The cost of capital is | the rate of return a firm must earn on its investments in projects in order to maintain the market value of its stock |

The cost of capital reflects | the cost of funds over a long-run time period |

The cost of capital depends on | the risk-free cost of that type of funds, the business risk of the firm and the financial risk of the firm |

The cost of capital is a weighted average of | The cost of funds which refects the interelatioship of financing decisions |

The four basic sources of long-term funds for the business firm are | 1. long-term debt2. preferred stock3. retained earnings4. new common stock |

A tax adjustment | must be made in determening the cost of long-term debt |

Debt is generally the least expensive source of | capital, primarily due to the tax deductibility of interest payments |

The yield to maturity is | a market determined rate and can be found by examining the relationships of security price, periodic interest payments, maturity value, and length of time to maturity |

Preferred stock | is similar to debt in that the preferred dividen is fixed |

The firm’s ability to acquire equity capital is through | retained earnings or through new common stock |

The cost of common stock equity may be estimated by using the | Gordon model or the capital asset pricing model (CAPM) |

The cost of retained earnings can be explained as | an opportunity cost for the use of the stock holders’ funds |

The cost of new common stock financing is higher than the cost of retained earnings due to | flotation costs and underpricing |

The firm’s optimal mix of debt and equity is called | its target capital structure |

The optimal capital structure is the one that balances return and risk factors in order to | maximize market value |

The before-tax cost of debt for a 15-year, 11 percent coupon rate, $1,000 par value bond selling at $950 is | 15 11I/Y $1,000PV CPT PMT =11.72% |

A firm has issued preferred stock at its $120 per share par value. The stock will pay a $15 annual dividened. The cost of issuing and selling the stock was $3 per share. The cost of the preferred stock is | 15/(120-3) = 12.82% |

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 4 percent. The cost of the firm’s common stock equity is | (2/25)+.04 =12% |

Capital budgeting is the process of | evaluating and selectiong long-term investments consistent with the firm’s goal of owner wealth maximization |

Earning assets are fixed assets that | provide the basis for the firm’s profit and value |

The most common motive for adding fixed assets to the firm is | Expansion |

Projects that compete with one another, so that the acceptance of one eliminates the others from further consideration are called | Mutually exclusive projects |

A firm with limited dollars available for capital expenditures is subject to | capital rationing |

The payback period is | the exact amount of time it takes the firm to recover its initial investment |

The minimum return that must be earned on a project in order to leave the firm’s value unchanged is | the cost of capital |

Net present Value (NPV) | -is a sophisticated capital budgeting technique -found by subtracting a projects initial investment from the present value of its cash inflows discounted at a rate equal to the firm’s cost of capital |

The internal rate of return (IRR) | the discount rate that equates the present values of the cash inflows with the initial investment |

Comparing net present value and internal rate of return analysis | always results in the same accept/reject decision |

On a purely theoretical basis, the NPV is the better approach to capital budgeting because | it measures the benefits relative to the amount invested |

In comparing the internal rate of return and net present value methods of evaluation, | net present value is superior, but financial managers prefer to use internal rate of return |

The profitability index (PI) | is the present value of cash inflows divided by the initial cash outflow |

The change in net working capital when evaluating a capital budgeting decision | is the change in current assets minus the change in current liabilities |

When evaluating a capital budgeting project, the change in net working capital must be considered as | part of the initial investment |

Sunk costs are cash outlays that had been previously made and have | no effect on the cash flows relevant to a current decision |

Opportunity costs | cash flow that could be realized from the best alternative use of an owned asset |

The book value of an asset is equal to | the original purchase price minus accumulated depreciation |

In the context of capital budgeting, risk refers to | the degree of variablity of the cash inflows |

Sensitivity analysis measures | the risk of a capital budgeting project by estimating the NPVs associated with the optimistic, most likely, and pessimistic cash flow estimates |

Scenario analysis is a behavioral approach that | evaluates the impact on the firm’s return of simultaneous changes in a number of project variables |

The risk-adjusted discount rate (RADR) reflects | -the return that must be earned on the given project to compensate the firm’s owners adequately according to the project’s variability of cash flows-It is the preferred approach for risk adjustment of capital budgeting cash flows, from a practical viewpoint |

Important types of risk in an international capital budgeting context include (2) | 1. exchange rate risk2. political risk |

The annualized net present value approach | is used to convert the net present value of unequal-lived projects into an equivalent annual amount |

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