Fiancial Management Ch. 12 Cost of Capital

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

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.

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 of the SML is Blank______.

RE = Rf + β × (RM − Rf)

What is the equation for finding the cost of preferred stock?

RP = D/P0

According to the CAPM, what is the expected return on a stock if its beta is equal to zero?

The risk-free rate

Given V = E + D, if we divide both E and D by Blank, 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 Blank______.

[E/V] × RE + [D/V] × RD ×(1 − TC)

If a firm has multiple projects, each project should be discounted using Blank______.

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 Blank______.

adding these two components

The following are advantages of the SML approach:

adjusts for risk does not require the company to pay a dividend

The discount rate for the firm's projects equals the cost of capital for the firm as a whole when Blank______.

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

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

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: The cost of capital depends on the source of the funds.

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

Components of the WACC include funds that come from ______ .

investors

Finding a firm's overall cost of equity is difficult because Blank______.

it cannot be observed directly

If a firm issues no debt, its average cost of capital will equal Blank______.

its cost of equity

The growth rate of dividends can be found using Blank______.

security analysts' forecasts historical dividend growth rates

It is difficult to establish discount rate for individual projects, so firms often adopt an approach that involves making Blank adjustments to the overall WACC.

subjective

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

If a firm uses its overall cost of capital to discount cash flows from projects in higher risk divisions, it will accept Blank______ projects.

too many

The cost of capital depends primarily on the Blank______ of funds, not the Blank______.

use; source

For a firm with outstanding debt, the cost of debt will be the Blank______ on that debt.

yield to maturity

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.

The dividend growth model is applicable to companies that pay .

dividends

The return an investor in a security receives is Blank______ the cost of the security to the company that issued it.

equal to

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: The discount rate is also known as the expected return.

false

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

True or false: RP = D/P0

true

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

True or false: For publicly traded companies, the component of the dividend yield that must be estimated is the dividend.

false

To estimate the dividend yield of a particular stock, we need Blank______.

forecasts of the dividend growth rate, g the current stock price the last dividend paid, D0

Preferred stock Blank______.

pays a constant dividend pays dividends in perpetuity

True or false: Projects should always be discounted at the firm's overall cost of capital.

false

True or false: The cost of equity is D1/P0 minus the analysts' estimates of growth.

false

True or false: The growth rate of dividends can be found using the CAPM.

false

True or false: The primary disadvantage of the dividend growth model approach is its simplicity.

false

To estimate a firm's equity cost of capital using the SML approach, we need to know the Blank______.

market risk premium risk-free rate stock's beta

The WACC is the overall rate of return the firm must earn on its existing assets to maintain the Blank of its stock.

price

Other companies that specialize only in projects similar to the project your firm is considering are called Blank______.

pure plays

The formula for calculating the cost of equity capital that is based on the dividend discount model is Blank______.

RE = D1/P0 + g