Managerial Finance Ch. 12

Including preferred stock in the WACC formula adds which term if P is the market value of preferred stock and RP is the cost of preferred?

(P/V) × RP

Which of the following are components used in the construction of the WACC?

-Cost of common stock -Cost of debt -Cost of preferred stock

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

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

The following are advantages of the SML approach:

-Does not require the company to pay a dividend -Adjusts for risk

To estimate the dividend yield of a particular stock, we need ________

-Forecasts of the dividend growth rate, g -The last dividend paid, D0 -The current stock price

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

-Required return -Cost of capital -Discount rate

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

A discount rate commensurate with the project's risk

Which of the following is tax deductible to the firm?

Coupon interest paid on bonds

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: In the WACC calculation, V = E − D

False V = E + D

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 formula of the SML is _____

RE = Rf + β × (RM − Rf)

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, when it should be accepted

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 ______ projects

Too many

Free cash flow is better described as ______

Total distributable cash flow

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 ______

[E/V] × RE + [D/V] × RD ×(1 - T c)

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 expected percentage is the overall rate of return the firm must earn on its existing assets to maintain the value of its stock

False

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

Its cost of equity

The growth rate of dividends can be found using ________

-Historical dividend growth rates -Security analysts' forecasts

Which of the following are true?

-Ideally, we should use market values in the WACC -The market value of debt and equity are not reliable in case of privately owned company

Which of the following is true about a firm's cost of debt?

-It is easier to estimate than the cost of equity -Yields can be calculated from observable data

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 -The firm overall will become riskier -It will accept projects that it should have rejected

Preferred stock _____

-Pays a constant dividend -Pays dividends in perpetuity

The following are disadvantages of the SML approach:

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

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

-Risk-free rate -Market risk premium -Stock's beta

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

A discount rate commensurate with the project's risk

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 these two components

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 ______ be deducted from the payer's taxable income for tax purposes

Cannot

The dividend growth model is applicable to companies that pay _______

Dividends

To calculate cash flow from assets, we need to first calculate what the firm's tax bill would have been if it had not used debt financing. What is the expression for the "would-have-been" tax bill?

Earnings before interest and taxes (EBIT) times the firm's tax rate (TC)

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

False

True or false: The SML approach is advantageous because all it requires is the 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 growth rate of dividends can be found using the CAPM

False

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

False

In the WACC calculation, D represents the _______ value of the firm's debt

Market

We should use _______ values in the WACC. Because ______ values are often similar to market values for debt, we often use book value for debt and market value for equity.

Market ; Book

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

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

Pure plays

What is the required return on a stock (RE), according to the constant dividend growth model, if the growth rate (g) is zero?

RE = D1/P0

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 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, when it should be accepted

The WACC of a firm reflects the ________ and the target capital structure of the firm's existing assets as a whole

Risk

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

True or false: Free cash flow is very similar to cash flow from assets

True

True or false: Interest paid is a tax-deductible expense, so a company's tax bill is lower than it would have been had the company not used debt financing

True

True or false: RP = D/P0

True

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

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

Use ; Source

Given V = E + D, if we divide both E and D by ______, we can calculate the capital structure weights

V or Value

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

Value or Price

What is the appropriate discount rate to use only if the proposed investment is a replica of the firm's existing operating activities?

WACC

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