FIN 351 final- ch 12, 13, 14

Which one of the following statements is correct? A. We can use the dividend growth model for firms that do not pay dividends. B. If we need to determine cost of equity for a new riskier project, the SML approach should be used. C. If we need to determine cost of equity for a private company, we should use the dividend growth model.

. If we need to determine cost of equity for a new riskier project, the SML approach should be used.

The Weak form of market efficiency indicates _____ is useless. A. technical analysis B. fundamental analysis C. insider trading

. technical analysis

1. Which of the following is different between bonds and common stocks? ❑voting rights ❑fixed (pre-determined) payments ❑tax-deductible expense • 2. Which of the following is different between preferred stocks and common stocks? ❑voting rights ❑fixed (pre-determined) payments ❑tax-deductible expense

1. all are different 2. all but tax deductible expenses

The Tribiani Company just issued a dividend of $3.45 per share on its common stock. The company is expected to maintain a constant 7.1 percent growth rate in its dividends indefinitely. If the stock sells for $69 a share, what is the company's cost of equity?

12.46 Let ke be cost of equity Current Price = (Next Period Dividend) / ( Cost Of Equity - Growth Rate) 69 = (3.45 * (1.071)) / (ke - 0.071) 69 ke - 4.899 = 3.69495 ke = 0.12455 = 12.46%

• Investors may accept an asset with greater risk, only if the asset ______. A. costs less B. costs more C. offers greater risk premium D. offers less risk premium

. offers greater risk premium

The Swanson Corporation's common stock has a beta of 1.2. If the risk-free rate is 5.2 percent and the expected return on the market is 10 percent, what is the company's cost of equity capital?

10.96% Cost of equity capital % = rf + B (rm - rf) = 0.052 + 1.20 (0.10 - 0.052) = 0.1096 or 10.96%

Which component of cost of capital enters into the WACC formula on an after-tax basis? A. Cost of Equity B. Cost of Debt C. Cost of Income D. Cost of Working Capital

Cost of Debt

What are the methods we can used to determine the cost of Equity ❑Dividend Growth model ❑SML approach ❑CAPM model ❑Retained Earnings model ❑Income statement model

Dividend Growth model SML approach CAPM model

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 value s.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.

What role has the cost of capital play in the IRR decision rule? A. It is used to forecast cash flows. B. It serves as the hurdle rate. C. It determines the number of time periods. D. It is used as the growth rate.

It serves as the hurdle rate.

Ninecent Corporation has a target capital structure of 60 percent common stock, 5 percent preferred stock, and 35 percent debt. Its cost of equity is 12 percent, the cost of preferred stock is 8 percent, and the pretax cost of debt is 9 percent. The relevant tax rate is 24 percent. a. What is the company's WACC? b. What is the aftertax cost of debt?

a. 9.94% b. 6.84% WACC= 0.35*6.84% % + 0.60*13% + 0.05*6% = 1.8375 + 7.80 + 0.30= 9.9375%= 9.94% aftercost=before tax cost of debt*(1- tax rate)= 9%*(1-0.24)

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 stock is considered having greater systematic risk than the market if ______. A. its beta is greater than 1. B. its beta is less than 1. C. its beta is equal to 1. D. its beta is greater than 0.

beta is greater than 1.

Wright Market Research is able to borrow money at a rate of 6.8 percent per year. This interest rate is called the: compound rate. current yield. cost of debt. capital gains yield. cost of capital.

cost of debt.

Okonjo Economics has a debt-equity ratio of .38. All of the firm's outstanding shares were purchased by a small number of investors. The return these investors require is called the: dividendyield.\ cost of equity. capital gains yield .cost of capital. income return.

cost of equity.

For any given capital project proposal, the discount rate should be based on the: company's overall weighted average cost of capital. actual sources of funding used for the project. average of the company's overall cost of capital for the past five years. current risk level of the overall firm. risks associated with the use of the funds required by the project.

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

If a market is in an equilibrium, ______ will lie on the Security Market Line. ❑the market portfolio ❑the large company stocks ❑the small company stocks ❑the bonds ❑the T-bills

the market portfolio the large company stocks the small company stocks the bonds the T-bills

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.

Fundamental analysis can be useful under which form of the Efficient Market Hypothesis (EMH)? Strong form EMH Semi-strong form EMH Weak form EMH Semi-weak form EMH

weak

Which one of the following portfolios is the most diversified? A. Holding 100 internet company stocks. B. Holding 100 stocks of Ohio companies. C. Holding 100 randomly picked stocks and bonds D. Holding 100 randomly picked bonds.

Holding 100 randomly picked stocks and bonds

Of the options listed below, which are examples of diversifiable risk? I. Wildfires damage an entire town II. The federal government imposes a $1,000 fee on all business entities III. Payroll taxes are increased nationally IV. All software providers are required to improve their privacy standards

I and IV

Which of the following represent components of total return? ❑Income yield ❑Capital gains yield ❑Dividend yield ❑current yield

Income yield ❑Capital gains yield ❑Dividend yield ❑current yield

What role does cost of capital play in the NPV decision rule? A. It is used to forecast cash flows. B. It serves as the discount rate. C. It determines the number of time periods. D. It is used as the hurdle rate.

It serves as the discount rate.

Based on the capital asset pricing model (CAPM), which of the following should earn the highest risk premium? Diversified portfolio with returns similar to the overall market Stock with a beta of 1.24 Stock with a beta of .63 U.S. Treasury bill Portfolio with a beta of 1.12

Stock with a beta of 1.24

• Insiders could make profit from insider trading in _______. ❑a weak form efficient market ❑a semi-strong form efficient market ❑a strong form efficient market

a semi-strong form efficient market a weak form efficient market

Jiminy's Cricket Farm issued a bond with 20 years to maturity and a semiannual coupon rate of 4 percent 6 years ago. The bond currently sells for 95 percent of its face value. The company's tax rate is 25 percent. a. What is the pretax cost of debt? b.What is the aftertax cost of debt? c. Which is more relevant, the pretax or the aftertax cost of debt? Aftertax cost of debt Pretax cost of debt

a. 4.47% b.3.37% c. aftertax A)Calculation of pretax cost of debt: =[Annual coupon+(Face value-Price)/Years to maturity]/(Face value+Price)/2 Face value=$1000 Annual coupon=Face value*Coupon rate =($1000*4%)=$40 Years to maturity=(20-6)=14 Price=Face value*95%=$1000*95%=$950 Accordingly, pretax cost of debt is: =[$40+($1000-$950)/14]/($1000+$950)/2 =($40+$3.571)/$975 =0.0447 or 4.47% However, if you use exact formula then pretax cost of debt shall be 4.49% B)Calculation of after tax cost of debt: After tax cost of debt is:=Pretax cost of debt(1-tax rate) =4.49%(1-0.25) =3.37% C)After tax cost of debt is more relevant. Interest paid on debt is tax deductible, thus beneift of tax saving due to interest on debt should be factored in cost of debt.

What are the components of cost of capital? ❑cost of debt ❑cost of equity ❑cost of asset ❑cost of income ❑weight of debt ❑weight of equity ❑tax rate

cost of debt cost of equity weight of debt weight of equity tax rate

Assume Barnes' Boots has a debt-equity ratio of .52. The firm uses the capital asset pricing model to determine its cost of equity. Accordingly, the firm's estimated cost of equity: is affected by the firm's rate of growth projections. implies that the firm pays out all of its earnings to its shareholders. is dependent upon a reliable estimate of the market risk premium. would be unaffected if the dividend discount model were applied instead. will be unaffected by changes in overall market risks.

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

CAPM captures the positive association between _____ and _____. ❑stock price, expected return ❑risk premium, stock beta ❑expected return, stock unsystematic risk ❑expected return, stock systematic risk

risk premium, stock beta expected return, stock systematic risk

The inputs useful to estimate required rate of return with CAPM are _______. ❑risk-free rate ❑market expected return ❑market risk premium ❑beta ❑unsystematic risk ❑systematic risk

risk-free rate market expected return market risk premium beta systematic risk

A normal distribution is defined by _____. ❑the mean ❑the standard deviation ❑the total return ❑the capital structure

the mean the standard deviation

Diversification is effective to reduce _______. ❑market risk ❑systematic risk ❑unsystematic risk ❑firm-specific risk

unsystematic risk firm-specific risk

Too Young, Incorporated, has a bond outstanding with a coupon rate of 6.7 percent and semiannual payments. The bond currently sells for $948 and matures in 24 years. The par value is $1,000. What is the company's pretax cost of debt? Multiple Choice 7.29% 7.75% 7.16% 7.50% 3.54%

7.16

Brannan Manufacturing has a target debt-equity ratio of .45. Its cost of equity is 11 percent, and its cost of debt is 6 percent. If the tax rate is 25 percent, what is the company's WACC?

8.,98% Ke - Cost of common stock. Cost of debt after tax = Cost of debt ( 1 - Tax rate ) = 6 % * ( 1 - 0.25 )= 6 % * 0.75= 4.5 % WACC Calculation: debt: 0.3103 X 4.50% = 1.40% common stock: 0.6897 X 11.00% = 7.59% 1.40% +7.59%= 8.98%

A collection of assets is considered as _________. A. a group B. a portfolio C. an account D. a fund

B a porfolio

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.

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

Ginger Industries stock has a beta of 1.30. The company just paid a dividend of $.30, and the dividends are expected to grow at 4 percent. The expected return on the market is 13 percent, and Treasury bills are yielding 4.8 percent. The most recent stock price for the company is $65. a. Calculate the cost of equity using the DGM method. b. Calculate the cost of equity using the SML method.

a. 4.48% b. 15.46% Part A: DDM Method: Cost of Equity = D1/Current Stock Price + Growth Rate = .30*(1+.04)/65 + .04 = 4.48% or 4.5% ---------------- Part B: SML Method: Cost of Equity = Risk Free Rate + Beta*(Market Return - Risk Free Rate) = 4.8 + 1.30*(13 - 4.8) = 15.46%

A firm's aftertax cost of debt will increase if there is a(n): 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.