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Exam 11: Cost of Capital

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Question 21

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A firm's debt-to-equity ratio varies at times because

A) a firm will want to sell common stock when prices are high and bonds when interest rates are low.
B) a firm will want to take advantage of timing its fund-raising in order to minimize costs over the long run.
C) the market allows some leeway in the debt-to-equity ratio before penalizing the firm with a higher cost of capital.
D) All of these are accurate statements.

E) C) and D)
F) None of the above

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Question 22

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Regardless of the particular source of funds utilized for a project, the required rate of return, or discount rate, will be the weighted average cost of capital.

A) True
B) False

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Question 23

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Debreu Beverages has an optimal capital structure that is 70% common equity, 20% debt, and 10% preferred stock. Debreu's pretax cost of equity is 9%. Its pretax cost of preferred equity is 7%, and its pretax cost of debt is also 5%. If the corporate tax rate is 35%, what is the weighed average cost of capital?

Jury Company wants to calculate the component costs in its capital structure. Common stock currently sells for $33, and is expected to pay a dividend of $.50. Jury's dividend growth rate is 8%, and flotation cost is $1.25. Preferred stock sells for $40, pays a dividend of $3.00, and carries a flotation cost of $1.10. Jury Company bonds yield 7% in the market. Jury is in the 30% tax bracket. Calculate the cost of debt, cost of new common stock, cost of preferred stock, and cost of retained earnings.

It is standard practice to evaluate investment decisions using the cost of the specific financing method involved.

K_e represents an expected return to stockholders as well as a cost to the firm.

Firm X has a tax rate of 30%. The price of its new preferred stock is $75 and its flotation cost is $3.15. The cost of new preferred stock is 8%. What is the firm's dividend?

A firm's cost of financing, in an overall sense, is equal to its

The coupon rate on an issue of debt is 8%. The yield to maturity on this issue is 10%. The corporate tax rate is 31%. What would be the approximate after-tax cost of debt for a new issue of bonds?

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

A firm's cost of preferred stock is equal to the preferred dividend divided by market price plus the dividend growth rate (K_p = D/P₀ + g). The correct formula is K_p = D_p/(P_p - F).

A firm that does not earn the cost of capital in the short run will probably be in bankruptcy. Proper management of the sources of capital can allow a firm to survive short-term interruptions in its income stream.

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.

If the flotation cost goes up, the cost of retained earnings will

In determining the cost of retained earnings

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

Which of the following is not true about debt financing and the weighted average cost of capital?

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

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

Financial capital does not include