FIN305 M

Which one of the following statements is correct concerning the weighted average cost of capital (WACC)? A. The WACC may decrease as a firm's debt-equity ratio increases. b. When computing the WACC, the weight assigned to the preferred stock is based on the coupon rate multiplied by the par value of the stock. c. A firm's WACC will decrease as the corporate tax rate decreases. d. The weight of the common stock used in the computation of the WACC is based on the number of shares outstanding multiplied by the book value per share. e. The WACC will remain constant unless a firm retires some of its debt.

A

The aftertax cost of debt generally increases when: I. a firm's bond rating increases. II. the market rate of interest increases. III. tax rates decrease. IV. bond prices rise. A. I and III only B. II and III only C. I, II, and III only D. II, III, and IV only E. I, II, III, and IV

B. II and III only

The weighted average cost of capital for a firm may be dependent upon the firm's: I. rate of growth. II. debt-equity ratio. III. preferred dividend payment. IV. retention ratio. A. I and III only B. II and IV only C. I, II, and IV only D. I, III, and IV only E. I, II, III, and IV

E. I, II, III,

If a firm uses its WACC as the discount rate for all of the projects it undertakes then the firm will tend to: I. reject some positive net present value projects. II. accept some negative net present value projects. III. favor high risk projects over low risk projects. IV. increase its overall level of risk over time. A. I and III only B. III and IV only C. I, II, and III only D. I, II, and IV only E. I, II, III, and IV

E. I, II, III, and IV

The capital structure weights used in computing a firm's weighted average cost of capital: A. Are based on the book values of the firm's debt and equity. B. Are based on the market values of the firm's debt and equity securities. C. Depend upon the financing obtained to fund each specific project. D. Remain constant over time unless the firm issues new securities. E. Are restricted to the firm's debt and common stock.

are based on the market values of the firm's debt and equity securities

Preston Industries has two separate divisions. Each division is in a separate line of business. Division A is the largest division and represents 70 percent of the firm's overall sales. Division A is also the riskier of the two divisions. Division B is the smaller and least risky of the two. When management is deciding which of the various divisional projects should be accepted, the managers should: A. Allocate more funds to Division A since it is the largest of the two divisions. B. Fund all of Division B's projects first since they tend to be less risky and then allocate the remaining funds to the Division A projects that have the highest net present values. C. Allocate the company's funds to the projects with the highest net present values based on the firm's weighted average cost of capital. D. Assign appropriate, but differing, discount rates to each project and then select the projects with the highest net present values. E. Fund the highest net present value projects from each division based on an allocation of 70 percent of the funds to Division A and 30 percent of the funds to Division B.

assign appropriate, but differing, discount rates to each project and then select the projects with the highest and present values

High Adventure is considering a new project that is similar in risk to the firm's current operations. The firm maintains a debt-equity ratio of .55 and retains all profits to fund the firm's rapid growth. How should the firm determine its cost of equity? A. By adding the market risk premium to the after tax cost of debt. B. By multiplying the market risk premium by 1.55. C. By using the dividend growth model. D. By using the capital asset pricing model. E. By averaging the costs based on the dividend growth model and the capital asset pricing model.

by using the capital asset pricing model

Textile Mills borrows money at a rate of 13.5 percent. This interest rate is referred to as the: A. Compound rate. B. Current yield. C. Cost of debt. D. Capital gains yield. E. Cost of capital.

cost of debt

A group of individuals got together and purchased all of the outstanding shares of common stock of DL Smith, Inc. What is the return that these individuals require on this investment called? A. Dividend yield. B. Cost of equity. C. Capital gains yield. D. Cost of capital. E. Income return.

cost of equity

A firm's cost of capital: A. Will decrease as the risk level of the firm increases. B. For a specific project, is primarily dependent upon the source of the funds used for the project. C. Is independent of the firm's capital structure. D. Should be applied as the discount rate for any project considered by the firm. E. Depends upon how the funds raised are going to be spent.

depends upon how the funds raised are going to be spent

A firm's overall cost of equity is: A. Generally less than the firm's WACC given a debt-equity ratio of .40. B. Unaffected by changes in the market risk premium. C. Highly dependent upon the risk level of the firm. D. Generally less than the firm's after tax cost of debt. E. Inversely related to changes in the firm's tax rate.

highly dependent on the risk level of the firm

The aftertax cost of debt: A. Varies inversely to changes in market interest rates. B. Will generally exceed the cost of equity if the relevant tax rate is zero. C. Will generally equal the cost of preferred if the tax rate is zero. D. Is unaffected by changes in the market rate of interest. E. Is highly dependent upon the firm's tax rate.

is highly dependent upon the firm's tax rate

The weighted average cost of capital for a wholesaler: A. Is equivalent to the after tax cost of the firm's liabilities. B. Should be used as the required return when analyzing a potential acquisition of a retail outlet. C. Is the return investors require on the total assets of the firm. D. Remains constant when the debt-equity ratio changes. E. Is unaffected by changes in corporate tax rates.

is the return investors require on the total assets of the firm

The weighted average cost of capital for a firm with debt is the: A. Discount rate that the firm should apply to all of the projects it undertakes. B. Rate of return a firm must earn on its existing assets to maintain the current value of its stock. C. Coupon rate the firm should expect to pay on its next bond issue. D. Minimum discount rate the firm should require on any new project. E. Rate of return shareholders should expect to earn on their investment in this firm.

rate of return a firm must earn on its existing assets to maintain the current value of its stock

The discount rate assigned to an individual project should be based on the: A. Firm's weighted average cost of capital. B. Actual sources of funding used for the project. C. Average of the firm's overall cost of capital for the past five years. D. Current risk level of the overall firm. E. Risks associated with the use of the funds required by the project.

risks associated with the use of the funds required by the project

The weighted average cost of capital for a firm can depend on all of the following except the: A. Firm's beta. B. Coupon rate of the outstanding bonds. C. Growth rate of the firm's dividends. D. Firm's marginal tax rate. E. Standard deviation of the firm's common stock.

standard deviation of the firm's common stock

Black River Tours has a capital structure of 55 percent common stock, 5 percent preferred stock, and 40percent debt. The firm has a 30 percent dividend payout ratio, a beta of 1.21, and a tax rate of 34 percent. Given this, which one of the following statements is correct? A. The after tax cost of debt will be greater than the current yield-to-maturity on the firm's outstanding bonds. B. The firm's cost of preferred is most likely less than the firm's actual cost of debt. C. The firm's cost of equity is unaffected by a change in the firm's tax rate. D. The cost of equity can only be estimated using the capital asset pricing model. E. The firm's weighted average cost of capital will remain constant as long as the firm's capital structure remains constant.

the firm's cost of equity is unaffected by a change in the firm's tax rate

Which one of the following is the primary determinant of a firm's cost of capital? A. Debt-equity ratio. B. Applicable tax rate. C. Cost of equity. D. Cost of debt. E. Use of the funds.

use of the funds

The average of a firm's cost of equity and after tax cost of debt that is weighted based on the firm's capital structure is called the: A. Reward to risk ratio. B. Weighted capital gains rate. C. Structured cost of capital. D. Subjective cost of capital. E. Weighted average cost of capital.

weighted average cost of capital

Phil's is a sit-down restaurant that specializes in home-cooked meals. Theresa's is a walk-in deli that specializes in specialty soups and sandwiches. Both firms are currently considering expanding their operations during the summer months by offering pre-wrapped donuts, sandwiches, and wraps at a local beach. Phil's currently has a WACC of 14 percent while Theresa's WACC is 10 percent. The expansion project has a projected net present value of $12,600 at a 10 percent discount rate and a net present value of -$2,080 at a 14 percent discount rate. Which firm or firms should expand and offer food at the local beach during the summer months? A. Phil's only B. Theresa's only C. both Phil's and Theresa's D. neither Phil's nor Theresa's E. cannot be determined from the information provided

C. both Phil's and Theresa's

Which of the following statements are correct? I. The SML approach is dependent upon a reliable measure of a firm's unsystematic risk. II. The SML approach can be applied to firms that retain all of their earnings. III. The SML approach assumes a firm's future risks are similar to its past risks. IV. The SML approach assumes the reward-to-risk ratio is constant. A. I and III only B. II and IV only C. III and IV only D. I, II, and III only E. II, III, and IV only

E. II, III, and IV only

The aftertax cost of debt: A. varies inversely to changes in market interest rates. B. will generally exceed the cost of equity if the relevant tax rate is zero. C. will generally equal the cost of preferred if the tax rate is zero. D.is unaffected by changes in the market rate of interest. E. has a greater effect on a firm's cost of capital when the debt-equity ratio increases.

E. has a greater effect on a firm's cost of capital when the debt-equity ratio increases.

Which one of these will increase a firm's aftertax cost of debt? A. a Decrease in the market value of the firm's outstanding bonds. B. a Decrease in the firm's tax rate. C. An increase in the bond's credit rating. D. An increase in the firm's beta. E. A Decrease in the market rate of interest.

a decrease in the firm's tax rate

All else constant, which one of the following will increase a firm's cost of equity if the firm computes that cost using the security market line approach? Assume the firm currently pays an annual dividend of $1 a share and has a beta of 1.2. A. A reduction in the dividend amount. B. An increase in the dividend amount. C. A reduction in the market rate of return. D. A reduction in the firm's beta. E. A reduction in the risk-free rate.

a reduction in the risk-free rate

If a firm uses its WACC as the discount rate for all of the projects it undertakes, then the firm will tend to do all of the following except: A. Reject some positive net present value projects. B. Lower the average risk level of the firm over time. C. Increase the firm's overall level of risk over time. D. Accept some negative net present value projects. E. Favor high risk projects over low risk projects.

lower the average risk level of the firm overtime

Assigning discount rates to individual projects based on the risk level of each project: A. May cause the firm's overall weighted average cost of capital to either increase or decrease over time. B. Will prevent the firm's overall cost of capital from changing over time. C. Will cause the firm's overall cost of capital to decrease over time. D. Decreases the value of the firm over time. E. Negates the firm's goal of creating the most value for the shareholders.

may cause the firm's overall weighted average cost of capital to either increase or decrease overtime

Jenner's is a multi division firm that uses its overall WACC as the discount rate for all proposed projects. Each division is in a separate line of business and each presents risks unique to those lines. Given this, a division within the firm will tend to: A. Receive less project funding if its line of business is riskier than that of the other divisions. B. Avoid risky projects so it can receive more project funding. C. Become less risky over time based on the projects that are accepted. D. Have an equal probability with all the other divisions of receiving funding. E. Prefer higher risk projects over lower risk projects.

prefer higher risk projects over lower risk projects

Which one of the following statements related to WACC is correct for a firm that uses debt in its capital structure? A. The WACC should decrease as the firm's debt-equity ratio increases. B. The weight assigned to preferred stock decreases as the market value of the stock increases. C. The WACC will decrease as the corporate tax rate decreases. D. The weight of equity is based on the number of shares outstanding and the book value per share. E. The WACC will remain constant unless a firm retires some of its debt.

the WACC should decrease as the firm's debt-equity ratio increases