividend was $1.50. It is expected that to sell, a new common stock issue must be underpriced $1 per share in
floatation costs. Additionally, the firm's marginal tax rate is 40 percent.


-The firm's cost of preferred stock is

A) 8.3 percent.
B) 13.3 percent.
C) 13.9 percent.
D) 7.2 percent.

Question 32

The weighted marginal cost of capital is _________function of total financing in dollars; the internal rate of return on individual projects is _________function of the total capital investment in dollars.

A) an increasing; an increasing
B) an increasing; a decreasing
C) a decreasing; an increasing
D) a decreasing; a decreasing

Question 33

If a corporation has an average tax rate of 40 percent, the approximate annual, aftertax cost of debtfor a 10-year, 8 percent, $1,000 par value bond selling at $1,150 is

A) 6 percent.
B) 8 percent.
C) 4.2 percent.
D) 4.8 percent.

Question 34

Firms underprice new issues of common stock for the following reason(s):

A) when additional shares are issued, each share's percent of ownership in the firm is diluted, thereby justifying a lower share value.
B) when the market is in equilibrium, additional demand for shares can be achieved only at a lower price.
C) many investors view the issuance of additional shares as a signal that management is using common stock equity financing because it believes that the shares are currently overpriced.
D) all of the above.

Question 35

A firm has determined its optimal capital structure which is composed of the following sources and target market value proportions
$$\begin{array} { l c } \text { Source of capital } & \begin{array} { c } \text { Target market } \\\text { proportions }\end{array} \\\hline \text { Long-term debt } & 20 \% \\\text { Preferred stock } & 10 \\\text { Common stock equity } & 70\end{array}$$
DEBT: The firm can sell a 12-year, $1,000 par value, 7 percent bond for $960. A flotation cost of 2 percent of the face value would be required in addition to the discount of $40.
PREFERRED STOCK: The firm has determined it can issue preferred stock at $75 per share par value. The stock will pay a
$10 annual dividend. The cost of issuing and selling the stock is $3 per share.
COMMON STOCK: A firm's common stock is currently selling for $18 per share. The dividend expected to be paid at the
end of the coming year is $1.74. Its dividend payments have been growing at a constant rate for the last five years. Five years ago, the dividend was $1.50. It is expected that to sell, a new common stock issue must be underpriced $1 per share in
floatation costs. Additionally, the firm's marginal tax rate is 40 percent.


-The weighted average cost of capital up to the point when retained earnings are exhausted is

A) 11.2 percent.
B) 8.65 percent.
C) 10.4 percent.
D) 7.5 percent.

Question 36

The firm's beforetax cost of debt is

A) 12.7 percent.
B) 11.2 percent.
C) 10.6 percent.
D) 7.4 percent.

Question 37

Firms typically raise long-term funds

A) on a continuous basis.
B) in proportion to the capital mixture of the target capital structure.
C) in lump sums as needed.
D) only at the inception of the firm.

Question 38

What is your portfolio beta if 50% of your money is invested in the market portfolio and the remainder is invested in a risk-free asset?

A) 0.25
B) 0.75
C) 1.00
D) 0.50

Question 39

A firm has common stock with a market price of $100 per share and an expected dividend of $5.61 per share at the end of the coming year. A new issue of stock is expected to be sold for $98, with $2 per share representing the underpricing necessary in the competitive capital market. Flotationcosts are expected to total $1 per share. The dividends paid on the outstanding stock over the past five years are as follows: $$\begin{array} { c c } \text { Year } & \text { Dividend } \\\hline 1 & \$ 4.00 \\2 & 4.28 \\3 & 4.58 \\4 & 4.90 \\5 & 5.24\end{array}$$ The cost of this new issue of common stock is

A) 7.7 percent.
B) 10.8 percent.
C) 12.8 percent.
D) 5.8 percent.

Question 40

An investment opportunity/cost schedule

A) ranks capital projects by net present value, and then compares the marginal return to the cost.
B) ranks capital projects by net present value, from highest to lowest, and then compares the discount rate to the marginal cost of capital.
C) ranks capital projects by internal rate of return from lowest to highest and marginal cost from highest to lowest, and then compares the marginal return to the marginal cost.
D) ranks capital projects by internal rate of return from the highest to lowest and marginal cost from lowest to highest, and then compares the marginal return to the marginal cost.

Question 41

A firm has determined its optimal capital structure which is composed of the following sources and target market value proportions.
$$\begin{array} { l c } \text { Source of capital } & \begin{array} { c } \text { Target market } \\\text { proportions }\end{array} \\\hline \text { Long-term debt } & 20 \% \\\text { Preferred stock } & 10 \\\text { Common stock equity } & 70\end{array}$$
DEBT: The firm can sell a 12-year, $1,000 par value, 7 percent bond for $960. A flotation cost of 2 percent of the face value would be required in addition to the discount of $40.
PREFERRED STOCK: The firm has determined it can issue preferred stock at $75 per share par value. The stock will pay a
$10 annual dividend. The cost of issuing and selling the stock is $3 per share.
COMMON STOCK: A firm's common stock is currently selling for $18 per share. The dividend expected to be paid at the
end of the coming year is $1.74. Its dividend payments have been growing at a constant rate for the last five years. Five years ago, the dividend was $1.50. It is expected that to sell, a new common stock issue must be underpriced $1 per share in
floatation costs. Additionally, the firm's marginal tax rate is 40 percent.


-The weighted average cost of capital after all retained earnings are exhausted is

A) 13.6 percent.
B) 10.4 percent.
C) 11.0 percent.
D) 11.5 percent.

Question 42

A firm has determined its optimal structure which is composed of the following sources and target market value proportions
$$\begin{array} { l c } \text { Source of capital } & \begin{array} { c } \text { Target market } \\\text { Proportions }\end{array} \\\hline \text { Long-term debt } & 60 \% \\\text { Common stock equity } & 40\end{array}$$
DEBT: The firm can sell a 15-year, $1,000 par value, 8 percent bond for $1,050. A flotation cost of 2 percent of the face value would be required in addition to the premium of $50.
COMMON STOCK: A firm's common stock is currently selling for $75 per share. The dividend expected to be paid at the end of the coming year is $5. Its dividend payments have been growing at a constant rate for the last five years. Five years ago, the dividend was $3.10. It is expected that to sell, a new common stock issue must be underpriced $2 per share and the firm must pay $1 per share in flotation costs. Additionally, the firm has a marginal tax rate of 40 percent.


-The firm's aftertax cost of debt is

A) 7.7 percent.
B) 7 percent.
C) 4.7 percent.
D) 6 percent.

Question 43

The __________is a schedule or graph relating the firm's weighted average cost of capital to the level of new financing.

A) breaking point
B) weighted marginal cost of capital
C) weighted average cost of capital
D) target capital structure

Question 44

In order to recognize the interrelationship between financing and investments, the firm should use__________when evaluating an investment.

A) the current opportunity cost
B) the least costly source of financing
C) the most costly source of financing
D) the weighted average cost of all financing sources

Question 45

The approximate before-tax cost of debt for a 15-year, 10 percent, $1,000 par value bond selling at$950 is

A) 15.4 percent.
B) 10.6 percent.
C) 10 percent.
D) 12 percent.

Question 46

The__________ is the rate of return required by the market suppliers of capital in order to attract their funds to the firm.

A) gross profit margin
B) internal rate of return
C) cost of capital
D) yield to maturity

Question 47

A corporation expects to have earnings available to common shareholders (net income minuspreferred dividends) of $1,000,000 in the coming year. The firm plans to pay 40 percent of earningsavailable in cash dividends. If the firm has a target capital structure of 40 percent long-term debt,10 percent preferred stock, and 50 percent common stock equity, what capital budget could thefirm support without issuing new common stock?

A) $800,000
B) $600,000
C) $2,000,000
D) $1,200,000

Question 48

A corporation has concluded that its financial risk premium is too high. In order to decrease this, the firm can

A) increase the proportion of common stock equity to decrease financial risk.
B) increase the proportion of long-term debt to decrease the cost of capital.
C) decrease the proportion of common stock equity to decrease financial risk.
D) increase short-term debt to decrease the cost of capital.

Question 49

A tax adjustment must be made in determining the cost of__________

A) long-term debt
B) preferred stock
C) common stock
D) retained earnings

Question 50

Weighing schemes for calculating the weighted average cost of capital include all of the followingEXCEPT

A) market value weights.
B) book value weights.
C) target weights.
D) optimal value weights.

Question 51

If a corporation has an average tax rate of 40 percent, the approximate, annual, aftertax cost of debtfor a 15-year, 12 percent, $1,000 par value bond, selling at $950 is

A) 6.0 percent.
B) 10 percent.
C) 10.6 percent.
D) 7.6 percent.

Question 52

In order to recognize the interrelationship between financing and investments, the firm should use__________when evaluating an investment.

A) the current opportunity cost
B) the weighted average cost of all financing sources
C) the most costly source of financing
D) the least costly source of financing

Question 53

When calculating a firm's cost of equity using CAPM, it is generally recommended that_________be used as the risk-free rate.

A) Government of Canada long-term bonds
B) the prime lending rate offered by banks
C) Government of Canada T-bills
D) long-term corporate bonds

Question 54

The approximate aftertax cost of debt for a 20-year, 7 percent, $1,000 par value bond selling at $960(assume a marginal tax rate of 40 percent) is

A) 5.2 percent.
B) 7.3 percent.
C) 4.4 percent.
D) 7 percent.

Question 55

Which of the following industries has the least business risk?

A) Restaurants
B) Telecommunications
C) Utilities
D) Air Transport

Question 56

The cost of each type of capital depends on the

A) financial risk of the firm.
B) risk-free cost of that type of funds.
C) business risk of the firm.
D) all of the above.

Question 57

Circumstances in which the constant growth valuation model-the Gordon model-for estimating the value of a share of stock should be used include

A) the lack of dividends.
B) a steady growth rate in dividends.
C) an erratic dividend stream.
D) declining dividends.

Question 58

In which country would IBM attach the highest business risk premium?

A) Iran
B) Japan
C) Canada
D) U.S.A.

Question 59

The firm's optimal mix of debt and equity is called its

A) maximum wealth.
B) target capital structure.
C) optimal ratio.
D) maximum book value.

Question 60

As a source of financing, once retained earnings have been exhausted, the weighted average cost of capital will

A) remain the same.
B) change in an undetermined direction.
C) decrease.
D) increase.

Question 61

The wealth-maximizing investment decision for a firm occurs when

A) the weighted marginal cost of capital equals the investment opportunity schedule.
B) the cost of capital equals the return on the project.
C) the weighted marginal cost of capital is less than the investment opportunity schedule.
D) the weighted cost of capital exceeds the marginal cost of capital.

Question 62

The__________ from the sale of a security are the funds actually received from the sale after__________, or the total costs of issuing and selling the security, which have been subtracted from thetotal proceeds.

A) gross proceeds; the after-tax costs
B) gross proceeds; the flotation costs
C) net proceeds; the after-tax costs
D) net proceeds; the flotation costs

Question 63

A firm has a beta of 1.2. The market return equals 14 percent and the risk-free rate of return equals6 percent. The estimated cost of common stock equity is

A) 15.6 percent.
B) 7.2 percent.
C) 14 percent.
D) 6 percent.

Question 64

A firm has common stock with a market price of $25 per share and an expected dividend of $2 pershare at the end of the coming year. The growth rate in dividends has been 5 percent. The cost ofthe firm's common stock equity is

A) 5 percent.
B) 10 percent.
C) 13 percent.
D) 8 percent.

Question 65

The cost of new common stock financing is higher than the cost of retained earnings due to

A) commission costs and overpricing.
B) flotation costs and underpricing.
C) flotation costs and overpricing.
D) flotation costs and commission costs.

Question 66

The preferred capital structure weights to be used in the weighted average cost of capital are

A) target weights.
B) historic weights.
C) market weights.
D) nominal weights.

Question 67

A firm has determined its optimal capital structure which is composed of the following sources and target market value proportions.
$$\begin{array} { l c } \text { Source of capital } & \begin{array} { c } \text { Target market } \\\text { proportions }\end{array} \\\hline \text { Long-term debt } & 20 \% \\\text { Preferred stock } & 10 \\\text { Common stock equity } & 70\end{array}$$
DEBT: The firm can sell a 12-year, $1,000 par value, 7 percent bond for $960. A flotation cost of 2 percent of the face value would be required in addition to the discount of $40.
PREFERRED STOCK: The firm has determined it can issue preferred stock at $75 per share par value. The stock will pay a
$10 annual dividend. The cost of issuing and selling the stock is $3 per share.
COMMON STOCK: A firm's common stock is currently selling for $18 per share. The dividend expected to be paid at the
end of the coming year is $1.74. Its dividend payments have been growing at a constant rate for the last five years. Five years ago, the dividend was $1.50. It is expected that to sell, a new common stock issue must be underpriced $1 per share in
floatation costs. Additionally, the firm's marginal tax rate is 40 percent.

-The firm's cost of retained earnings is (See Figure 9.1)

A) 13.6 percent.
B) 13.9 percent.
C) 10.2 percent.
D) 12.7 percent.

Question 68

The before-tax cost of debt for a firm which has a 40 percent marginal tax rate is 12 percent. Theaftertax cost of debt is

A) 6.0 percent.
B) 7.2 percent.
C) 12 percent.
D) 4.8 percent.

Question 69

The __________is the rate of return a firm must earn on its investments in projects in order tomaintain the market value of its stock.

A) internal rate of return
B) gross profit margin
C) net present value
D) cost of capital

Question 70

A firm has determined its optimal structure which is composed of the following sources and target market value proportions.
$$\begin{array} { l c } \text { Source of capital } & \begin{array} { c } \text { Target market } \\\text { Proportions }\end{array} \\\hline \text { Long-term debt } & 60 \% \\\text { Common stock equity } & 40\end{array}$$
DEBT: The firm can sell a 15-year, $1,000 par value, 8 percent bond for $1,050. A flotation cost of 2 percent of the face value would be required in addition to the premium of $50.
COMMON STOCK: A firm's common stock is currently selling for $75 per share. The dividend expected to be paid at the end of the coming year is $5. Its dividend payments have been growing at a constant rate for the last five years. Five years ago, the dividend was $3.10. It is expected that to sell, a new common stock issue must be underpriced $2 per share and the firm must pay $1 per share in flotation costs. Additionally, the firm has a marginal tax rate of 40 percent.



-The firm's cost of retained earnings is

A) 10.2 percent.
B) 14.3 percent.
C) 17.0 percent.
D) 16.7 percent.

Question 71

Using the capital asset pricing model, the cost of common stock equity is the return required byinvestors as compensation for

A) the firm's nondiversifiable risk.
B) the specific risk of the firm.
C) the firm's diversifiable risk.
D) price volatility of the stock.

Question 72

The__________ is the level of total financing at which the cost of one of the financing componentsrises.

A) weighted average cost of capital
B) target capital structure
C) breaking point
D) weighted marginal cost of capital

Question 73

As the volume of financing increases, the costs of the various types of financing will __________,the firm's weighted average cost of capital.

A) decrease, lowering
B) increase, lowering
C) decrease, raising
D) increase, raising

Question 74

The approximate beforetax cost of debt for a 10-year, 8 percent, $1,000 par value bond selling at$1,150 is

A) 9 percent.
B) 8.8 percent.
C) 7 percent.
D) 8.3 percent.

Question 75

A firm has determined its optimal structure which is composed of the following sources and target market value proportions.
$$\begin{array} { l c } \text { Source of capital } & \begin{array} { c } \text { Target market } \\\text { Proportions }\end{array} \\\hline \text { Long-term debt } & 60 \% \\\text { Common stock equity } & 40\end{array}$$
DEBT: The firm can sell a 15-year, $1,000 par value, 8 percent bond for $1,050. A flotation cost of 2 percent of the face value would be required in addition to the premium of $50.
COMMON STOCK: A firm's common stock is currently selling for $75 per share. The dividend expected to be paid at the end of the coming year is $5. Its dividend payments have been growing at a constant rate for the last five years. Five years ago, the dividend was $3.10. It is expected that to sell, a new common stock issue must be underpriced $2 per share and the firm must pay $1 per share in flotation costs. Additionally, the firm has a marginal tax rate of 40 percent.



-The firm's beforetax cost of debt is

A) 7.7 percent.
B) 12.7 percent.
C) 10.6 percent.
D) 11.2 percent.

Question 76

A project's rate of return should be_________than the weighted marginal cost of financing. Thecumulative acceptance of projects _________the weighted marginal cost of capital.

A) less; increases
B) greater; increases
C) less; decreases
D) greater; decreases

Question 77

The four basic sources of long-term funds for the business firm are

A) long-term debt, common stock, preferred stock, and retained earnings.
B) current liabilities, long-term debt, common stock, and preferred stock.
C) current liabilities, long-term debt, common stock, and retained earnings.
D) long-term debt, paid-in capital in excess of par, common stock, and retained earnings.

Question 78

Debt is generally the least expensive source of capital. This is primarily due to

A) the tax deductibility of interest payments.
B) its position in the priority of claims on assets and earnings in the event of liquidation.
C) the secured nature of a debt obligation.
D) fixed interest payments.

Question 79

In utilizing the investment opportunity schedule and the weighted marginal cost of capital, a capital project will be

A) acceptable as long as the marginal return equals or exceeds the weighted marginal cost of capital.
B) unacceptable if the marginal return equals the weighted marginal cost of capital.
C) unacceptable if the marginal return equals or exceeds the weighted marginal cost of capital.
D) acceptable as long as the marginal return equals or exceeds the average cost of capital over all levels of needed funding.

Question 80

In comparing the constant growth model and the capital asset pricing model (CAPM) to calculatethe cost of common stock equity,

A) the CAPM directly considers risk as reflected in the beta, while the constant growth model uses dividend expectations as a reflection of risk.
B) the CAPM directly considers risk as reflected in the beta, while the constant growth model uses the market price as a reflection of the expected risk-return preference of investors.
C) the CAPM indirectly considers risk as reflected in the market return, while the constant growth model uses dividend expectations as a reflection of risk.
D) the constant growth model ignores risk, while the CAPM directly considers risk as reflected in the beta.