Chapter 12 Financial Management (read and answer)
What is the appropriate discount rate to use only if the proposed investment is a replica of the firm's existing operating activities? Multiple choice question. -percentage of completion -TC -RD -WACC
WACC
The WACC of a firm reflects the ____ and the target capital structure of the firm's existing assets as a whole.
risk
The formula for calculating the cost of equity capital that is based on the dividend discount model is Blank______. Multiple choice question. -RE = D1/P0 + g -RE = (D1/P0)/g -RE = D1/P0 − g -RE = D0/P1 + g
-RE = D1/P0 + g
Select all that apply What will happen over time if a firm uses its overall WACC to evaluate all projects, regardless of each project's risk level? Multiple select question. -It will accept projects that it should have rejected. -Using the firm's WACC to evaluate all projects is appropriate. -The firm's risk will not change over time. -It will reject projects that it should have accepted. -The firm overall will become riskier.
-It will accept projects that it should have rejected. -It will reject projects that it should have accepted. -The firm overall will become riskier.
Select all that apply Which of the following are components used in the construction of the WACC? Multiple select question. -cost of preferred stock -cost of common stock -cost of accounts payable -cost of debt
-cost of preferred stock -cost of common stock -cost of debt
The most appropriate weights to use in the WACC are the Blank______ weights. Multiple choice question. -market value -book value -salvage value -government-mandated
market value
We should use _____ values in the WACC. Because _____ values are often similar to market values for debt, we often use book value for debt and market value for equity.
market, book
It is difficult to establish discount rate for individual projects, so firms often adopt an approach that involves ____ making adjustments to the overall WACC.
subjective
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? Multiple choice question. -the beta for the textbook industry as a whole -the beta for SmartKids -the beta for software companies as a whole -the beta for software companies that collect and store data
the beta for software companies that collect and store data
Select all that apply Which of the following are true? Multiple select question. -Ideally, we should use book values in the WACC. -Book values are often similar to market values for equity. -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.
-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.
Components of the WACC include funds that come from ______ . Multiple choice question. -investors -accruals -non-cash expenses
investors
In the WACC calculation, D represents the ______ value of the firm's debt.
market
True or false: RP = D/P0 True False
True
True or false: The SML approach is advantageous because all it requires is estimation of beta. True False
False
True or false: The cost of capital depends on the source of the funds. True False
False
True or false: The cost of equity is D1/P0 minus the analysts' estimates of growth. True False
False
True or false: The discount rate is also known as the expected return. True False
False
If a firm uses its overall cost of capital to discount cash flows from projects in higher risk divisions, it will accept Blank______ projects. Multiple choice question. -the optimal number of -too few -too many
too many
Select all that apply To estimate a firm's equity cost of capital using the SML approach, we need to know the Blank______. Multiple select question. -annual dividend amount -risk-free rate -stock's beta -market risk premium
-risk-free rate -stock's beta -market risk premium
The formula of the SML is Blank______. Multiple choice question. -RE = Rf + β/(RM + Rf) -RE = Rf − β + RM − Rf -RE = Rf + β × (RM − Rf)
RE = Rf + β × (RM − Rf)
According to the CAPM, what is the expected return on a stock if its beta is equal to zero? Multiple choice question. -The risk-free rate -The return on the market minus the risk-free rate -Zero -The market-risk premium
The risk-free rate
What does WACC stand for? Multiple choice question. -weighted average company cost -working amount of corporate cost -working amount of corporate cash -weighted average cost of capital
-weighted average cost of capital
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? Multiple choice question. -(P/V) × RP -(V/P) × RP -[P/(E + D)] × RP
(P/V) × RP
Which of the following is tax-deductible to the firm? Multiple choice question. -Coupon interest paid on bonds -Principal amounts paid on debt -Dividends paid on preferred stock -Dividends paid on common stock
-Coupon interest paid on bonds
For a firm with outstanding debt, the cost of debt will be the Blank______ on that debt. Multiple choice question. -average yield -coupon rate -yield to maturity -current yield
-yield to maturity
Select all that apply What can we say about the dividends paid to common and preferred stockholders? Multiple select question. -Dividends are guaranteed for both preferred and common stockholders. -Preferred stock dividends change every year based on the earnings of the firm. -Dividends to common stockholders are not fixed. -Dividends to preferred stockholders are fixed.
-Dividends to common stockholders are not fixed. -Dividends to preferred stockholders are fixed.
Select all that apply What can we say about the dividends paid to common and preferred stockholders? Multiple select question. -Dividends to common stockholders are not fixed. -Preferred stock dividends change every year based on the earnings of the firm. -Dividends to preferred stockholders are fixed. -Dividends are guaranteed for both preferred and common stockholders.
-Dividends to common stockholders are not fixed. -Dividends to preferred stockholders are fixed.
Select all that apply Which of the following is true about a firm's cost of debt? Multiple select question. -Yields can be checked by using the DDE model. -It is easier to estimate than the cost of equity. -Yields can be calculated from observable data.
-It is easier to estimate than the cost of equity. -Yields can be calculated from observable data.
Select all that apply The following are advantages of the SML approach: Multiple select question. -requires estimation of the market risk premium -does not require the company to pay a dividend -adjusts for risk -requires estimation of beta
-does not require the company to pay a dividend -adjusts for risk
What is the equation for finding the cost of preferred stock? Multiple choice question. -RP = D(1 + g)/P0 -RP = D/P0 -RP = P0/D
RP = D/P0
If D is the market value of a firm's debt, E the market value of that same firm's equity, V the total value of the firm (E + D), RD the yield on the firm's debt, TC is the corporate tax rate, and RE the cost of equity, the weighted average cost of capital is Blank______. Multiple choice question. -[E/V] × RE + [D/V] × RD ×(1 − TC) -[(E + D)/E] × RE + [(E + D)/D] × RD × (1 − TC) -[E/D] × RE + [D/E] × RD × (1 − TC)
-[E/V] × RE + [D/V] × RD ×(1 − TC)
If a firm has multiple projects, each project should be discounted using Blank______. Multiple choice question. -the average cost of capital -the marginal cost of capital for the latest project -the firm's overall cost of capital -a discount rate commensurate with the project's risk
-a discount rate commensurate with the project's risk
Using an analyst's forecast for a firm's earnings growth and a stock's dividend yield, you can find the cost of equity by Blank______. Multiple choice question. -multiplying the components by the inflation rate -adding these two components -multiplying these two components -subtracting the first from the second
-adding these two components
Select all that apply To estimate the dividend yield of a particular stock, we need Blank______. Multiple select question. -forecasts of the dividend growth rate, g -the last dividend paid, D0 -the risk-free rate from a bank's CD rates -the current stock price -beta from the Wall Street Journal
-forecasts of the dividend growth rate, g -the last dividend paid, D0 -the current stock price
Select all that apply The growth rate of dividends can be found using Blank______. Multiple select question. -the perpetuity model -historical dividend growth rates -security analysts' forecasts -the capital asset pricing model
-historical dividend growth rates -security analysts' forecasts
If a firm issues no debt, its average cost of capital will equal Blank______. Multiple choice question. -its cost of debt -its cost of equity -half the sum of the cost of debt and equity -its dividend yield
-its cost of equity
If an all-equity firm discounts a project's cash flows with the firm's overall weighted average cost of capital even though the project's beta is less than the firm's overall beta, it is possible that the project might be Blank______. Multiple choice question. -rejected, when it should be accepted -rejected, as it should be -accepted, when it should be rejected -accepted, as it should be
-rejected, when it should be accepted
Select all that apply The rate used to discount project cash flows is known as the Blank______. Multiple select question. -discount rate -market rate -required return -cost of capital
-required return -cost of capital -discount rate
True or false: According to the CAPM, if the market risk premium is zero, then the expected return on a stock is equal to the required return. True False
False
True or false: Conglomerates are companies that specialize only in projects similar to the project your firm is considering. True False
False
True or false: Finding the cost of equity is fairly straightforward. True False
False
True or false: For publicly traded companies, the component of the dividend yield that must be estimated is the dividend. True False
False
True or false: In the WACC calculation, V = E − D. True False
False
True or false: Projects should always be discounted at the firm's overall cost of capital. True False
False
True or false: The expected percentage is the overall rate of return the firm must earn on its existing assets to maintain the value of its stock. True False
False
True or false: The growth rate of dividends can be found using the CAPM. True False
False
True or false: The primary disadvantage of the dividend growth model approach is its simplicity. True False
False
The discount rate for the firm's projects equals the cost of capital for the firm as a whole when Blank______. Multiple choice question. -the average risk of the firm's projects is constant -all projects have a "bell curve" of risks -all projects have the same risk as that of the firm overall
all projects have the same risk as that of the firm overall
Some risk adjustment to a firm's WACC for projects of differing risk, even if it is subjective, is probably Blank______. Multiple choice question. -better than no risk adjustment -preferred over the pure play approach -an irreducible absurdity -uncalled for
better than no risk adjustment
Dividends paid to common stockholders Blank______ be deducted from the payer's taxable income for tax purposes. Multiple choice question. -should -cannot -can -may
cannot
WACC is used to discount Blank______. Multiple choice question. -news -political unrest -cash flows -common stock dividends
cash flows
The dividend growth model is applicable to companies that pay _____
dividends
The return an investor in a security receives is Blank______ the cost of the security to the company that issued it. Multiple choice question. -unrelated to -equal to -greater than -less than
equal to
If the firm is all-equity, the discount rate is equal to the firm's cost of Blank______ capital. Multiple choice question. -equity -government -debt -derivative
equity
Other companies that specialize only in projects similar to the project your firm is considering are called Blank______. Multiple choice question. -pure plays -matched pairs -knock-offs -conglomerates
pure plays
The cost of capital depends primarily on the Blank______ of funds, not the Blank______. Multiple choice question. -use; cost -source; use -source; cost -use; source
use; source
The WACC is the overall rate of return the firm must earn on its existing assets to maintain the _______ of its stock.
value