Chapter 12 LearnSmart
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) x Rp
Preferred stock ____.
- pays a constant dividend - pays dividends in perpetuity
If an analyst's forecast for a firm's earnings growth is 7%, and its dividend yield is 3%, its cost of equity will be _____.
10% 3%+7%=10%
WACC was used to compute the following project NPVs: Project A = $100, Project B = -$50, Project C = -$10, Project D = $40. Which project should the firm accept?
A and D
what is the equation for finding the cost of preferred stock?
Dividend/Po
If the firm is all-equity, the discount rate is equal to the firm's cost of ___ capital.
Equity
True or False: Projects should always be discounted at the firm's overall cost of capital.
False
The formula for calculating the cost of equity capital that is based on the dividend discount model is:
R_E = D_1 / P_0 + g
The following are disadvantages of the SML approach
Requires estimation of the market risk premium Requires estimation of beta
The cost of capital depends primarily on the ___ of funds, not the ____.
The risk-free rate
The cost of capital depends primarily on the ___ of funds, not the ____.
Use, Source
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
The dividend growth model is applicable to companies that pay ______________.
dividends
The return an investor in a security receives is _____ ____ the cost of the security to the company that issued it.
equal to
Other companies that specialize only in projects similar to the project your firm is considering are called _____.
pure plays
The following are advantages of the SML approach
- Does not require the company to pay a dividend - Adjusts for risk
A company has a borrowing rate of 15 percent and a tax rate of 30 percent. What is its aftertax cost of debt
10.5%
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.
Which of the following are components used in the construction of the WACC?
- cost of debt - cost of preferred stock - cost of common stock
To estimate the dividend yield of a particular stock, we need:
- the current stock price - forecasts of the dividend growth rate, g - the last dividend paid, D0
Which of the following are true?
- the market value of debt and equity are not reliable in case of privately owned company - Ideally, we should use market values in the WACC
To estimate a firms equity cost of capital using the CAPM, we need to know:
-Stocks beta -Market Risk Premium -Risk-Free Rate
The rate used to discount project cash flows is known as the:
-discount rate -required return -cost of capital
The growth rate of dividends can be found using :
-security analysts forecast -Historical dividends growth rates
Suppose a firm's capital structure consists of 30% debt, 10% preferred stock and 60% equity. The firm's bonds yield 10% on average before taxes, the cost of preferred stock is 8% and the cost of equity is 16%. Calculate the firm's WACC assuming a tax rate of 40%
12.20% 0.6 x 16% +.3 x 10% x (1-.4) +.1 x 8% = 12.20
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 SmartKids The beta for software companies that collect and store data The beta for software companies as a whole The beta for the textbook industry as a whole
The beta for software companies that collect and store data
Finding a firm's overall cost of equity is difficult because:
it cannot be observed directly
The most appropriate weights to use in the WACC are the ___ weights.
market values