Finance Chapter 12

A firm uses its weighted average cost of capital to evaluate the proposed projects for all of its varying divisions. By doing so, the firm: A. automatically gives preferential treatment in the allocation of funds to its riskiest division. B. encourages the division managers to recommend only their most conservative projects. C. maintains the current risk level and capital structure of the firm. D. automatically maximizes the total value created for its shareholders. E. allocates capital funds evenly among its divisions.

A

All else constant, the weighted average cost of capital for a risky, levered firm will decrease if: A. the firm's bonds start selling at a premium rather than at a discount. B. the market risk premium increases. C. the firm replaces some of its debt with preferred stock. D. corporate taxes are eliminated. E. the dividend yield on the common stock increases.

A

Which one of the following will increase the cost of equity, all else held constant? A. Increase in the dividend growth rate B. Decrease in beta C. Decrease in future dividends D. Increase in stock price E. Decrease in market risk premium

A

Which of the following features are advantages of the dividend growth model? I. Easy to understand II. Model simplicity III. Constant dividend growth rate IV. Model's applicability to all common stocks

1 and 2 only

Judy's Boutique just paid an annual dividend of $1.65 on its common stock. The firm increases its dividend by 2.5 percent annually. What is the rate of return on this stock if the current stock price is $38.20 a share? A. 6.93 percent B. 7.37 percent C. 7.54 percent D. 8.19 percent E. 8.33 percent

1.65 (1.025)/ 38.2 +.025= 6.93

The aftertax cost of which of the following is affected by a change in a firm's tax rate? I. Preferred stock II. Debt III. Equity IV. Capital

2 and 4

Four years ago, the Morgan Co. issued 15-year, 7.0 percent semiannual coupon bonds at par. Today, the bonds are quoted at 101.6. What is this firm's pretax cost of debt? A. 6.97 percent B. 7.08 percent C. 6.79 percent D. 6.83 percent E. 7.39 percent

22=N 35=PMT 1000=FV -1016=PV I/Y=3.395*2 =6.79 C

Titans, Inc. has 6 percent bonds outstanding that mature in 14 years. The bonds pay interest semiannually and have a face value of $1,000. Currently, the bonds are selling for $993 each. What is the firm's pretax cost of debt? A. 5.97 percent B. 6.08 percent C. 6.14 percent D. 6.31 percent E. 6.40 percent

28=N -993=PV 30=PMT 1000=FV I/Y=3.04*2 6.08

41. Derek's is a brick-and-mortar toy store. The firm is considering expanding its operations to include Internet sales. Which one of the following would be the best firm to use in a pure play approach to analyzing this proposed expansion? A. Another brick-and-mortar store that also sells online B. A wholesale toy distributor C. A toy store that sells online only D. The oldest online retailer of any product E. Derek's own store Refer to Section 12.5.

C

42. Kelly's uses the firm's WACC as the required return for some of its projects. For other projects, the firms uses a rate equal to WACC plus 1 percent, while another set of projects is assigned rates equal to WACC minus some amount. Which one of the following factors should be the key factor the firm uses to determine the amount of the adjustment it will make when assigning the project a discount rate? A. Firm beta B. Date for project commencement C. Risk level of project D. Division within the firm that will be assigned to manage the project E. Current debt-equity ratio Refer to Section 12.5.

C

43. A firm has multiple divisions of similar nature, yet varying degrees of risk. Which one of the following would be the most appropriate, yet relatively easy, means of assigning discount rates to each of its proposed investments? A. Assign every project a rate equal to the firm's cost of equity B. Assign every firm a random rate that varies between the firm's cost of debt and its cost of equity C. Assign every project a rate equal to the firm's WACC plus or minus a subjective adjustment D. Determine the best pure play rate for each project E. Assign every project a rate equal to the market rate of return at the time of the proposal Refer to Section 12.5.

C

Which one of the following is most apt to cause a wise manager to increase a project's cost of capital? Assume the firm is levered. A. Management decides to issue new stock to finance the project. B. The initial cash outlay requirement is reduced. C. She learns the project is riskier than previously believed. D. The aftertax cost of debt just decreased. E. The project's life is shortened.

C

Tennessee Valley Antiques would like to issue new equity shares if its cost of equity declines to 10.5 percent. The company pays a constant annual dividend of $1.80 per share. What does the market price of the stock need to be for the firm to issue the new shares? A. $14.48 B. $14.83 C. $17.14 D. $17.92 E. $18.80

C P0 = $1.80/0.105 = $17.14

You need to use the pure play approach to assign a cost of capital to a proposed investment. Which one of the following characteristics should you most concentrate on as you search for an appropriate pure play firm? A. Firm size B. Firm location C. Firm experience D. Firm operations E. Firm management

D

40. When using the pure play approach for a proposed investment, a firm is primarily seeking a rate of return that: A. is based on the actual source of funds that will be used to fund the project. B. creates a positive net present value for the project. C. reflects the size and life of the project. D. most closely correlates with the proposed investment's internal rate of return. E. best matches the risk level of the proposed investment. Refer to Section 12.5.

E

44. The computation of which one of the following requires assigning every proposed investment to a particular risk class? A. Pure play cost of capital B. Cost of equity C. Aftertax cost of debt D. WACC E. Subjective cost of capital Refer to Section 12.5.

E

Which one of the following statements is accurate for a levered firm? A. WACC should be used as the required return for all proposed investments. B. A firm's WACC will decrease whenever the firm's tax rate decreases. C. An increase in the market risk premium will decrease a firm's WACC. D. The subjective approach totally ignores a firm's own WACC. E. A reduction in the risk level of a firm will tend to decrease the firm's WACC.

E

All else constant, which of the following will increase the aftertax cost of debt for a firm? I. Increase in the yield to maturity of the firm's outstanding debt II. Decrease in the yield to maturity of the firm's outstanding debt III. Increase in the firm's tax rate IV. Decrease in the firm's tax rate

I and IV

Piedmont Hotels is an all-equity firm with 60,000 shares of stock outstanding. The stock has a beta of 1.27 and a standard deviation of 13.8 percent. The market risk premium is 9.1 percent and the risk-free rate of return is 4.5 percent. The company is considering a project that it considers riskier than its current operations so it wants to apply an adjustment of 1 percent to the project's discount rate. What should the firm set as the required rate of return for the project? A. 12.54 percent B. 13.92 percent C. 15.39 percent D. 17.06 percent E. 17.33 percent

Project cost of capital = 0.045 + 1.27(0.091) + 0.01 = 17.06 percent risk free rate plus the risk premium Capital asset pricing model to account for systematic risk multiply the premium by the beta

46. Farm Equipment, Inc. announced this morning that its next annual dividend will be decreased to $1.80 a share and that all future dividends will be decreased by an additional 1.5 percent annually. What is the current value per share of this stock if the required return is 16.5 percent? A. $8 B. $10 C. $12 D. $14 E. $16

P0= 1.8/ .165-(-.015) =10 rearrange equation B

Kate is the CFO of a major firm and has the job of assigning discount rates to each project that is under consideration. Kate's method of doing this is to assign an incrementally higher rate as the risk level of the project increases over that of the current firm. Likewise, she assigns lower rates as the risk level declines. Which one of the following approaches is Kate using to assign the discount rates?

subjective approach

Madison Square Stores has a $20 million bond issue outstanding that currently has a market value of $18.6 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? A. 4.21 percent B. 8.42 percent C. 7.58 percent D. 7.74 percent E. 7.80 percent

treat the 18.6 million as a percent of 20 million, so FV is still 1000, and PV is -930 Current bond price = (18.6/20) × $1,000 = $930

Trendsetters has a cost of equity of 18.1 percent. The market risk premium is 10.2 percent and the risk-free rate is 4.4 percent. The company is acquiring a competitor, which will increase the company's beta to 1.6. What effect, if any, will the acquisition have on the firm's cost of equity capital? A. No effect B. Decrease of 2.62 percent C. Decrease of 0.84 percent D. Increase of 2.62 percent E. Increase of 4.13 percent

RE = 0.044 + 1.6(0.102) = 20.72 percent Increase in cost of equity = 20.72 percent - 18.1 percent = 2.62 percent D

The common stock of Wiley and Sons has a beta that is 25 percent larger than the overall market beta. Currently, the market risk premium is 9.5 percent while the U.S. Treasury bill is yielding 4.7 percent. What is the cost of equity for this firm? A. 13.76 percent B. 14.96 percent C. 15.80 percent D. 16.58 percent E. 16.85 percent

RE = 0.047 + 1.25(0.095) = 16.58 percent

The common stock of Contemporary Interiors has a beta of 1.65 and a standard deviation of 27.4 percent. The market rate of return is 13.2 percent and the risk-free rate is 4.8 percent. What is the cost of equity for this firm? A. 18.66 percent B. 18.76 percent C. 21.08 percent D. 24.40 percent E. 26.05 percent

RE = 0.048 + 1.65(0.132 - 0.048) = 18.66 percent A!

Electronic Products has 35,000 bonds outstanding that are currently quoted at 102.3. The bonds mature in 11 years and carry a 9 percent annual coupon. What is the firm's aftertax cost of debt if the applicable tax rate is 30 percent? A. 4.47 percent B. 4.79 percent C. 6.07 percent D. 6.98 percent E. 8.67 percent

Solve like pretax and then multiply the I/Y times (1-T) I/Y=8.6673 Aftertax= 8.6673 (1-.30)= 6.07 for semi- annual do not forget to multiply x2

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 using today'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

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 statements is correct concerning capital structure weights?

The repurchase of preferred stock will increase the weight of debt.

Western Electric has 23,000 shares of common stock outstanding at a price per share of $57 and a rate of return of 14.2 percent. The firm has 6,000 shares of 7 percent preferred stock outstanding at a price of $48 a share. The preferred stock has a par value of $100. The outstanding debt has a total face value of $350,000 and currently sells for 102 percent of face. The yield to maturity on the debt is 8.49 percent. What is the firm's weighted average cost of capital if the tax rate is 34 percent? A. 12.69 percent B. 13.44 percent C. 14.19 percent D. 14.47 percent E. 14.92 percent

WACC = ($1,311,000/$1,956,000)(0.142) + ($288,000/$1,956,000)(0.07 × $100/$48) + ($357,000/$1,956,000)(0.0849)(1 - 0.34) = 12.69 percent the YTM is the cost of the bond in this case

Which one of the following statements is correct? Assume the pretax cost of debt is less than the cost of equity. A. A firm may change its capital structure if the government changes its tax policies. B. A decrease in the dividend growth rate increases the cost of equity. C. A decrease in the systematic risk of a firm will increase the firm's cost of capital. D. A decrease in a firm's debt-equity ratio will decrease the firm's cost of capital. E. The cost of preferred stock decreases when the tax rate increases.

a

Farmer's Supply, Inc. 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 that should be used to evaluate this proposed expansion. Which one of the following terms is used to describe the approach Farmer's Supply is taking to establish an appropriate discount rate for the project?

pure play approach

The Color Box uses a combination of common stock, preferred stock, and debt financing. The company wants preferred stock to represent 8 percent of the total financing. It also wants to structure the firm in a manner that will produce a weighted average cost of capital of 10.25 percent. The aftertax cost of debt is 5.1 percent, the cost of preferred is 9.3 percent, and the cost of common stock is 15.6 percent. What percentage of the firm's capital funding should be debt financing? A. 46.12 percent B. 52.03 percent C. 54.15 percent D. 58.78 percent E. 63.21 percent

(1 - 0.08 - x)(0.156) + (0.08)(0.093) + (x)(0.051) = 0.1025 x = 46.12 percent = Weight of debt

Bob's is a retail chain of specialty hardware stores. The firm has 21,000 shares of stock outstanding that are currently valued at $68 a share and provide a 13.2 percent rate of return. The firm also has 500 bonds outstanding that have a face value of $1,000, a market price of $1,068, and a 7 percent coupon. These bonds mature in 6 years and pay interest semiannually. The tax rate is 35 percent. The firm is considering expanding by building a new superstore. The superstore will require an initial investment of $12.3 million and is expected to produce cash inflows of $1.1 million annually over its 10-year life. The risks associated with the superstore are comparable to the risks of the firm's current operations. The initial investment will be depreciated on a straight line basis over the life of the project. At the end of the 10 years, the firm expects to sell the superstore for $6.7 million. Should the firm accept or reject the superstore project and why? A. Accept; the project's NPV is $1.27 million. B. Accept; the NPV is $4.89 million. C. Reject; the NPV is $1.06 million. D. Reject; the NPV -$3.27 million. E. Reject; the NPV is -$5.71 million.

1) solve for the return on debt (calc) 2)calculate WACC 3) Solve for NPV normally 4) input salvage value by doing 6.7/(1.106065^10) 5) add to NPV=-3.27 mil still negative so do not accept

Casper's is analyzing a proposed expansion project that is much riskier than the firm's current operations. Thus, the project will be assigned a discount rate equal to the firm's cost of capital plus 3 percent. The proposed project has an initial cost of $17.2 million that will be depreciated on a straight-line basis over 20 years. The project also requires additional inventory of $687,000 over the project's life. Management estimates the facility will generate cash inflows of $2.78 million a year over its 20-year life. After 20 years, the company plans to sell the facility for an estimated $1.3 million. The company has 60,000 shares of common stock outstanding at a market price of $49 a share. This stock just paid an annual dividend of $1.84 a share. The dividend is expected to increase by 3.5 percent annually. The firm also has 10,000 shares of 12 percent preferred stock with a market value of $98 a share. The preferred stock has a par value of $100. The company has a 9 percent, semiannual coupon bond issue outstanding with a total face value of $1.1 million. The bonds are currently priced at 102 percent of face value and mature in 16 years. The tax rate is 33 percent. Should the firm pursue the expansion project at this point in time? Why or why not? A. Accept; the NPV is $2.648 million. B. Accept; the NPV is $4.507 million. C. Reject; the NPV is -$3.241 million. D. Reject; the NPV is -$3.027 million. E. Reject; the NPV is -$1.040 million.

1)calculate the weights of all of the debt and equity 2)Calculate the return on CS and the return on PS 3)Plug in for the return on debt 4) plug all of the above into WACC (projected cost of capital) with the tax rate Project cost of capital = ($2,940,000/$5,042,000)(0.073865) + ($980,000/$5,042,000)(0.122449) + ($1,122,000/$5,042,000)(0.087652)(1 - 0.33) + 0.03 = 0.109939 5)Calculate NPV subtract the additional value at the beginning and add back at the end add back salvage value and add. inventory/ (PVF^20) after calculating NPV NPV = -$17.2m - $687,000 + $2.78m(PVIFA20, 10.9939%) + ($1.3m + 687000) /(1.109939)^20 = $4.507 million The firm should proceed with the expansion project because the NPV is positive. B

Kim's Bridal Shoppe has 15,000 shares of common stock outstanding at a price of $11 a share. It also has 2,000 shares of preferred stock outstanding at a price of $34 a share. There are 50 bonds outstanding that have a 7.5 percent semiannual coupon. The bonds mature in six years, have a face value of $1,000, and sell at 96 percent of par. What is the capital structure weight of the common stock?

15000x11=165k 2000x34=68k 50x960=48k total=281k 165/281=.5872 ignore tax rates for now

31. Old Town Industries has three divisions. Division X has been in existence the longest and has the most stable sales. Division Y has been in existence for five years and is slightly less risky than the overall firm. Division Z is the research and development side of the business. When allocating funds, the firm should probably: A. require the highest rate of return from Division X since it has been in existence the longest. B. assign the highest cost of capital to Division Z because it is most likely the riskiest of the three divisions. C. use the firm's WACC as the cost of capital for Division Z as it provides analysis for the entire firm. D. use the firm's WACC as the cost of capital for Divisions A and B because they are part of the revenue-producing operations of the firm. E. allocate capital funds evenly amongst the divisions to maintain the current capital structure of the firm. Refer to Section 12.5.

B

47. The Green Balloon just paid its first annual dividend of $0.12 a share. The firm plans to increase the dividend by 3.5 percent per year indefinitely. What is the firm's cost of equity if the current stock price is $6.50 a share? A. 5.35 percent B. 5.41 percent C. 14.42 percent D. 18.79 percent E. 19.98 percent

B

A firm that uses its weighted average cost of capital as the required return for all of its investments will: A. maintain a constant value for its shareholders. B. increase the risk level of the firm over time. C. make the best possible accept and reject decisions related to those investments. D. find that its cost of capital declines over time. E. accept only the projects that add value to the firm's shareholders.

B

Boone Brothers remodels homes and replaces windows. Ace Builders constructs new homes. If Boone Brothers considers expanding into new home construction, it should evaluate the expansion project using which one of the following as the required return for the project? A. Boone Brothers' cost of capital B. Ace Builders' cost of capital C. Average of Boone Brothers' and Ace Builders' cost of capital D. Lower of Boone Brothers' or Ace Builders' cost of capital E. Higher of Boone Brothers' or Ace Builders' cost of capital

B

The Cracker Barrel has a beta of 0.98, a dividend growth rate of 3.2 percent, a stock price of $33 a share, and an expected annual dividend of $1.06 per share next year. The market rate of return is 11.2 percent and the risk-free rate is 3.7 percent. What is the firm's cost of equity? A. 7.74 percent B. 8.73 percent C. 9.30 percent D. 9.72 percent E. 17.46 percent

B

Which one of the following statements is correct, all else held constant? A. Beta is used to compute the return on equity and the standard deviation is used to compute the return on preferred. B. A decrease in a firm's WACC will increase the attractiveness of the firm's investment options. C. The aftertax cost of debt increases when the market price of a bond increases. D. If you have both the dividend growth and the security market line's costs of equity, you should use the higher of the two estimates when computing WACC. E. WACC is applicable only to firms that issue both common and preferred stock.

B

The cost of capital for a project depends primarily on which one of the following? A. Source of funds used for the project B. Division within the firm that undertakes the project C. Project's modified internal rate of return D. How the project uses its funds E. Project's fixed costs

D

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

33. Kurt, who is a divisional manager, continually brags that his division's required return for its projects is 1 percent lower than the return required for any other division of the firm. Which one of the following most likely contributes the most to the lower rate requirement for Kurt's division? A. Kurt tends to overestimate the projected cash inflows on his projects. B. Kurt tends to underestimate the variable costs of his projects. C. Kurt has the most efficiently managed division. D. Kurt's division is less risky than the other divisions. E. Kurt's projects are generally financed with debt while the other divisions' projects are financed with equity. Refer to Section 12.5.

D

36. Marine Expeditors has three divisions. Division A is the core of the business and represents 80 percent of the firm's operations. Division B is involved only with contractual short-term projects and therefore has about 8 percent less risk than Division A. Division C develops and markets new products and is about 12 percent riskier than Division A and about equal in size to Division B. The manager of Division A has suggested that the operations of his division be increased by 10 percent next year. The proposed project should probably be assigned a required return that is equal to _____ percent of the firm's weighted average cost of capital. A. 40 B. 60 C. 80 D. 100 E. 110 Refer to Section 12.5.

D

A firm has a cost of equity of 13 percent, a cost of preferred of 11 percent, and an aftertax cost of debt of 6 percent. Given this, which one of the following will increase the firm's weighted average cost of capital? A. Increasing the firm's tax rate B. Issuing new bonds at par C. Redeeming shares of common stock D. Increasing the firm's beta E. Increasing the debt-equity ratio

D

Musical Charts just paid an annual dividend of $2.45 per share. This dividend is expected to increase by 3.3 percent annually. Currently, the firm has a beta of 1.09 and a stock price of $36 a share. The risk-free rate is 4.2 percent and the market rate of return is 12.6 percent. What is the cost of equity capital for this firm? A. 10.28 percent B. 11.84 percent C. 12.29 percent D. 12.95 percent E. 13.42 percent

Have to do it both ways and then average! B

Great Lakes Packing has two bond issues outstanding. The first issue has a coupon rate of 9 percent, matures in 3 years, has a total face value of $6 million, and is quoted at 108 percent of face value. The second issue has a 7.5 percent coupon, matures in 16 years, has a total face value of $18 million, and is quoted at 97 percent of face value. Both bonds pay interest semiannually. What is the firm's weighted average aftertax cost of debt if the tax rate is 35 percent? A. 4.78 percent B. 5.12 percent C. 5.63 percent D. 5.95 percent E. 6.08 percent

I/Y for first bond=6.044273 I/Y for 2nd=7.832113 Total Market values: ($6m × 1.08) + ($18m × 0.97) = $6.48m + $17.46m = $23.94m After finding market value find the weights! Aftertax cost of debt = [($6.48m/$23.94m)(0.060443) + ($17.46m/$23.94m)(0.078321)] × (1 - 0.35) = 4.78 percent Use WACC formula

Which of the following are weaknesses of the dividend growth model? I. Market risk premium fluctuations II. Lack of dividends for some firms III. Reliance on historical beta IV. Sensitivity of model to dividend growth rate

II and IV only

Which of the following will increase the cost of equity for a firm with a beta of 1.1? I. Decrease in the security's beta II. Decrease in the market risk premium III. Decrease in the risk-free rate IV. Increase in the risk-free rate

III only

In an efficient market, the cost of equity for a risky firm does which one of the following according to the security market line?

Increases in direct relation to the stock's systematic risk

The 7.5 percent preferred stock of Home Town Brewers is selling for $45 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? A. 7.50 percent B. 15.92 percent C. 16.17 percent D. 16.52 percent E. 16.67 percent

Rp = (0.075 × $100)/$45 = 16.67 percent E

Alpha Industries is considering a project with an initial cost of $7.4 million. The project will produce cash inflows of $1.54 million a year for seven years. The firm uses the subjective approach to assign discount rates to projects. For this project, the subjective adjustment is +1.5 percent. The firm has a pretax cost of debt of 8.6 percent and a cost of equity of 13.7 percent. The debt-equity ratio is 0.0.65 and the tax rate is 35 percent. What is the net present value of the project? A. -$372,951 B. -$187,016 C. $48,209 D. $133,333 E. $269,480

WACC = (1/1.65)(0.137) + (0.65/1.65)(0.086)(1 - 0.35) = 0.105051 Project WACC = 0.105051 + 0.015 = 0.120051 NPV = -$7.4m + ($1.54m) [1-(1/1+.120051)^7 )/.120051]= -$372,951 Add adjustment after you calculate the WACC Calculate the WACC add 1.5 Add add cash flows to the calc, put the WACC as the I/Y and 7 as N

A firm wants to create a WACC of 10.4 percent. The firm's cost of equity is 14.5 percent and its pretax cost of debt is 8.5 percent. The tax rate is 34 percent. What does the debt-equity ratio need to be for the firm to achieve its target WACC? A. 0.51 B. 0.57 C. 0.62 D. 0.70 E. 0.86

WACC = 0.104 = (1 - x)(0.145) + (x)(0.085)(1 - 0.34)] x = 0.4612 Debt-equity ratio = 0.4612/(1 - 0.4612) = 0.86

Bermuda Cruises issues only common stock and coupon bonds. The firm has a debt-equity ratio of 0.65. The cost of equity is 18.3 percent and the pretax cost of debt is 9.9 percent. What is the capital structure weight of the firm's equity if the firm's tax rate is 34 percent? A. 46.75 percent B. 49.97 percent C. 52.93 percent D. 59.08 percent E. 60.61 percent

Weight of equity = 1/(1.65) = 60.61 percent

Which one of the following represents the rate of return a firm must earn on its assets if it is to maintain the current value of its securities?

Weighted average cost of capital

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 project

20. Which one of the following statements is correct? A. An increase in the market value of preferred stock will increase a firm's weighted average cost of capital. B. The cost of preferred stock is unaffected by the issuer's tax rate. C. Preferred stock is generally the cheapest source of capital for a firm. D. The cost of preferred stock remains constant from year to year. E. Preferred stock is valued using the capital asset pricing model. Refer to Section 12.3.

b

All else constant, an increase in a firm's cost of debt: A. could be caused by an increase in the firm's tax rate. B. will result in an increase in the firm's cost of capital. C. will lower the firm's weighted average cost of capital. D. will lower the firm's cost of equity. E. will increase the firm's capital structure weight of debt.

b

Which one of the following will decrease the aftertax cost of debt for a firm? A. Decrease in the firm's beta B. Increase in tax rates C. Increase in the risk-free rate of return D. Decrease in the market price of the debt E. Decrease in a bond's yield to maturity

b

Which one of the following is the pretax cost of debt? A. Average coupon rate on the firm's outstanding bonds B. Coupon rate on the firm's latest bond issue C. Weighted average yield to maturity on the firm's outstanding debt D. Average current yield on the firm's outstanding debt E. Annual interest divided by the market price per bond for the latest bond issue

c

Which one of the following is the primary determinant of an investment's cost of capital? A. Life of investment B. Initial cash outlay C. Level of risk D. Source of funds used for the investment E. Investment's net present value Refer to Section 12.5.

c

Which one of the following will affect the capital structure weights used to compute a firm's weighted average cost of capital? A. Decrease in the book value of a firm's equity B. Decrease in a firm's tax rate C. Increase in the market value of the firm's common stock D. Increase in the market risk premium E. Increase in the firm's beta Refer to Section 12.4.

c

The Five and Dime Store has a cost of equity of 15.8 percent, a pretax cost of debt of 7.7 percent, and a tax rate of 35 percent. What is the firm's weighted average cost of capital if the debt-equity ratio is 0.40? A. 10.18 percent B. 11.72 percent C. 12.72 percent D. 13.49 percent E. 14.93 percent

cannot forget pemdas WACC = (1/1.40)(0.158) + (0.40/1.40)(0.077)(1 - 0.35) = 12.72 percent C If it is pre tax then you must subtract the tax, but if it is after tax you do not have to

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 and its aftertax cost of debt.

The cost of preferred stock: A. increases when a firm's tax rate decreases. B. is constant over time. C. is unaffected by changes in the market price. D. is equal to the stock's dividend yield. E. increases as the price of the stock increases.

d