Exam 500304 cost of capital


1.   What’s the abbreviation for the overall return that   a firm must make on its existing assets, used as the required rate of return   on any investment that has essentially the same risks as existing operations?   







C. CM 




2.   Analysts project Microsoft (MSFT) will have an   annualized dividend of $1.50 and a long-term growth rate of 10 percent.   Currently, the stock price is $60. Using the dividend growth model approach,   what’s the implied cost of equity? 



A. 12.5 percent 


B. 11 percent 


C. 10 percent 


D. 2.5 percent 


3.   New Schools expects an EBIT of $87,000 every year,   forever. The firm currently has no debt, and its cost of equity is 14.6   percent. The firm can borrow at 7.4 percent, and the corporate tax rate is 34   percent. What will the value of the firm be if it converts to 50 percent   debt? 



 A.     $460,146.57 


B. $381,796.47 


C. $377,407.16 


D. $437,552.08


4.   Galaxy Products is comparing two different capital   structures, an all-equity plan (Plan I) and a levered plan (Plan II). Under   Plan I, the company would have 175,000 shares of stock outstanding. Under   Plan II, there would be 90,000 shares of stock outstanding and $1.4 million   in debt. The interest rate on the debt is 7 percent, and there are no taxes.   What’s the break-even EBIT? 



 A.     $201,764.71 


B. $341,414.14 


C. $351,111.11 


D. $287,878.78 



5.   What’s the concept of using debt to make a       return known as? 



A. Debt         reliance 


B. Financial         liquidity 


C. Debt         coverage 


D. Financial leverage 


6.   Because the WACC varies with the use of funds         rather than the source of funds, some firms evaluate new projects by         sorting projects into risk classes, and add or subtract adjustment         factors from the WACC. This approach is called the 



A. DuPont           approach. 


B. divisional           approach. 


C. pure play           approach. 


D. subjective approach. 



7.   According to the static             tradeoff theory, what’s the optimal capital structure? 



A. A firm should borrow up to the               point at which the tax benefit from an extra dollar in debt is               exactly equal to the cost that comes from the increased               probability of financial distress. 


B. A firm should borrow up to the point at which the tax               benefit from an extra dollar is equal to zero. 


C. A firm should have equal parts equity and debt. 


D. A firm should borrow up to the point at which the               interest is equal to the total tax expense. 



8.   Which of the following is not a major         disadvantage to the SML approach? 



A. We rely           on the past to predict the future, and economic conditions can change           quickly. 


B. It           requires that we estimate the market risk premium, and if this           estimate is poor, the resulting cost of equity will also be poor. 


C. It           requires that we estimate the beta coefficient of the stock, and if           this estimate is poor, the resulting cost of equity will also be           poor. 


D. It doesn’t explicitly adjust for risk


9.   Silo Mills is an all-equity financed firm that has a   beta of 1.14 and a cost of equity of 12.8 percent. The risk-free rate of   return is 2.8 percent. The firm is currently considering a project that has a   beta of 1.03 and a project life of six years. What discount rate should be   assigned to this project? 



A. 13.62 percent 


B. 11.84 percent 


C. 13.33 percent 


D. 12.09 percent 



10.   Which of the following is true about a firm   with no equity financing? 



 A. The     after-tax cost of debt = WACC 


B. The return on     equity = WACC 


C. The cost of     debt = WACC 


D. The return on     equity = cost of debt 


11.   A higher debt level usually equates to a 



A. larger tax     shield and decreased financial risk. 


B. smaller tax     shield and increased financial risk. 


C. larger tax shield but increased financial risk. 


D. smaller tax     shield and decreased financial risk. 


12.   Under the Bankruptcy Abuse Prevention and Consumer   Protection Act of 2005, how long after a firm files for bankruptcy protection   do creditors have to wait before submitting their own reorganization plan to   the court? 



A. 18 months 


B. 45 days 


 C. 180 days     


D. 12 months 


13.   Alphabet, Inc. (GOOGL) has a 40 percent debt/asset   ratio; assume a tax rate of 16 percent. The average yield to maturity on   GOOGL’s bonds is 3 percent. Your market analyst estimates that the risk-free   rate is 1 percent and that the market risk premium is 7 percent. The firm’s   beta coefficient is 0.97. What’s Alphabet’s weighted average cost of capital   (WACC)? (Round to the nearest tenth of a percent.) 



A. 6 percent 


B. 5.7 percent 


C. 5.9 percent 


D. 7.3 percent 


14.   The Shoe Outlet has paid annual dividends of $.65,   $.70, $.72, and $.75 per share throughout the last four years, respectively.   The stock is currently selling for $9 a share. What’s this firm’s cost of   equity? 



A. 11.79 percent 


B. 9.53 percent 


C. 13.65 percent 


D. 8.74 percent 


15.   Deep Mines has 14 million shares of common stock   outstanding with a beta of 1.15 and a market price of $42 a share. There are   900,000 shares of 9 percent preferred stock outstanding, valued at $80 a   share. The 10 percent semiannual bonds have a face value of $1,000 and are   selling at 91 percent of par. There are 220,000 bonds outstanding that mature   in 17 years. The market risk premium is 11½ percent, T-bills are yielding 7½   percent, and the firm’s tax rate is 32 percent. What discount rate should the   firm apply to a new project’s cash flows if the project has the same risk as   the firm’s typical project? 



A. 14.72 percent 


B. 13.15 percent 


C. 15.54 percent 


D. 14.59 percent


16.   Hanover Tech is currently an all-equity firm that   has 320,000 shares of stock outstanding with a market price of $19 a share.   The current cost of equity is 15.4 percent, and the tax rate is 34 percent.   The firm is considering adding $1.2 million of debt with a coupon rate of 8   percent to its capital structure. The debt will be sold at par value. What’s   the levered value of the equity? 



A. $5.209 million 


B. $6.708 million 


C. $6.512 million 


D. $5.288 million 


17.   Mulberry, Inc. has a weighted average cost of   capital (ignoring taxes) of 20 percent. It can borrow at 10 percent. Mulberry   has a target ½ debt/equity ratio. Using the M&M Proposition II, what’s   the cost of equity? 



A. 29 percent 


 B. 25     percent 


C. 31 percent 


D. 15 percent 


18.   Flotation costs are the costs associated with 



A. market     inefficiencies. 


B. reporting. 


C. bankruptcy. 


 D. new     stock or bond issues. 


19.   The dividend growth model is used to calculate 



A. the cost of     debt by using the equation for a growing perpetuity, plugging in the     current price of the bond, the coupon, and the expected growth rate and     solving for R(D). 


B. the weighted     average cost of capital by using the equation for a growing perpetuity,     plugging in the current price of the stock, the dividend paid, and the     expected growth rate. Then we solve for R(E). 


C. the cost of equity     by comparing the dividend growth to similar firms. 


 D. the cost of equity by using the equation for a     growing perpetuity, plugging in the current price of the stock, the     dividend paid, and the expected growth rate. Then we solve for R(E). 



20.   Amazon Inc. (AMZN) has 55 percent equity-to-asset   ratio. The average yield to maturity on AMZN’s bonds is 3.2 percent; assume a   tax rate of 30 percent. The firm’s estimated required rate of return on   equity is estimated at about 10.8 percent. What’s Amazon’s weighted average   cost of capital (WACC)? (Round to the nearest tenth of a percent.) 



A. 6.1 percent 


B. 7.3 percent 


C. 6.6 percent 


D. 6.9 percent 

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