Question 1

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?

Accepted Answer

A)   Firm size
B)   Firm location
C)   Firm experience
D)   Firm operations
E)   Firm managementF) C) and E)
G) A) and D)

Question 2

The computation of which one of the following requires assigning every proposed investment to a particular risk class?

Accepted Answer

A)   Pure play cost of capital
B)   Cost of equity
C)   Aftertax cost of debt
D)   WACC
E)   Subjective cost of capitalF) B) and D)
G) A) and B)

Question 3

A firm wants to create a weighted average cost of capital (WACC)  of 10.4 percent. The firm's cost of equity is 14.5 percent and its pre-tax cost of debt is 8.5 percent. The tax rate is 34 percent. What does the debt-equity ratio need to be for the firm to achieve its target WACC?

Accepted Answer

A)   0.51
B)   0.57
C)   0.62
D)   0.70
E)   0.86F) B) and D)
G) B) and C)

Question 4

Orchard Farms has a pre-tax cost of debt of 7.68 percent and a cost of equity of 15.2 percent. The firm uses the subjective approach to determine project discount rates. Currently, the firm is considering a project to which it has assigned an adjustment factor of -0.5 percent. The firm's tax rate is 34 percent and its debt-equity ratio is 0.45. The project has an initial cost of $4.3 million and produces cash inflows of $1.27 million a year for 5 years. What is the net present value of the project?

Accepted Answer

A)   $121,619
B)   $328,895
C)   $514,370
D)   $561,027
E)   $628,721F) A) and C)
G) C) and D)

Question 5

Birds and Yards has 10-year bonds outstanding that carry an annual coupon of 8 percent. The bonds mature in 7 years and are currently priced at 108.4 percent of face value. What is the firm's pre-tax cost of debt?

Accepted Answer

A)   6.47 percent
B)   6.82 percent
C)   7.34 percent
D)   7.70 percent
E)   8.23 percentF) A) and B)
G) A) and C)

Question 6

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?

Accepted Answer

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 ratioF) A) and E)
G) B) and C)

Question 7

Stock in ABC Enterprises has a beta of 1.06. The market risk premium is 6.8 percent, and T-bills are currently yielding 3.2 percent. ABC's most recent dividend was $1.56 per share, and dividends are expected to grow at a 4 percent annual rate indefinitely. If the stock sells for $43 a share, what is your best estimate of ABC's cost of equity?

Accepted Answer

A)   7.78 percent
B)   8.82 percent
C)   9.09 percent
D)   9.41 percent
E)   9.69 percentF) All of the above
G) B) and D)

Question 8

Bob's is a retail chain of specialty hardware stores. The firm has 21,000 shares of stock outstanding that are currently valued at $68 a share and provide a 13.2 percent rate of return. The firm also has 500 bonds outstanding that have a face value of $1,000, a market price of $1,068, and a 7 percent coupon. These bonds mature in 6 years and pay interest semiannually. The tax rate is 35 percent. The firm is considering expanding by building a new superstore. The superstore will require an initial investment of $12.3 million and is expected to produce cash inflows of $1.1 million annually over its 10-year life. The risks associated with the superstore are comparable to the risks of the firm's current operations. The initial investment will be depreciated on a straight line basis over the life of the project. At the end of the 10 years, the firm expects to sell the superstore for $6.7 million. Should the firm accept or reject the superstore project and why?

Accepted Answer

A)   Accept; The project's NPV is $1.27 million.
B)   Accept; The NPV is $4.89 million.
C)   Reject; The NPV is $1.06 million
D)   Reject; The NPV -$3.27 million.
E)   Reject; The NPV is -$5.71 million.F) B) and D)
G) A) and D)

Question 9

The cost of capital for a project depends primarily on which one of the following?

Accepted Answer

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 costsF) C) and E)
G) A) and C)

Question 10

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?

Accepted Answer

A)   10.28 percent
B)   11.84 percent
C)   12.29 percent
D)   12.95 percent
E)   13.42 percentF) B) and C)
G) C) and E)

Question 11

When using the pure play approach for a proposed investment, a firm is primarily seeking a rate of return which:

Accepted Answer

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.F) A) and C)
G) A) and D)

Question 12

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?

Accepted Answer

A)   $8
B)   $10
C)   $12
D)   $14
E)   $16F) A) and B)
G) B) and C)

Question 13

Which one of the following statements is accurate for a levered firm?

Accepted Answer

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.F) B) and E)
G) None of the above

Question 14

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

Accepted Answer

A)   I only
B)   I and III only
C)   I and IV only
D)   II and III only
E)   II and IV onlyF) A) and E)
G) D) and E)

Question 15

Bruceton Hotels is an all-equity firm with 60,000 shares of stock outstanding. The stock has a beta of 1.27 and a standard deviation of 13.8 percent. The market risk premium is 9.1 percent and the risk-free rate of return is 4.2 percent. The company is considering a project that it considers riskier than its current operations so it wants to apply an adjustment of 1 percent to the project's discount rate. What should the firm set as the required rate of return for the project?

Accepted Answer

A)   12.54 percent
B)   13.92 percent
C)   15.39 percent
D)   16.76 percent
E)   17.03 percentF) B) and E)
G) C) and D)

Question 16

Which one of the following statements is correct, all else held constant?

Accepted Answer

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.F) A) and E)
G) A) and B)

Question 17

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?

Accepted Answer

A)   18.32 percent
B)   19.97 percent
C)   21.08 percent
D)   24.40 percent
E)   26.05 percentF) A) and C)
G) B) and E)

Question 18

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

Accepted Answer

A)   II only
B)   I and III only
C)   II and IV only
D)   I and II only
E)   I, II, and III onlyF) B) and E)
G) A) and B)

Question 19

Which one of the following is the primary determinant of an investment's cost of capital?

Accepted Answer

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 valueF) A) and B)
G) B) and D)

Question 20

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?

Accepted Answer

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 proposalF) A) and C)
G) A) and E)

Exam 12: Cost of Capital

The computation of which one of the following requires assigning every proposed investment to a particular risk class?

Correct Answer
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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?

Correct Answer
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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?

Correct Answer
verified

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?

Correct Answer
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Correct Answer
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Which one of the following statements is accurate for a levered firm?

Correct Answer
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Correct Answer
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Correct Answer
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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?

Correct Answer
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Correct Answer
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Correct Answer
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Birds and Yards has 10-year bonds outstanding that carry an annual coupon of 8 percent. The bonds mature in 7 years and are currently priced at 108.4 percent of face value. What is the firm's pre-tax cost of debt?

Correct Answer
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The cost of capital for a project depends primarily on which one of the following?

Correct Answer
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Correct Answer
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When using the pure play approach for a proposed investment, a firm is primarily seeking a rate of return which:

Correct Answer
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Which one of the following is the primary determinant of an investment's cost of capital?

Correct Answer
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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

Correct Answer
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Correct Answer
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A firm wants to create a weighted average cost of capital (WACC) of 10.4 percent. The firm's cost of equity is 14.5 percent and its pre-tax cost of debt is 8.5 percent. The tax rate is 34 percent. What does the debt-equity ratio need to be for the firm to achieve its target WACC?

Correct Answer
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Which one of the following statements is correct, all else held constant?

Correct Answer
verified

Exam 12: Cost of Capital

The computation of which one of the following requires assigning every proposed investment to a particular risk class?

Correct AnswerverifiedShow Answer

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?

Correct AnswerverifiedShow Answer

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?

Correct AnswerverifiedShow Answer

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?

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Which one of the following statements is accurate for a levered firm?

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

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?

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Birds and Yards has 10-year bonds outstanding that carry an annual coupon of 8 percent. The bonds mature in 7 years and are currently priced at 108.4 percent of face value. What is the firm's pre-tax cost of debt?

Correct AnswerverifiedShow Answer

The cost of capital for a project depends primarily on which one of the following?

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

When using the pure play approach for a proposed investment, a firm is primarily seeking a rate of return which:

Correct AnswerverifiedShow Answer

Which one of the following is the primary determinant of an investment's cost of capital?

Correct AnswerverifiedShow Answer

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

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

A firm wants to create a weighted average cost of capital (WACC) of 10.4 percent. The firm's cost of equity is 14.5 percent and its pre-tax cost of debt is 8.5 percent. The tax rate is 34 percent. What does the debt-equity ratio need to be for the firm to achieve its target WACC?

Correct AnswerverifiedShow Answer

Which one of the following statements is correct, all else held constant?

Correct AnswerverifiedShow Answer

Correct Answer
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