Corporate Finance Chapter 12

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/(E+D)] × RP (V/P) × RP (P/V) × RP

(P/V) × RP

The growth rate of dividends can be found using: historical dividend growth rates the perpetuity model the capital asset pricing model security analysts' forecasts

- security analysts' forecasts - historical dividend growth rates

The following are advantages of the SML approach Requires estimation of the market risk premium Adjusts for risk Requires estimation of beta Does not require the company to pay a dividend

Adjusts for risk Does not require the company to pay a dividend

Dividends paid to common stockholders ______ be deducted from the payer's taxable income for tax purposes. can should may cannot

Cannot

Which of the following are components used in the construction of the WACC Cost of accounts payable Cost of common stock Cost of debt Cost of preferred stock

Cost of common stock Cost of debt Cost of preferred stock

The dividend growth model is applicable to companies that pay ______

Dividends

T/F: 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

T/F: Conglomerates are companies that specialize only in projects similar to the project your firm is considering.

False

T/F: Finding the cost of equity is fairly straightforward.

False

T/F: For publicly traded companies, the component of the dividend yield that must be estimated is the dividend

False

Which of the following are true? -Ideally, we should use book values in the WACC. -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. -Book values are often similar to market values for equity.

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.

In the WACC calculation, D represents the ________ value of the firm's debt

Market

The formula for calculating the cost of equity capital that is based on the dividend discount model is: RE = D1/P0 + g RE = D0/P1 + g RE = D1/P0 - g RE = (D1/P0)/g

RE = D1/P0 + g

What is the equation for finding the cost of preferred stock RP=D(1+g)/P0 RP=P0/D RP=D/P0

RP=D/P0

The WACC of a firm reflects the ________ and the target capital structure of the firm's existing assets as a whole.

Risk

Given V = E + D, if we divide both V and D by ________, we can calculate the capital structure weights.

V

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. Yields can be checked by using the DDE model.

Yields can be calculated from observable data It is easier to estimate than the cost of equity.

If a firm has multiple projects, each project should be discounted using ___ the firm's overall cost of capital the average cost of capital the marginal cost of capital for the latest project a discount rate commensurate with the project's risk

a discount rate commensurate with the project's risk

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: multiplying the components by the inflation rate multiplying these two components. adding these two components. subtracting the first from the second.

adding these two components.

Some risk adjustment to a firm's WACC for projects of differing risk, even if it is subjective, is probably: an irreducible absurdity better than no risk adjustment preferred over the pure play approach uncalled for

better than no risk adjustment

The rate used to discount project cash flows is known as the ___ cost of capital market rate discount rate required return

cost of capita discount rate required return

Components of the WACC include funds that come from ______ investors accruals non-cash expenses

investors

If a firm issues no debt, its average cost of capital will equal ___. its cost of equity its dividend yield its cost of debt half the sum of the cost of debt and equity

its cost of equity

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 ___. does not pay dividends pays a constant dividend pays dividends in perpetuity will never be repaid

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 __ conglomerates matched pairs pure plays knock-offs

pure plays

To estimate a firm's equity cost of capital using the CAPM, we need to know the __ risk-free rate annual dividend amount stock's beta market risk premium

risk-free rate stock's beta market risk premium

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 as a whole the beta for SmartKids the beta for software companies that collect and store data the beta for the textbook industry as a whole

the beta for software companies that collect and store data

What will happen over time if a firm uses its overall WACC to evaluate all projects, regardless of each project's risk level? -the firm overall will become riskier -it will accept projects that it should have rejected -It will reject projects that it should have accepted -the firm's risk will not change over time -using the firm's WACC to evaluate all projects is appropriate

the firm overall will become riskier it will accept projects that it should have rejected It will reject projects that it should have accepted

The WACC is the minimum required return for _______ a firm's stockholders a firm's bondholders the NYSE the SEC the overall firm

the overall firm

What does WACC stand for? Working amount of corporate cost Weighted average cost of capital Weighted average company cost Working amount of corporate cash

weighted average cost of capital

For a firm with outstanding debt, the cost of debt will be the ________ on that debt.. coupon rate yield to maturity current yield average yield

yield to maturity

The following are disadvantages of the SML approach Adjusts for risk Does not require the company to pay a dividend Requires estimation of beta Requires estimation of the market risk premium

Adjusts for risk Does not require the company to pay a dividend

Which of the following is tax-deductible to the firm? Dividends paid on preferred stock Principal amounts paid on debt Dividends paid on common stock Coupon interest paid on bonds

Coupon interest paid on bonds

What can we say about the dividends paid to common and preferred stockholders? -Dividends to preferred stockholders are fixed. -Dividends are guaranteed for both preferred and common stockholders. -Dividends to common stockholders are not fixed. -Preferred stock dividends change every year based on the earnings of the firm

Dividends to preferred stockholders are fixed Dividends to common stockholders are not fixed.

T/F: Projects should always be discounted at the firm's overall cost of capital.

False

T/F: The SML approach is advantageous because all it requires is estimation of beta

False

T/F: The cost of equity is D1/P0 minus the analysts' estimates of growth.

False

T/F: The discount rate is also known as the expected return

False

T/F: The return an investor in a security receives is equal to the cost of the security to the company that issued it

True

Finding a firm's overall cost of equity is difficult because: it cannot be observed directly it requires the use of differential equations the federal government refuses to disclose equity costs it can only be guessed at

it cannot be observed directly

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: accepted, as it should be accepted, when it should be rejected rejected, as it should be rejected, when it should be accepted

rejected, when it should be accepted

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 the risk-free rate from a bank's CD rates beta from the Wall Street Journal

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 the optimal number of too few

too many

The return an investor in a security receives is ______ _____ the cost of the security to the company that issued it less than greater than unrelated to equal to

Equal to

T/F: The growth rate of dividends can be found using the CAPM.

False

T/F: The primary disadvantage of the dividend growth model approach is its simplicity.

False

The formula of the SML is: RE = Rf + Beta x (RM- Rf) RE = Rf + Beta/(RM+ Rf) RE = Rf - Beta + RM- Rf

RE = Rf + Beta x (RM- Rf)

T/F: RP=D/P0

True

The cost of capital depends primarily on the ______ of funds, not the _____. use; cost use; source source; use source; cost

use; source