Topic Review 4 Multiple choice Fnce 125

Assume a firm utilizes the security market line approach to determine the cost of equity. If the firm currently pays an annual dividend of $2.40 per share and has a beta of 1.42, all else constant, which of the following actions will decrease the firm's cost of equity? A decrease in the dividend amount An increase in the dividend amount An increase in the market rate of return A decrease in the firm's beta A decrease in the risk-free rate

A decrease in the firm's beta.

When calculating a firm's weighted average cost of capital, the capital structure weights are based on the book values of debt and equity. are based on the market values of the outstanding securities. depend upon the financing obtained to fund each specific project. remain constant over time unless new securities are issued or outstanding securities are redeemed. are restricted to debt and common stock.

are based on the market values of the outstanding securities.

A firm's aftertax cost of debt will increase if there is a decrease in the company's debt-equity ratio. decrease in the company's tax rate. increase in the credit rating of the company's bonds. increase in the company's beta. decrease in the market rate of interest.

decrease in the company's tax rate.

To determine a firm's cost of capital, one must include only the return required by the firm's current shareholders. only the current market rate of return on equity shares. the weighted costs of all future funding sources. the returns currently required by both debtholders and stockholders. the company's original debt-equity ratio.

the returns currently required by both debtholders and stockholders.

The cost of preferred stock is equivalent to the pretax cost of debt. rate of return on an annuity. aftertax cost of debt. rate of return on a perpetuity. cost of an irregular growth common stock.

rate of return on a perpetuity.

Assume a firm utilizes the security market line approach to determine the cost of equity. If the firm currently pays an annual dividend of $3.36 per share and has a beta of 1.38, all else constant, which of the following actions will increase the firm's cost of equity? A decrease in the dividend amount An increase in the dividend amount A decrease in the market rate of return A decrease in the firm's beta A decrease in the risk-free rate

A decrease in the risk-free rate.

With respect to evaluating capital projects, which of the following statements is accurate? Firms should accept low-risk projects prior to funding high-risk projects. Making subjective adjustments to a company's WACC when determining project discount rates unfairly punishes low-risk divisions within the company. A project that is unacceptable today might be acceptable tomorrow given a change in market returns. The pure play method is most frequently used for projects involving the growth of a company's current operations. Companies that elect to use the pure play method for determining a discount rate for a project cannot subjectively adjust the pure play rate.

A project that is unacceptable today might be acceptable tomorrow given a change in market returns.

Which of the following statements is accurate regarding the dividend growth model? It is only as reliable as the estimated rate of growth. It can only be used if historical dividend information is available. It considers the risk that future dividends may vary from their estimated values. It applies only when a company is currently paying dividends. It is based solely on historical dividend information.

It is only as reliable as the estimated rate of growth.

Which of the following statements regarding the weighted average cost of capital is accurate? It equals the aftertax cost of the outstanding liabilities. It should be used as the required return when analyzing any new project. It is the return investors require on the total assets of the firm. It remains constant when the debt-equity ratio changes. It is unaffected by changes in corporate tax rates.

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

Which of the following is the main advantage of using the dividend growth model to estimate a firm's cost of equity? The ability to apply either current or future tax rates. The model's applicability to all corporations. The model's consideration of risk. The stability of the computed cost of equity over time. The simplicity of the model.

The simplicity of the model.

When evaluating any capital project proposal, the cost of capital: is determined by the overall risk level of the firm. is dependent upon the source of the funds obtained to fund that project. is dependent upon the firm's overall capital structure. should be applied as the discount rate for all other projects considered by the firm. depends upon how the funds raised for that project are going to be spent.

depends upon how the funds raised for that project are going to be spent.

Assume a firm has a debt-equity ratio of 0.48. The firm's cost of equity is generally less than its WACC. unaffected by changes in the market risk premium. directly related to the risk level of the firm. generally less than the firm's aftertax cost of debt. inversely related to changes in the level of inflation.

directly related to the risk level of the firm.

Assume a firm utilizes its WACC as the discount rate for every capital project it implements. Accordingly, the firm will tend to accept all positive net present value projects. increase the average risk level of the company over time. reject all high-risk projects. reject all negative net present value projects. favor low-risk projects over high-risk projects.

increase the average risk level of the company over time.

Assume a manager determines the cost of capital for a specific project based on the cost of capital at another firm with a line of business that is similar to the project. Accordingly, the manager is using the subjective risk pure play divisional cost of capital capital adjustment security market line

pure play approach.

Which of the following statements regarding a firm's pretax cost of debt is accurate? It is based on the current yield to maturity of the company's outstanding bonds. It is equal to the coupon rate on the latest bonds issued by the company. It is equivalent to the average current yield on all of a company's outstanding bonds. It is based on the original yield to maturity on the latest bonds issued by a company. It must be estimated as it cannot be directly observed in the market.

It is based on the current yield to maturity of the company's outstanding bonds.

Velasquez Manufacturing has two vastly different lines of business: Alpha and Omega. The Alpha line is the riskiest of the two, and accounts for 72% of the firm's sales. When deciding which project proposals should be accepted, the managers should allocate more funds to Alpha since it is the largest line of business. fund all of Omega's projects first since they tend to be less risky and then allocate the remaining funds to the Alpha projects that have the highest net present values. allocate the company's funds to the projects with the highest net present values based on the company's weighted average cost of capital. assign appropriate, but differing, discount rates to each business line and then select the projects with the highest net present values. fund the highest net present value projects from each line of business based on an allocation of 72 percent of the funds to Alpha and the remainder to Omega.

assign appropriate, but differing, discount rates to each business line and then select the projects with the highest net present values.

When using the subjective approach to project analysis, a firm must have an all-equity capital structure. uses the WACC of Firm X as the basis for the discount rate for a project under consideration by Firm Y. assigns discount rates to projects based on the discretion of the senior managers of a firm. allows managers to randomly adjust the discount rate assigned to a project once the project's standard deviation has been determined. applies a lower discount rate to projects that are financed totally with equity as compared to those that are partially financed with debt.

assigns discount rates to projects based on the discretion of the senior managers of a firm.