Chapter 14

The weighted average cost of capital for a firm may be dependent upon the firm's:

. rate of growth. II. debt-equity ratio. III. preferred dividend payment. IV. retention ratio.

Which one of the following statements is correct?

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

Which one of the following statements is correct for a firm that uses debt in its capital structure?

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

Morris Industries has a capital structure of 55 percent common stock, 10 percent preferred stock, and 45 percent debt. The firm has a 60 percent dividend payout ratio, a beta of 0.89, and a tax rate of 38 percent. Given this, which one of the following statements is correct?

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

Which one of the following statements related to the SML approach to equity valuation is correct? Assume the firm uses debt in its capital structure

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

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 reduction in the risk-free rate

The capital structure weights used in computing the weighted average cost of capital:

are based on the market value 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

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

Flotation costs for a levered firm should:

be weighted and included in the initial cash flow.

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?

both Phil's and Theresa's

Scholastic Toys is considering developing and distributing a new board game for children. The project is similar in risk to the firm's current operations. The firm maintains a debt-equity ratio of 0.40 and retains all profits to fund the firm's rapid growth. How should the firm determine its cost of equity?

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:

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?

cost of equity

A firm's cost of capital:

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

A firm's overall cost of equity is:

highly dependent upon the growth rate and risk level of the firm.

The cost of equity for a firm:

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

Incorporating flotation costs into the analysis of a project will:

increase the initial cash outflow of the project.

When a firm has flotation costs equal to 7 percent of the funding need, project analysts should:

increase the initial project cost by dividing that cost by (1 - 0.07).

The cost of preferred stock:

is equal to the dividend yield.

The dividend growth model:

is only as reliable as the estimated rate of growth.

The weighted average cost of capital for a wholesaler:

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

Assigning discount rates to individual projects based on the risk level of each project:

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

Wilderness Adventures specializes in back-country tours and resort management. Travel Excitement specializes in making travel reservations and promoting vacation travel. Wilderness Adventures has an aftertax cost of capital of 13 percent and Travel Excitement has an aftertax cost of capital of 11 percent. Both firms are considering building wilderness campgrounds complete with man-made lakes and hiking trails. The estimated net present value of such a project is estimated at $87,000 at a discount rate of 11 percent and -$12,500 at a 13 percent discount rate. Which firm or firms, if either, should accept this project?

neither Wilderness Adventures nor Travel Excitement

Markley and Stearns is a multi-divisional firm that uses its 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:

prefer higher risk projects over lower risk projects

The weighted average cost of capital for a firm is the:

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

The cost of preferred stock is computed the same as the:

return on a perpetuity.

The aftertax cost of debt generally increases when:

the market rate of interest increases. III. tax rates decrease.

The discount rate assigned to an individual project should be based on:

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

The flotation cost for a firm is computed as:

the weighted average of the flotation costs associated with each form of financing.

Which one of the following is the primary determinant of a firm's cost of capital?

use of the funds

The average of a firm's cost of equity and aftertax cost of debt that is weighted based on the firm's capital structure is called the:

weighted average cost of capital.