Chapter 12 - Cost of Capital
17. Which one of the following will decrease the aftertax cost of debt for a firm? A. Decrease in the firm's beta B. Increase in tax rates
C. Increase in the risk-free rate of return D. Decrease in the market price of the debt E. Decrease in a bond's yield-to-maturity
18. All else constant, an increase in a firm's cost of debt: A. could be caused by an increase in the firm's tax rate. B. will result in an increase in the firm's cost of capital. C. will lower the firm's weighted average cost of capital. D. will lower the firm's cost of equity.
E. will increase the firm's capital structure weight of debt.
19. The cost of preferred stock:
A. increases when a firm's tax rate decreases. B. is constant over time.
C. is unaffected by changes in the market price. D. is equal to the stock's dividend yield.
E. increases as the price of the stock increases.
20. Which one of the following statements is correct?
A. An increase in the market value of preferred stock will increase a firm's weighted average cost of capital.
B. The cost of preferred stock is unaffected by the issuer's tax rate. C. Preferred stock is generally the cheapest source of capital for a firm. D. The cost of preferred stock remains constant from year to year. E. Preferred stock is valued using the capital asset pricing model.
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Chapter 12 - Cost of Capital
21. Which one of the following will affect the capital structure weights used to compute a firm's weighted average cost of capital?
A. Decrease in the book value of a firm's equity B. Decrease in a firm's tax rate
C. Increase in the market value of the firm's common stock D. Increase in the market risk premium E. Increase in the firm's beta
22. The aftertax cost of which of the following are affected by a change in a firm's tax rate? I. preferred stock II. debt III. equity IV. capital
A. I and III only B. II and IV only C. I, II, and IV only D. II, III, and IV only E. I, II, III, and IV
23. Which one of the following statements is correct concerning capital structure weights? A. Target rates are less relevant to a project than are historical rates. B. The weights are unaffected when a bond issue matures.
C. An increase in the debt-equity ratio will increase the weight of the common stock. D. The repurchase of preferred stock will increase the weight of debt.
E. The issuance of additional shares of common stock will increase the weight of the preferred stock.
24. Which one of the following statements is correct? Assume the pre-tax cost of debt is less than the cost of equity.
A. A firm may change its capital structure if the government changes its tax policies. B. A decrease in the dividend growth rate increases the cost of equity.
C. A decrease in the systematic risk of a firm will increase the firm's cost of capital. D. A decrease in a firm's debt-equity ratio will decrease the firm's cost of capital. E. The cost of preferred stock decreases when the tax rate increases.
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Chapter 12 - Cost of Capital
25. Which one of the following represents the rate of return a firm must earn on its assets if it is to maintain the current value of its securities? A. Cost of equity
B. Internal rate of return C. Aftertax cost of debt
D. Weighted average cost of capital E. Debt-equity ratio
26. Which one of the following statements is accurate for a levered firm? A. WACC should be used as the required return for all proposed investments. B. A firm's WACC will decrease whenever the firm's tax rate decreases. C. An increase in the market risk premium will decrease a firm's WACC. D. The subjective approach totally ignores a firm's own WACC.
E. A reduction in the risk level of a firm will tend to decrease the firm's WACC.
27. Which one of the following statements is correct, all else held constant?
A. Beta is used to compute the return on equity and the standard deviation is used to compute the return on preferred.
B. A decrease in a firm's WACC will increase the attractiveness of the firm's investment options.
C. The aftertax cost of debt increases when the market price of a bond increases.
D. If you have both the dividend growth and the security market line's costs of equity, you should use the higher of the two estimates when computing WACC.
E. WACC is only applicable to firms that issue both common and preferred stock.
28. A firm has a cost of equity of 13 percent, a cost of preferred of 11 percent, and an aftertax cost of debt of 6 percent. Given this, which one of the following will increase the firm's weighted average cost of capital? A. Increasing the firm's tax rate B. Issuing new bonds at par
C. Redeeming shares of common stock D. Increasing the firm's beta
E. Increasing the debt-equity ratio
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Chapter 12 - Cost of Capital
29. All else constant, the weighted average cost of capital for a risky, levered firm will decrease if:
A. the firm's bonds start selling at a premium rather than at a discount. B. the market risk premium increases.
C. the firm replaces some of its debt with preferred stock. D. corporate taxes are eliminated.
E. the dividend yield on the common stock increases.
30. A firm that uses its weighted average cost of capital as the required return for all of its investments will:
A. maintain a constant value for its shareholders. B. increase the risk level of the firm over time.
C. make the best possible accept and reject decisions related to those investments. D. find that its cost of capital declines over time.
E. accept only the projects that add value to the firm's shareholders.
31. Old Town Industries has three divisions. Division X has been in existence the longest and has the most stable sales. Division Y has been in existence for five years and is slightly less risky than the overall firm. Division Z is the research and development side of the business. When allocating funds, the firm should probably:
A. require the highest rate of return from division X since it has been in existence the longest. B. assign the highest cost of capital to division Z because it is most likely the riskiest of the three divisions.
C. use the firm's WACC as the cost of capital for division Z as it provides analysis for the entire firm.
D. use the firm's WACC as the cost of capital for divisions A and B because they are part of the revenue-producing operations of the firm.
E. allocate capital funds evenly amongst the divisions to maintain the current capital structure of the firm.
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Chapter 12 - Cost of Capital
32. A firm uses its weighted average cost of capital to evaluate the proposed projects for all of its varying divisions. By doing so, the firm:
A. automatically gives preferential treatment in the allocation of funds to its riskiest division. B. encourages the division managers to only recommend their most conservative projects. C. maintains the current risk level and capital structure of the firm. D. automatically maximizes the total value created for its shareholders. E. allocates capital funds evenly amongst its divisions.
33. Kurt, who is a divisional manager, continually brags that his division's required return for its projects is one percent lower than the return required for any other division of the firm. Which one of the following most likely contributes the most to the lower rate requirement for Kurt's division?
A. Kurt tends to overestimate the projected cash inflows on his projects. B. Kurt tends to underestimate the variable costs of his projects. C. Kurt has the most efficiently managed division. D. Kurt's division is less risky than the other divisions.
E. Kurt's projects are generally financed with debt while the other divisions' projects are financed with equity.
34. Which one of the following is the primary determinant of an investment's cost of capital? A. Life of investment B. Initial cash outlay C. Level of risk
D. Source of funds used for the investment E. Investment's net present value
35. The cost of capital for a project depends primarily on which one of the following? A. Source of funds used for the project
B. Division within the firm that undertakes the project C. Project's modified internal rate of return D. How the project uses its funds E. Project's fixed costs
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