Test 4 CH. 14

Return an investor

A security receives is less than the cost of the security to the company that issued it.

raise capital via bond issue:

B/H demand YTM as a return

A firm's overall cost of capital will include both its cost of BLANK capital and equity capital.

Debt

Cost of capital

Depends on the USE of funds, not the SOURCE of funds.

Finding a firm's overall cost of equity is...

Difficult

Cost of Equity

Return demanded by equity holders Required rate of return for common stock

Cost of preferred stock

Return demanded by preferred holders• Required rate of return for preferred stock (RP)• Remember: Preferred stock pays a fixed dividend

To raise capital via a stock issue

S/H demand capital gains (and dividends) as a return

Which of the following variables is not required to calculate the expected return on a risky asset ?

The risk of inflation

The cost of capital depends primarily on the BLANK of funds

USE

WACC is used to discount

cash flows

WACC

weighted average cost of capital

Components used in the construction of the WACC

1. Cost of debt 2. Cost of common stock 3. Cost of preferred stock

True or false: The return an investor in a security receives is equal to the cost of the security to the company that issued it.

TRUE

Firms overall cost of equity

There is no way of directly observing the return that the firm's equity investors require on their investment

Dividend

To apply the dividend growth model to a particular stock, you need to assume that the firm's ___ will grow at a constant rate.

Cost of debt

return demanded by bond holders required rate of return for bonds