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-time period. |

The cost of each type 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. |

Treasury Bill | is equal to the value of the risk free rate of return |

The cost of capital is a weighted average of the | cost of funds which reflects the interrelationship of financing decisions. |

THe four basic sources of long-term funds for the business firm are | 1. long-term debt2. preferred stock3. retained earnings 4. new common stock |

A tax adjustment must be made in | determining 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 dividend is fixed |

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

Retained earnings is whatever is | not handed out as dividends income. |

The cost of common stock equity may be estimated by | using the Godron 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 stockholders’ funds. |

The cost of new common stock financing is higher than the cost of retained earnings due to | (1) flotation costs and (2) 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 | 110 PMT950 PV15 N1000 FVCMPT I/Y = 11.79% |

A firm has issued preferred stock at its $120 per share par value. The Stock will pay a $15 annual dividend. 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 commons 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 selecting 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 exact amount of time it takes the firm to revere its initial investment | The payback period |

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

How do you find the NPV | subtract a project’s initial investment from the present value of its cash inflows discounted at a rate equal to the firm’s cost of capital. |

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

Comparing (?) and (?) always results in the same accept/reject decision | The net present value and the internal rate of return |

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

In comparing the IRR and NPV methods of evaluation, | NPV is superior but financial managers prefer to use the IRR |

Profitability Index (PI) is | the PV of cash flows divided by initial cash outflows. |

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

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

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

Cash flows that could be realized from the best alternative use of an owned asset | opportunity costs |

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 variability 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. |

is the preferred approach for risk adjustment of capital budgeting cash flows, from a practical viewpoint | RADR |

Important types of risk in an international capital budgeting context include | exchange rate risk, and political risk |

The annualized NPV approach is used to | convert the NPV of unequal-lived projects into an equivalent annual amount. |

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