Quiz 9

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What is the dividend on an 8% preferred stock that currently sells for $45 and has a face value of $50 per share

$4

Firms underprice new issues of common stock for the following reason(s)

1.When additional shares are issued, each share's percent of the ownership in the firm is diluted thereby justifying a lower share value 2.Many investors view the issuance of additional shares as a signal that management is using common stock equity financing bc it believes that the shares are currently overpriced 3.When the market is in equilibrium, additional demand for shares can be achieved only at a lower price

The before tax cost of debt for a firm which has a 40% marginal tax rate is 12%. The after-tax cost of debt is

7.2%

The cost of common stock equity may be estimated by using (2)

Gordon Model Capital asset pricing Model

Weighing schemes for calculating the weighted average cost of capital include all of the following EXCEPT

Optimal value weights

Underpriced stocks are sold at a price

below current market price

The ____ is the rate of return a firm must earn on its investments in projects in order to maintain the market value of its stock.

cost of capital

Target weights

either book or market value weights based on DESIRED capital

Historical weights

either book values or market value weights based on ACTUAL capital

Capital budgeting it the process of

evaluating and selecting long term investments and maximize shareholders wealth

The cost of new common stock financing is higher than the cost of retained earnings due to

flotation costs and underpricing

Net Proceeds

funds firm receives from sale

As the volume of financing increase, the costs of the various types of financing will ____ , ____ the firm's weighted average cost of capital

increase raising

A tax adjustment must be made in determining the cost of

long term debt

The four basic sources of long term funds for the business firm are

long term debt common stock preferred stock retained earnings

When discussing weighting schemes for calculating the weighted average cost of capital, the preferences can be stated as

market value weights are preferred over book value weights and target weights are preferred over historic weights

The ____ from the sale of a security are the funds actually received from the sales after ____, or the total costs of issuing and selling the security, which have been subtracted from the total proceeds.

net proceeds the flotation costs

Cost of preferred stock

ratio of preferred stock dividend to the firm's net proceeds from the sale of preferred stock

Capital asset pricing model describes the relationship between

required return and non diversifiable risk

The firm's optimal mix of debt and equity is called its

target capital structure

The preferred capital structure weights to be used in the weighted average cost of capital are

target weights

Weighing schemes include

target weights market weights book value weights

In comparing the constant growth model and the capital asset pricing model (CAPM) to calculate the cost of common stock equity,

the CAPM directly considers risk as reflected in the beta, while the constant growth model uses the market price as a reflection of the expected risk-return preference of investors

Using the capital asset pricing model, the cost of common stock equity is the return required by investors as compensation for

the firm's nondiversifiable risk

The cost of common stock equity is

the rate at which investors discount the expected dividends of the firm

Debt is generally the least expensive source of capital. This is primarily due to

the tax deductibility of interest payments

In order to recognize the interrelationship between financing and investments, the firm should use ______ when evaluating an investment

the weighted average cost of all financing sources

Flotation Costs are the

total costs of issuing and selling securities

Book value weights

use accounting values to measure the proportions of each type of capital

Market value weights

use market values to measure the proportions of each type of capital


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