1. A group of individuals got together and purchased all of the outstanding shares of common stock of DL Smith, Inc. What is the return that these individuals require on this investment called?
A. dividend yield
B. cost of equity
C. capital gains yield
D.
B. cost of equity
Textile Mills borrows money at a rate of 13.5 percent. This interest rate is referred to as the:
A. compound rate.
B. current yield.
C. cost of debt.
D. capital gains yield.
E. cost of capital.
C. cost of debt.
The average of a firm's cost of equity and aftertax cost of debt that is weighted based on the firm's capital structure is called the:
A. reward to risk ratio.
B. weighted capital gains rate.
C. structured cost of capital.
D. subjective cost of capital.
E
E. weighted average cost of capital.
When a manager develops a cost of capital for a specific project based on the cost of capital for another firm which has a similar line of business as the project, the manager is utilizing the _____ approach.
A. subjective risk
B. pure play
C. divisional
B. pure play
A firm's cost of capital:
A. will decrease as the risk level of the firm increases.
B. for a specific project is primarily dependent upon the source of the funds used for the project.
C. is independent of the firm's capital structure.
D. should be applied
E. depends upon how the funds raised are going to be spent.
The weighted average cost of capital for a wholesaler:
A. 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 retail outlet.
C. is the return investors require
C. is the return investors require on the total assets of the firm.
Which one of the following is the primary determinant of a firm's cost of capital?
A. debt-equity ratio
B. applicable tax rate
C. cost of equity
D. cost of debt
E. use of the funds
E. use of the funds
Scholastic Toys is considering developing and distributing a new board game for children. The project is similar in risk to the firm's current operations. The firm maintains a debt-equity ratio of 0.40 and retains all profits to fund the firm's rapid grow
D. by using the capital asset pricing model
All else constant, which one of the following will increase a firm's cost of equity if the firm computes that cost using the security market line approach? Assume the firm currently pays an annual dividend of $1 a share and has a beta of 1.2.
A. a reducti
E. a reduction in the risk-free rate
A firm's overall cost of equity is:
A. is generally less that the firm's WACC given a leveraged firm.
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
C. highly dependent upon the growth rate and risk level of the firm.
The cost of equity for a firm:
A. tends to remain static for firms with increasing levels of risk.
B. increases as the unsystematic risk of the firm increases.
C. ignores the firm's risks when that cost is based on the dividend growth model.
D. equals the
C. ignores the firm's risks when that cost is based on the dividend growth model.
The dividend growth model can be used to compute the cost of equity for a firm in which of the following situations?
I. firms that have a 100 percent retention ratio
II. firms that pay a constant dividend
III. firms that pay an increasing dividend
IV. fir
E. II, III, and IV only
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. is only as reliable as the estimated rate of growth.
Which one of the following statements related to the SML approach to equity valuation is correct? Assume the firm uses debt in its capital structure.
A. This model considers a firm's rate of growth.
B. The model applies only to non-dividend paying firms.
C. The model is dependent upon a reliable estimate of the market risk premium.
Which of the following statements are correct?
I. The SML approach is dependent upon a reliable measure of a firm's unsystematic risk.
II. The SML approach can be applied to firms that retain all of their earnings.
III. The SML approach assumes a firm's f
E. II, III, and IV only
The pre-tax cost of debt:
A. is based on the current yield to maturity of the firm's outstanding bonds.
B. is equal to the coupon rate on the latest bonds issued by a firm.
C. is equivalent to the average current yield on all of a firm's outstanding bonds
A. is based on the current yield to maturity of the firm's outstanding bonds.
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
B. II and III only
The cost of preferred stock is computed the same as the:
A. pre-tax cost of debt.
B. return on an annuity.
C. aftertax cost of debt.
D. return on a perpetuity.
E. cost of an irregular growth common stock.
D. return on a perpetuity.
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. is independent of the stock's price.
E. decreases when tax rates increase.
A. is equal to the dividend yield.
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
B. are based on the market value of the firm's debt and equity securities.
Morris Industries has a capital structure of 55 percent common stock, 10 percent preferred stock, and 45 percent debt. The firm has a 60 percent dividend payout ratio, a beta of 0.89, and a tax rate of 38 percent. Given this, which one of the following st
C. The firm's cost of equity is unaffected by a change in the firm's tax rate.
The aftertax cost of debt:
A. varies inversely to changes in market interest rates.
B. will generally exceed the cost of equity if the relevant tax rate is zero.
C. will generally equal the cost of preferred if the tax rate is zero.
D. is unaffected by ch
E. has a greater effect on a firm's cost of capital when the debt-equity ratio increases.
The weighted average cost of capital for a firm may be dependent upon the firm's:
I. rate of growth.
II. debt-equity ratio.
III. preferred dividend payment.
IV. retention ratio.
A. I and III only
B. II and IV only
C. I, II, and IV only
D. I, III, and IV o
E. I, II, III, and IV
The weighted average cost of capital for a firm is the:
A. 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
B. rate of return a firm must earn on its existing assets to maintain the current value of its stock.
Which one of the following statements is correct for a firm that uses debt in its capital structure?
A. The WACC should decrease as the firm's debt-equity ratio increases.
B. When computing the WACC, the weight assigned to the preferred stock is based on
A. The WACC should decrease as the firm's debt-equity ratio increases.
If a firm uses its WACC as the discount rate for all of the projects it undertakes then the firm will tend to:
I. reject some positive net present value projects.
II. accept some negative net present value projects.
III. favor high risk projects over low
E. I, II, III, and IV
Preston Industries has two separate divisions. Each division is in a separate line of business. Division A is the largest division and represents 70 percent of the firm's overall sales. Division A is also the riskier of the two divisions. Division B is th
D. assign appropriate, but differing, discount rates to each project and then select the projects with the highest net present values.
Markley and Stearns is a multi-divisional firm that uses its WACC as the discount rate for all proposed projects. Each division is in a separate line of business and each presents risks unique to those lines. Given this, a division within the firm will te
E. prefer higher risk projects over lower risk projects.
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.
E. the risks associated with the use of the funds required by the project.
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 cha
A. may cause the firm's overall weighted average cost of capital to either increase or decrease over time.
Which one of the following statements is correct?
A. Firms should accept low risk projects prior to funding high risk projects.
B. Making subjective adjustments to a firm's WACC when determining project discount rates unfairly punishes low-risk divisions
C. A project that is unacceptable today might be acceptable tomorrow given a change in market returns.
Phil's is a sit-down restaurant that specializes in home-cooked meals. Theresa's is a walk-in deli that specializes in specialty soups and sandwiches. Both firms are currently considering expanding their operations during the summer months by offering pre
C. both Phil's and Theresa's
Wilderness Adventures specializes in back-country tours and resort management. Travel Excitement specializes in making travel reservations and promoting vacation travel. Wilderness Adventures has an aftertax cost of capital of 13 percent and Travel Excite
D. neither Wilderness Adventures nor Travel Excitement
The subjective approach to project analysis:
A. is used only when a firm has an all-equity capital structure.
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
C. assigns discount rates to projects based on the discretion of the senior managers of a firm.
Which one of the following statements is correct?
A. The subjective approach assesses the risks of each project and assigns an adjustment factor that is unique just for that project.
B. Overall, a firm makes better decisions when it uses the subjective ap
B. Overall, a firm makes better decisions when it uses the subjective approach than when it uses its WACC as the discount rate for all projects.
When a firm has flotation costs equal to 7 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 1.07.
B. increase the project's discount rate to offset the
E. increase the initial project cost by dividing that cost by (1 - 0.07).
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
B. the weighted average of the flotation costs associated with each form of financing.
Incorporating flotation costs into the analysis 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 rate of return.
D. increase the initial cash outflow of the pro
D. increase the initial cash outflow of the project.
Flotation costs for a levered firm should:
A. be ignored when analyzing a project because they are not an actual project cost.
B. be spread over the life of a project thereby reducing the cash flows for each year of the project.
C. only be considered when
D. be weighted and included in the initial cash flow.