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Quiz on Cost of Capital, created by lseyer436 on 27/11/2015.

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Cost of Capital

Question 1 of 43

1

The cost of capital is the rate of return a firm must earn on investments in order to leave share price unchanged.

Select one of the following:

  • True
  • False

Explanation

Question 2 of 43

1

If risk is unchanged, the undertaking of projects with a rate of return above the cost of capital will decrease the value of the firm.

Select one of the following:

  • True
  • False

Explanation

Question 3 of 43

1

The specific cost of each source of financing is viewed on a before tax basis.

Select one of the following:

  • True
  • False

Explanation

Question 4 of 43

1

The net proceeds used in calculation of the cost of long-term debt are funds actually received from the sale after paying flotation costs.

Select one of the following:

  • True
  • False

Explanation

Question 5 of 43

1

When the net proceeds from the sale of a bond equal its par value, the coupon interest rate will be the bond's before tax cost of capital.

Select one of the following:

  • True
  • False

Explanation

Question 6 of 43

1

The cost of preferred stock is typically lower than the cost of long-term debt because dividends paid on preferred stock are tax deductible.

Select one of the following:

  • True
  • False

Explanation

Question 7 of 43

1

The cost of common stock equity may be measured using either zero growth valuation model or the CAPM.

Select one of the following:

  • True
  • False

Explanation

Question 8 of 43

1

The cost of retained earnings is always lower than the cost of a new issue of common stock due to the absence of flotation costs.

Select one of the following:

  • True
  • False

Explanation

Question 9 of 43

1

The CAPM describes the relationship between the required return and the non systematic risk of the firm as measured by the beta coefficient.

Select one of the following:

  • True
  • False

Explanation

Question 10 of 43

1

Larger volumes of new financing are associated with greater risk and lead to higher financial costs.

Select one of the following:

  • True
  • False

Explanation

Question 11 of 43

1

Since preferred stock is a form of ownership, the stock will never mature.

Select one of the following:

  • True
  • False

Explanation

Question 12 of 43

1

The weighted marginal cost of capital is the firm's weighted average cost of capital associated with its next dollar of total financing.

Select one of the following:

  • True
  • False

Explanation

Question 13 of 43

1

A firm's investment opportunities schedule is a ranking of investment possibilities for worse (lowest return) to best (highest return).

Select one of the following:

  • True
  • False

Explanation

Question 14 of 43

1

As cumulative amount of money invested in a firm's capital project increases, its returns on the projects will increase.

Select one of the following:

  • True
  • False

Explanation

Question 15 of 43

1

According to the firm's owner wealth maximization goal, the firm should accept projects up to the point where the marginal return on its investment equals its weighted marginal cost of capital.

Select one of the following:

  • True
  • False

Explanation

Question 16 of 43

1

The component cost of capital are market-determined variables in as much as they are based on investor's required returns.

Select one of the following:

  • True
  • False

Explanation

Question 17 of 43

1

The cost of issuing preferred stock by a corporation must be adjusted to an after-tax figure because of the 70% dividend exclusion provision for corporations holding other corporations' preferred stock.

Select one of the following:

  • True
  • False

Explanation

Question 18 of 43

1

The weighted average cost of capital increases if the total funds required call for an amount of equity in excess of what can be obtained as retained earnings.

Select one of the following:

  • True
  • False

Explanation

Question 19 of 43

1

In capital budgeting and cost of capital analyses, the firm should always consider retained earnings as the first source of capital, since this is a free source of funding to the firm.

Select one of the following:

  • True
  • False

Explanation

Question 20 of 43

1

The cost of capital should reflect the average cost of the various sources of long-term funds a firm uses to support its assets.

Select one of the following:

  • True
  • False

Explanation

Question 21 of 43

1

The _____ is the rate of return a firm must earn on its investment in order to maintain the market value of its stock.

Select one of the following:

  • gross profit margin

  • internal rate of return

  • net present value

  • cost of capital

Explanation

Question 22 of 43

1

_____ refers to the risk of the firm being unable to cover its operation costs.

Select one of the following:

  • Financial risk

  • Total risk

  • Business risk

  • Nonsystematic

Explanation

Question 23 of 43

1

The cost of capital reflects the cost of funds _____.

Select one of the following:

  • over the short run

  • at current book value

  • at historical values

  • over the long run

Explanation

Question 24 of 43

1

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

Select one of the following:

  • target capital structure

  • maximum wealth ratio

  • optimal mix

  • debt to equity ratio

Explanation

Question 25 of 43

1

The specific cost of each source of long-term financing is based on _____ and _____ costs.

Select one of the following:

  • before-tax; current

  • after-tax; historical

  • after-tax; current

  • before-tax; historical

Explanation

Question 26 of 43

1

A tax adjustment must be made in determining the cost of _____.

Select one of the following:

  • common stock

  • long-term debt

  • retained earnings

  • preferred stock

Explanation

Question 27 of 43

1

A firm has issued 8% preferred stock, which sold for $100 per share par value. The flotation costs of the stock equaled $3 and the firm's marginal tax rate is 40%. The cost of the preferred stock is

Select one of the following:

  • 8.25%

  • 7.5%

  • 7.35%

  • 9.85%

Explanation

Question 28 of 43

1

The approximate before-tax cost of debt for a 20 year, 9%, $1000 par value bond selling at $950 is

Select one of the following:

  • 10.63%

  • 11.39%

  • 7.45%

  • 9.49%

Explanation

Question 29 of 43

1

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

Select one of the following:

  • IRR

  • NPV

  • Constant growth valuation model

  • MIRR model

Explanation

Question 30 of 43

1

The cost of retained earnings is equal t

Select one of the following:

  • the cost of long-term debt

  • the cost of common stock equity

  • zero

  • the marginal cost of capital

Explanation

Question 31 of 43

1

The firm has a beta of .90. The market return equals 12% and the risk free rate of return equals 4%. The estimated cost of common stock equity is _____

Select one of the following:

  • 11.2%

  • 9.8%

  • 10.4%

  • 12.6%

Explanation

Question 32 of 43

1

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

Select one of the following:

  • legal fees

  • underwriting fees

  • registration fees

  • underpricing

Explanation

Question 33 of 43

1

A firm has common stock with a market price of $45 per share and an expert dividend of $3 per share at the end of the coming year. The growth rate in dividends has been 4%. The cost of the firm's common stock equity is

Select one of the following:

  • 9.75%

  • 10.67%

  • 8.42%

  • 11.25%

Explanation

Question 34 of 43

1

Generally the least expensive form of long-term capital is _____

Select one of the following:

  • short-term debt

  • retained earnings

  • long-term debt

  • common stock

Explanation

Question 35 of 43

1

A firm has determined its cost of each source of capital and optimal capital structure, which is composed of the following sources:
Source of capital proportion after-tax cost
long-term debt 45% 7%
preferred stock 15% 10%
common stock equity 40% 14%

the weighted average cost of capital is _____

Select one of the following:

  • 10.25%

  • 11.45%

  • 9.75%

  • 8.35%

Explanation

Question 36 of 43

1

A firm's before-tax cost of long-term debt 10.45%. what is the firm's after tax cost of long-term debt if the firm has a 40% corporate tax rate?

Select one of the following:

  • 8.48%

  • 6.27%

  • 5.32%

  • 9.75%

Explanation

Question 37 of 43

1

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

Select one of the following:

  • Gordon model

  • variable growth model

  • zero growth model

  • CAPM

Explanation

Question 38 of 43

1

A firm has discovered that its retained earnings of $400,000 will soon be exhausted. What is the point at which th firm will non longer be able to sustain the retained earnings cost of 6% if the historical weight of debt in the firm's WACC is 40%.

Select one of the following:

  • $750,000

  • $160,000

  • $1,000,000

  • $100,000

Explanation

Question 39 of 43

1

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

Select one of the following:

  • risk

  • flotation cost

  • taxes

  • returns

Explanation

Question 40 of 43

1

When the face value of a bond equals its selling price, the firm's cost of the bond will be equal to

Select one of the following:

  • the coupon interest rate

  • the firm's WACC

  • the risk free rate

  • the firm's WMCC

Explanation

Question 41 of 43

1

Which of the following statements is most correct?

Select one of the following:

  • Under normal conditions, the CAPM approach to estimating a firm's cost of retained earnings gives a better estimate than other approaches.

  • The risk premium used in the bond-yield-plus-risk-premiun methods is the same as the one used in the CAPM method.

  • The CAPM approach is typically used to estimate a firm's flotation cost adjustment factor, and this factor is added to the DCF cost estimate.

  • The above statements are all false.

Explanation

Question 42 of 43

1

Micro Corp's common stock is currently selling sfor $50 per share. Current dividends is $2 per share. If dividends are expected to grow 6% per year and its flotation costs are 10%, then what is the firm's cost of retained earnings and cost of new common stock?

Select one of the following:

  • 10.71%; 10.24%

  • 10.24%; 10.71%

  • 10.24%; 11.38%

  • 11.38%; 10.71%

Explanation

Question 43 of 43

1

Project A has a cost of $200 million and a rate of return of 13%, while project B has a cost of $125 million and a rate of return of 10%. All of the company's potential projects are equally risky. Which of the following may be true concerning debt and equity?

Select one of the following:

  • Cost of debt of firm A > Cost of equity of firm A

  • Cost of debt of firm A > Cost of equity of firm B

  • the cost of internally generated equity for firm A > cost of externally generated equity funds of firm A

  • the cost of internally generated equity for firm A < cost of debt for firm A

Explanation

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