FINA 3770 Ch. 11

Use the dividend growth model to determine the required rate of return for equity. Yesterday your firm paid a dividend of​ $1.50 per share.​ Further, the recent stock price is​ $31.82 per​ share, and you anticipate a growth rate in dividends of​ 4.00% per year for the foreseeable future.

8.90%

The cost of retained earnings​ ________.

A. is the appropriate cost of capital for the shareholders B. is the loss of the dividend option for the owners C. is the cost of issuing new common stock without the flotation costs D. All of the above D**

The weighted average cost of capital is​ ________.

A. the cost of capital for the firm as a whole B. made up of three financing​ components: the cost of​ debt, the cost of preferred​ stock, and the cost of equity C. the average of the cost of each financing​ component, weighted by the proportion of each component D. All of the above D**

The cost of debt could be which of the​ following?

A.The required return on money borrowed as a long−term loan from a bank B.The required return on money borrowed from a venture capitalist C.The yield−to−maturity on money raised by selling bonds D.All of the choices above could be considered the cost of debt. D**

​________ refers to the way a company finances itself through some combination of​ loans, bond​ sales, preferred stock​ sales, common stock​ sales, and retention of earnings.

Capital structure

The cost of preferred stock to a firm must be adjusted to an after-tax figure because 70% of dividends received by a corporation may be excluded from the receiving corporation's taxable income.

False

To estimate the market value of a publicly traded bond that has a broad market with frequent​ trading, it is usually best to multiply the number of bonds outstanding by the bond par value.

False

Using the WACC to evaluate all projects has the effect of making low-risk projects look MORE attractive and high-risk projects look LESS attractive.

False

Which of the items below is sometimes termed hybrid equity​ financing?

Preferred stock

WACC. Eric has another​get-rich-quick idea, but needs funding to support it. He chooses an​all-debt funding scenario. He will borrow $4,000 from​ Wendy, who will charge him 9​% on the loan. He will also borrow $10,000 from​ Bebe, who will charge him 11​% on the​loan, and $2,000 from​Shelly, who will charge him 17​% on the loan. What is the weighted average cost of capital for​ Eric?

The cost of capital used to fund a project is the sum of percentages of the total funding amount for each financing component multiplied by the cost of that component. The total amount of capital financed is ​$16,000 ​($4,000 ​+ ​$10,000 ​+$2,000​), the sum of the individual loans. The weighted average cost of capital is computed as​ follows: WACC=$4,000$16,000×0.09+$10,000$16,000×0.11+$2,000$16,000×0.17=0.1125=11.25% ​Thus, the weighted average cost of capital for Eric is 11.25​%.

Under which of the following circumstances is the pure play method of estimating a​ project's beta particularly​ useful?

The firm is looking to expand its current business operations into a brand new area unlike any of its internal projects.

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

When estimating the cost of debt financing from​ bonds, a firm can use the yield−to−maturity as the before−tax cost of debt.

True

The​ ________ of an asset or liability is its cost carried on the balance sheet.

book value

An investment​ banker's fees are part of the​ ________ realized for issuing new debt or equity.

floatation costs

Investors​ ________ for estimating the WACC.

prefer market value to book value