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Managerial Finance: Chapter 12

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Managerial Finance: Chapter 12
Parappu Adai
Quiz by Parappu Adai, updated more than 1 year ago
Parappu Adai
Created by Parappu Adai almost 7 years ago
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Resource summary

Question 1

Question
The cost of preferred stock:
Answer
  • increases when a firm's tax rate decreases.
  • is constant over time.
  • is unaffected by changes in the market price of the stock.
  • is equal to the stock's dividend yield.
  • increases as the price of the stock increases.

Question 2

Question
Which one of the following will decrease the aftertax cost of debt for a firm?
Answer
  • Decrease in the firm's beta
  • Increase in tax rates
  • Increase in the risk-free rate of return
  • Decrease in the market price of the debt
  • Increase in a bond's yield to maturity

Question 3

Question
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 numerous proposed investments?
Answer
  • Assign every project a rate equal to the firm's cost of equity
  • Assign every investment a random rate that varies between the firm's cost of debt and its cost of equity
  • Assign every project a rate equal to the firm's WACC plus or minus a subjective adjustment
  • Determine the best pure play rate for each project
  • Assign every project a rate equal to the market rate of return at the time of the proposal

Question 4

Question
Which statement is true?
Answer
  • An increase in the market value of preferred stock will increase a firm's weighted average cost of capital.
  • The cost of preferred stock is unaffected by the issuer's tax rate.
  • Preferred stock is generally the cheapest source of capital for a firm.
  • The cost of preferred stock remains constant from year to year.
  • Preferred stock is valued using the capital asset pricing model.

Question 5

Question
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. Given this, the firm should probably:
Answer
  • require the highest rate of return from Division X since it has been in existence the longest.
  • assign the highest cost of capital to Division Z because it is most likely the riskiest of the three divisions.
  • use the firm's WACC as the cost of capital for Division Z as it provides analysis for the entire firm.
  • 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.
  • allocate capital funds evenly amongst the divisions to maintain the current capital structure of the firm.

Question 6

Question
A firm that uses its weighted average cost of capital as the required return for all of its investments will:
Answer
  • maintain a constant value for its shareholders.
  • increase the risk level of the firm over time.
  • make the best possible accept and reject decisions related to those investments.
  • find that its cost of capital declines over time.
  • accept only the projects that add value to the firm's shareholders.

Question 7

Question
In an efficient market, the cost of equity for a highly risky firm:
Answer
  • will be less than the market rate but higher than the risk-free rate.
  • must equal the market rate of return.
  • changes by 1 percent for every 1 percent change in the risk-free rate.
  • decreases as the beta of the firm's stock increases.
  • increases in direct relation to the stock's systematic risk.

Question 8

Question
Boone Brothers remodels homes and replaces windows. Ace Builders constructs new homes. If Boone Brothers considers expanding into new home construction, it should evaluate the expansion project using which one of the following as the required return for the project?
Answer
  • Boone Brothers' cost of capital
  • Ace Builders' cost of capital
  • Average of Boone Brothers' and Ace Builders' cost of capital
  • Lower of Boone Brothers' or Ace Builders' cost of capital
  • Higher of Boone Brothers' or Ace Builders' cost of capital

Question 9

Question
Which one of the following statements is correct? Assume the pretax cost of debt is less than the cost of equity.
Answer
  • A firm may change its capital structure if the government changes its tax policies.
  • A decrease in the dividend growth rate increases the cost of equity.
  • A decrease in the systematic risk of a firm will increase the firm's cost of capital.
  • A decrease in a firm's debt-equity ratio will decrease the firm's cost of capital.
  • The cost of preferred stock decreases when the tax rate increases.

Question 10

Question
Which one of the following is used as the pretax cost of debt?
Answer
  • Average coupon rate on the firm's outstanding bonds
  • Coupon rate on the firm's latest bond issue
  • Weighted average yield to maturity on the firm's outstanding debt
  • Average current yield on the firm's outstanding debt
  • Annual interest divided by the market price per bond for the latest bond issue

Question 11

Question
Which one of the following is the primary determinant of an investment's cost of capital?
Answer
  • Life of the investment
  • Amount of the initial cash outlay
  • The investment’s level of risk
  • The source of funds used for the investment
  • The investment's net present value

Question 12

Question
All else constant, an increase in a firm's cost of debt:
Answer
  • could be caused by an increase in the firm's tax rate.
  • will result in an increase in the firm's cost of capital.
  • will lower the firm's weighted average cost of capital.
  • will lower the firm's cost of equity.
  • will increase the firm's capital structure weight of debt.

Question 13

Question
Which one of the following statements is correct related to the dividend growth model approach to computing the cost of equity?
Answer
  • The rate of growth must exceed the required rate of return.
  • The rate of return must be adjusted for taxes.
  • The annual dividend used in the computation must be for Year 1 if you are Time 0’s stock price to compute the return.
  • The cost of equity is equal to the return on the stock plus the risk-free rate.
  • The cost of equity is equal to the return on the stock multiplied by the stock's beta.

Question 14

Question
Kelly's uses the firm's WACC as the required return for some of its projects. For other projects, the firms uses a rate equal to WACC plus one percent, while another set of projects is assigned rates equal to WACC minus some amount. Which one of the following factors should be the key factor the firm uses to determine the amount of the adjustment it will make when assigning a discount rate to a specific project?
Answer
  • The current market rate of interest
  • Actual source of funds used to finance the project
  • The perceived risk level of project
  • The division within the firm that will be assigned to manage the project
  • The firm’s current debt-equity ratio

Question 15

Question
Kurt, who is a divisional manager, continually brags that his division's required return for its projects is one percent lower than the return required for any other division of the firm. Which one of the following most likely contributes the most to the lower rate requirement for Kurt's division?
Answer
  • Kurt tends to overestimate the projected cash inflows on his projects.
  • Kurt tends to underestimate the variable costs of his projects.
  • Kurt has the most efficiently managed division.
  • Kurt's division is less risky than the other divisions.
  • Kurt's projects are generally financed with debt while the other divisions' projects are financed with equity.

Question 16

Question
Black Stone Furnaces wants to build a new facility. The cost of capital for this investment is primarily dependent on which one of the following?
Answer
  • The firm's overall source of funds
  • Source of the funds used to build the facility
  • Current tax rate
  • The nature of the investment
  • Firm's historical average rate of return

Question 17

Question
Kate is the CFO of a major firm and has the job of assigning discount rates to each project under consideration. Kate's method of doing this is to assign an incrementally higher rate as the risk level of the project increases and a lower rate as the risk level declines. Kate is applying the ___ approach.
Answer
  • pure play
  • divisional rating
  • subjective
  • straight WACC
  • equity rating

Question 18

Question
Ted is trying to decide what cost of capital he should assign to a project. Which one of the following should be his primary consideration in this decision?
Answer
  • Amount of debt used to finance the project
  • Use, or lack, of preferred stock as a financing option
  • Mix of funds used to finance the project
  • Risk level of the project
  • Length of the project's life

Question 19

Question
Katie owns 100 shares of ABC stock. Which one of the following terms is used to refer to the return that Katie and the other shareholders require on their investment in ABC?
Answer
  • Weighted average cost of capital
  • Pure play cost
  • Cost of equity
  • Subjective cost
  • Cost of debt

Question 20

Question
Which one of the following represents the minimum rate of return a firm must earn on its assets if it is to maintain the current value of its securities?
Answer
  • Cost of equity
  • Pretax cost of debt
  • Aftertax cost of debt
  • Weighted average cost of capital
  • Weighted average cost of preferred and common stock
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