公司理财精要第十二章题库.doc

Chapter 12 - Cost of CapitalChapter 12Cost of Capital Multiple Choice Questions1.Katie owns 100 shares of ABC stock. Which one of the following terms is used to refer to the return that Katie and the other shareholders require on their investment in ABC?A.Weighted average cost of capitalB.Pure play costC.Cost of equityD.Subjective costE.Cost of debt2.Lester lent money to The Corner Store by purchasing bonds issued by the store. The rate of return that he and the other lenders require is referred to as the:A.pure play cost.B.cost of debt.C.weighted average cost of capital.D.subjective cost.E.cost of equity.3.The weighted average cost of capital is defined as the weighted average of a firms:A.return on its investments.B.cost of equity and its aftertax cost of debt.C.pretax cost of debt and equity securities.D.bond coupon rates.E.dividend and capital gains yields.4.Farmers Supply, Inc. is considering opening a clothing store, which would be a new line of business for the firm. Management has decided to use the cost of capital of a similar clothing store as the discount rate that should be used to evaluate this proposed expansion. Which one of the following terms is used to describe the approach Farmers Supply is taking to establish an appropriate discount rate for the project?A.Equity approachB.Aftertax approachC.Subjective approachD.Market playE.Pure play approach5.Kate is the CFO of a major firm and has the job of assigning discount rates to each project that is under consideration. Kates method of doing this is to assign an incrementally higher rate as the risk level of the project increases over that of the current firm. Likewise, she assigns lower rates as the risk level declines. Which one of the following approaches is Kate using to assign the discount rates?A.Pure play approachB.Divisional ratingC.Subjective approachD.Straight WACC approachE.Equity rating6.Ted is trying to decide what cost of capital he should assign to a project. Which one of the following should be his primary consideration in this decision?A.Amount of debt used to finance the projectB.Use, or lack thereof, of preferred stock to finance the projectC.Mix of funds used to finance the projectD.Risk level of the projectE.Length of the projects life7.Black Stone Furnaces wants to build a new facility. The cost of capital for this investment is primarily dependent upon which one of the following?A.Firms overall source of fundsB.Source of the funds used to build the facilityC.Current tax rateD.The nature of the investmentE.Firms historical average rate of return8.Which one of the following statements is correct related to the dividend growth model approach to computing the cost of equity?A.The rate of growth must exceed the required rate of return.B.The rate of return must be adjusted for taxes.C.The annual dividend used in the computation must be for year one if you are using todays stock price to compute the return.D.The cost of equity is equal to the return on the stock plus the risk-free rate.E.The cost of equity is equal to the return on the stock multiplied by the stocks beta.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 firms WACC?A.12.4 percent because it is lower than 18.7 percentB.18.7 percent because it is higher than 12.4 percentC.The arithmetic average of 12.4 percent and 18.7 percentD.The arithmetic average of 12.4 percent, 13.5 percent, and 18.7 percentE.13.5 percent10.Which of the following features are advantages of the dividend growth model?I. easy to understandII. model simplicityIII. constant dividend growth rateIV. models applicability to all common stocksA.II onlyB.I and III onlyC.II and IV onlyD.I and II onlyE.I, II, and III only11.Which of the following are weaknesses of the dividend growth model?I. market risk premium fluctuationsII. lack of dividends for some firmsIII. reliance on historical betaIV. sensitivity of model to dividend growth rateA.II onlyB.I and II onlyC.I and III onlyD.II and IV onlyE.I, II, III, and IV12.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 rateB.Equals the market rate of return for all stocksC.Has a maximum cost equal to the market rate of returnD.Decreases as the beta of the firms stock increasesE.Increases in direct relation to the stocks systematic risk13.Which of the following will increase the cost of equity for a firm with a beta of 1.1?I. decrease in the securitys betaII. decrease in the market risk premiumIII. decrease in the risk-free rateIV. increase in the risk-free rateA.II onlyB.III onlyC.I and II onlyD.II and III onlyE.I and IV only14.Which one of the following will increase the cost of equity, all else held constant?A.Increase in the dividend growth rateB.Decrease in betaC.Decrease in future dividendsD.Increase in stock priceE.Decrease in market risk premium15.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 firms outstanding debtII. decrease in the yield to maturity of the firms outstanding debtIII. increase in the firms tax rateIV. decrease in the firms tax rateA.I onlyB.I and III onlyC.I and IV onlyD.II and III onlyE.II and IV only16.Which one of the following is the pre-tax cost of debt?A.Average coupon rate on the firms outstanding bondsB.Coupon rate on the firms latest bond issueC.Weighted average yield-to-maturity on the firms outstanding debtD.Average current yield on the firms outstanding debtE.Annual interest divided by the market price per bond for the latest bond issue17.Which one of the following will decrease the aftertax cost of debt for a firm?A.Decrease in the firms betaB.Increase in tax ratesC.Increase in the risk-free rate of returnD.Decrease in the market price of the debtE.Decrease in a bonds yield-to-maturity18.All else constant, an increase in a firms cost of debt:A.could be caused by an increase in the firms tax rate.B.will result in an increase in the firms cost of capital.C.will lower the firms weighted average cost of capital.D.will lower the firms cost of equity.E.will increase the firms capital structure weight of debt.19.The cost of preferred stock:A.increases when a firms tax rate decreases.B.is constant over time.C.is unaffected by changes in the market price.D.is equal to the stocks 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 firms weighted average cost of capital.B.The cost of preferred stock is unaffected by the issuers 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.21.Which one of the following will affect the capital structure weights used to compute a firms weighted average cost of capital?A.Decrease in the book value of a firms equityB.Decrease in a firms tax rateC.Increase in the market value of the firms common stockD.Increase in the market risk premiumE.Increase in the firms beta22.The aftertax cost of which of the following are affected by a change in a firms tax rate?I. preferred stockII. debtIII. equityIV. capitalA.I and III onlyB.II and IV onlyC.I, II, and IV onlyD.II, III, and IV onlyE.I, II, III, and IV23.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 firms cost of capital.D.A decrease in a firms debt-equity ratio will decrease the firms cost of capital.E.The cost of preferred stock decreases when the tax rate increases.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 equityB.Internal rate of returnC.Aftertax cost of debtD.Weighted average cost of capitalE.Debt-equity ratio26.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 firms WACC will decrease whenever the firms tax rate decreases.C.An increase in the market risk premium will decrease a firms WACC.D.The subjective approach totally ignores a firms own WACC.E.A reduction in the risk level of a firm will tend to decrease the firms 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 firms WACC will increase the attractiveness of the firms 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 lines 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 firms weighted average cost of capital?A.Increasing the firms tax rateB.Issuing new bonds at parC.Redeeming shares of common stockD.Increasing the firms betaE.Increasing the debt-equity ratio29.All else constant, the weighted average cost of capital for a risky, levered firm will decrease if:A.the firms 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 firms 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 firms WACC as the cost of capital for division Z as it provides analysis for the entire firm.D.use the firms 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.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 divisions 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 Kurts 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.Kurts division is less risky than the other divisions.E.Kurts 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 investments cost of capital?A.Life of investmentB.Initial cash outlayC.Level of riskD.Source of funds used for the investmentE.Investments net present value35.The cost of capital for a project depends primarily on which one of the following?A.Source of funds used for the projectB.Division within the firm that undertakes the projectC.Projects modified internal rate of returnD.How the project uses its fundsE.Projects fixed costs36.Marine Expeditors has three divisions. Division A is the core of the business and represents 80 percent of the firms 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 firms weighted average cost of capital.A.40B.60C.80D.100E.11037.Which one of the following is most apt to cause a wise manager to increase a projects 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 projects 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 capitalB.Ace Builders cost of capitalC.Average of Boone Brothers and Ace Builders cost of capitalD.Lower of Boone Brothers or Ace Builders cost of capitalE.Higher of Boone Brothers or Ace Builders cost of capital39.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 sizeB.Firm locationC.Firm experienceD.Firm operationsE.Firm management40.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 investments internal rate of return.E.best matches the risk level of the proposed investment.41.Dereks 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 onlineB.A wholesale toy distributorC.A toy store that only sells onlineD.The oldest online retailer of any productE.Dereks own store42.Kellys uses the firms 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 betaB.Date for project commencementC.Risk level of projectD.Division within the firm that will be assigned to manage the projec