Finance Ch 12

Madison Square Stores has a $20 million bond issue outstanding that currently has a market value of $19.4 million. The bonds mature in 6.5 years and pay semiannual interest payments of $35 each. What is the firm's pretax cost of debt

Current bond price = (19.4/20) x $1,000 = $970 $970 = $35 x ({1-1/[1+(RD/2)]^13}/(RD/2))+$1,000/[1+(RD/2)]^13 RD=7.59 percent

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

Increase in the dividend growth rate

Which one of the following statements is correct related to the dividend growth model approach to computing the cost of equity?

The annual dividend used in the computation must be for Year 1 if you are Time 0's stock price to compute the return

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)

The arithmetic average of 12.4 percent and 18.7 percent

The results of the dividend growth model:

are sensitive to the rate of dividend growth

Assume a firm has a beta of 1.2. All else held constant, the cost of equity for this firm will increase if the:

risk-free rate decreases

An increase in a levered firm's tax rate will:

decrease the firm's cost of capital

Katie owns 100 shares of ABC stock. Which one of the following terms is used to refer to the return that Katie and the other shareholders require on their investment in ABC

Cost of equity

Farmer's Supply is considering opening a clothing store which would be a new line of business for the firm. Management has decided to use the cost of capital of a similar clothing store as the discount rate to evaluate this proposed expansion. Which one of the following terms describes this evaluation approach

Pure play approach

The common stock of Contemporary Interiors has a beta of 1.13 and a standard deviation of 21.4 percent. The market rate of return is 12.7 percent and the risk-free rate is 4.1 percent. What is the cost of equity for this firm?

RE = .041 + 1.13 x (.127-.041) = .1382, or 13.82 percent

The 6.5 percent preferred stock of Home Town Brewers is selling for $42 a share. What is the firm's cost of preferred stock if the tax rate is 35 percent and the par value per share is $100

RP = (.065 x $100)/$42 = .1548, or 15.48 percent

Ted is trying to decide what cost of capital he should assign to a project. Which one of the following should be his primary consideration in this decision?

Risk level of the project

Kate is the CFO of a major firm and has the job of assigning discount rates to each project under consideration. Kates method of doing this is to assign an incrementally higher rate as the risk level of the project increases and a lower rate as the risk level declines. Kate is applying the _______ approach

Subjective

Black Stone Furnaces wants to build a new facility. The cost of capital for this investment is primarily dependent on which one of the following

The nature of the investment

Which one of the following is used as the pretax cost of debt?

Weighted average yield to maturity on the firm's outstanding debt

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

cost of debt

The weighted average cost of capital is defined as the weighted average of a firm's

cost of equity, cost of preferred, and its aftertax cost of debt

In an efficient market, the cost of equity for a highly risky firm:

increases in direct relation to the stock's systematic risk

When evaluating a project, the dividend growth model:

is relatively simple to use