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Exam 11: Cost of Capital

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Question 21

Multiple Choice

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In determining the cost of retained earnings

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 D)
F) All of the above

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Question 22

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Most firms are able to use _____ percent debt in their capital structure without exceeding norms acceptable to creditors and investors.

A) 30-50
B) 40-60
C) 50-70
D) 60-80

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

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Question 23

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Individual common stocks' betas have a tendency to move toward 1.0 over time.

A firm that does not earn the cost of capital in the short run will probably be in bankruptcy.

A firm is paying an annual dividend of $2.65 for its preferred stock which 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%?

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

The pretax cost of debt is less than the pretax cost of equity.

The Accidental Petroleum Company is trying to determine its weighted average cost of capital for use in making a number of investment decisions. The firm's bonds were issued 6 years ago and have 14 years left until maturity. They carried an 8% coupon rate, and are currently selling for $910.00. The firm's preferred stock carries a $3.10 dividend and is currently selling at $42.50 per share. Accidental's investment banker has stated that issue costs for new preferred will be 50 cents per share. The firm has significant retained earnings, but will also need to sell new common stock to finance the projects it is now considering. Accidental Petroleum common stock is expected to pay a $1.75 per share dividend next year, and is expected to maintain an 8% growth rate for the foreseeable future. The stock is currently priced at $50 per share, but new common stock will have flotation costs of 70 cents per share. Calculate the costs of the various components of Accidental Petroleum's capital (K_d, K_p, K_e, K_n). The firm's tax rate is 30%.

A firm's cost of preferred stock is equal to the preferred dividend divided by the net price after flotation costs.

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

In computing the cost of common equity, if D₁ goes downward and P_o goes up, K_e will

The general rule for using the weighted average cost of capital (WACC) in capital budgeting decisions is accept all projects with

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

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

Expected cash dividends are $3.00, the dividend yield is 4%, flotation costs are 4% of price, and the growth rate is 3%. Compute cost of new common stock.

The only difference in the cost of retained earnings (K_e) and the cost of new common stock (K_n) is the flotation cost on new common stock.

Lewis, Schultz and Nobel Development Corp. has an after-tax cost of debt of 4.5 percent. With a tax rate of 30 percent, what is the yield on the debt?

A firm in a cyclical industry should use

The coupon rate on a debt issue is 6%. If the yield to maturity on the debt is 9%, what is the after-tax cost of debt in the weighted average cost of capital if the firm's tax rate is 34%?

The use of common stock equity in the weighted average cost of capital is always (K_e) and not (K_n), the cost of new common stock.