FIN_3610_CH_14_20

The pretax cost of debt: A. Is based on the current yield to maturity of the firm's outstanding bonds. B. Is equal to the coupon rate on the latest bonds issued by a firm. C. Is equivalent to the average current yield on all of a firm's outstanding bonds. D. Is based on the original yield to maturity on the latest bonds issued by a firm. E. Has to be estimated as it cannot be directly observed in the market.

A. Is based on the current yield to maturity of the firm's outstanding bonds.

The cost of preferred stock: A. Is equal to the dividend yield. B. Is equal to the yield to maturity. C. Is highly dependent on the dividend growth rate. D. Is independent of the stock's price. E. Decreases when tax rates increase.

A. Is equal to the dividend yield.

The dividend growth model: A. Is only as reliable as the estimated rate of growth. B. Can only be used if historical dividend information is available. C. Considers the risk that future dividends may vary from their estimated values. D. Applies only when a firm is currently paying dividends. E. Uses beta to measure the systematic risk of a firm.

A. Is only as reliable as the estimated rate of growth.

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.

B. Are based on the market values of the firm's debt and equity securities

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.

B. Cost of equity.

When a manager develops a cost of capital for a specific project based on the cost of capital for another firm that has a similar line of business as the project, the manager is utilizing the _____ approach. A. Subjective risk. B. Pure play. C. Divisional cost of capital. D. Capital adjustment. E. Security market line.

B. Pure play.

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.

B. a Decrease in the firm's tax rate.

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.

C. Cost of debt.

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.

C. Highly dependent upon the risk level of the firm.

The cost of equity for a firm with a debt-equity ratio of .35: A. Tends to remain static for firms with increasing levels of risk. B. Increases as the unsystematic risk of the firm increases. C. Ignores the firm's risks when that cost is based on the dividend growth model. D. Equals the risk-free rate plus the market risk premium. E. Equals the firm's pretax weighted average cost of capital.

C. Ignores the firm's risks when that cost is based on the dividend growth model.

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.

C. Is the return investors require on the total assets of the firm.

Which one of the following statements related to the capital asset pricing model approach to equity valuation is correct? Assume the firm uses debt in its capital structure. A. This model considers a firm's rate of growth. B. The model applies only to non-dividend-paying firms. C. The model is dependent upon a reliable estimate of the market risk premium. D. The model generally produces the same cost of equity as the dividend growth model. E. This approach generally produces a cost of equity that equals the firm's overall cost of capital.

C. The model is dependent upon a reliable estimate of the market risk premium.

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.

D. By using the capital asset pricing model.

The cost of preferred stock is computed the same as the: A. Pretax cost of debt. B. Rate of return on an annuity. C. Aftertax cost of debt. D. Rate of return on a perpetuity. E. Cost of an irregular growth common stock.

D. Rate of return on a perpetuity.

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.

E. A reduction in the risk-free rate.

The capital asset pricing model approach to equity valuation: A. Is dependent upon the unsystematic risk of a security. B. Assumes the reward-to-risk ratio increases as beta increases. C. Can only be applied to dividend-paying firms. D. Assumes a firm's future risks will be higher than its current risks. E. Assumes the reward-to-risk ratio is constant.

E. Assumes the reward-to-risk ratio is constant.

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.

E. Depends upon how the funds raised are going to be spent.

The dividend growth model cannot be used to compute the cost of equity for a firm that: A. Pays an increasing dividend. B. Reduces its dividend on a regular basis. C. Has a dividend payout ratio of 100 percent. D. Pays a constant dividend year after year. E. Has a retention ratio of 100 percent.

E. Has a retention ratio of 100 percent.

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.

E. 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.

E. Weighted average cost of capital.