Finance – Chapter 9

The ___ is the rate of return that a firm must earn on its investments in order to maintain the market value of its stock cost of capital
The ____ is the rate of return required by the market suppliers of capital in order to attract their funds to the firm cost of capital
The cost of capital reflects the cost of funds over a long run time period
Although a firms existing mix of financing sources may reflect its target capital structure, it is ultimately the marginal cost of capital that is relevant for evaluating the firms future investment opportunities
The ____ is a weighted average of the cost of funds which reflects the interrelationship of financing decisions cost of capital
The ____ is the firms desired optimal mix of debt and equity financing target capital structure
The cost of a firm of each type of capital is dependent upon the risk free rate of each type of capital plus the business risk and the financial risk of the firm
In order to recognize the interrelationship between financing and investments, a firm should use _____ when evaluating an investment the weighted average cost of all financing sources
The four basic sources of long term funds for a firm are long term debt, common stock, preferred stock, and retained earnings
Which of the following is true of long term debts? they are the sources that supply the financing necessary to support a firms capital budgeting activities
Which of the following is a source of long term funds retained earnings
Generally the order of cost, from the least expensive to the most expensive, for long term capital of a corporation is long term debt, preferred stock, retained earnings, new common stock
Generally the least expensive source of long term capital is long term debt
A tax adjustment must be made in determining the cost of long term debt
The ____ from the sale of a security are the funds actually received form the sale after ___ net proceeds; reducing the flotation costs
The approximate before tax cost of debt for a 15 year, 10%, $1000 par value bond selling at $950 is 10.7%
The approximate before tax cost of debt for a 10 year, 8%, $1000 par value bond selling at $1150 is 5.97%
The before tax cost of debt for a firm which has a marginal tax rate of 40% is 12%. The after tax cost of debt is 7.2%
The specific cost of each source of long term financing is based on _____ and _____ costs after tax; current
When determining the after tax cost of a bond, the face value of the issue must be adjusted to the net proceeds amounts by considering the flotation costs
If a corporation has an average tax rate of 40% the approximate annual after tax cost of debt for a 15 year, 12% $1000 par value bond selling at $950 is 7.7%
If a corporation has an average tax rate of 40% the approximate annual after tax cost of debt for a 10 year, 8% $1000 par value bond selling at $1150 is 3.6%
The approximate after tax cost of debt for a 20 year 7% $1000 par value bond selling at $960 (40% tax rate) is 4.43%
Debt is generally the least expensive source of capital. This is primarily due to the tax deductibility of interest payments
Nico Trading Corporation is considering issuing long term debt. The debt would have a 30 year maturity and a 10% coupon rate. In order to sell the issue the bonds must be underpriced at a discount of 5% of face value. In addition the firm would have to pay flotation costs of 5% of face value. The firms tax rate is 35%. Given this information, the after tax cost of debt would be 7.26%
Tangshan Mining is considering issuing long term debt. The debt would have a 30 year maturity and a 12% coupon rate and make semiannual coupon payments. In order to sell the issue the bonds must be underpriced at a discount of 2.5% of face value. In addition the firm would have to pay flotation costs of 2.5% of face value. The firms tax rate is 33%. Given this information, the after tax cost of debt would be 8.48%
What is the dividend on an 8% preferred stock that currently sells for $45 and has a face value of $50 per share $4
A firm has issued 10% preferred stock, which sold for $100 per share par value. The cost of issuing and selling the stock was $2 per share. The firms marginal tax rate is 40%. The cost of the preferred stock is 10.2%
A firm has issued preferred stock at its $125 per share par value. The stock will pay a $15 annual dividend. The cost of issuing and selling the stock was $4 per share. The cost of the preferred stock is 12.4%
A firm has determined it can issue preferred stock at $115 per share par value. The stock will pay a $12 annual dividend. The cost of issuing and selling the stock is $3 per share. The cost of the preferred stock is 10.7%
Tangshan Mining is considering issuing preferred stock. The preferred stock would have a par value of $75 and a 5.5% dividend. What is the cost of preferred stock for Tangshan if flotation costs would amount to 5.5% of par value? 5.82%
The cost of common stock equity is the rate at which investors discount the expected dividends of the firm to determine its share value
The cost of common stock equity may be estimated using the gordon model
The cost of common stock equity may be estimated using the capital asset pricing model (CAPM)
The cost of retained earnings is equal to the cost of common stock equity
A corporation has concluded that its financial risk premium is too high. In order to decrease this, the firm can increase the proportion of common stock equity to decrease financial risk
The constant growth valuation model is based on the premise that the value of a share of common stock is equal to the present value of all expected future dividends
In calculating the cost of common stock equity, the model which describes the relationship between the required return and the nondiversifiable risk of the firm is the capital asset pricing model
A firm has a beta of 1.2. The market return equals 14% and the risk free rate of return is 6%. The estimated cost of common stock equity is 15.6%
One major expense associated with issuing new shares of common stock is underpricing
One of the circumstances in which the Gordon growth valuation model for estimating the value of a share of stock should be used is a steady growth rate in dividends
A firm has common stock with a market price of $25 per share and an expected dividend of $2 per share at the end of the coming year. The growth rate in dividends has been 5%. The cost of the firms common stock equity is 13%
A firm has common stock with a market price of $55 per share and an expected dividend of $2.81 over share at the end of the coming year. The dividends paid on the outstanding stock over the past five years are as follows: Year 1: $2Year 2: $2.14Year 3: $2.29Year 4: $2.45Year 5: $2.62The cost of the firms common stock equity is 12.1%
Using the CAPM, the cost of common stock equity is the return required by investors as compensation for a firms nondiversifiable risk
A firm has common stock with a market price of $100 per share and an expected dividend of $5.61 per share at the end of the coming year. A new issue of common stock is expected to be sold for $98 with $2 representing the underpricing necessary in the competitive capital market. Flotation costs are expected to total $1 per share. The dividends paid on the outstanding stock over the past five years are as follows: Year 1: $4Year 2: $4.28Year 3: $4.58Year 4: $4.90Year 5: $5.24The cost of this new issue of common stock is 12.8%
In comparing the constant growth model and the CAPM to calculate the cost of common stock equity the CAPM directly considers risk as reflected in the beta while the constant growth model uses the market price as a reflection of the expected risk return preference of investors
In calculating the cost of common stock equity the use of the constant growth valuation model is often preferred because the data required are more ready available
Given that the cost of common stock is 18%, dividends are $1.50 and the price of the stock is $12.50 what is the annual growth rate of dividends? 6%
What would be the cost of new common stock equity for Tangshan Mining if the firm just paid a dividend of $4.25 the stock price is $55 dividends are expected to grow at 8.5% and flotation costs are $6.25 per share? 17.22%
What would be the cost of retained earnings equity for Tangshan Mining if the expected return on US treasury bills is 5% the market risk is 10% and the firms beta is 1.3? 18%
The cost of new common stock financing is higher than the cost of retained earnings due to flotation costs and underpricing
Since retained earnings are viewed as a fully subscribed issue of additional common stock, the cost of retained earnings is less than the cost of new common stock equity
Which of the following is a reason for a firm to underprice new issues when the market is in equilibrium, additional demand for shares can be achieved only at a lower price
The weights used in WACC must be nonnegative
The preferred capital structure weights to be used in the WACC are target weights
A firm as determined its cost of each source of capital and optimal capital structure, which is composed of the following sources and target market value proportions: Long term debt: 40% * 6%Preferred stock: 10% * 11%Common stock: 50% * 15%The WACC is 11%
A firm has determined its cost of each source of capital and optimal capital structure, which is composed of the following and current market value proportions: Long term debt: 45% * 5%Preferred stock: 10% * 14%Common stock: 45% * 22%Other things remaining constant, if the firm were to shift toward a capital structure with ______ the WACC will be higher. 20% long term60% common stock20% preferred stock
As the need for capital increases beyond the optimum capital structure, the cost of debt of financing will ____ the firms WACC increase, raising
When discussing weighing schemes for calculating WACC, market value weights are preferred over book value weights and target weights are preferred over historical weights
The firms before tax cost of debt is (Table 9.1) 7.8%
The firms after tax cost of debt is (Table 9.1) 4.67%
The firms cost of preferred stock is (Table 9.1) 13.9%
The firms cost of a new issue of common stock is (Table 9.1) 14.2%
The firms cost of retained earnings is (Table 9.1) 13.7%
The WACC up to the point when retained earnings are exhausted is (Table 9.1) 11.9%
If the target market proportion is reduced to 15%, what will be the revised WACC? (Table 9.1) 12.34%
The firms before tax cost of debt is (Table 9.2) 7.7%
The firms after tax cost of debt is (Table 9.2) 4.6%
The firms cost of a new issue of common stock is (Table 9.2) 19.2%
The firms cost of retained earnings is (Table 9.2) 18.9%
The WACC up to the point when retained earnings are exhausted is (Table 9.2) 9.44%
Assuming the firm plans to pay out all of its earnings as dividends, the WACC is 10.44%
Given this after tax cost of each source of capital, the WACC using book weights for general talc mines is (Table 9.3) 15.5%
The WACC using market value weights is (Table 9.3) 15.8%

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