implies a project will produce a positive net present value only when the rate of return on the project is less than the predetermined cost of capital.. an increase in the market rate of
Trang 1Multiple Choice Questions
1 The return shareholders require on their investment in a firm is called the:
3 The weighted average of a firm's cost of equity and aftertax cost of debt is called the:
a reward to risk ratio
b weighted capital gains rate
c pure play cost of capital
Trang 34 When a manager develops a cost of capital for a specific project based on the cost of capitalfor another firm which has a similar line of business as the project, the manager is utilizing the _ approach
5 The cost of capital:
a will decrease as the risk level of a firm increases
b is primarily dependent upon the source of the funds used for a project
c implies a project will produce a positive net present value only when the rate of return on the project is less than the predetermined cost of capital
d remains constant for all projects undertaken by the same firm
E depends on how the funds are going to be utilized.
SECTION: 15.1
TOPIC: COST OF CAPITAL
TYPE: CONCEPTS
Trang 4a is equivalent to the aftertax cost of the firm's liabilities.
b should be used as the required return when analyzing a potential acquisition of a wholesale distributor
C reflects the return investors require on the total assets of the firm.
d remains constant when the debt-equity ratio changes
e is unaffected by changes in corporate tax rates
SECTION: 15.1
TOPIC: COST OF CAPITAL
TYPE: CONCEPTS
Trang 57 The cost of capital primarily depends on the:
a debt-equity ratio
b applicable tax rate
c cost of equity financing
a by adding the market risk premium to the aftertax cost of debt
b by treating the common stock as if it were preferred stock
c by using the dividend growth formula
D by using the security market line approach
e by averaging the cost determined by both the dividend growth formula and the security market line approach
SECTION: 15.2
TOPIC: COST OF EQUITY
TYPE: CONCEPTS
Trang 6computes that cost using the security market line approach? Assume the firm currently pays
an annual dividend of $2.10 a share and has a beta of 1.1
a a reduction in the dividend amount
b an increase in the dividend amount
c a reduction in the market risk premium
d a reduction in the firm's beta
E an increase in the market rate of return
SECTION: 15.2
TOPIC: COST OF EQUITY
TYPE: CONCEPTS
Trang 710 A firm's overall cost of equity is:
a directly observable in the financial markets
b unaffected by changes in the market risk premium
C highly dependent upon the growth rate and risk level of the firm.
d generally less than the firm's aftertax cost of debt
e inversely related to change in the firm's tax rate
SECTION: 15.2
TOPIC: COST OF EQUITY
TYPE: CONCEPTS
11 The cost of equity for a firm is:
a dependent upon the firm's debt-equity ratio
B based on estimates derived from financial models.
c equivalent to a leveraged firm's cost of capital
d equal to the risk-free rate of return plus the market risk premium
e equal to the firm's pretax weighted average cost of capital
SECTION: 15.2
TOPIC: COST OF EQUITY
TYPE: CONCEPTS
12 The dividend growth model:
a can be used to estimate the cost of equity for any corporation
b is applicable only to firms that pay a constant dividend
c is unaffected by the estimated rate of dividend growth
D can be applied to firms that are reducing their dividend amount.
e considers the risk level of the firm
Trang 813 The dividend growth model:
A is only as reliable as the estimated rate of growth.
b can only be used if historical dividend information is available
c considers the risk that future dividends may vary from their estimated values
d applies only when a firm is currently paying dividends
e uses beta to measure the systematic risk of a firm
SECTION: 15.2
TOPIC: DIVIDEND GROWTH MODEL
TYPE: CONCEPTS
14 The market risk premium:
A can vary over time.
b is equal to the risk premium for a security minus the market rate of return
c is equal to zero for a risk-free asset
d is equal to the risk-free rate multiplied by the beta of a firm
e is constant over time
SECTION: 15.2
TOPIC: SECURITY MARKET LINE APPROACH
TYPE: CONCEPTS
Trang 915 Which of the following statements are correct concerning the security market line (SML) approach to determining the cost of equity for a firm?
I The SML approach considers the amount of unsystematic risk associated with a firm
II The SML approach can be applied to more firms than the dividend growth model can.III The SML approach considers only future information
IV The SML approach assumes the reward-to-risk ratio is constant
a I and III only
B II and IV only
c III and IV only
d I, II, and III only
e I, II, III, and IV
SECTION: 15.2
TOPIC: SECURITY MARKET LINE APPROACH
TYPE: CONCEPTS
Trang 1016 The pre-tax cost of debt for a firm:
A is based on the yield to maturity on the firm's outstanding bonds.
b is equal to the coupon rate for the latest bond issue
c is equivalent to the current yield on the outstanding bonds of the firm
d is based on the yield to maturity that existed when the currently outstanding bonds were originally issued
e has to be estimated as it cannot be directly observed in the market
SECTION: 15.3
TOPIC: COST OF DEBT
TYPE: CONCEPTS
17 The aftertax cost of debt generally increases when:
I a firm's bond rating increases
II the market rate of interest increases
III tax rates decrease
IV bond prices rise
a I and III only
B II and III only
c I, II, and III only
d II, III, and IV only
e I, II, III, and IV
SECTION: 15.3
TOPIC: COST OF DEBT
TYPE: CONCEPTS
Trang 1118 The cost of preferred stock is computed the same as the:
a pre-tax cost of debt
Trang 1219 The cost of preferred stock:
A is equal to the dividend yield.
b is equal to the yield to maturity
c is highly dependent on the dividend growth rate
d varies directly with the stock's price
e is relatively difficult to determine
SECTION: 15.3
TOPIC: COST OF PREFERRED STOCK
TYPE: CONCEPTS
20 The capital structure weights used in computing the weighted average cost of capital:
a are based on the book values of total debt and total equity
B are based on the market value of the firm's debt and equity securities.
c are computed using the book value of the long-term debt and the book value of equity
d remain constant over time unless the firm issues new securities
e are restricted to the firm's debt and common stock
a market price of the common stock
b number of shares of preferred stock outstanding
c book value of the outstanding shares of common stock
D number of bonds outstanding
e number of shares of stock outstanding
Trang 1322 The aftertax cost of debt:
a varies inversely to market interest rates
b will generally exceed the cost of equity if the relevant tax rate is zero
c is equal to the pre-tax cost of debt
d is directly related to the cost of equity
E has a greater effect on a firm's cost of capital when the debt-equity ratio increases.
SECTION: 15.3
TOPIC: WEIGHTED AVERAGE COST OF CAPITAL
TYPE: CONCEPTS
23 The weighted average cost of capital for a firm is dependent upon the firm's:
I level of systematic risk
II debt-equity ratio
III preferred dividend amount
IV outstanding bonds' yield to maturity
a I and III only
b II and IV only
c I, II, and IV only
d I, III, and IV only
E I, II, III, and IV
SECTION: 15.4
TOPIC: WEIGHTED AVERAGE COST OF CAPITAL
TYPE: CONCEPTS
Trang 14a discount rate which the firm should apply to all of the projects it undertakes.
B rate of return a firm must earn on its existing assets to maintain the current value of its
stock
c coupon rate the firm should expect to pay on its next bond issue
d maximum rate which the firm should require on any projects it undertakes
e required rate which every project's internal rate of return must exceed
SECTION: 15.4
TOPIC: WEIGHTED AVERAGE COST OF CAPITAL
TYPE: CONCEPTS
Trang 1525 Which one of the following statements is correct concerning the weighted average cost of capital (WACC)?
A The WACC may decrease as a firm's debt-equity ratio increases.
b When computing the WACC, the weight assigned to the preferred stock is based on the coupon rate multiplied by the par value of the stock
c A firm's WACC will decrease as the corporate tax rate decreases
d The weight of the common stock used in the computation of the WACC is based on the number of shares outstanding multiplied by the book value per share
e The WACC will remain constant unless a firm retires some of its debt
I reject some positive net present value projects
II accept some negative net present value projects
III favor high risk projects over low risk projects
IV maintain its current level of risk
a I and III only
b III and IV only
C I, II, and III only
d I, II, and IV only
e I, II, III, and IV
SECTION: 15.4
TOPIC: WEIGHTED AVERAGE COST OF CAPITAL
TYPE: CONCEPTS
Trang 1627 Swanson & Sons has two separate divisions Each division is in a separate line of
business Division A is the largest division and represents 65 percent of the firm's overall sales Division A is also the riskier of the two divisions Division B is the smaller and least risky of the two When management is deciding which of the various divisional projects should be accepted, the managers should:
a allocate more funds to Division A since it is the largest of the two divisions
b fund all of Division B's projects first since they tend to be less risky and then allocate the remaining funds to the Division A projects that have the highest net present values
c allocate the company's funds to the projects with the highest net present values based on thefirm's weighted average cost of capital
D assign appropriate, but differing, discount rates to each project and then select the projects
with the highest net present values
e fund the highest net present value projects from each division based on an allocation of 65 percent of the funds to Division A and 35 percent of the funds to Division B
a receive less funding if they represent the riskiest operations of the firm
b avoid risky projects so that they will receive more funding
c become less risky over time based on the projects that are accepted
d have equal probabilities of receiving funding for their projects
E propose higher risk projects than if separate discount rates were applied to each project.
SECTION: 15.5
TOPIC: DIVISIONAL COST OF CAPITAL
TYPE: CONCEPTS
Trang 1729 The discount rate assigned to an individual project should be based on:
a the firm's weighted average cost of capital
b the actual sources of funding used for the project
c an average of the firm's overall cost of capital for the past five years
d the current risk level of the overall firm
E the risks associated with the use of the funds utilized for the project.
SECTION: 15.5
TOPIC: PROJECT COST OF CAPITAL
TYPE: CONCEPTS
Trang 1830 Assigning discount rates to individual projects based on the risk level of each project:
A may cause the firm's overall weighted average cost of capital to either increase or decrease
over time
b will prevent the firm's overall cost of capital from changing over time
c will cause the firm's overall cost of capital to decrease over time
d decreases the value of the firm over time
e negates the firm's goal of creating the most value for the shareholders
SECTION: 15.5
TOPIC: PROJECT COST OF CAPITAL
TYPE: CONCEPTS
31 The cost of capital assigned to an individual project should be that rate which:
a corresponds to the risk level of the firm's division which has responsibility for the project
B is relevant to the intended use of the funds.
c equals the firm's WACC unless the pure play approach is utilized
d is the firm's current weighted average cost of capital
e represents the actual sources of funds used for the project
SECTION: 15.5
TOPIC: PROJECT COST OF CAPITAL
TYPE: CONCEPTS
Trang 1932 Wayne's of New York specializes in clothing for female executives living and working in the financial district of New York City Allen's of PA specializes in clothing for women who live and work in the rural areas of Western Pennsylvania Both firms are currently consideringexpanding their clothing line to encompass working women in the rural upstate region of NewYork state Wayne's currently has a cost of capital of 11 percent while Allen's cost of capital
is 9 percent The expansion project has a projected net present value of $36,900 at a 9 percent discount rate and a net present value of $13,200 at an 11 percent discount rate Which firm
or firms should expand into rural New York state?
a Wayne's only
b Allen's only
C both Wayne's and Allen's
d neither Wayne's nor Allen's
e cannot be determined from the information provided
SECTION: 15.5
TOPIC: PURE PLAY APPROACH
TYPE: CONCEPTS
Trang 2033 The Jasper Mountain Co specializes in back-country camping facilities across the nation The Plan It Co specializes in making travel reservations and promoting vacation travel Jasper has an aftertax cost of capital of 12 percent and Plan It has an aftertax cost of capital of
10 percent Both firms are considering building wilderness campgrounds complete with their own lakes and numerous mountain trails The estimated net present value of such a project is estimated at $113,000 at a discount rate of 10 percent and $64,500 at a 12 percent discountrate Which firm or firms, if either, should accept this project?
a Jasper only
b Plan It only
c both Jasper and Plan It
D neither Jasper nor Plan It
e cannot be determined without further information
SECTION: 15.5
TOPIC: PURE PLAY APPROACH
TYPE: CONCEPTS
34 The subjective approach to project analysis:
a is used only when the firm is an all-equity firm
b uses the WACC of firm X as the basis for the discount rate for a project under consideration
by firm Y
C assigns discount rates to projects based on the discretion of the senior managers of a firm.
d allows managers to randomly adjust the discount rate assigned to a project once the
project's beta has been determined
e applies a lower discount rate to projects that are financed with internal rather than external equity
SECTION: 15.5
TOPIC: SUBJECTIVE APPROACH
TYPE: CONCEPTS
Trang 2135 When a firm uses the subjective approach to assign discount rates to projects, the firm's managers:
I will assign its highest discount rate to those projects which are mandated by the
government
II risk accepting projects that should have been rejected
III assign the highest discount rates to those projects the managers personally prefer
IV generally make better decisions than they would if they applied the firm's weighted average cost of capital to all projects
a I and III only
B II and IV only
c I, II, and III only
d II, III, and IV only
e I, II, III, and IV
SECTION: 15.5
TOPIC: SUBJECTIVE APPROACH
TYPE: CONCEPTS
Trang 2236 When a firm has flotation costs equal to 6 percent of the funding need, project analysts should:
a increase the project's discount rate to offset these expenses by multiplying the firm's WACC
by 1.06
b increase the project's discount rate to offset these expenses by dividing the firm's WACC by(1 .06)
c add 6 percent to the firm's WACC to get the discount rate for the project
d increase the initial project cost by multiplying that cost by 1.06
E increase the initial project cost by dividing that cost by (1 .06).
SECTION: 15.6
TOPIC: FLOTATION COSTS AND WACC
TYPE: CONCEPTS
37 The flotation cost for a firm is computed as:
a the arithmetic average of the flotation costs of both debt and equity
B the weighted average of the flotation costs associated with each form of financing.
c the geometric average of the flotation costs associated with each form of financing
d one-half of the flotation cost of debt plus one-half of the flotation cost of equity
e a weighted average based on the book values of the firm's debt and equity
SECTION: 15.6
TOPIC: FLOTATION COSTS AND WACC
TYPE: CONCEPTS
Trang 2338 Incorporating flotation costs into the initial cash flow of a project will:
a cause the project to be improperly evaluated
b increase the net present value of the project
c increase the project's internal rate of return
D increase the initial cash outflow of the project thereby lowering the project's net present
Trang 2439 Flotation costs should:
a be ignored when analyzing a project because flotation costs are not an actual cost of the project
b be averaged over the life of the project thereby reducing the cash flows for each year of the project
c only be considered when two projects have the same net present value
D be included in the initial cost of a project before the net present value of the project is
Trang 2541 Photo Imaging, Inc has paid annual dividends of $1.00, $1.05, $1.10, and $1.18 per share over the last four years, respectively The stock is currently selling for $38 a share What is this firm's cost of equity?
Trang 2643 The common stock of Jack's Hardware has a growth rate of 2 percent and a required return
of 9 percent If the current price of the stock is $24.67 what was the amount of the last
Trang 2745 Ronald's Fast Food just paid their annual dividend of $1.05 a share The stock has a market price of $26 and a beta of 1.15 The return on the U.S Treasury bill is 3 percent and the market risk premium is 7 percent What is the cost of equity?
Trang 2847 HBS, Inc has a growth rate of 6 percent and is equally as risky as the market The stock iscurrently selling for $15 a share The overall stock market has a 12 percent rate of return and arisk premium of 9 percent What is the expected rate of return on HBS's stock?
Increase in cost of equity = (1.9 1.6) .07 = 2.10 percent
AACSB TOPIC: ANALYTIC
SECTION: 15.2
TOPIC: COST OF EQUITY
TYPE: PROBLEMS
Trang 2949 The Lawson Company has a seven-year bond outstanding with a 6 percent coupon Interest payments are paid semi-annually The face amount of the bond is $1,000 This bond
is currently selling for 101 percent of its face value What is the company's pre-tax cost of debt?
Trang 3051 The Fix-it Shop has zero coupon bonds outstanding that mature in three years The bonds have a face value of $1,000 and a current market price of $860 What is the company's pre-taxcost of debt?