CH14 Cost of Capital

ULC and LEV have earnings before interest and taxes of $110. LEV has $20 of interest expense. Both companies are taxed at 30%, ULC aftertax earnings are ___, which is ______ than LEV's aftertax earnings.

$77; $14 greater

Sigma corporation consists of 2 divisions A and B. A is riskier than B. If Sigma Corp uses the firm's overall WACC to evaluate both divisions projects, which division will probably not receive all of its potentially profitable projects?

Division B

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

Re= D1/P0 + g

The market risk premium is defined as

Rm-Rf

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

a discount rate commensurate with the project's risk

the rate used to discount project cash flows is known as the _____

1. required return 2. cost of capital 3. discount rate

Which of the following methods for calculating the cost of equity ignores risk?

the dividend growth model

What can we say about the dividends paid to common stock and preferred stock holders?

1. Dividends to common stockholders are not fixed 2. Dividends to preferred stock holders are fixed

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

1. cost of common stock 2. cost of debt 3. cost of preferred stock

Dang's Donut has EBIT of $25,432 depreciation $1,500, and a tax rate of 18%. The company will not be changing it's net working capital, but plans a capital expenditure of $6,324. What is Dant's adjusted cash flow from assets?

16030.24

Finding a firm's overall cost of equity is difficult to calculate because:

it cannot be observed directly

To calculate the firm's equity cost of capital using the CAPM, we need to know the _____.

1. risk free rate 2. market risk premium 3. beta

The SML approach requires estimates of

1. market risk premium 2. beta coefficient

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

equal to

If the firm is all equity, the discount rate is equal to the firms cost of ______ capital

equity

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

flotation

If an equity's 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

the WACC is the minimum return a company needs to earn to satisfy _______

1. the bondholders 2. the stakeholders

To estimate the growth rate of a particular stock, we can _____

1. use security analysts forecasts 2. use the historical dividend growth rate