Quiz 9
What is the dividend on an 8% preferred stock that currently sells for $45 and has a face value of $50 per share
$4
Firms underprice new issues of common stock for the following reason(s)
1.When additional shares are issued, each share's percent of the ownership in the firm is diluted thereby justifying a lower share value 2.Many investors view the issuance of additional shares as a signal that management is using common stock equity financing bc it believes that the shares are currently overpriced 3.When the market is in equilibrium, additional demand for shares can be achieved only at a lower price
The before tax cost of debt for a firm which has a 40% marginal tax rate is 12%. The after-tax cost of debt is
7.2%
The cost of common stock equity may be estimated by using (2)
Gordon Model Capital asset pricing Model
Weighing schemes for calculating the weighted average cost of capital include all of the following EXCEPT
Optimal value weights
Underpriced stocks are sold at a price
below current market price
The ____ is the rate of return a firm must earn on its investments in projects in order to maintain the market value of its stock.
cost of capital
Target weights
either book or market value weights based on DESIRED capital
Historical weights
either book values or market value weights based on ACTUAL capital
Capital budgeting it the process of
evaluating and selecting long term investments and maximize shareholders wealth
The cost of new common stock financing is higher than the cost of retained earnings due to
flotation costs and underpricing
Net Proceeds
funds firm receives from sale
As the volume of financing increase, the costs of the various types of financing will ____ , ____ the firm's weighted average cost of capital
increase raising
A tax adjustment must be made in determining the cost of
long term debt
The four basic sources of long term funds for the business firm are
long term debt common stock preferred stock retained earnings
When discussing weighting schemes for calculating the weighted average cost of capital, the preferences can be stated as
market value weights are preferred over book value weights and target weights are preferred over historic weights
The ____ from the sale of a security are the funds actually received from the sales after ____, or the total costs of issuing and selling the security, which have been subtracted from the total proceeds.
net proceeds the flotation costs
Cost of preferred stock
ratio of preferred stock dividend to the firm's net proceeds from the sale of preferred stock
Capital asset pricing model describes the relationship between
required return and non diversifiable risk
The firm's optimal mix of debt and equity is called its
target capital structure
The preferred capital structure weights to be used in the weighted average cost of capital are
target weights
Weighing schemes include
target weights market weights book value weights
In comparing the constant growth model and the capital asset pricing model (CAPM) to calculate the cost of common stock equity,
the CAPM directly considers risk as reflected in the beta, while the constant growth model uses the market price as a reflection of the expected risk-return preference of investors
Using the capital asset pricing model, the cost of common stock equity is the return required by investors as compensation for
the firm's nondiversifiable risk
The cost of common stock equity is
the rate at which investors discount the expected dividends of the firm
Debt is generally the least expensive source of capital. This is primarily due to
the tax deductibility of interest payments
In order to recognize the interrelationship between financing and investments, the firm should use ______ when evaluating an investment
the weighted average cost of all financing sources
Flotation Costs are the
total costs of issuing and selling securities
Book value weights
use accounting values to measure the proportions of each type of capital
Market value weights
use market values to measure the proportions of each type of capital
