FINANCE CHATER 12 MCGRAWHILL 3/26/22-DUE MARCH 31.2022
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?
(P/V) × RP
What will happen over time if a firm uses its overall WACC to evaluate all projects, regardless of each project's risk level?
--It will accept projects that it should have rejected. --The firm overall will become riskier. --It will reject projects that it should have accepted.
What can we say about the dividends paid to common and preferred stockholders?
-Dividends to common stockholders are not fixed. -Dividends to preferred stockholders are fixed.
Which of the following is true about a firm's cost of debt?
-Yields can be calculated from observable data. It is easier to estimate than the cost of equity.
The following are advantages of the SML approach:
-adjusts for risk -does not require the company to pay a dividend
The following are disadvantages of the SML approach:
-requires estimation of beta -requires estimation of the market risk premium
Preferred stock Blank______.
=pays dividends in perpetuity =pays a constant dividend
True or false: The discount rate is also known as the expected return.
False
True or false: The primary disadvantage of the dividend growth model approach is its simplicity.
False
The most appropriate weights to use in the WACC are the Blank______ weights.
Market value
What is the required return on a stock (RE), according to the constant dividend growth model, if the growth rate (g) is zero?
RE = D1/P0
The formula for calculating the cost of equity capital that is based on the dividend discount model is
RE = D1/P0 + g
What is the equation for finding the cost of preferred stock?
RP = D/P0
Which of the following are true?
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.
According to the CAPM, what is the expected return on a stock if its beta is equal to zero?
The risk-free rate
What is the appropriate discount rate to use only if the proposed investment is a replica of the firm's existing operating activities?
WACC
What does WACC stand for?
Weighted average cost of capital
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______.
adding these two components
The discount rate for the firm's projects equals the cost of capital for the firm as a whole when
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______.
better than no risk adjustment
Dividends paid to common stockholders Blank______ be deducted from the payer's taxable income for tax purposes.
cannot
WACC is used to discount Blank______.
cash flows
The rate used to discount project cash flows is known as the Blank______.
cost of capital required return discount rate
Which of the following are components used in the construction of the WACC?
cost of common stock cost of debt cost of preferred stock
The dividend growth model is applicable to companies that pay
dividends
If the firm is all-equity, the discount rate is equal to the firm's cost of Blank______ capital.
equity
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.
false
True or false: Conglomerates are companies that specialize only in projects similar to the project your firm is considering.
false
True or false: Finding the cost of equity is fairly straightforward.
false
True or false: For publicly traded companies, the component of the dividend yield that must be estimated is the dividend.
false
True or false: In the WACC calculation, V = E − D.
false
True or false: Projects should always be discounted at the firm's overall cost of capital.
false
True or false: The SML approach is advantageous because all it requires is the estimation of beta.
false
True or false: The cost of equity is D1/P0 minus the analysts' estimates of growth
false
True or false: The discount rate is also known as the expected return.
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.
false
True or false: The growth rate of dividends can be found using the CAPM.
false
Components of the WACC include funds that come from ______ .
investors
Finding a firm's overall cost of equity is difficult because
it cannot be observed directly
If a firm issues no debt, its average cost of capital will equal ______.
its cost of equity
In the WACC calculation, D represents the --------- value
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
Preferred stock Blank______.
pays a constant dividend pays dividends in perpetuity
Other companies that specialize only in projects similar to the project your firm is considering are called
pure plays
To estimate a firm's equity cost of capital using the SML approach, we need to know the
risk-free rate market risk premium stock's beta
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
The WACC of a firm reflects the____ and the target capital structure of the firm's existing assets as a whole.
the risk
True or false: RP = D/P0
true
For a firm with outstanding debt, the cost of debt will be the Blank______ on that debt.
yield to maturity
True or false: The SML approach is advantageous because all it requires is estimation of beta.
FALSE
True or false: The cost of capital depends on the source of the funds.
False
Finding a firm's overall cost of equity is difficult because Blank______.
it cannot be observed directly
Which of the following is tax-deductible to the firm?
Coupon interest paid on bonds
The return an investor in a security receives is Blank______ the cost of the security to the company that issued it.
EQUAL TO
The formula of the SML is
RE = Rf + β × (RM − Rf)
True or false: The return an investor in a security receives is equal to the cost of the security to the company that issued it.
True
If a firm has multiple projects, each project should be discounted using .
a discount rate commensurate with the project's risk
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______.
rejected;when it should be accepted
If a firm uses its overall cost of capital to discount cash flows from projects in higher risk divisions, it will accept-----projects.
too many
Given V = E + D, if we divide both E and D by___ , we can calculate the capital structure weights.
value
The WACC is the overall rate of return the firm must earn on its existing assets to maintain the ------ of its stock.
value
The growth rate of dividends can be found using
-security analysts' forecasts -historical dividend growth rates
The formula for calculating the cost of equity capital that is based on the dividend discount model is Blank______.
RE = D1/P0 + g
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______.
[E/V] × RE + [D/V] × RD ×(1 − TC)
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?
the beta for software companies that collect and store data
The cost of capital depends primarily on the Blank______ of funds, not the Blank______.
use;source
To estimate the dividend yield of a particular stock, we need Blank______.
the current stock price the last dividend paid, D0 forecasts of the dividend growth rate, g