Chapter 11 Finance Questions

Which of the following makes this a true statement? Ideally, when searching for a beta for a new line of business

All of the answers make this statement true: A. one could find other firms engaged in the proposed new line of business and use their betas as proxies to estimate the project's risk. B. one would like to find at least three or four pure-play proxies. C. two, or even one, proxies might represent a suitable sample if their line of business resembles the proposed new project closely enough.

Which of the following will impact the cost of equity component in the weighted average cost of capital?

All of these: A. The risk-free rate B. Beta C. Expected return on the market

Why do we use market-value weights instead of book-value weights?

Because we are interested in determining what the cost of financing the firm's assets would be given today's market situation and the component costs the firm currently faces, not what the historical prices would have been.

Which of the following will directly impact the cost of debt?

Coupon Rate

An estimated WACC computed using some sort of proxy for the average equity risk of the projects in a particular business unit is known as the ____________.

Divisional WACC

This is an estimated WACC computed using some sort of proxy for the average equity risk of the projects in a particular division.

Divisional WACC

Which of the following is most correct?

An increase in the risk-free rate will increase the cost of equity.

Which of the following statements is correct?

An increase in the firm's marginal corporate tax rate will decrease the weighted average cost of capital.

Which of the following statements is correct?

An increase in the market risk premium is likely to increase the weighted average cost of capital.

Which of the following statements is correct?

If a new project is riskier than the firm's existing projects, then it should be expect to be "charged" a higher cost of capital than the firm's overall WACC.

Which of the following is a reason why the divisional cost of capital approach may cause problems if new projects are assigned to the wrong division?

If projects are assigned to the wrong division, the risk of that division may be significantly different than the risk of the project, implying that the project will be evaluated with a divisional cost of capital that is much different from what a project-specific cost of capital would be.

Which of the following statements is true?

If the new project is riskier than the firm's existing projects, then it should be charged a higher cost of capital.

Which of these statements is true regarding calculating weights for WACC?

If we are calculating WACC for the firm, then equity, preferred stock and debt would be the entire market value of each source of capital.

The reason that we do not use an after-tax cost of preferred stock is __________.

None of these answers are correct: A. because preferred dividends are paid out of before-tax income B. because most of the investors in preferred stock do not pay tax on the dividends C. because we can only estimate the marginal tax rate of the preferred stockholders

Which of the following statements is correct?

None of these statements is correct. A. If the risk-free rate increases, it will have no impact on the weighted average cost of capital. B. Investor returns are reduced when float costs increase, and therefore float costs reduce the weighted average cost of capital. C. The weighted average cost of capital is a historical cost.

Which of the following statements is correct?

None of these statements is correct: A. A decrease in the firm's marginal corporate tax rate will decrease the weighted average cost of capital. B. Flotation costs can decrease the weighted average cost of capital. C. The cost of debt is based on the cost of all liabilities, including accounts payable and accruals.

Which of the following is a true statement regarding the appropriate tax rate to be used in the WACC?

One would use the weighted average of the marginal tax rates that would have been paid on the taxable income shielded by the interest deduction.

Which of the following will directly impact the cost of equity?

Stock price

Which of the following statements is correct?

The WACC measures the marginal cost of capital.

What is the theoretical minimum for the weighted average cost of capital?

The after-tax cost of debt

Which of the following will increase the cost of equity?

The firm's share price falls 10%.

Which of the following statements is correct?

The flotation-adjusted cost of equity will always be more than the cost of equity that has not been adjusted for flotation costs.

Which of the following is a true statement?

To estimate the before-tax cost of debt, we need to solve for the Yield to Maturity (YTM) on the firm's existing debt.

Which of these statements is true regarding divisional WACC?

Using a simple firmwide WACC to evaluate new projects would give an unfair advantage to projects that present more risk than the firm's average beta.

Which of the following is a situation in which you would want to use the constant growth model approach for estimating the component cost of equity?

When the firm's stock is expected to experience constant dividend growth.

Which of following is a situation in which you would want to use the CAPM approach for estimating the component cost of equity?

When you are able to estimate the firm's beta with certainty.

Suppose a new project was going to be financed partially with retained earnings. What flotation costs should you use for retained earnings?

Zero

Flotation costs are _______________

commissions to the underwriting firm that floats the issue

An objective approach to calculating divisional WACCs would be done by

computing the average beta per division, using these figures for each division in the CAPM formula, and then constructing divisional WACCs.

These are fees paid by firms to investment bankers for issuing new securities.

flotation costs

When calculating the weighted average cost of capital, weights are based on

market values

The ___________ approach to computing a divisional weighted average cost of capital (WACC) uses the average beta of projects in each division to calculate the WACC.

objective

Which of these completes this statement to make it true? The constant growth model is

only going to be appropriate for the limited number of stocks that just happen to expect constant growth.

An average of which of the following will give a fairly accurate estimate of what a project's beta will be?

proxy beta

This is a principle of capital budgeting which states that the calculations of cash flows should remain independent of financing.

separation principle

The ____________ approach to computing a divisional weighted average cost of capital (WACC) requires only that WACCs for "risky" and "relatively safe" divisions be adjusted.

subjective

A proxy beta is _________________

the average beta of firms that are only engaged in the proposed new line of business

Which statement makes this a false statement? When a firm pays commissions to underwriting firms that float the issuance of new stock,

the component cost will need to be integrated to figure project WACCs.

Which of the following makes this a true statement? If the new project does significantly increase the firm's overall risk,

the increased risk will be borne disproportionately by common stockholders.

Which of these makes this a true statement? When determining the appropriate weights used in calculating a WACC, it should reflect

the relative sizes of the total market capitalizations for each kind of security that the firm issues.

Which of these makes this a true statement? The WACC formula

uses the after-tax costs of capital to compute the firm's weighted average cost of debt financing.