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Exam 11: Cost of Capital

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Question 61

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In the Net Operating Income approach to cost-of-capital analysis, a firm's value depends on:

A) its net operating income.
B) its use of debt.
C) size of the firm.
D) retained earnings as a proportion of debt.

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Question 62

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An increase in investors' aversion to risk causes the SML to shift up parallel to the old SML.

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Question 63

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In determining the optimum capital structure it is assumed that the firm will raise capital in the optimum proportions every year.

If the flotation cost goes up, the cost of retained earnings will:

Although the after tax cost of debt is below the cost of equity, firms cannot increase their use of debt without limit.

The cost of debt is determined by taking the:

Beta is a good measure of a stock's risk when the stock is combined into a portfolio.

Although debt financing is usually the cheapest component of capital, it cannot be used to excess because:

The Abacus Computer Company has decided to use the Capital Asset Pricing Model to estimate its cost of equity. The firm's beta was estimated at 1.4. The S&P/TSX Composite-stock index has returned 12.5% to investors over a fairly long period of time, and Abacus has decided to use this value as the market return. Treasury bills are currently providing investors with a 6.5% yield. A) Calculate Abacus's cost of equity using the CAPM. B) If its beta was incorrectly estimated, and a new revised estimate of 1.8 was used in the calculations, what would its new estimate of the cost of equity be?

The cost of capital is used as a discount rate because:

A general increase in interest rates will raise the required rates of return for all stocks.

K_e represents an expected return to shareholders as well as a cost to the firm.

The required rate of return for a stock which has 1.5 times the risk of the market in general will be:

A firm's cost of preferred stock is equal to the preferred dividend divided by the net price after flotation costs K_p = (D_p/P_o - F).

The after tax cost of debt will usually be below:

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

Jury Company has the following capital structure: 55% debt, 35% equity, and 10% preferred stock. Calculate Jury's weighted average cost of capital (WACC) assuming no new common shares are issued, using the answers obtained from question 117.

A firm's stock is selling for $78. The next annual dividend is expected to be $2.34. The growth rate is 9%. The flotation cost is $5.00. What is the cost of retained earnings?

Financial capital does not include:

The cost of capital for each source of funds is a cost dependent on current market conditions and expected rates of return.