Finance Chapter 12

The following are advantages of the SML approach: - requires estimation of beta - requires estimation of the market risk premium - adjusts for risk - does not require the company to pay a dividend

- adjusts for risk - does not require the company to pay a dividend

Preferred stock ______ - will never be paid - pays a constant dividend - does not pay dividends - pays dividends in perpetuity

- pays a constant dividend - pays dividends in perpetuity

The following are disadvantages of the SML approach: - requires estimation of beta - requires estimation of the market risk premium - adjusts for risk - does not require the company to pay a dividend

- requires estimation of beta - requires estimation of the market risk premium

Which of the following are components used in the construction of the WACC? - the cost of debt - the cost of preferred stock - the cost of accounts payable - the cost of common stock

- the cost of debt - the cost of preferred stock - the cost of common stock

What will happen over time if a firm uses its overall WACC to evaluate all projects, regardless of each project's risk level?

It will reject projects that it should have accepted, it will accept projects that it should have rejected, and the firm overall will become riskier

The formula of the SML is _______

RE = Rf + β × (RM − Rf)

the formula for calculating the cost of equity capital that is based on the dividend discount model is ______

Re = (D1/P0) + g

What is the equation for finding the cost of preferred stock?

Rp = D/P0

If D is the market value of a firm's debt, E the market value of that same firm's equity, V the total value of the firm (E + D), RD the yield on the firm's debt, TC is the corporate tax rate, and RE the cost of equity, the weighted average cost of capital is _________

WACC = (E/V) x Re + (D/V) x Rd x (1-Tc)

Using an analyst's forecast for a firm's earnings growth and a stock's dividend yield, you can find the cost of equity by ___________

adding the two

Some risk adjustment to a firm's WACC for projects of differing risk, even if it is subjective, is probably___________

better than no risk adjustment

Dividends paid to common stockholders (can/cannot) be deducted from the payer's taxable income for tax purposes.

cannot

The dividend growth model is applicable to companies that pay ______

dividends

What can we say about the dividends paid to common and preferred stockholders?

dividends are guaranteed for both preferred and common stock holders dividends to common stock holders are not fixed

The return an investor in a security receives is _____ the cost of the security to the company that issued it

equal to

If the firm is all-equity, the discount rate is equal to the firm's cost of _________ capital.

equity

True or false: Conglomerates are companies that specialize only in projects similar to the project your firm is considering

false

True or false: Finding the cost of equity is fairly straightforward.

false

True or false: For publicly traded companies, the component of the dividend yield that must be estimated is the dividend.

false

True or false: Projects should always be discounted at the firm's overall cost of capital

false

True or false: The SML approach is advantageous because all it requires is estimation of beta

false

True or false: The cost of capital depends on the source of the funds.

false

True or false: The cost of equity is D1/P0 minus the analysts' estimates of growth.

false

True or false: The discount rate is also known as the expected return.

false

True or false: The primary disadvantage of the dividend growth model approach is its simplicity

false

true or false: The growth rate of dividends can be found using the CAPM.

false

Components of the WACC include funds that come from ______

investors

Finding a firm's overall cost of equity is difficult because _________

it cannot be observed directly

The most appropriate weights to use in the WACC are the _________ weights

market value

Other companies that specialize only in projects similar to the project your firm is considering are called ___________

pure plays

If an all-equity firm discounts a project's cash flows with the firm's overall weighted average cost of capital even though the project's beta is less than the firm's overall beta, it is possible that the project might be

rejected, even though it should be accepted

To estimate a firm's equity cost of capital using the SML approach, we need to know the ________

stock's beta, market risk premium, and risk-free rate

It is difficult to establish discount rate for individual projects, so firms often adopt an approach that involves making ___________ adjustments to the overall WACC.

subjective

SmartKids, a textbook publisher, is considering investing in a software company that collects and stores data. What beta should SmartKids use to assess the risk of the project?

the beta for software companies that collect and store data

The WACC is the minimum required return for _____

the overall firm

If a firm uses its overall cost of capital to discount cash flows from projects in higher risk divisions, it will accept too (many/little) projects

too many

The cost of capital depends primarily on the _____ of funds, not the ______

use; source

The WACC is the overall rate of return the firm must earn on its existing assets to maintain the ________ of its stock.

value

What does WACC stand for?

weighted average cost of capital

For a firm with outstanding debt, the cost of debt will be the _____ on that debt.

yield to maturity