Financial Management - Chapter 14 Cost of Capital

Chapter 14 Cost of Capital

 

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.  cost of capital E.  income return Refer to section 14.2

AACSB: Analytic Blooms: Remember Difficulty: 1 Easy Learning Objective: 14-01 How to determine a firm's cost of equity capital. Section: 14.2 Topic: Cost of equity

2.	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. Refer to section 14.3

AACSB: Analytic Blooms: Remember Difficulty: 1 Easy Learning Objective: 14-02 How to determine a firm's cost of debt. Section: 14.3 Topic: Cost of debt

3.

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.  weighted average cost of capital. Refer to section 14.4

AACSB: Analytic Blooms: Remember Difficulty: 1 Easy Learning Objective: 14-03 How to determine a firm's overall cost of capital. Section: 14.4 Topic: Weighted average cost of capital

4.

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 cost of capital D.  capital adjustment E.  security market line Refer to section 14.5

AACSB: Analytic Blooms: Remember Difficulty: 1 Easy Learning Objective: 14-05 Some of the pitfalls associated with a firm's overall cost of capital and what to do about them. Section: 14.5 Topic: Pure Play

5.

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 as the discount rate for any project considered by the firm. E.  depends upon how the funds raised are going to be spent. Refer to section 14.1

AACSB: Analytic Blooms: Understand Difficulty: 1 Easy Learning Objective: 14-03 How to determine a firm's overall cost of capital. Section: 14.1 Topic: Cost of capital

6.

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 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. Refer to section 14.1

AACSB: Analytic Blooms: Understand Difficulty: 1 Easy Learning Objective: 14-03 How to determine a firm's overall cost of capital. Section: 14.1 Topic: WACC

7.	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 Refer to section 14.1

AACSB: Analytic Blooms: Remember Difficulty: 1 Easy Learning Objective: 14-03 How to determine a firm's overall cost of capital. Section: 14.1 Topic: Cost of capital

8.

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 growth. How should the firm determine its cost of equity?    A.  by adding the market risk premium to the aftertax cost of debt B.  by multiplying the market risk premium by (1 - 0.40) C.  by using the dividend growth model D.  by using the capital asset pricing model E.  by averaging the costs based on the dividend growth model and the capital asset pricing model Refer to section 14.2

AACSB: Analytic Blooms: Understand Difficulty: 1 Easy Learning Objective: 14-01 How to determine a firm's cost of equity capital. Section: 14.2 Topic: Cost of equity

9.

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 reduction in the dividend amount B.  an increase in the dividend amount C.  a reduction in the market rate of return D.  a reduction in the firm's beta E.  a reduction in the risk-free rate Refer to section 14.2

AACSB: Analytic Blooms: Understand Difficulty: 2 Medium Learning Objective: 14-01 How to determine a firm's cost of equity capital. Section: 14.2 Topic: CAPM

10.

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's aftertax cost of debt. E.  inversely related to changes in the firm's tax rate. Refer to section 14.2

AACSB: Analytic Blooms: Understand Difficulty: 1 Easy Learning Objective: 14-01 How to determine a firm's cost of equity capital. Section: 14.2 Topic: Cost of equity

11.

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 risk-free rate plus the market risk premium. E.  equals the firm's pretax weighted average cost of capital. Refer to section 14.2

AACSB: Analytic Blooms: Understand Difficulty: 1 Easy Learning Objective: 14-01 How to determine a firm's cost of equity capital. Section: 14.2 Topic: Cost of equity

12.

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. firms that pay a decreasing dividend    A.  I and II only B.  I and III only C.  II and III only D.  I, II, and III only E.  II, III, and IV only Refer to section 14.2

AACSB: Analytic Blooms: Understand Difficulty: 1 Easy Learning Objective: 14-01 How to determine a firm's cost of equity capital. Section: 14.2 Topic: Dividend growth model

13.

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. Refer to section 14.2

AACSB: Analytic Blooms: Understand Difficulty: 1 Easy Learning Objective: 14-01 How to determine a firm's cost of equity capital. Section: 14.2 Topic: Dividend growth model

14.

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. D.  The model generally produces the same cost of equity as the dividend growth model. E.  This approach generally produces a cost of equity that equals the firm's overall cost of capital. Refer to section 14.2

AACSB: Analytic Blooms: Understand Difficulty: 1 Easy Learning Objective: 14-01 How to determine a firm's cost of equity capital. Section: 14.2 Topic: SML approach

15.

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 future risks are similar to its past risks. 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.  II, III, and IV only Refer to section 14.2

AACSB: Analytic Blooms: Understand Difficulty: 2 Medium Learning Objective: 14-01 How to determine a firm's cost of equity capital. Section: 14.2 Topic: SML approach

16.

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. D.  is based on the original yield to maturity on the latest bonds issued by a firm. E.  has to be estimated as it cannot be directly observed in the market. Refer to section 14.3

AACSB: Analytic Blooms: Understand Difficulty: 1 Easy Learning Objective: 14-02 How to determine a firm's cost of debt. Section: 14.3 Topic: Cost of debt

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 Refer to section 14.3

AACSB: Analytic Blooms: Understand Difficulty: 2 Medium Learning Objective: 14-02 How to determine a firm's cost of debt. Section: 14.3 Topic: Cost of debt

18.	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. Refer to section 14.3

AACSB: Analytic Blooms: Understand Difficulty: 1 Easy Learning Objective: 14-01 How to determine a firm's cost of equity capital. Section: 14.3 Topic: Cost of preferred

19.	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. Refer to section 14.3

AACSB: Analytic Blooms: Remember Difficulty: 1 Easy Learning Objective: 14-01 How to determine a firm's cost of equity capital. Section: 14.3 Topic: Cost of preferred

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. Refer to section 14.4

AACSB: Analytic Blooms: Remember Difficulty: 1 Easy Learning Objective: 14-03 How to determine a firm's overall cost of capital. Section: 14.4 Topic: WACC

21.

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 statements is correct?    A.  The aftertax cost of debt will be greater than the current yield-to-maturity on the firm's bonds. B.  The firm's cost of preferred is most likely less than the firm's actual cost of debt. C.  The firm's cost of equity is unaffected by a change in the firm's tax rate. D.  The cost of equity can only be estimated using the SML approach. E.  The firm's weighted average cost of capital will remain constant as long as the capital structure remains constant. Refer to section 14.4

AACSB: Analytic Blooms: Understand Difficulty: 2 Medium Learning Objective: 14-03 How to determine a firm's overall cost of capital. Section: 14.4 Topic: WACC

22.

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 changes in the market rate of interest. E.  has a greater effect on a firm's cost of capital when the debt-equity ratio increases. Refer to section 14.3

AACSB: Analytic Blooms: Understand Difficulty: 2 Medium Learning Objective: 14-02 How to determine a firm's cost of debt. Section: 14.3 Topic: Cost of debt

23.

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 only E.  I, II, III, and IV Refer to section 14.4

AACSB: Analytic Blooms: Understand Difficulty: 2 Medium Learning Objective: 14-03 How to determine a firm's overall cost of capital. Section: 14.4 Topic: WACC

24.

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 the firm should expect to pay on its next bond issue. D.  minimum discount rate the firm should require on any new project. E.  rate of return shareholders should expect to earn on their investment in this firm. Refer to section 14.4

AACSB: Analytic Blooms: Understand Difficulty: 1 Easy Learning Objective: 14-03 How to determine a firm's overall cost of capital. Section: 14.4 Topic: WACC

25.

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 the coupon rate multiplied by the par value of the preferred. C.  The 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. Refer to section 14.4

AACSB: Analytic Blooms: Understand Difficulty: 2 Medium Learning Objective: 14-03 How to determine a firm's overall cost of capital. Section: 14.4 Topic: WACC

26.

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 risk projects. IV. increase its overall level of risk over time.    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 Refer to section 14.5

AACSB: Analytic Blooms: Understand Difficulty: 1 Easy Learning Objective: 14-05 Some of the pitfalls associated with a firm's overall cost of capital and what to do about them. Section: 14.5 Topic: WACC

27.

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 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 the firm'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 70 percent of the funds to Division A and 30 percent of the funds to Division B. Refer to section 14.5

AACSB: Analytic Blooms: Understand Difficulty: 1 Easy Learning Objective: 14-05 Some of the pitfalls associated with a firm's overall cost of capital and what to do about them. Section: 14.5 Topic: Divisional cost of capital

28.

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 tend to:    A.  receive less project funding if its line of business is riskier than that of the other divisions. B.  avoid risky projects so it can receive more project funding. C.  become less risky over time based on the projects that are accepted. D.  have equal probability of receiving funding as compared to the other divisions. E.  prefer higher risk projects over lower risk projects. Refer to section 14.5

AACSB: Analytic Blooms: Understand Difficulty: 1 Easy Learning Objective: 14-05 Some of the pitfalls associated with a firm's overall cost of capital and what to do about them. Section: 14.5 Topic: Divisional cost of capital

29.

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 required by the project. Refer to section 14.5

AACSB: Analytic Blooms: Remember Difficulty: 1 Easy Learning Objective: 14-05 Some of the pitfalls associated with a firm's overall cost of capital and what to do about them. Section: 14.5 Topic: Divisional cost of capital

30.

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. Refer to section 14.5

AACSB: Analytic Blooms: Understand Difficulty: 1 Easy Learning Objective: 14-05 Some of the pitfalls associated with a firm's overall cost of capital and what to do about them. Section: 14.5 Topic: Project cost of capital

31.

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 within a firm. C.  A project that is unacceptable today might be acceptable tomorrow given a change in market returns. D.  The pure play method is most frequently used for projects involving the expansion of a firm's current operations. E.  Firms that elect to use the pure play method for determining a discount rate for a project cannot subjectively adjust the pure play rate. Refer to section 14.5

AACSB: Analytic Blooms: Understand Difficulty: 2 Medium Learning Objective: 14-05 Some of the pitfalls associated with a firm's overall cost of capital and what to do about them. Section: 14.5 Topic: Cost of capital

32.

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-wrapped donuts, sandwiches, and wraps at a local beach. Phil's currently has a WACC of 14 percent while Theresa's WACC is 10 percent. The expansion project has a projected net present value of $12,600 at a 10 percent discount rate and a net present value of -$2,080 at a 14 percent discount rate. Which firm or firms should expand and offer food at the local beach during the summer months?    A.  Phil's only B.  Theresa's only C.  both Phil's and Theresa's D.  neither Phil's nor Theresa's E.  cannot be determined from the information provided Refer to section 14.5

AACSB: Analytic Blooms: Understand Difficulty: 1 Easy Learning Objective: 14-05 Some of the pitfalls associated with a firm's overall cost of capital and what to do about them. Section: 14.5 Topic: Project cost of capital

33.

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 Excitement has an aftertax cost of capital of 11 percent. Both firms are considering building wilderness campgrounds complete with man-made lakes and hiking trails. The estimated net present value of such a project is estimated at $87,000 at a discount rate of 11 percent and -$12,500 at a 13 percent discount rate. Which firm or firms, if either, should accept this project?    A.  Wilderness Adventures only B.  Travel Excitement only C.  both Wilderness Adventures and Travel Excitement D.  neither Wilderness Adventures nor Travel Excitement E.  cannot be determined without further information Refer to section 14.5

AACSB: Analytic Blooms: Understand Difficulty: 1 Easy Learning Objective: 14-05 Some of the pitfalls associated with a firm's overall cost of capital and what to do about them. Section: 14.5 Topic: Project cost of capital

34.

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 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 totally with equity as compared to those that are partially financed with debt. Refer to section 14.5

AACSB: Analytic Blooms: Remember Difficulty: 1 Easy Learning Objective: 14-05 Some of the pitfalls associated with a firm's overall cost of capital and what to do about them. Section: 14.5 Topic: Project cost of capital

35.

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 approach than when it uses its WACC as the discount rate for all projects. C.  Firms will correctly accept or reject every project if they adopt the subjective approach. D.  Mandatory projects should only be accepted if they produce a positive NPV when the firm's WACC is used as the discount rate. E.  The pure play approach should only be used with low-risk projects. Refer to section 14.5

AACSB: Analytic Blooms: Understand Difficulty: 1 Easy Learning Objective: 14-05 Some of the pitfalls associated with a firm's overall cost of capital and what to do about them. Section: 14.5 Topic: Subjective approach

36.

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 these expenses by dividing the firm's WACC by (1 - 0.07). C.  add 7 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 1.07. E.  increase the initial project cost by dividing that cost by (1 - 0.07). Refer to section 14.6

AACSB: Analytic Blooms: Remember Difficulty: 1 Easy Learning Objective: 14-04 How to correctly include flotation costs in capital budgeting projects. Section: 14.6 Topic: Flotation costs

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. Refer to section 14.6

AACSB: Analytic Blooms: Remember Difficulty: 1 Easy Learning Objective: 14-04 How to correctly include flotation costs in capital budgeting projects. Section: 14.6 Topic: Flotation costs

38.

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 project. E.  have no effect on the present value of the project. Refer to section 14.6

AACSB: Analytic Blooms: Understand Difficulty: 1 Easy Learning Objective: 14-04 How to correctly include flotation costs in capital budgeting projects. Section: 14.6 Topic: Flotation costs

39.

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 two projects are mutually exclusive. D.  be weighted and included in the initial cash flow. E.  be totally ignored when internal equity funding is utilized. Refer to section 14.6

AACSB: Analytic Blooms: Understand Difficulty: 1 Easy Learning Objective: 14-04 How to correctly include flotation costs in capital budgeting projects. Section: 14.6 Topic: Flotation costs

40.

Chelsea Fashions is expected to pay an annual dividend of $0.80 a share next year. The market price of the stock is $19.60 and the growth rate is 5 percent. What is the firm's cost of equity?    A.  7.58 percent B.  7.91 percent C.  8.24 percent D.  9.08 percent E.  10.00 percent R = (.80/19.60) + .05 = 9.08 percent

AACSB: Analytic Blooms: Apply Difficulty: 1 Easy Learning Objective: 14-01 How to determine a firm's cost of equity capital. Section: 14.2 Topic: Cost of equity

41.

The Shoe Outlet has paid annual dividends of $0.65, $0.70, $0.72, and $0.75 per share over the last four years, respectively. The stock is currently selling for $26 a share. What is this firm's cost of equity?    A.  7.56 percent B.  7.93 percent C.  10.38 percent D.  10.53 percent E.  11.79 percent ($0.70 - $0.65)/$0.65 = 0.076923 ($0.72 - $0.70)/$0.70 = 0.028571 ($0.75 - $0.72)/$0.72 = 0.041667 g = (0.076923 + 0.028571 + 0.041667)/3 = .049054 Re = [($0.75 × 1.049054)/$26] + .049054 = 7.93 percent

AACSB: Analytic Blooms: Apply Difficulty: 1 Easy Learning Objective: 14-01 How to determine a firm's cost of equity capital. Section: 14.2 Topic: Cost of equity

42.

Sweet Treats common stock is currently priced at $18.53 a share. The company just paid $1.25 per share as its annual dividend. The dividends have been increasing by 2.5 percent annually and are expected to continue doing the same. What is this firm's cost of equity?    A.  6.03 percent B.  6.18 percent C.  8.47 percent D.  9.41 percent E.  9.82 percent e = [($1.25 × 1.025)/$18.53] + 0.025 = 9.41 percent

AACSB: Analytic Blooms: Apply Difficulty: 1 Easy Learning Objective: 14-01 How to determine a firm's cost of equity capital. Section: 14.2 Topic: Cost of equity

43.

The common stock of Metal Molds has a negative growth rate of 1.5 percent and a required return of 18 percent. The current stock price is $11.40. What was the amount of the last dividend paid?    A.  $2.07 B.  $2.11 C.  $2.19 D.  $2.22 E.  $2.26 D1 = [(0.18 - (-0.015)) × $11.40] = $2.223; D0 = $2.223/(1 - 0.015) = $2.26

AACSB: Analytic Blooms: Apply Difficulty: 1 Easy Learning Objective: 14-01 How to determine a firm's cost of equity capital. Section: 14.2 Topic: Dividend growth

44.

Highway Express has paid annual dividends of $1.05, $1.20, $1.25, $1.15, and $0.95 over the past five years, respectively. What is the average dividend growth rate?    A.  -1.74 percent B.  -3.60 percent C.  2.28 percent D.  2.47 percent E.  4.39 percent ($1.20 - $1.05)/$1.05 = 0.142857 ($1.25 - $1.20)/$1.20 = 0.041667 ($1.15 - $1.25)/$1.25 = -0.08 ($0.95 - $1.15)/$1.15 = -0.17391 g = (0.142857 + 0.041667 - 0.08 - 0.17391)/4 = -1.74 percent

AACSB: Analytic Blooms: Apply Difficulty: 1 Easy Learning Objective: 14-01 How to determine a firm's cost of equity capital. Section: 14.2 Topic: Dividend growth

45.

Southern Home Cookin' just paid its annual dividend of $0.65 a share. The stock has a market price of $13 and a beta of 1.12. The return on the U.S. Treasury bill is 2.5 percent and the market risk premium is 6.8 percent. What is the cost of equity?    A.  9.98 percent B.  10.04 percent C.  10.12 percent D.  10.37 percent E.  10.45 percent Re = 0.025 + (1.12 × 0.068) = 10.12 percent

AACSB: Analytic Blooms: Apply Difficulty: 1 Easy Learning Objective: 14-01 How to determine a firm's cost of equity capital. Section: 14.2 Topic: Cost of equity

46.

National Home Rentals has a beta of 1.24, a stock price of $22, and recently paid an annual dividend of $0.94 a share. The dividend growth rate is 4.5 percent. The market has a 10.6 percent rate of return and a risk premium of 7.5 percent. What is the firm's cost of equity?    A.  7.05 percent B.  8.67 percent C.  9.13 percent D.  10.30 percent E.  10.68 percent Re = (0.106 - 0.075) + (1.24 × 0.075) = 0.124 Re = [($0.94 × 1.045)/$22] + 0.045 = 0.08965 Re Average = (0.124 + 0.08965)/2 = 10.68 percent

AACSB: Analytic Blooms: Apply Difficulty: 1 Easy Learning Objective: 14-01 How to determine a firm's cost of equity capital. Section: 14.2 Topic: Cost of equity

47.

Henessey Markets has a growth rate of 4.8 percent and is equally as risky as the market. The stock is currently selling for $17 a share. The overall stock market has a 10.6 percent rate of return and a risk premium of 8.7 percent. What is the expected rate of return on this stock?    A.  8.7 percent B.  9.2 percent C.  10.6 percent D.  11.3 percent E.  11.7 percent Re = (0.106 - 0.087) + (1.00 × 0.087) = 10.6 percent

AACSB: Analytic Blooms: Apply Difficulty: 1 Easy Learning Objective: 14-01 How to determine a firm's cost of equity capital. Section: 14.2 Topic: Cost of equity

48.

Tidewater Fishing has a current beta of 1.21. The market risk premium is 8.9 percent and the risk-free rate of return is 3.2 percent. By how much will the cost of equity increase if the company expands its operations such that the company beta rises to 1.50?    A.  1.88 percent B.  2.58 percent C.  2.60 percent D.  3.10 percent E.  3.26 percent Increase in cost of equity = (1.50 - 1.21) × 0.089 = 2.58 percent

AACSB: Analytic Blooms: Apply Difficulty: 1 Easy Learning Objective: 14-01 How to determine a firm's cost of equity capital. Section: 14.2 Topic: Cost of equity

49.

Wind Power Systems has 20-year, semi-annual bonds outstanding with a 5 percent coupon. The face amount of each bond is $1,000. These bonds are currently selling for 114 percent of face value. What is the company's pre-tax cost of debt?    A.  3.98 percent B.  4.42 percent C.  4.71 percent D.  5.36 percent E.  5.55 percent

AACSB: Analytic Blooms: Apply Difficulty: 1 Easy Learning Objective: 14-02 How to determine a firm's cost of debt. Section: 14.3 Topic: Cost of debt

50.

Boulder Furniture has bonds outstanding that mature in 15 years, have a 6 percent coupon, and pay interest annually. These bonds have a face value of $1,000 and a current market price of $1,075. What is the company's aftertax cost of debt if its tax rate is 32 percent?    A.  2.97 percent B.  3.24 percent C.  3.58 percent D.  5.21 percent E.  5.53 percent

AACSB: Analytic Blooms: Apply Difficulty: 1 Easy Learning Objective: 14-02 How to determine a firm's cost of debt. Section: 14.3 Topic: Cost of debt

51.	Handy Man, Inc. has zero coupon bonds outstanding that mature in 8 years. The bonds have a face value of $1,000 and a current market price of $640. What is the company's pre-tax cost of debt?    A.  2.55 percent B.  5.09 percent C.  5.66 percent D.  7.31 percent E.  7.48 percent

AACSB: Analytic Blooms: Apply Difficulty: 1 Easy Learning Objective: 14-02 How to determine a firm's cost of debt. Section: 14.3 Topic: Cost of debt

52.

Dog Gone Good Engines has a bond issue outstanding with 17 years to maturity. These bonds have a $1,000 face value, a 9 percent coupon, and pay interest semi-annually. The bonds are currently quoted at 82 percent of face value. What is the company's pre-tax cost of debt if the tax rate is 38 percent?    A.  4.10 percent B.  4.42 percent C.  6.61 percent D.  8.90 percent E.  11.42 percent

AACSB: Analytic Blooms: Apply Difficulty: 1 Easy Learning Objective: 14-02 How to determine a firm's cost of debt. Section: 14.3 Topic: Cost of debt

53.

The Corner Bakery has a bond issue outstanding that matures in 7 years. The bonds pay interest semi-annually. Currently, the bonds are quoted at 101.4 percent of face value and carry a 9 percent coupon. What is the firm's aftertax cost of debt if the tax rate is 30 percent?    A.  4.88 percent B.  5.36 percent C.  5.45 percent D.  6.11 percent E.  8.74 percent

AACSB: Analytic Blooms: Apply Difficulty: 1 Easy Learning Objective: 14-02 How to determine a firm's cost of debt. Section: 14.3 Topic: Cost of debt

54.

The outstanding bonds of Tech Express are priced at $989 and mature in 10 years. These bonds have a 6 percent coupon and pay interest annually. The firm's tax rate is 35 percent. What is the firm's aftertax cost of debt?    A.  3.01 percent B.  3.22 percent C.  3.35 percent D.  4.00 percent E.  4.41 percent

AACSB: Analytic Blooms: Apply Difficulty: 1 Easy Learning Objective: 14-02 How to determine a firm's cost of debt. Section: 14.3 Topic: Cost of debt

55.	Simple Foods has a zero coupon bond issue outstanding that matures in 9 years. The bonds are selling at 42 percent of par value. What is the company's aftertax cost of debt if the tax rate is 38 percent?    A.  5.48 percent B.  5.73 percent C.  6.12 percent D.  7.73 percent E.  9.88 percent

AACSB: Analytic Blooms: Apply Difficulty: 1 Easy Learning Objective: 14-02 How to determine a firm's cost of debt. Section: 14.3 Topic: Cost of debt

56.

Grill Works and More has 7 percent preferred stock outstanding that is currently selling for $49 a share. The market rate of return is 14 percent and the firm's tax rate is 37 percent. What is the firm's cost of preferred stock?    A.  13.77 percent B.  13.29 percent C.  13.67 percent D.  14.29 percent E.  14.54 percent Rp = (0.07 × $100)/$49 = 14.29 percent

AACSB: Analytic Blooms: Apply Difficulty: 1 Easy Learning Objective: 14-02 How to determine a firm's cost of debt. Section: 14.3 Topic: Cost of preferred

57.

Samuelson Plastics has 7.5 percent preferred stock outstanding. Currently, this stock has a market value per share of $52 and a book value per share of $38. What is the cost of preferred stock?    A.  7.50 percent B.  13.88 percent C.  14.42 percent D.  19.29 percent E.  19.74 percent Rp = (0.075 × $100)/$52 = 14.42 percent

AACSB: Analytic Blooms: Apply Difficulty: 1 Easy Learning Objective: 14-02 How to determine a firm's cost of debt. Section: 14.3 Topic: Cost of preferred

58.

New York Deli has 7 percent preferred stock outstanding that sells for $34 a share. This stock was originally issued at $45 per share. What is the cost of preferred stock?    A.  13.68 percent B.  14.00 percent C.  18.29 percent D.  20.59 percent E.  20.80 percent Rp = (0.07 × $100)/$34 = 20.59 percent

AACSB: Analytic Blooms: Apply Difficulty: 1 Easy Learning Objective: 14-02 How to determine a firm's cost of debt. Section: 14.3 Topic: Cost of preferred

59.

Nelson's Landscaping has 1,200 bonds outstanding that are selling for $990 each. The company also has 2,500 shares of preferred stock at a market price of $28 a share. The common stock is priced at $37 a share and there are 28,000 shares outstanding. What is the weight of the common stock as it relates to the firm's weighted average cost of capital?    A.  43.08 percent B.  45.16 percent C.  47.11 percent D.  54.00 percent E.  55.45 percent

AACSB: Analytic Blooms: Apply Difficulty: 1 Easy Learning Objective: 14-03 How to determine a firm's overall cost of capital. Section: 14.4 Topic: Weighted average