CHP 14

If the firm issued so much debt that its equity is valueless, its average cost of capital would equal

1 x the aftertax cost of debt

Which one of the following statements is correct?

A project that is unacceptable today might be acceptable tomorrow given a change in market returns.

The subjective approach to project anyalsis

Assigns discount rates to projects based on the discretion of the senior managers of a firm

An important advantage to a firm raising equity internally is not having to pay

Flotation costs

Finding a firms overall cost of equity is difficult because

It cannot be observed directly

Preferred Stock

Pays a constant dividend Pays dividends in perpetuity

Jenner's is a multi division firm that uses its overall 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:

Prefer higher risk projects over lower risk projects.

When a manager develops a cost of capital for a specific project based on the cost of capital for another firm that has a similar line of business as the project, the manager is utilizing the _____ approach.

Pure Play

When a manager develops a cost of capital for a specific project based on the cost of capital for another firm that has a similar line of business as the project, the manager is utilizing the _____ approach.

Pure play.

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

Re = D1/P0 + g

The CAPM can be used to estimate

Required return on equity

The market risk premium is defined as

Rm - Rf

The weighted average cost of capital for a firm can depend on all of the following except the:

Standard deviation of the firm's common stock.

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

Stock's beta Risk-Free Rate Market Risk Premium

A firm that uses debt in its capital structure

The WACC should decrease as the firm's debt-equity ratio increases

Flotation costs are costs incurred to

bring new securities to the market

The aftertax cost of debt

has a greater effect on a firm's cost of capital when the debt-equity ratio increases.