FNAN 250 CHAP 12
The following are advantages of the SML approach
Adjusts for risk Does not require the company to pay a dividend
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 following are disadvantages of the SML approach
Does not require the company to pay a dividend Requires estimation of the market risk premium Adjusts for risk Requires estimation of beta
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.
F
True or false: Conglomerates are companies that specialize only in projects similar to the project your firm is considering.
F
Which of the following are true?
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.
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
The formula of the SML is:
RE = Rf + Beta x (RM- Rf)
It is difficult to establish discount rate for individual projects, so firm's often adopt an approach that involves making____adjustments to the overall WACC.
Subjective
True or false: RP=D/P0
True
Given V = E + D, if we divide both V and D by _______ we can calculate the capital structure weights.
V
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:
[E/V] × RE + [D/V] × RD ×(1 - T c)
Dividends paid to common stockholders ______ be deducted from the payer's taxable income for tax purposes.
cannot
The rate used to discount project cash flows is known as the ___.
discount rate cost of capital required return
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
In the WACC calculation, D represents the___value of the firm's debt.
market
The most appropriate weights to use in the WACC are the ______ weights.
market value
Preferred stock ___.
pays a constant dividend pays dividends in perpetuity
The WACC of a firm reflects the______and the target capital structure of the firm's existing assets as a whole.
risk
To estimate a firm's equity cost of capital using the CAPM, we need to know the ___.
stock's beta market risk premium risk-free rate
To estimate the dividend yield of a particular stock, we need:
the current stock price the last dividend paid, D0 forecasts of the dividend growth rate, g
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
For a firm with outstanding debt, the cost of debt will be the ________ on that debt..
yield to maturity
True or false: The growth rate of dividends can be found using the CAPM
F
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
The dividend growth model is applicable to companies that pay
dividend
If a firm issues no debt, its average cost of capital will equal ___.
its cost of equity
Other companies that specialize only in projects similar to the project your firm is considering are called ___.
pure plays
True or false: The cost of capital depends on the source of the funds.
F
If the firm is all-equity, the discount rate is equal to the firm's cost of ______ capital.
equity
True or false: In the WACC calculation, V = E - D.
F
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
True or false: The discount rate is also known as the expected return.
F
Including preferred stock in the WACC formula adds which term if P is the market value of preferred stock and RPis the cost of preferred?
(P/V) × RP
Which of the following is tax-deductible to the firm?
Coupon interest paid on bonds
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.
True or false: For publicly traded companies, the component of the dividend yield that must be estimated is the dividend.
F
True or false: Projects should always be discounted at the firm's overall cost of capital.
F
True or false: The SML approach is advantageous because all it requires is estimation of beta.
F
True or false: The SML approach is advantageous because all it requires is the estimation of beta.
F
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.
F
True or false: The growth rate of dividends can be found using the CAPM.
F
True or false: The primary disadvantage of the dividend growth model approach is its simplicity.
F
What is the equation for finding the cost of preferred stock?
RP=D/P0
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.
T
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
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.
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:
adding these two components.
The return an investor in a security receives is ______ _____ the cost of the security to the company that issued it.
equal to
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:
rejected, when it should be accepted
The cost of capital depends primarily on the ______ of funds, not the _____.
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
The growth rate of dividends can be found using:
- security analysts' forecasts - historical dividend growth rates
True or false: Finding the cost of equity is fairly straightforward.
F
Some risk adjustment to a firm's WACC for projects of differing risk, even if it is subjective, is probably:
better than no risk adjustment
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
True or false: The cost of capital depends on the source of the funds
F
True or false: The cost of equity is D1/P0 minus the analysts' estimates of growth.
F
If a firm has multiple projects, each project should be discounted using ___.
a discount rate commensurate with the project's risk
