FRL 3000 ch 14

WACC was used to compute the following project NPVs: Project A = $100, Project B = -$50, Project C = -$10, Project D = $40. Which projects should the firm accept?

A and D

Which of the following is true?

A company can deduct interest paid on debt when computing taxable income.

Which of the following are components used in the construction of the WACC?

Cost of common stock Cost of preferred stock Cost of debt

Sigma Corporation consists of two divisions: A and B. Division A is riskier than Division B. If Sigma Corporation uses the firm's overall WACC to evaluate both Divisions' projects, which Division will probably not receive enough resources to fund all of its potentially profitable projects?

Division B

The issuance costs of bonds and stocks are referred to as ______ costs.

Floatation

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

Which of the following variables is not required to calculate the expected return on a risky asset?

The rate of inflation

If a firm has two divisions and one division is riskier than the other, what would be the potential result if the firm used its overall WACC to evaluate the projects in both divisions?

The riskier division's projects will typically receive full funding and the less risky division's projects will often be incorrectly rejected.

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

Which one of the following is true?

Under U.S. tax law, a corporation's interest payments are deductible for tax purposes.

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

a discount rate that commensurates with the project's risk.

WACC is used to discount

cash flows

The WACC is the minimum return a company needs to earn to satisfy _____.

its stockholders its bondholders

Preferred stock ___.

pays a constant dividend pays dividends in perpetuity

Projects that have the same risk are said to be in the same _____.

risk class

To estimate the expected return on a risky asset, we need to know the ___.

risk-free rate stock's beta market risk premium

The market value cost of debt is often ______ the book value cost of debt.

similar to

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

too many high-risk

Economic value added (EVA) is a means of evaluating corporate performance.

true

MNO preferred stock pays a dividend of $2 per year and has a price of $20. If MNO's tax rate is 21 percent, the required rate of return on its preferred stock is found by which formula?

$2/$20

Including preferred stock in the WACC adds the term:

(P/V) × RP

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 the current firm

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

Flotation costs are costs incurred to ____.

bring new security issues to the market

A firm's overall cost of capital will include both its cost ________ of capital and equity capital.

debt

Finding a firm's overall cost of equity is (straightforward/difficult).

difficult

The most well-known approach to company performance evaluation is the _____ method.

economic value added

An important advantage to a firm raising equity internally is not having to pay ___.

floatation costs

In reality, most firms cover the equity portion of their capital spending with ___.

internally generated cash flow

The ________ _________approach is the use of a WACC that is unique to a particular project, based on companies in similar lines of business.

pure play

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

pure plays

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

Capital _______ weights can be interpreted just like portfolio weights.

structure

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

there is no way of directly observing the return that the firm's equity investors require on their investment

To apply the dividend growth model to a particular stock, you need to assume that the firm's ___ will grow at a constant rate.

dividend

The best way to include flotation costs is to ___.

add them to the initial investment

With the use of the ________ approach to estimating WACC, the firm's WACC may change through time as economic conditions change.

subjective

The cost of capital depends on the _____ of funds, not the _____ of funds.

use; source

The cost of ______ can be observed because it is the interest rate the firm must pay on new loans.

debt

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

equal to

The cost of capital depends primarily on the (use/source) of funds.

use

Which is true of flotation costs in calculating WACC?

They are relevant cash flows.

True or false: The cost of debt on the market value basis is typically much higher than the cost of debt on the book value basis.

False

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.

The most appropriate weights to use in the WACC are the ______ weights.

market value

A firm's cost of debt can be ___.

*obtained by checking yields on publicly traded bonds *estimated easier than its cost of equity *obtained by talking to investment bankers