Business Finance Test Chapter 12

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 debt C- Cost of equity
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. B- cost of debt.
The weighted average cost of capital is defined as the weighted average of a firm’s:A- return on all of its investments.B- cost of equity, cost of preferred, and its aftertax cost of debt.C-cpretax cost of debt and its preferred and common equity securities.D- bond coupon rates.E- common and preferred stock. B- cost of equity, cost of preferred, and its aftertax cost of debt.
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, of preferred stock as a financing optionC- Mix of funds used to finance the projectD- Risk level of the projectE- Length of the project’s life D- Risk level of the project
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 1 if you are Time 0’s 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 stock’s beta. C- The annual dividend used in the computation must be for Year 1 if you are Time 0’s stock price to compute the return.
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 firm’s weighted average cost of capital (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 percent C- The arithmetic average of 12.4 percent and 18.7 percent
The results of the dividend growth model:A- vary directly with the market rate of return.B- can only be applied to projects that have a growth rate equal to that of the current firm.C- are highly dependent upon the beta used in the model.D- are sensitive to the rate of dividend growth.E- are most reliable when the growth rate exceeds 10 percent. D- are sensitive to the rate of dividend growth.
In an efficient market, the cost of equity for a highly risky firm:A- will be less than the market rate but higher than the risk-free rate.B- must equal the market rate of return.C- changes by 1 percent for every 1 percent change in the risk-free rate.D- decreases as the beta of the firm’s stock increases.E- increases in direct relation to the stock’s systematic risk. E- increases in direct relation to the stock’s systematic risk.
Assume a firm has a beta of 1.2. All else held constant, the cost of equity for this firm will increase if the: A- market risk premium decreases.B- risk-free rate decreases.C- market rate of return decreases.D- beta decreases.E- either the risk-free rate or the market rate of return decreases. B- risk-free rate decreases.
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 premium A- Increase in the dividend growth rate
Which one of the following will decrease the aftertax cost of debt for a firm?A- Decrease in the firm’s betaB- Increase in tax ratesC- Increase in the risk-free rate of returnD- Decrease in the market price of the debtE- Increase in a bond’s yield to maturity B- Increase in tax rates
All else constant, an increase in a firm’s cost of debt:A- could be caused by an increase in the firm’s tax rate.B- will result in an increase in the firm’s cost of capital.C- will lower the firm’s weighted average cost of capital.D- will lower the firm’s cost of equity.E- will increase the firm’s capital structure weight of debt. B- will result in an increase in the firm’s cost of capital.
Which one of the following represents the minimum 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- Pretax cost of debtC- Aftertax cost of debtD- Weighted average cost of capitalE- Weighted average cost of preferred and common stock D- Weighted average cost of capital
Which statement 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 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 applicable only to firms that issue both common and preferred stock. B- A decrease in a firm’s WACC will increase the attractiveness of the firm’s investment options.
A firm has a cost of equity of 13 percent, a cost of preferred of 11 percent, an aftertax cost of debt of 5.2 percent, and a tax rate of 35 percent. Given this, which one of the following will increase the firm’s weighted average cost of capital?A- Increasing the firm’s tax rateB- Issuing new bonds at parC- Redeeming shares of common stockD- Increasing the firm’s betaE- Increasing the debt-equity ratio D- Increasing the firm’s beta
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 recommend only 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 among its divisions. A- automatically gives preferential treatment in the allocation of funds to its riskiest division.
Which one of the following is the primary determinant of an investment’s cost of capital?A- Life of the investmentB- Amount of the initial cash outlayC- The investment’s level of riskD- The source of funds used for the investmentE- The investment’s net present value C- The investment’s level of risk

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