Finance Ch 10

Which of the following assets has the highest flotation costs to the issuing firm?

Common stock

The MacMillen Company has equal amounts of low-risk, average-risk, and high-risk projects. The firm's overall WACC is 12%. The CFO believes that this is the correct WACC for the company's average-risk projects, but that a lower rate should be used for lower-risk projects and a higher rate for higher-risk projects. The CEO disagrees, on the grounds that even though projects have different risks, the WACC used to evaluate each project should be the same because the company obtains capital for all projects from the same sources. If the CEO's position is accepted, what is likely to happen over time?

Company will take on too many high-risk projects and reject too many low-risk projects

10. Duval Inc. uses only equity capital, and it has two equally-sized divisions. Division A's cost of capital is 10.0%, Division B's cost is 14.0%, and the corporate (composite) WACC is 12.0%. All of Division A's projects are equally risky, as are all of Division B's projects. However, the projects of Division A are less risky than those of Division B. Which of the following projects should the firm accept

Division B project, 15% return Division A project, 11% return, 13% return

The lower the firm's tax rate, the lower will be its after-tax cost of debt and also its WACC, other things held constant

False

Which of the following can be written off against a corporation's taxes

Interest payments on debt

WACC uses

Market rates and values

LaPango Inc estimate that its average-risk projects have a WAVV of 10%, its below-average risk projects have a WACC 8%, and its above-average risk projects have a WACC of 12%. What project should the company accept?

Project B, which is of below-average risk and has a return of 8.5%

Capital is something defined as funds supplied to a firm by investors

True

For capital budgeting and cost of capital purposes, the firm should assume that each dollar of capital is obtained in accordance with tis target capital structure, which for many firms means partly as debt, partly as preferred stock, and partly common equity

True

If a company's tax rate increases but the YTM on its noncallable bonds remains the same, the after-tax cost of its debt will fall

True

If a firm is privately owed, and its stock is not traded in public markets, then we cannot measure its beta for use in the CAPM model, we cannot observe its stock price for use in the DCF model, and we don't know what the risk premium is for use in the bond-yield-plus-risk-premium method. All this makes it especially difficult to estimate the cost of equity for a private company

True

If a firm's marginal tax rate is increased, this would, other things held constant, lower the cost of debt used to calculate its WACC

True

The component costs of capital are market-determined variables in the sense that they are based on investors' required returns

True

The cost of capital used in capital budgeting should reflect the average cost of the various sources of investor-supplied funds a fund uses to acquire assets

True

When calculating the cost of debt, a company needs to adjust for taxes, because interest payments are deductible by the paying corporation

True

The cost of debt is equal to which characteristic of the bond?

Yield to maturity

Source of capital from highest to lowest: cost of debt (before tax), cost of common stock, cost of debt (after tax)

cost of common stock, cost of debt before tax, cost of debt after tax