Chapter 13 & 15

retire debt

A sinking fund is used to:

Financial; operational

Changes in_______ leverage and _______ leverage will affect beta. (Enter only one word per blank.)

a discount rate commensurate with the project's risk

If a firm has multiple projects, each project should be discounted using ___.

dividend discount

One method for estimating the cost of equity is based on the ______ model.

when economic conditions change quickly

One of the disadvantages of using historical returns to estimate the market risk premium is that the past may not be a good guide to the future:

RM - RF

The market risk premium is defined as ___.

False

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

False

True or false: The CAPM is the only method to compute the cost of equity.

True

True or false: The correct discount rate on a project should be the expected return on a financial asset of comparable risk.

Cash Flows

WACC is used to discount ______ ______.

Betas can change over time. Betas are more likely to be stable if the firm remains in the same industry.

What do we know about the stability of a firm's beta?

Weighted average cost of capital

What does WACC stand for?

It is the part of the bond indenture that protects bondholders by limiting the actions of the corporation.

What is a protective covenant?

can be called and redeemed by the corporation before the maturity date

A callable bond:

down

A cyclical firm is one in which revenues go ______ in the contraction phase of the business cycle.

equal to or greater than

A firm should only undertake a project if its expected return is ______ that of a financial asset of comparable risk.

levered

A firm with debt in its capital structure is said to be:

risk free rate

According to the CAPM, what is the expected return on a stock if its beta is equal to zero?

Flotation Costs

An important advantage to a firm raising equity internally is not having to pay ___.

also increase

If a firm increases its level of debt, its beta will ___.

internally generated cash flow

In reality, most firms cover the equity portion of their capital spending with ___.

equity

Regression analysis on stock returns against the risk premium on the market can be used to estimate the ______ beta of a levered firm.

its stockholders its bondholders

The WACC is the minimum return a company needs to earn to satisfy ___.

WACC

The ______ is the overall expected return the firm must earn on its existing assets to maintain its value if the firm is levered.

should be

The correct discount rate on a project ______ the expected return on a financial asset of comparable risk.

supply

The cost of capital is an appropriate name since a project must earn enough to pay those who ______ the capital.

cost

The discount rate of a project is said to be its ______ of capital.

the retention ratio × ROE historical dividend growth rates security analysts' forecasts

The growth rate of dividends can be estimated using ___.

flotation

The issuance costs of bonds and stocks are referred to as ______ costs.

discount rate required return cost of capital

The rate used to discount project cash flows is known as the ___.

the same as

The risk free measure for the risk-free rate should be ______ the risk-free rate used for the market risk premium.

more

The sales of cyclical firms are ______ sensitive to the business cycle than are the sales of non-cyclical firms.

beta

The slope of the characteristic line of a firm's returns versus those of the market is the ___.

value

The weighted average cost of capital (RWACC) is the overall expected return the firm must earn on its existing assets to maintain its ___.

1 * Cost of Equity

The weighted average cost of capital (WACC) formula, for a firm with no debt or preferred stock will have a WACC of:

- Common stock pays dividends while bonds pay interest. - Dividends are not based on the par value of stock, but interest is generally based on a bond's par value. - Dividends are not fixed, but interest is generally a fixed dollar amount.

What are some differences in the income received by common stockholders and the income received by bondholders?

Distribution of assets in the event of liquidation Payment of dividends

What are the two areas where preferred stockholders have greater rights relative to common stockholders?

Dividends to common stockholders are not fixed. Dividends to preferred stockholders are fixed.

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

It is a fund set up for the repayment of bonds.

What is a sinking fund?

its cost of equity

If a firm issues no debt, its average cost of capital will equal ___.

reject

If the expected return of a project is below that of a financial asset of comparable risk, the firm should ______ the project.

equity; cost

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

Equity

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

risk-free rate stock's beta market risk premium

To estimate a firm's equity cost of capital using the CAPM, we need to know the ___.

stock's beta market risk premium risk-free rate

To estimate a firm's equity cost of capital using the CAPM, we need to know the ___.

default

U.S. Treasury securities considered to be risk-free because they have minimal, if any, ____ risk.

It is the principal value of the bond. It is the value stated on a bond certificate.

Which of the following are true regarding the face value of a bond?

rate of inflation

Which of the following variables is NOT required when using the CAPM to compute the cost of equity capital?

True

T/F A company can deduct interest paid on debt up to 30% of EBIT when computing taxable income.

The coupon rate The face value of the bond The call provisions

What is included in the bond indenture?

After tax profits

What is the primary source of dividends?

In the event of default by the corporation

When is the seniority of debt of particular importance?

equity

When using regression analysis with stock returns as inputs, the __________ beta is estimated.

terminal

When valuing a firm with the weighted average cost of capital, the ________ value of the firm can be estimated by assuming a constant perpetual growth rate for cash flows beyond the horizon.

All common stockholders with a right to vote

Which group of equityholders can participate in the election of the board of directors?

the same

The discount rate for the firm's projects equals the cost of capital for the firm as a whole when all projects have ______ risk as the firm.

1

A firm's target capital structure weights are evenly split between debt and equity. What is the firm's target debt-equity ratio?

required by investors

A project should only be accepted if its return is above what is ___.

financial leverage

An increase in a firm' s level of debt is an example of ___.

pays dividends in perpetuity pays a constant dividend

Preferred stock ___.

RS = RF + β× (RM- RF)

What is the CAPM formula?

The principal Coupon payments

Which of the following are fixed for a conventional bond?

They have never defaulted. They are not expected to default at this time.

Which of the following are true about U.S. Treasury instruments?

- It is also referred to as the discount rate that is used to discount cash flows in capital budgeting problems. - It represents the marginal cost of capital.

Which of the following is true about the WACC?

The covariance between the stock and the market index's returns. The variance of the market index's returns.

Which of the following variables do we need to compute the beta for a company's stock?

the rate of inflation

Which of the following variables is NOT required when using the CAPM to compute the cost of equity capital?

bondholders

Who does the trustee represent?

the bondholders

Whose interest does a deferred call provision protect?

Current management and an outside group of shareholders

Which two groups usually compete to obtain votes from shareholders during a proxy fight?

True

T/F Under U.S. tax law, a corporation's interest payments up to 30% of EBIT are tax deductible.

beta; slope

The ____ of the characteristic line of a stock's returns versus those of the market measures the stock's systematic risk.

beta

The covariance between the stock and the market index's returns divided by the variance of the market index's returns represents the ______ for a company's stock.

Premium

The difference between the expected return on the market portfolio and the risk-free rate is the market risk _______

all projects have the same risk as the current firm

The discount rate for the firm's projects equals the cost of capital for the firm as a whole when ___.