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Exam 12: Cost of Capital

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Question 41

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Which one of the following will increase the cost of equity,all else held constant?

A) Increase in the dividend growth rate
B) Decrease in beta
C) Decrease in future dividends
D) Increase in stock price
E) Decrease in market risk premium

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Question 42

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Which one of the following statements is correct,all else held constant?

A) Beta is used to compute the return on equity and the standard deviation is used to compute the return on preferred.
B) A decrease in a firm's WACC will increase the attractiveness of the firm's investment options.
C) The aftertax cost of debt increases when the market price of a bond increases.
D) If you have both the dividend growth and the security market line's costs of equity, you should use the higher of the two estimates when computing WACC.
E) WACC is applicable only to firms that issue both common and preferred stock.

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Question 43

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The cost of preferred stock:

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?

Bermuda Cruises issues only common stock and coupon bonds.The firm has a debt-equity ratio of 0.65.The cost of equity is 18.3 percent and the pretax cost of debt is 9.9 percent.What is the capital structure weight of the firm's equity if the firm's tax rate is 34 percent?

Traditional Bank has an issue of preferred stock with a $4.80 stated dividend that just sold for $80 a share.What is the bank's cost of preferred stock?

Precision Cuts has a target debt-equity ratio of 0.55.Its cost of equity is 15.4 percent,and its pretax cost of debt is 7.8 percent.If the tax rate is 32 percent,what is the company's WACC?

Which one of the following statements is correct concerning capital structure weights?

Assume the federal government decides to permanently eliminate corporate income taxes as a means of encouraging economic development and job growth.What effect,if any,would this change have on the evaluation of a proposed project?

In an efficient market,the cost of equity for a risky firm does which one of the following according to the security market line?

Which one of the following is most apt to cause a wise manager to increase a project's cost of capital? Assume the firm is levered.

Piedmont Hotels is an all-equity firm with 60,000 shares of stock outstanding.The stock has a beta of 1.27 and a standard deviation of 13.8 percent.The market risk premium is 9.1 percent and the risk-free rate of return is 4.5 percent.The company is considering a project that it considers riskier than its current operations so it wants to apply an adjustment of 1 percent to the project's discount rate.What should the firm set as the required rate of return for the project?

Which of the following are weaknesses of the dividend growth model? I.Market risk premium fluctuations II.Lack of dividends for some firms III.Reliance on historical beta IV.Sensitivity of model to dividend growth rate

Derek's is a brick-and-mortar toy store.The firm is considering expanding its operations to include Internet sales.Which one of the following would be the best firm to use in a pure play approach to analyzing this proposed expansion?

Kurt,who is a divisional manager,continually brags that his division's required return for its projects is 1 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?

Great Lakes Packing has two bond issues outstanding.The first issue has a coupon rate of 9 percent,matures in 3 years,has a total face value of $6 million,and is quoted at 108 percent of face value.The second issue has a 7.5 percent coupon,matures in 16 years,has a total face value of $18 million,and is quoted at 97 percent of face value.Both bonds pay interest semiannually.What is the firm's weighted average aftertax cost of debt if the tax rate is 35 percent?

The Cracker Barrel has a beta of 0.98,a dividend growth rate of 3.2 percent,a stock price of $33 a share,and an expected annual dividend of $1.06 per share next year.The market rate of return is 11.2 percent and the risk-free rate is 3.7 percent.What is the firm's cost of equity?

Lester lent money to The Corner Store by purchasing bonds issued by the store.The rate of return that he and the other lenders require is referred to as the:

Assume the federal government mandates that all retail stores in the northern states install heated sidewalks to help minimize the number of injuries that occur from people falling as a result of snow and ice buildup on those sidewalks.How should a firm determine the cost of capital for a project such as this?

A firm has a return on equity of 12.4 percent according to the dividend growth model and a return of 18.7 percent according to the capital asset pricing model.The market rate of return is 13.5 percent.What rate should the firm use as the cost of equity when computing the firm's weighted average cost of capital (WACC) ?