WACC connect

When using the subjective approach to project analysis, a firm:

assigns discount rates to projects based on the discretion of the senior managers of a firm.

Assume a firm utilizes its WACC as the discount rate for every capital project it implements. Accordingly, the firm will tend to:

increase the average risk level of the company over time.

Assume Barnes' Boots has a debt-equity ratio of .52. The firm uses the capital asset pricing model to determine its cost of equity. Accordingly, the firm's estimated cost of equity:

is dependent upon a reliable estimate of the market risk premium.

The flotation cost for a company is computed as: -the arithmetic average of the flotation costs of both debt and equity. -the weighted average of the flotation costs associated with each form of financing. -the geometric average of the flotation costs associated with each form of financing. -one-half of the flotation cost of debt plus one-half of the flotation cost of equity. -a weighted average based on the book values of the company's outstanding securities.

the weighted average of the flotation costs associated with each form of financing.

When determining a firm's cost of capital, the most important determinant is the:

use of the funds raised.

Flotation costs for a levered firm should be:

weighted and included in the initial cash flow.

Flotation costs for a levered firm should be: -ignored when analyzing a project because they are a sunk cost. -spread over the life of a project thereby reducing the cash flows for each year of the project. -considered only when two projects are mutually exclusive. -weighted and included in the initial cash flow. -totally ignored when internal equity funding is utilized.

weighted and included in the initial cash flow.

Assume a firm utilizes the security market line approach to determine the cost of equity. If the firm currently pays an annual dividend of $2.40 per share and has a beta of 1.42, all else constant, which of the following actions will decrease the firm's cost of equity? -A decrease in the dividend amount -An increase in the dividend amount -An increase in the market rate of return -A decrease in the firm's beta -A decrease in the risk-free rate

A decrease in the firm's beta

When determining a firm's cost of capital, the most important determinant is the: -debt-equity ratio of any new funds raised. -marginal tax rate. -pretax cost of equity - aftertax cost of equity - use of the funds raised.

-use of the funds

Which of the following statements regarding the cost of preferred stock is accurate? -It equals the dividend yield. -It equals the yield to maturity. -It is highly dependent on the dividend growth rate. -It is independent of the preferred stock's price. -It decreases when tax rates increase.

It equals the dividend yield.

When calculating a firm's weighted average cost of capital, the capital structure weights:

are based on the market values of the outstanding securities.

Incorporating flotation costs into the analysis of a project will:

increase the initial cash outflow of the project.

The cost of preferred stock is equivalent to the: -pretax cost of debt. -rate of return on an annuity. aftertax cost of debt. -rate of return on a perpetuity. -cost of an irregular growth common stock.

rate of return on a perpetuity.

With respect to evaluating capital projects, which of the following statements is accurate? -Firms should accept low-risk projects prior to funding high-risk projects. -Making subjective adjustments to a company's WACC when determining project discount rates unfairly punishes low-risk divisions within the company. -A project that is unacceptable today might be acceptable tomorrow given a change in market returns. -The pure-play method is most frequently used for projects involving the growth of a company's current operations. -Companies that elect to use the pure play method for determining a discount rate for a project cannot subjectively adjust the pure play rate.

A project that is unacceptable today might be acceptable tomorrow given a change in market returns.

Incorporating flotation costs into the analysis of a project will: -cause the project to be improperly evaluated. -increase the net present value of the project. -increase the project's rate of return. -increase the initial cash outflow of the project. -have no effect on the present value of the project.

increase the initial cash outflow of the project.

The cost of preferred stock is equivalent to the:

rate of return on a perpetuity.

Assume Barnes' Boots has a debt-equity ratio of .52. The firm uses the capital asset pricing model to determine its cost of equity. Accordingly, the firm's estimated cost of equity: -is affected by the firm's rate of growth projections. -implies that the firm pays out all of its earnings to its shareholders. -is dependent upon a reliable estimate of the market risk premium. -would be unaffected if the dividend discount model were applied instead. - -will be unaffected by changes in overall market risks.

is dependent upon a reliable estimate of the market risk premium.

Which of the following statements regarding a firm's pretax cost of debt is accurate? -It is based on the current yield to maturity of the company's outstanding bonds. -It is equal to the coupon rate on the latest bonds issued by the company. -It is equivalent to the average current yield on all of a company's outstanding bonds. -It is based on the original yield to maturity on the latest bonds issued by a company. -It must be estimated as it cannot be directly observed in the market.

It is based on the current yield to maturity of the company's outstanding bonds.

Which of the following statements regarding the weighted average cost of capital is accurate?

It is the return investors require on the total assets of the firm.

Which of the following statements regarding the weighted average cost of capital is accurate? -It equals the aftertax cost of the outstanding liabilities. -It should be used as the required return when analyzing any new project. -It is the return investors require on the total assets of the firm. -It remains constant when the debt-equity ratio changes. -It is unaffected by changes in corporate tax rates.

It is the return investors require on the total assets of the firm.

When determining a firm's weighted average cost of capital, the item with the least amount of impact is the: -company's beta. -coupon rate of the company's outstanding bonds. -growth rate of the company's dividends. -company's marginal tax rate. -standard deviation of the company's common stock.

standard deviation of the company's common stock.

Assume a firm utilizes the security market line approach to determine the cost of equity. If the firm currently pays an annual dividend of $3.36 per share and has a beta of 1.38, all else constant, which of the following actions will increase the firm's cost of equity? - A decrease in the dividend amount -- -An increase in the dividend amount -A decrease in the market rate of return -A decrease in the firm's beta -A decrease in the risk-free rate

A decrease in the risk-free rate

To determine a firm's cost of capital, one must include: -only the return required by the firm's current shareholders. -only the current market rate of return on equity shares. -the weighted costs of all future funding sources. -the returns currently required by both debtholders and stockholders. -the company's original debt-equity ratio.

The returns currently required by both debtholders and stockholders.

Wright Market Research is able to borrow money at a rate of 6.8 percent per year. This interest rate is called the: compound rate. current yield. cost of debt. capital gains yield. cost of capital.

cost of debt.

When evaluating capital project proposals, assume a firm assigns unique discount rates based on the risk level of each project. Accordingly the: -company's overall cost of capital may increase or decrease over time. -company's overall cost of capital will not change over time. -company's overall cost of capital will decrease over time. -value of the company will decrease over time. firm will be unable to maximize value for its shareholders.

company's overall cost of capital may increase or decrease over time.

Okonjo Economics has a debt-equity ratio of .38. All of the firm's outstanding shares were purchased by a small number of investors. The return these investors require is called the:

cost of equity.

Okonjo Economics has a debt-equity ratio of .38. All of the firm's outstanding shares were purchased by a small number of investors. The return these investors require is called the: -dividend yield. -cost of equity. -capital gains yield. -cost of capital. -income return.

cost of equity.

Assume a firm utilizes the security market line approach to determine the cost of equity. If the firm currently pays an annual dividend of $3.36 per share and has a beta of 1.38, all else constant, which of the following actions will increase the firm's cost of equity? -A decrease in the dividend amount -An increase in the dividend amount -A decrease in the market rate of return -A decrease in the firm's beta -A decrease in the risk-free rate

A decrease in the risk-free rate

With respect to capital project analysis, which of the following statements is accurate? -The subjective approach assigns a discount rate to each project based on other companies in the same category as the project. -Overall, a company makes better decisions when it uses the subjective approach than when it uses its WACC as the discount rate for all projects. -Companies will correctly accept or reject every project if they adopt the subjective approach. - -Mandatory projects should only be accepted if they produce a positive NPV when the overall company WACC is used as the discount rate. -The pure play approach should only be used with low-risk projects.

Overall, a company makes better decisions when it uses the subjective approach than when it uses its WACC as the discount rate for all projects.

When calculating a firm's weighted average cost of capital, the capital structure weights: -are based on the book values of debt and equity. are based on the market values of the outstanding securities. -depend upon the financing obtained to fund each specific project. -remain constant over time unless new securities are issued or outstanding securities are redeemed. -are restricted to debt and common stock.

are based on the market values of the outstanding securities.

When using the subjective approach to project analysis, a firm: must have an all-equity capital structure.uses the WACC of Firm X as the basis for the discount rate for a project under consideration by Firm Y. -assigns discount rates to projects based on the discretion of the senior managers of a firm. - allows managers to randomly adjust the discount rate assigned to a project once the project's standard deviation has been determined. -applies a lower discount rate to projects that are financed totally with equity as compared to those that are partially financed with debt.

assigns discount rates to projects based on the discretion of the senior managers of a firm.

Assume a firm utilizes its WACC as the discount rate for every capital project it implements. Accordingly, the firm will tend to: -accept all positive net present value projects. -increase the average risk level of the company over time. -reject all high-risk projects. reject all negative net present value projects. -favor low-risk projects over high-risk projects.

increase the average risk level of the company over time.

Thornton Homes has multiple divisions which operate as separate lines of business and face risks unique to those lines. The firm uses its overall WACC as the discount rate to evaluate all proposed projects. Accordingly, each division within the firm will tend to: -receive less project funding if its line of business is riskier than that of the other divisions. -avoid risky projects so it can receive more project funding. -become less risky over time based on the projects that are accepted. -have an equal probability with all the other divisions of receiving funding. - prefer higher risk projects over lower risk projects.

prefer higher risk projects over lower risk projects.

Which of the following statements is accurate regarding the dividend growth model?

It is only as reliable as the estimated rate of growth.

The capital structure of Pendekanti Products is 58 percent common stock, 2 percent preferred stock, and 40 percent debt. The firm maintains a dividend payout ratio of 24 percent, has a beta of 1.08, and has an income tax rate of 21 percent. Given this information, which one of the following statements is accurate? -The aftertax cost of debt will be greater than the current yield to maturity on the company's outstanding bonds. -The company's cost of preferred is most likely less than the company's actual cost of debt. -The cost of equity is unaffected by a change in the company's tax rate. -The cost of equity can be estimated only by using the capital asset pricing model. -The weighted average cost of capital will remain constant as long as the company's capital structure remains constant.

The cost of equity is unaffected by a change in the company's tax rate.

A firm's after-tax cost of debt will increase if there is a(n): -decrease in the company's debt-equity ratio. -decrease in the company's tax rate. -increase in the credit rating of the company's bonds. -increase in the company's beta. -decrease in the market rate of interest.

decrease in the company's tax rate.

When evaluating any capital project proposal, the cost of capital: -is determined by the overall risk level -of the firm. -is dependent upon the source of the funds obtained to fund that project. -is dependent upon the firm's overall capital structure. -should be applied as the discount rate for all other projects considered by the firm. -depends upon how the funds raised for that project are going to be spent.

depends upon how the funds raised for that project are going to be spent.

Assume a firm has a debt-equity ratio of .48. The firm's cost of equity is: -generally less than its WACC. - -unaffected by changes in the market risk premium. -directly related to the risk level of the firm. -generally less than the firm's after-tax cost of debt. -inversely related to changes in the level of inflation.

directly related to the risk level of the firm.

Assume a manager determines the cost of capital for a specific project based on the cost of capital at another firm with a line of business that is similar to the project. Accordingly, the manager is using the ________ approach. subjective risk pure play divisional cost of capital capital adjustment security market line

pure play

Assume a firm has a debt-equity ratio of .62. The firm's weighted average cost of capital is the: -discount rate that the firm should apply to all of the projects it undertakes. -rate of return a company must earn on its existing assets to maintain the current value of its stock. -coupon rate the firm should expect to pay on its next bond issue. -minimum discount rate the firm should require on any new project. -rate of return debtholders should expect to earn on their investment in this firm.

rate of return a company must earn on its existing assets to maintain the current value of its stock.

For any given capital project proposal, the discount rate should be based on the: - company's overall weighted average cost of capital. -actual sources of funding used for the project. -average of the company's overall cost of capital for the past five years. current risk level of the overall firm. - -risks associated with the use of the funds required by the project.

risks associated with the use of the funds required by the project.

With respect to evaluating capital projects, which of the following statements is accurate? -Firms should accept low-risk projects prior to funding high-risk projects. -Making subjective adjustments to a company's WACC when determining project discount rates unfairly punishes low-risk divisions within the company. -A project that is unacceptable today might be acceptable tomorrow given a change in market returns. -The pure play method is most frequently used for projects involving the growth of a company's current operations. -Companies that elect to use the pure play method for determining a discount rate for a project cannot subjectively adjust the pure play rate.

A project that is unacceptable today might be acceptable tomorrow given a change in market returns.

Assume a firm employs debt in its capital structure. Which of the following statements is accurate? -The WACC would most likely decrease if the firm replaced its preferred stock with debt. -In the WACC calculation, the weight assigned to preferred stock decreases as the market value of the preferred stock increases. - The WACC will decrease as the corporate tax rate decreases. -In the WACC calculation, the weight of equity is based on the number of shares outstanding and the book value per share. -The WACC will remain constant unless a company retires some of its debt.

The WACC would most likely decrease if the firm replaced its preferred stock with debt.

assume a firm has a debt-equity ratio of .36. The firm's cost of equity: -tends to remain static even as the company's level of risk increases. - -increases as the unsystematic risk of the company's stock increases. -is affected by both a change in the firm's beta and the firm's projected rate of growth. -equals the risk-free rate plus the market risk premium. -equals the company's pretax weighted average cost of capital.

is affected by both a change in the firm's beta and the firm's projected rate of growth.