Finance 3000 Chapter 11

d

Suppose a new project was going to be financed partially with retained earnings. What flotation costs should you use for retained earnings? A. Use the same flotation cost that would be used to issue new common stock. B. Use an average of the flotation costs for debt, preferred and common stock. C. Use the industry average flotation cost for common stock. D. Zero.

b

The ___________ approach to computing a divisional weighted average cost of capital (WACC) uses the average beta of projects in each division to calculate the WACC. A. subjective B. objective C. firmwide D. implicit

a

The ____________ approach to computing a divisional weighted average cost of capital (WACC) requires only that WACCs for "risky" and "relatively safe" divisions be adjusted. A. subjective B. objective C. firmwide D. implicit

d

The reason that we do not use an after-tax cost of preferred stock is __________. A. because preferred dividends are paid out of before-tax income B. because most of the investors in preferred stock do not pay tax on the dividends C. because we can only estimate the marginal tax rate of the preferred stockholders D. None of these answers is correct.

a

These are fees paid by firms to investment bankers for issuing new securities. A. flotation costs B. interest expense C. seller financing charges D. user fees

c

This is a principle of capital budgeting which states that the calculations of cash flows should remain independent of financing. A. generally accepted accounting principle B. financing principle C. separation principle D. WACC principle

b

This is an estimated WACC computed using some sort of proxy for the average equity risk of the projects in a particular division. A. Average WACC B. Divisional WACC C. Proxy WACC D. Pure-play WACC

a

What is the theoretical minimum for the weighted average cost of capital? A. The after-tax cost of debt B. The cost of preferred stock C. CAPM D. The cost of equity

c

When calculating the weighted average cost of capital, weights are based on A. book values. B. book weights. C. market values. D. market betas.

c

Which of following is a situation in which you would want to use the CAPM approach for estimating the component cost of equity? A. When you are able to estimate the market risk premium with certainty. B. When you are able to estimate the risk-free rate with certainty. C. When you are able to estimate the firm's beta with certainty. D. When the firm pays a constant dividend.

c

Which of the following is a reason why the divisional cost of capital approach may cause problems if new projects are assigned to the wrong division? A. Managers in different divisions may use different methods to calculate the WACC. B. The expected return of the new project may be incorrect. C. If projects are assigned to the wrong division, the risk of that division may be significantly different than the risk of the project, implying that the project will be evaluated with a divisional cost of capital that is much different from what a project-specific cost of capital would be. D. None of these answers is correct.

c

Which of the following is a situation in which you would want to use the constant growth model approach for estimating the component cost of equity? A. When the firm has a low beta. B. When the firm has multiple divisions. C. When the firm's stock is expected to experience constant dividend growth. D. When the firm has a high level of financial leverage.

c

Which of the following is a true statement regarding the appropriate tax rate to be used in the WACC? A. One would use the marginal tax rate that the firm paid the prior year. B. One would use the average tax rate that the firm paid the prior year. C. One would use the weighted average of the marginal tax rates that would have been paid on the taxable income shielded by the interest deduction. D. One would use the marginal tax rates that would have been paid on the taxable income shielded by the interest deduction.

a

Which of the following is a true statement? A. To estimate the before-tax cost of debt, we need to solve for the Yield to Maturity (YTM) on the firm's existing debt. B. To estimate the before-tax cost of debt, we need to solve for the Yield to Call (YTC) on the firm's existing debt. C. To estimate the before-tax cost of debt, we use the coupon rate on the firm's existing debt. D. To estimate the before-tax cost of debt, we use the average rate on the firm's existing debt.

c

Which of the following is most correct? A. When comparing two firms within the same industry, most analysts calculate the weighted average cost of capital on a before-tax basis to facilitate comparisons. B. Firms should use historical costs rather than marginal costs of capital. C. An increase in the risk-free rate will increase the cost of equity. D. All of these statements are equally correct.

d

Which of the following makes this a true statement? Ideally, when searching for a beta for a new line of business A. one could find other firms engaged in the proposed new line of business and use their betas as proxies to estimate the project's risk. B. one would like to find at least three or four pure-play proxies. C. two, or even one, proxies might represent a suitable sample if their line of business resembles the proposed new project closely enough. D. All the answers make this a true statement

d

Which of the following makes this a true statement? If the new project does significantly increase the firm's overall risk, A. the increased risk will be borne equally amongst the bond holders, preferred stockholders, and common stockholders. B. the increased risk will be borne disproportionately by bond holders. C. the increased risk will be borne disproportionately by preferred stockholders. D. the increased risk will be borne disproportionately by common stockholders.

d

Which of the following statements is correct? A. A decrease in the firm's marginal corporate tax rate will decrease the weighted average cost of capital. B. Flotation costs can decrease the weighted average cost of capital. C. The cost of debt is based on the cost of all liabilities, including accounts payable and accruals. D. None of these statements is correct.

a

Which of the following statements is correct? A. If a new project is riskier than the firm's existing projects, then it should be expect to be "charged" a higher cost of capital than the firm's overall WACC. B. If a new project is riskier than the firm's existing projects, then it should be expect to be "charged" a lower cost of capital than the firm's overall WACC. C. The project's risk and the cost of capital to which it is compared are independent. D. None of these answers is correct.

d

Which of the following statements is correct? A. If the risk-free rate increases, it will have no impact on the weighted average cost of capital. B. Investor returns are reduced when float costs increase, and therefore float costs reduce the weighted average cost of capital. C. The weighted average cost of capital is a historical cost. D. None of these statements is correct.

b

Which of the following statements is correct? A. The WACC is a measure of the before-tax cost of capital. B. The WACC measures the marginal cost of capital. C. It is common that the after-tax cost of debt exceeds the cost of equity. D. None of these statements is correct.

b

Which of the following statements is correct? A. The WACC measures the before-tax cost of capital. B. An increase in the firm's marginal corporate tax rate will decrease the weighted average cost of capital. C. Flotation costs can decrease the weighted average cost of capital. D. None of these statements is correct.

b

Which of the following statements is correct? A. The flotation-adjusted cost of equity will always be less than the cost of equity that has not been adjusted for flotation costs. B. The flotation-adjusted cost of equity will always be more than the cost of equity that has not been adjusted for flotation costs. C. The flotation-adjusted cost of equity may be more than or less than the cost of equity that has not been adjusted for flotation costs. D. None of these statements is correct.

b

Which of the following statements is correct? A. The weighted average cost of capital is calculated on a before-tax basis. B. An increase in the market risk premium is likely to increase the weighted average cost of capital. C. The weights of debt and equity should be based on the balance sheet because this is the most accurate assessment of the valuation. D. All of these statements are correct

a

Which of the following statements is true? A. If the new project is riskier than the firm's existing projects, then it should be charged a higher cost of capital. B. If the new project is riskier than the firm's existing projects, then it should be charged a lower cost of capital. C. If the new project is riskier than the firm's existing projects, then it should be charged the firm's cost of capital. D. The new project's risk is not a factor in determining its cost of capital.

c

Which of the following will directly impact the cost of debt? A. Capital Structure B. Debt Ratio C. Coupon Rate D. Competition within the industry

c

Which of the following will directly impact the cost of equity? A. Expected growth rate in sales B. Expected future tax rates C. Stock price D. Profit margins

d

Which of the following will impact the cost of equity component in the weighted average cost of capital? A. The risk-free rate B. Beta C. Expected return on the market D. All of these

a

Which of the following will increase the cost of equity? A. The firm's share price falls 10%. B. The firm is expected to reduce its dividend. C. The firm's corporate tax rate increases. D. None of these answers is correct.

c

Which of these completes this statement to make it true? The constant growth model is A. always going to have assumptions that will hold true. B. able to be adjusted for stocks that don't expect constant growth without sizeable errors. C. only going to be appropriate for the limited number of stocks that just happen to expect constant growth. D. only going to be appropriate for the limited number of stocks that just happen to expect nonconstant growth.

b

Which of these makes this a true statement? The WACC formula A. is not impacted by taxes. B. uses the after-tax costs of capital to compute the firm's weighted average cost of debt financing. C. uses the pre-tax costs of capital to compute the firm's weighted average cost of debt financing. D. focuses on operating costs only to keep them separate from financing costs.

b

Which of these makes this a true statement? When determining the appropriate weights used in calculating a WACC, it should reflect A. the relative sizes of the total book capitalizations for each kind of security that the firm issues. B. the relative sizes of the total market capitalizations for each kind of security that the firm issues. C. only the market after-tax cost of debt. D. only the market after-tax cost of equity.

b

Which of these statements is true regarding divisional WACC? A. Using a divisional WACC vs a WACC for the firm's current operations will result in quite a few incorrect decisions. B. Using a simple firmwide WACC to evaluate new projects would give an unfair advantage to projects that present more risk than the firm's average beta. C. Using a simple firmwide WACC to evaluate new projects would give an unfair advantage to projects that present less risk than the firm's average beta. D. Using a firmwide WACC to evaluate new projects would have no impact on projects that present less risk than the firm's average beta.

a

Which statement makes this a false statement? When a firm pays commissions to underwriting firms that float the issuance of new stock, A. the component cost will need to be integrated to figure project WACCs. B. the component cost will need to be integrated only for the firm's WACC. C. the firm can increase the project's WACC to incorporate the flotation costs' impact. D. the firm can leave the WACC alone and adjust the project's initial investment upwards.

b

Why do we use market-value weights instead of book-value weights? A. Because often-times firms "window-dress" their financial statements. B. Because we are interested in determining what the cost of financing the firm's assets would be given today's market situation and the component costs the firm currently faces, not what the historical prices would have been. C. Because it is required in the Sarbanes-Oxley regulations. D. None of these answers is correct.

b

5. Which of these statements is true regarding calculating weights for WACC? A. If we are calculating WACC for the firm, then equity, preferred stock and debt would be the entire book value of each source of capital. B. If we are calculating WACC for the firm, then equity, preferred stock and debt would be the entire market value of each source of capital. C. If we are calculating WACC for a project, then equity, preferred stock and debt would be the entire book value of each source of capital. D. If we are calculating WACC for a project, then equity, preferred stock and debt would be the entire market value of each source of capital.

a

A proxy beta is _________________. A. the average beta of firms that are only engaged in the proposed new line of business B. the industry average beta that is used in lieu of the firm's beta because the firm has not existed long enough to have a beta calculated C. the beta used when the firm has a great deal of business risk D. None of these answers is correct.

b

An average of which of the following will give a fairly accurate estimate of what a project's beta will be? A. flotation beta B. proxy beta C. pure-play proxies D. weighted average beta

c

An estimated WACC computed using some sort of proxy for the average equity risk of the projects in a particular business unit is known as the ____________. A. Business unit WACC B. Pure play beta C. Divisional WACC D. Component cost

c

An objective approach to calculating divisional WACCs would be done by A. simply considering the project's risk relative to the firm's lines of business and adjusting upward or downward to account for subjective opinions of project risk. B. computing the average beta for the firm, the firm's CAPM formula, and the firm's WACC. C. computing the average beta per division, using these figures for each division in the CAPM formula, and then constructing divisional WACCs. D. simply averaging out all the WACCs for all the firm's projects.

c

Flotation costs are _______________. A. insignificant and can be assumed away B. the difference between the bid-ask spread on the sale of the security C. commissions to the underwriting firm that floats the issue D. None of these answers are correct.