Chapter 12 LearnSmart

Including preferred stock in the WACC formula adds which term if P is the market value of preferred stock and Rp is the cost of preferred?

(P/V) x Rp

Preferred stock ____.

- pays a constant dividend - pays dividends in perpetuity

If an analyst's forecast for a firm's earnings growth is 7%, and its dividend yield is 3%, its cost of equity will be _____.

10% 3%+7%=10%

WACC was used to compute the following project NPVs: Project A = $100, Project B = -$50, Project C = -$10, Project D = $40. Which project should the firm accept?

A and D

what is the equation for finding the cost of preferred stock?

Dividend/Po

If the firm is all-equity, the discount rate is equal to the firm's cost of ___ capital.

Equity

True or False: Projects should always be discounted at the firm's overall cost of capital.

False

The formula for calculating the cost of equity capital that is based on the dividend discount model is:

R_E = D_1 / P_0 + g

The following are disadvantages of the SML approach

Requires estimation of the market risk premium Requires estimation of beta

The cost of capital depends primarily on the ___ of funds, not the ____.

The risk-free rate

The cost of capital depends primarily on the ___ of funds, not the ____.

Use, Source

Some risk adjustment to a firm's WACC for projects of differing risk, even if it is subjective, is probably

better than no risk adjustment

The dividend growth model is applicable to companies that pay ______________.

dividends

The return an investor in a security receives is _____ ____ the cost of the security to the company that issued it.

equal to

Other companies that specialize only in projects similar to the project your firm is considering are called _____.

pure plays

The following are advantages of the SML approach

- Does not require the company to pay a dividend - Adjusts for risk

A company has a borrowing rate of 15 percent and a tax rate of 30 percent. What is its aftertax cost of debt

10.5%

Which of the following is true about a firm's cost of debt?

- Yields can be calculated from observable data - it is easier to estimate than the cost of equity.

Which of the following are components used in the construction of the WACC?

- cost of debt - cost of preferred stock - cost of common stock

To estimate the dividend yield of a particular stock, we need:

- the current stock price - forecasts of the dividend growth rate, g - the last dividend paid, D0

Which of the following are true?

- the market value of debt and equity are not reliable in case of privately owned company - Ideally, we should use market values in the WACC

To estimate a firms equity cost of capital using the CAPM, we need to know:

-Stocks beta -Market Risk Premium -Risk-Free Rate

The rate used to discount project cash flows is known as the:

-discount rate -required return -cost of capital

The growth rate of dividends can be found using :

-security analysts forecast -Historical dividends growth rates

Suppose a firm's capital structure consists of 30% debt, 10% preferred stock and 60% equity. The firm's bonds yield 10% on average before taxes, the cost of preferred stock is 8% and the cost of equity is 16%. Calculate the firm's WACC assuming a tax rate of 40%

12.20% 0.6 x 16% +.3 x 10% x (1-.4) +.1 x 8% = 12.20

SmartKids, a textbook publisher, is considering investing in a software company that collects and stores data. What beta should SmartKids use to assess the risk of the project? The beta for SmartKids The beta for software companies that collect and store data The beta for software companies as a whole The beta for the textbook industry as a whole

The beta for software companies that collect and store data

Finding a firm's overall cost of equity is difficult because:

it cannot be observed directly

The most appropriate weights to use in the WACC are the ___ weights.

market values