Chapter 14 - Cost of Capital
11. The cost of equity for a firm:
A. tends to remain static for firms with increasing levels of risk. B. increases as the unsystematic risk of the firm increases.
C. ignores the firm's risks when that cost is based on the dividend growth model. D. equals the risk-free rate plus the market risk premium. E. equals the firm's pretax weighted average cost of capital. Refer to section 14.2
AACSB: N/A
Bloom's: Comprehension Difficulty: Basic
Learning Objective: 14-1 Section: 14.2
Topic: Cost of equity
12. The dividend growth model can be used to compute the cost of equity for a firm in which of the following situations?
I. firms that have a 100 percent retention ratio II. firms that pay a constant dividend III. firms that pay an increasing dividend IV. firms that pay a decreasing dividend A. I and II only B. I and III only C. II and III only D. I, II, and III only E. II, III, and IV only Refer to section 14.2
AACSB: N/A
Bloom's: Comprehension Difficulty: Basic
Learning Objective: 14-1 Section: 14.2
Topic: Dividend growth model
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Chapter 14 - Cost of Capital
13. The dividend growth model:
A. is only as reliable as the estimated rate of growth.
B. can only be used if historical dividend information is available.
C. considers the risk that future dividends may vary from their estimated values. D. applies only when a firm is currently paying dividends. E. uses beta to measure the systematic risk of a firm. Refer to section 14.2
AACSB: N/A
Bloom's: Comprehension Difficulty: Basic
Learning Objective: 14-1 Section: 14.2
Topic: Dividend growth model
14. Which one of the following statements related to the SML approach to equity valuation is correct? Assume the firm uses debt in its capital structure. A. This model considers a firm's rate of growth.
B. The model applies only to non-dividend paying firms.
C. The model is dependent upon a reliable estimate of the market risk premium.
D. The model generally produces the same cost of equity as the dividend growth model. E. This approach generally produces a cost of equity that equals the firm's overall cost of capital.
Refer to section 14.2
AACSB: N/A
Bloom's: Comprehension Difficulty: Basic
Learning Objective: 14-1 Section: 14.2
Topic: SML approach
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Chapter 14 - Cost of Capital
15. Which of the following statements are correct?
I. The SML approach is dependent upon a reliable measure of a firm's unsystematic risk. II. The SML approach can be applied to firms that retain all of their earnings. III. The SML approach assumes a firm's future risks are similar to its past risks. IV. The SML approach assumes the reward-to-risk ratio is constant. A. I and III only B. II and IV only C. III and IV only D. I, II, and III only E. II, III, and IV only Refer to section 14.2
AACSB: N/A
Bloom's: Comprehension Difficulty: Intermediate Learning Objective: 14-1 Section: 14.2
Topic: SML approach
16. The pre-tax cost of debt:
A. is based on the current yield to maturity of the firm's outstanding bonds. B. is equal to the coupon rate on the latest bonds issued by a firm.
C. is equivalent to the average current yield on all of a firm's outstanding bonds. D. is based on the original yield to maturity on the latest bonds issued by a firm. E. has to be estimated as it cannot be directly observed in the market. Refer to section 14.3
AACSB: N/A
Bloom's: Comprehension Difficulty: Basic
Learning Objective: 14-2 Section: 14.3
Topic: Cost of debt
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Chapter 14 - Cost of Capital
17. The aftertax cost of debt generally increases when: I. a firm's bond rating increases.
II. the market rate of interest increases. III. tax rates decrease. IV. bond prices rise. A. I and III only B. II and III only C. I, II, and III only D. II, III, and IV only E. I, II, III, and IV Refer to section 14.3
AACSB: N/A
Bloom's: Comprehension Difficulty: Intermediate Learning Objective: 14-2 Section: 14.3
Topic: Cost of debt
18. The cost of preferred stock is computed the same as the: A. pre-tax cost of debt. B. return on an annuity. C. aftertax cost of debt. D. return on a perpetuity.
E. cost of an irregular growth common stock. Refer to section 14.3
AACSB: N/A
Bloom's: Comprehension Difficulty: Basic
Learning Objective: 14-1 Section: 14.3
Topic: Cost of preferred
14-9
Chapter 14 - Cost of Capital
19. The cost of preferred stock: A. is equal to the dividend yield. B. is equal to the yield to maturity.
C. is highly dependent on the dividend growth rate. D. is independent of the stock's price. E. decreases when tax rates increase. Refer to section 14.3
AACSB: N/A
Bloom's: Knowledge Difficulty: Basic
Learning Objective: 14-1 Section: 14.3
Topic: Cost of preferred
20. The capital structure weights used in computing the weighted average cost of capital: A. are based on the book values of total debt and total equity.
B. are based on the market value of the firm's debt and equity securities.
C. are computed using the book value of the long-term debt and the book value of equity. D. remain constant over time unless the firm issues new securities. E. are restricted to the firm's debt and common stock. Refer to section 14.4
AACSB: N/A
Bloom's: Knowledge Difficulty: Basic
Learning Objective: 14-3 Section: 14.4 Topic: WACC
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