Question 1

There may be a change in the marginal cost of capital curve when

Accepted Answer

A)   the tax rate charged to investors changes.
B)   the firm has exhausted its supply of retained earnings.
C)   the firm is limited in the amount of depreciation it can take.
D)   the tax rate charged to investors changes and the firm has exhausted its supply of retained earnings.E) All of the above
F) B) and D)

Question 2

The use of the weighted average cost of capital assumes that the firm is in its optimum capital structure range and the cost of each component stays constant over the range of financing.

Accepted Answer

A) True 
 B)False

Question 3

A firm is paying an annual dividend of $2.65 for its preferred stock that is selling for $57.00. There is a selling cost of $3.30. What is the after-tax cost of preferred stock if the firm's tax rate is 33%?

Accepted Answer

A)   3.30%
B)   4.93%
C)   5.79%
D)   6.11%E) All of the above
F) A) and C)

Question 4

The cost of debt is equal to the current bond yield on bonds of similar risk class, adjusted for the corporate tax rate.

Accepted Answer

A) True 
 B)False

Question 5

A firm's stock is selling for $65. The dividend yield is 6%. A 7% growth rate is expected for the common stock. The firm's tax rate is 40%. What is the firm's cost of retained earnings?

Accepted Answer

A)   8.16%
B)   13.00%
C)   12.35%
D)   7.8%%E) A) and D)
F) B) and C)

Question 6

The weighted average cost of capital is used as a discount rate because

Accepted Answer

A)   it is an indication of how much the firm is earning overall.
B)   as long as the cost of capital is earned, the common stock value of the firm will be maintained.
C)   it is comparable to the prevailing market interest rates.
D)   returns below the cost of capital will cover all fixed costs associated with capital and provide an excess return to stockholders.E) None of the above
F) A) and B)

Question 7

In determining the cost of debt, a firm could use its yields and prices of outstanding bonds.

Accepted Answer

A) True 
 B)False

Question 8

A firm should always be at a single optimum debt-to-equity ratio to minimize its cost of capital.

Accepted Answer

A) True 
 B)False

Question 9

Why is the cost of debt normally lower than the cost of preferred stock?

Accepted Answer

A)   Preferred stock dividends are tax deductions.
B)   Interest on debt is tax deductible.
C)   Preferred stock dividends must be paid before common stock dividends.
D)   Common stock dividends are not tax-deductible.E) A) and C)
F) A) and D)

Question 10

The cost of equity capital in the form of new common stock will be higher than the cost of retained earnings because of

Accepted Answer

A)   the existence of taxes.
B)   the existence of flotation costs.
C)   investors' unwillingness to purchase additional shares of common stock.
D)   the existence of financial leverage.E) All of the above
F) A) and D)

Question 11

The out-of-pocket cost of common stock is a good approximation of the cost of common stock equity.
Flotation costs for new stock issues must be considered in the valuation, unlike existing stock.

Accepted Answer

A) True 
 B)False

Question 12

Companies prefer to maintain some financing flexibility in order to choose the lowest-cost source of funds at a single point in time.

Accepted Answer

A) True 
 B)False

Question 13

In determining the cost of retained earnings

Accepted Answer

A)   the dividend valuation model is inappropriate.
B)   flotation costs are included.
C)   growth is not considered.
D)   the capital asset pricing model can be used.E) A) and B)
F) All of the above

Question 14

New common stock is more expensive than required rate of return (Ke) because new common stock has to

Accepted Answer

A)   compensate for risk.
B)   compensate for more dividends.
C)   compensate for expansionary problems.
D)   cover distribution costs.E) B) and C)
F) A) and D)

Question 15

Flotation cost is the

Accepted Answer

A)   cost of holding stock on hand.
B)   cost of issuing new debt.
C)   cost of issuing new stock.
D)   sales price of common stock.E) B) and D)
F) A) and D)

Question 16

Taking on additional debt will reduce the cost of equity.

Accepted Answer

A) True 
 B)False

Question 17

Each project should be judged against

Accepted Answer

A)   the specific means of financing used to support its implementation.
B)   the exiting interest rate at that point in time.
C)   the cost of new common stock equity.
D)   None of these options are true.E) C) and D)
F) All of the above

Question 18

Within the capital asset pricing model

Accepted Answer

A)   the risk-free rate is usually higher than the return in the market.
B)   the higher the beta, the lower the required rate of return.
C)   beta measures the volatility of an individual stock relative to a stock market index.
D)   dividends are considered in the calculations.E) None of the above
F) B) and C)

Question 19

If flotation costs go down, the cost of new preferred stock will

Accepted Answer

A)   go up.
B)   go down.
C)   stay the same.
D)   slowly increase.E) B) and D)
F) A) and B)

Question 20

The cost of retained earnings is considered to be equal to the required rate of return on a firm's outstanding common stock.

Accepted Answer

A) True 
 B)False

Exam 11: Cost of Capital

The cost of retained earnings is considered to be equal to the required rate of return on a firm's outstanding common stock.

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Taking on additional debt will reduce the cost of equity.

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A firm is paying an annual dividend of $2.65 for its preferred stock that is selling for $57.00. There is a selling cost of $3.30. What is the after-tax cost of preferred stock if the firm's tax rate is 33%?

Correct AnswerverifiedShow Answer

If flotation costs go down, the cost of new preferred stock will

Correct AnswerverifiedShow Answer

There may be a change in the marginal cost of capital curve when

Correct AnswerverifiedShow Answer

New common stock is more expensive than required rate of return (Ke) because new common stock has to

Correct AnswerverifiedShow Answer

A firm should always be at a single optimum debt-to-equity ratio to minimize its cost of capital.

Correct AnswerverifiedShow Answer

The cost of equity capital in the form of new common stock will be higher than the cost of retained earnings because of

Correct AnswerverifiedShow Answer

A firm's stock is selling for $65. The dividend yield is 6%. A 7% growth rate is expected for the common stock. The firm's tax rate is 40%. What is the firm's cost of retained earnings?

Correct AnswerverifiedShow Answer

Flotation cost is the

Correct AnswerverifiedShow Answer

Within the capital asset pricing model

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In determining the cost of debt, a firm could use its yields and prices of outstanding bonds.

Correct AnswerverifiedShow Answer

The use of the weighted average cost of capital assumes that the firm is in its optimum capital structure range and the cost of each component stays constant over the range of financing.

Correct AnswerverifiedShow Answer

The out-of-pocket cost of common stock is a good approximation of the cost of common stock equity. Flotation costs for new stock issues must be considered in the valuation, unlike existing stock.

Correct AnswerverifiedShow Answer

In determining the cost of retained earnings

Correct AnswerverifiedShow Answer

Why is the cost of debt normally lower than the cost of preferred stock?

Correct AnswerverifiedShow Answer

The weighted average cost of capital is used as a discount rate because

Correct AnswerverifiedShow Answer

Companies prefer to maintain some financing flexibility in order to choose the lowest-cost source of funds at a single point in time.

Correct AnswerverifiedShow Answer

Each project should be judged against

Correct AnswerverifiedShow Answer

The cost of debt is equal to the current bond yield on bonds of similar risk class, adjusted for the corporate tax rate.

Correct AnswerverifiedShow Answer

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New common stock is more expensive than required rate of return (K_e) because new common stock has to

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