Question 1

The computation of which one of the following requires assigning every proposed investment to a particular risk class?

Accepted Answer

A)  Pure play cost of capital
B)  Cost of equity
C)  Aftertax cost of debt
D)  WACC
E)  Subjective cost of capitalF) B) and D)
G) B) and E)

Question 2

Tim's Tools just issued a dividend of $1.80 per share on its common stock.The company is expected to maintain a constant 4 percent growth rate in its dividends indefinitely.If the stock sells for $31 a share,what is the company's cost of equity?

Accepted Answer

A)  8.81 percent
B)  9.37 percent
C)  9.94 percent
D)  10.04 percent
E)  10.46 percentF) All of the above
G) B) and D)

Question 3

Beverly's is a retail chain selling the latest fashions through its outlets located in various neighborhood malls.Clothing Galore is a wholesaler that buys from textile mills and sells to retail outlets.Beverly's has a cost of capital of 13.6 percent,while Clothing Galore's cost of capital is 17.8 percent.Both firms are considering opening a retail outlet in a gigantic new mall.Both proposals are quite similar in design and have basically the following financial features: an initial cash outlay of $2.7 million,a projected five-year life with no salvage value,and cash inflows of $845,000 a year for the life of the project.Which firm or firms,if either,should open a retail outlet in the new mall?

Accepted Answer

A)  Beverly's only
B)  Clothing Galore only
C)  Both Beverly's and Clothing Galore
D)  Neither Beverly's nor Clothing Galore
E)  The answer cannot be determined based on the information provided.F) D) and E)
G) C) and E)

Question 4

Trendsetters has a cost of equity of 18.1 percent.The market risk premium is 10.2 percent and the risk-free rate is 4.4 percent.The company is acquiring a competitor,which will increase the company's beta to 1.6.What effect,if any,will the acquisition have on the firm's cost of equity capital?

Accepted Answer

A)  No effect
B)  Decrease of 2.62 percent
C)  Decrease of 0.84 percent
D)  Increase of 2.62 percent
E)  Increase of 4.13 percentF) A) and B)
G) A) and D)

Question 5

The common stock of Wiley and Sons has a beta that is 25 percent larger than the overall market beta.Currently,the market risk premium is 9.5 percent while the U.S.Treasury bill is yielding 4.7 percent.What is the cost of equity for this firm?

Accepted Answer

A)  13.76 percent
B)  14.96 percent
C)  15.80 percent
D)  16.58 percent
E)  16.85 percentF) A) and E)
G) D) and E)

Question 6

Old Town Industries has three divisions.Division X has been in existence the longest and has the most stable sales.Division Y has been in existence for five years and is slightly less risky than the overall firm.Division Z is the research and development side of the business.When allocating funds,the firm should probably:

Accepted Answer

A)  require the highest rate of return from Division X since it has been in existence the longest.
B)  assign the highest cost of capital to Division Z because it is most likely the riskiest of the three divisions.
C)  use the firm's WACC as the cost of capital for Division Z as it provides analysis for the entire firm.
D)  use the firm's WACC as the cost of capital for Divisions A and B because they are part of the revenue-producing operations of the firm.
E)  allocate capital funds evenly amongst the divisions to maintain the current capital structure of the firm.F) C) and D)
G) B) and D) B

Question 7

Casper's is analyzing a proposed expansion project that is much riskier than the firm's current operations.Thus,the project will be assigned a discount rate equal to the firm's cost of capital plus 3 percent.The proposed project has an initial cost of $17.2 million that will be depreciated on a straight-line basis over 20 years.The project also requires additional inventory of $687,000 over the project's life.Management estimates the facility will generate cash inflows of $2.78 million a year over its 20-year life.After 20 years,the company plans to sell the facility for an estimated $1.3 million.The company has 60,000 shares of common stock outstanding at a market price of $49 a share.This stock just paid an annual dividend of $1.84 a share.The dividend is expected to increase by 3.5 percent annually.The firm also has 10,000 shares of 12 percent preferred stock with a market value of $98 a share.The preferred stock has a par value of $100.The company has a 9 percent,semiannual coupon bond issue outstanding with a total face value of $1.1 million.The bonds are currently priced at 102 percent of face value and mature in 16 years.The tax rate is 33 percent.Should the firm pursue the expansion project at this point in time? Why or why not?

Accepted Answer

A)  Accept; the NPV is $2.648 million.
B)  Accept; the NPV is $4.507 million.
C)  Reject; the NPV is -$3.241 million.
D)  Reject; the NPV is -$3.027 million.
E)  Reject; the NPV is -$1.040 million.F) A) and B)
G) None of the above

Question 8

A firm has a cost of equity of 13 percent,a cost of preferred of 11 percent,and an aftertax cost of debt of 6 percent.Given this,which one of the following will increase the firm's weighted average cost of capital?

Accepted Answer

A)  Increasing the firm's tax rate
B)  Issuing new bonds at par
C)  Redeeming shares of common stock
D)  Increasing the firm's beta
E)  Increasing the debt-equity ratioF) C) and E)
G) A) and B) D

Question 9

Lester's is a globally diverse company with multiple divisions and a cost of capital of 15.8 percent.Med,Inc.is a specialty firm in the medical equipment field with a cost of capital of 13.7 percent.With the aging of America,both firms recognize the opportunities that exist in the medical field and are considering expansion in this area.At present,there is an opportunity for multiple firms to be involved in a new medical devices project.Each project will require an initial investment of $8.4 million with annual returns of $2.2 million per year for seven years.Which firm or firms,if either,should become involved in the new projects?

Accepted Answer

A)  Lester's only
B)  Med, Inc. only
C)  Both Lester's and Med, Inc.
D)  Neither Lester's nor Med, Inc.
E)  The answer cannot be determined based on the information provided.F) C) and D)
G) A) and E)

Question 10

Which one of the following will decrease the aftertax cost of debt for a firm?

Accepted Answer

A)  Decrease in the firm's beta
B)  Increase in tax rates
C)  Increase in the risk-free rate of return
D)  Decrease in the market price of the debt
E)  Decrease in a bond's yield to maturityF) C) and D)
G) D) and E)

Question 11

Which one of the following statements is correct?

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.F) A) and E)
G) C) and D)

Question 12

Orchard Farms has a pretax cost of debt of 7.68 percent and a cost of equity of 15.2 percent.The firm uses the subjective approach to determine project discount rates.Currently,the firm is considering a project to which it has assigned an adjustment factor of -0.5 percent.The firm's tax rate is 34 percent and its debt-equity ratio is 0.45.The project has an initial cost of $4.3 million and produces cash inflows of $1.27 million a year for 5 years.What is the net present value of the project?

Accepted Answer

A)  $121,619
B)  $328,895
C)  $514,370
D)  $561,027
E)  $628,721F) C) and D)
G) A) and E)

Question 13

A firm uses its weighted average cost of capital to evaluate the proposed projects for all of its varying divisions.By doing so,the firm:

Accepted Answer

A)  automatically gives preferential treatment in the allocation of funds to its riskiest division.
B)  encourages the division managers to recommend only their most conservative projects.
C)  maintains the current risk level and capital structure of the firm.
D)  automatically maximizes the total value created for its shareholders.
E)  allocates capital funds evenly among its divisions.F) A) and B)
G) A) and C)

Question 14

Titans,Inc.has 6 percent bonds outstanding that mature in 14 years.The bonds pay interest semiannually and have a face value of $1,000.Currently,the bonds are selling for $993 each.What is the firm's pretax cost of debt?

Accepted Answer

A)  5.97 percent
B)  6.08 percent
C)  6.14 percent
D)  6.31 percent
E)  6.40 percentF) A) and D)
G) C) and D)

Question 15

When using the pure play approach for a proposed investment,a firm is primarily seeking a rate of return that:

Accepted Answer

A)  is based on the actual source of funds that will be used to fund the project.
B)  creates a positive net present value for the project.
C)  reflects the size and life of the project.
D)  most closely correlates with the proposed investment's internal rate of return.
E)  best matches the risk level of the proposed investment.F) A) and E)
G) B) and C)

Question 16

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.F) A) and E)
G) A) and B)

Question 17

Which one of the following represents the rate of return a firm must earn on its assets if it is to maintain the current value of its securities?

Accepted Answer

A)  Cost of equity
B)  Internal rate of return
C)  Aftertax cost of debt
D)  Weighted average cost of capital
E)  Debt-equity ratioF) A) and E)
G) C) and D)

Question 18

The market rate of return is 14.8 percent and the risk-free rate is 4.45 percent.Galaxy Co.has 54 percent more systematic risk than the overall market and has a dividend growth rate of 5.5 percent.The firm's stock is currently selling for $39 a share and has a dividend yield of 3.6 percent.What is the firm's cost of equity?

Accepted Answer

A)  14.84 percent
B)  15.31 percent
C)  15.82 percent
D)  16.28 percent
E)  20.39 percentF) B) and C)
G) None of the above

Question 19

Assume a firm follows a policy of using its weighted average cost of capital as the required return for all of its proposed projects.Evaluate this policy.How will this policy affect the overall risk level of the firm over time?

Accepted Answer

When one rate of return is used as the required rate for all projects,the low-risk,low-return projects will oftentimes be rejected,even if they have positive net present values at an appropriate discount rate.The high-risk,high-return projects will be the first projects accepted,whether they are actually profitable or not given an appropriate discount rate.As the firm continues to adopt the highest-risk projects and reject the lowest-risk projects,the firm itself will become riskier.To help prevent this,each project should be assigned a discount rate based on the use of funds.Both the subjective approach and the pure play approach are designed to do this.

Question 20

A firm has multiple divisions of similar nature,yet varying degrees of risk.Which one of the following would be the most appropriate,yet relatively easy,means of assigning discount rates to each of its proposed investments?

Accepted Answer

A)  Assign every project a rate equal to the firm's cost of equity
B)  Assign every firm a random rate that varies between the firm's cost of debt and its cost of equity
C)  Assign every project a rate equal to the firm's WACC plus or minus a subjective adjustment
D)  Determine the best pure play rate for each project
E)  Assign every project a rate equal to the market rate of return at the time of the proposalF) B) and D)
G) A) and E)

Exam 12: Cost of Capital

The computation of which one of the following requires assigning every proposed investment to a particular risk class?

Correct Answer
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Tim's Tools just issued a dividend of $1.80 per share on its common stock.The company is expected to maintain a constant 4 percent growth rate in its dividends indefinitely.If the stock sells for $31 a share,what is the company's cost of equity?

Correct Answer
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Correct Answer
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Trendsetters has a cost of equity of 18.1 percent.The market risk premium is 10.2 percent and the risk-free rate is 4.4 percent.The company is acquiring a competitor,which will increase the company's beta to 1.6.What effect,if any,will the acquisition have on the firm's cost of equity capital?

Correct Answer
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The common stock of Wiley and Sons has a beta that is 25 percent larger than the overall market beta.Currently,the market risk premium is 9.5 percent while the U.S.Treasury bill is yielding 4.7 percent.What is the cost of equity for this firm?

Correct Answer
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Correct Answer
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B

Correct Answer
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A firm has a cost of equity of 13 percent,a cost of preferred of 11 percent,and an aftertax cost of debt of 6 percent.Given this,which one of the following will increase the firm's weighted average cost of capital?

Correct Answer
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D

Correct Answer
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Which one of the following will decrease the aftertax cost of debt for a firm?

Correct Answer
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Which one of the following statements is correct?

Correct Answer
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Correct Answer
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A firm uses its weighted average cost of capital to evaluate the proposed projects for all of its varying divisions.By doing so,the firm:

Correct Answer
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Titans,Inc.has 6 percent bonds outstanding that mature in 14 years.The bonds pay interest semiannually and have a face value of $1,000.Currently,the bonds are selling for $993 each.What is the firm's pretax cost of debt?

Correct Answer
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When using the pure play approach for a proposed investment,a firm is primarily seeking a rate of return that:

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

Correct Answer
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Which one of the following represents the rate of return a firm must earn on its assets if it is to maintain the current value of its securities?

Correct Answer
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Correct Answer
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Assume a firm follows a policy of using its weighted average cost of capital as the required return for all of its proposed projects.Evaluate this policy.How will this policy affect the overall risk level of the firm over time?

A firm has multiple divisions of similar nature,yet varying degrees of risk.Which one of the following would be the most appropriate,yet relatively easy,means of assigning discount rates to each of its proposed investments?

Correct Answer
verified

Exam 12: Cost of Capital

The computation of which one of the following requires assigning every proposed investment to a particular risk class?

Correct AnswerverifiedShow Answer

Tim's Tools just issued a dividend of $1.80 per share on its common stock.The company is expected to maintain a constant 4 percent growth rate in its dividends indefinitely.If the stock sells for $31 a share,what is the company's cost of equity?

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Trendsetters has a cost of equity of 18.1 percent.The market risk premium is 10.2 percent and the risk-free rate is 4.4 percent.The company is acquiring a competitor,which will increase the company's beta to 1.6.What effect,if any,will the acquisition have on the firm's cost of equity capital?

Correct AnswerverifiedShow Answer

The common stock of Wiley and Sons has a beta that is 25 percent larger than the overall market beta.Currently,the market risk premium is 9.5 percent while the U.S.Treasury bill is yielding 4.7 percent.What is the cost of equity for this firm?

Correct AnswerverifiedShow Answer

Correct AnswerverifiedB

Correct AnswerverifiedShow Answer

A firm has a cost of equity of 13 percent,a cost of preferred of 11 percent,and an aftertax cost of debt of 6 percent.Given this,which one of the following will increase the firm's weighted average cost of capital?

Correct AnswerverifiedD

Correct AnswerverifiedShow Answer

Which one of the following will decrease the aftertax cost of debt for a firm?

Correct AnswerverifiedShow Answer

Which one of the following statements is correct?

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

A firm uses its weighted average cost of capital to evaluate the proposed projects for all of its varying divisions.By doing so,the firm:

Correct AnswerverifiedShow Answer

Titans,Inc.has 6 percent bonds outstanding that mature in 14 years.The bonds pay interest semiannually and have a face value of $1,000.Currently,the bonds are selling for $993 each.What is the firm's pretax cost of debt?

Correct AnswerverifiedShow Answer

When using the pure play approach for a proposed investment,a firm is primarily seeking a rate of return that:

Correct AnswerverifiedShow Answer

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

Correct AnswerverifiedShow Answer

Which one of the following represents the rate of return a firm must earn on its assets if it is to maintain the current value of its securities?

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Assume a firm follows a policy of using its weighted average cost of capital as the required return for all of its proposed projects.Evaluate this policy.How will this policy affect the overall risk level of the firm over time?

A firm has multiple divisions of similar nature,yet varying degrees of risk.Which one of the following would be the most appropriate,yet relatively easy,means of assigning discount rates to each of its proposed investments?

Correct AnswerverifiedShow Answer

Correct Answer
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B

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D

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