Chapter 12 - Cost of Capital
36. Marine Expeditors has three divisions. Division A is the core of the business and represents 80 percent of the firm's operations. Division B is involved only with contractual short-term projects and therefore has about 8 percent less risk than division A. Division C develops and markets new products and is about 12 percent riskier than division A and about equal in size to division B. The manager of division A has suggested that the operations of his division be increased by 10 percent next year. The proposed project should probably be assigned a required return that is equal to _____ percent of the firm's weighted average cost of capital. A. 40 B. 60 C. 80 D. 100 E. 110
37. Which one of the following is most apt to cause a wise manager to increase a project's cost of capital? Assume the firm is levered.
A. Management decides to issue new stock to finance the project. B. The initial cash outlay requirement is reduced.
C. She learns the project is riskier than previously believed. D. The aftertax cost of debt just decreased. E. The project's life is shortened.
38. Boone Brothers remodels homes and replaces windows. Ace Builders constructs new
homes. If Boone Brothers considers expanding into new home construction, it should evaluate the expansion project using which one of the following as the required return for the project? A. Boone Brothers' cost of capital B. Ace Builders' cost of capital
C. Average of Boone Brothers' and Ace Builders' cost of capital D. Lower of Boone Brothers' or Ace Builders' cost of capital E. Higher of Boone Brothers' or Ace Builders' cost of capital
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Chapter 12 - Cost of Capital
39. You need to use the pure play approach to assign a cost of capital to a proposed investment. Which one of the following characteristics should you most concentrate on as you search for an appropriate pure play firm? A. Firm size B. Firm location C. Firm experience D. Firm operations E. Firm management
40. When using the pure play approach for a proposed investment, a firm is primarily seeking a rate of return which:
A. is based on the actual source of funds that will be used to fund the project. B. creates a positive net present value for the project. C. reflects the size and life of the project.
D. most closely correlates with the proposed investment's internal rate of return. E. best matches the risk level of the proposed investment.
41. Derek's is a brick-and-mortar toy store. The firm is considering expanding its operations to include Internet sales. Which one of the following would be the best firm to use in a pure play approach to analyzing this proposed expansion?
A. Another brick-and-mortar store that also sells online B. A wholesale toy distributor
C. A toy store that only sells online
D. The oldest online retailer of any product E. Derek's own store
42. Kelly's uses the firm's weighted average cost of capital (WACC) as the required return for some of its projects. For other projects, the firms uses a rate equal to WACC plus 1 percent, while another set of projects is assigned rates equal to WACC minus some amount. Which one of the following factors should be the key factor the firm uses to determine the amount of the adjustment it will make when assigning the project a discount rate? A. Firm beta
B. Date for project commencement C. Risk level of project
D. Division within the firm that will be assigned to manage the project E. Current debt-equity ratio
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Chapter 12 - Cost of Capital
43. A firm has multiple divisions of similar nature, yet varying degrees of risk. Which one of the following would be the most appropriate, yet relatively easy, means of assigning discount rates to each of its proposed investments?
A. Assign every project a rate equal to the firm's cost of equity
B. Assign every firm a random rate that varies between the firm's cost of debt and its cost of equity
C. Assign every project a rate equal to the firm's WACC plus or minus a subjective adjustment D. Determine the best pure play rate for each project
E. Assign every project a rate equal to the market rate of return at the time of the proposal
44. The computation of which one of the following requires assigning every proposed investment to a particular risk class? A. Pure play cost of capital B. Cost of equity
C. Aftertax cost of debt D. WACC
E. Subjective cost of capital
45. Judy's Boutique just paid an annual dividend of $1.65 on its common stock. The firm increases its dividend by 2.5 percent annually. What is the rate of return on this stock if the current stock price is $38.20 a share? A. 6.93 percent B. 7.37 percent C. 7.54 percent D. 8.19 percent E. 8.33 percent
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Chapter 12 - Cost of Capital
46. Farm Equipment, Inc. announced this morning that its next annual dividend will be
decreased to $1.80 a share and that all future dividends will be decreased by an additional 1.5 percent annually. What is the current value per share of this stock if the required return is 16.5 percent? A. $8 B. $10 C. $12 D. $14 E. $16
47. The Green Balloon just paid its first annual dividend of $0.12 a share. The firm plans to increase the dividend by 3.5 percent per year indefinitely. What is the firm's cost of equity if the current stock price is $6.50 a share? A. 5.35 percent B. 5.41 percent C. 14.42 percent D. 18.79 percent E. 19.98 percent
48. High Valley Antiques would like to issue new equity shares if its cost of equity declines to 10.5 percent. The company pays a constant annual dividend of $1.60 per share. What does the market price of the stock need to be for the firm to issue the new shares? A. $14.48 B. $14.83 C. $15.24 D. $15.92 E. $16.80
49. The common stock of Modern Interiors has a beta of 1.61 and a standard deviation of 27.4 percent. The market rate of return is 13.2 percent and the risk-free rate is 4.8 percent. What is the cost of equity for this firm? A. 18.32 percent B. 19.97 percent C. 21.08 percent D. 24.40 percent E. 26.05 percent
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Chapter 12 - Cost of Capital
50. Jet Setters has a cost of equity of 17.8 percent. The market risk premium is 10.2 percent and the risk-free rate is 4.4 percent. The company is acquiring a competitor, which will increase the company's beta to 1.6. What effect, if any, will the acquisition have on the firm's cost of equity capital? A. No effect
B. Decrease of 3.39 percent C. Decrease of 0.84 percent D. Increase of 2.92 percent E. Increase of 4.13 percent
51. The common stock of Yanderloft and Sons has a beta that is 25 percent larger than the overall market beta. Currently, the market risk premium is 9.2 percent while the U.S. Treasury bill is yielding 4.7 percent. What is the cost of equity for this firm? A. 13.76 percent B. 14.96 percent C. 15.80 percent D. 16.20 percent E. 17.85 percent
52. Musical Charts just paid an annual dividend of $2.45 per share. This dividend is expected to increase by 3.3 percent annually. Currently, the firm has a beta of 1.09 and a stock price of $36 a share. The risk-free rate is 4.2 percent and the market rate of return is 12.6 percent. What is the cost of equity capital for this firm? A. 10.28 percent B. 11.84 percent C. 12.29 percent D. 12.95 percent E. 13.42 percent
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