Chapter 12 - Cost of Capital
9. A firm has a return on equity of 12.4 percent according to the dividend growth model and a return of 18.7 percent according to the capital asset pricing model. The market rate of return is 13.5 percent. What rate should the firm use as the cost of equity when computing the firm's WACC?
A. 12.4 percent because it is lower than 18.7 percent B. 18.7 percent because it is higher than 12.4 percent
C. The arithmetic average of 12.4 percent and 18.7 percent
D. The arithmetic average of 12.4 percent, 13.5 percent, and 18.7 percent E. 13.5 percent Refer to section 12.2.
Bloom's: Comprehension Difficulty: Basic
Learning Objective: 12-01 Determine a firm's cost of equity capital Section: 12.2
Topic: Cost of equity
10. Which of the following features are advantages of the dividend growth model? I. easy to understand II. model simplicity
III. constant dividend growth rate
IV. model's applicability to all common stocks A. II only
B. I and III only C. II and IV only D. I and II only E. I, II, and III only Refer to section 12.2.
Bloom's: Comprehension Difficulty: Basic
Learning Objective: 12-01 Determine a firm's cost of equity capital Section: 12.2
Topic: Dividend growth model
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Chapter 12 - Cost of Capital
11. Which of the following are weaknesses of the dividend growth model? I. market risk premium fluctuations II. lack of dividends for some firms III. reliance on historical beta
IV. sensitivity of model to dividend growth rate A. II only
B. I and II only C. I and III only D. II and IV only E. I, II, III, and IV Refer to section 12.2.
Bloom's: Comprehension Difficulty: Basic
Learning Objective: 12-01 Determine a firm's cost of equity capital Section: 12.2
Topic: Dividend growth model
12. In an efficient market, the cost of equity for a risky firm does which one of the following according to the security market line?
A. Produces a return that will be less than the market rate but higher than the risk-free rate B. Equals the market rate of return for all stocks
C. Has a maximum cost equal to the market rate of return D. Decreases as the beta of the firm's stock increases
E. Increases in direct relation to the stock's systematic risk Refer to section 12.2.
Bloom's: Comprehension Difficulty: Basic
Learning Objective: 12-01 Determine a firm's cost of equity capital Section: 12.2
Topic: Security market line
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Chapter 12 - Cost of Capital
13. Which of the following will increase the cost of equity for a firm with a beta of 1.1? I. decrease in the security's beta
II. decrease in the market risk premium III. decrease in the risk-free rate IV. increase in the risk-free rate A. II only B. III only C. I and II only D. II and III only E. I and IV only Refer to section 12.2.
Bloom's: Comprehension Difficulty: Basic
Learning Objective: 12-01 Determine a firm's cost of equity capital Section: 12.2
Topic: Cost of equity
14. Which one of the following will increase the cost of equity, all else held constant? A. Increase in the dividend growth rate B. Decrease in beta
C. Decrease in future dividends D. Increase in stock price
E. Decrease in market risk premium Refer to section 12.2
Bloom's: Comprehension Difficulty: Basic
Learning Objective: 12-01 Determine a firm's cost of equity capital Section: 12.2
Topic: Cost of equity
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Chapter 12 - Cost of Capital
15. All else constant, which of the following will increase the aftertax cost of debt for a firm? I. increase in the yield to maturity of the firm's outstanding debt II. decrease in the yield to maturity of the firm's outstanding debt III. increase in the firm's tax rate IV. decrease in the firm's tax rate A. I only
B. I and III only C. I and IV only D. II and III only E. II and IV only Refer to section 12.3.
Bloom's: Comprehension Difficulty: Basic
Learning Objective: 12-02 Determine a firm's cost of debt Section: 12.3
Topic: Aftertax cost of debt
16. Which one of the following is the pre-tax cost of debt? A. Average coupon rate on the firm's outstanding bonds B. Coupon rate on the firm's latest bond issue
C. Weighted average yield-to-maturity on the firm's outstanding debt D. Average current yield on the firm's outstanding debt
E. Annual interest divided by the market price per bond for the latest bond issue Refer to section 12.3.
Bloom's: Comprehension Difficulty: Basic
Learning Objective: 12-02 Determine a firm's cost of debt Section: 12.3
Topic: Cost of debt
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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 Refer to section 12.3.
Bloom's: Comprehension Difficulty: Basic
Learning Objective: 12-02 Determine a firm's cost of debt Section: 12.3
Topic: Aftertax cost of debt
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. Refer to sections 12.3 and 12.4
Bloom's: Comprehension Difficulty: Basic
Learning Objective: 12-03 Determine a firm's overall cost of capital Section: 12.3 and 12.4 Topic: WACC
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