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FRL301 ch14
FRL301 Ch 14
| Question | Answer |
|---|---|
| A group of individuals got together and purchased all of the outstanding shares of common stock of DL Smith, Inc. What is the return that these individuals require on this investment called? | Cost of equity Refer to section 14.2 |
| Textile Mills borrows money at a rate of 13.5 percent. This interest rate is referred to as the: | The Cost of Debt Refer to section 14.3 |
| The average of a firm's cost of equity and aftertax cost of debt that is weighted based on the firm's capital structure is called the: | weighted average cost of capital. Refer to section 14.4 |
| When a manager develops a cost of capital for a specific project based on the cost of capital for another firm which has a similar line of business as the project, the manager is utilizing the _____ approach. | B. pure play Refer to section 14.5 |
| A firm's cost of capital: | E. depends upon how the funds raised are going to be spent. Refer to section 14.1 |
| The weighted average cost of capital for a wholesaler: | is the return investors require on the total assets of the firm.Refer to section 14.1 |
| Which one of the following is the primary determinant of a firm's cost of capital? | use of the funds Refer to section 14.1 |
| Scholastic Toys is considering developing and distributing a new board game for children. The project is similar in risk to the firm's current operations. How should the firm determine its cost of equity? | by using the capital asset pricing model.Refer to section 14.2 |
| All else constant, which one of the following will increase a firm's cost of equity if the firm computes that cost using the security market line approach? Assume the firm currently pays an annual dividend of $1 a share and has a beta of 1.2. | a reduction in the risk-free rate.Refer to section 14.2 |
| A firm's overall cost of equity is: | highly dependent upon the growth rate and risk level of the firm.Refer to section 14.2 |
| The cost of equity for a firm: | ignores the firm's risks when that cost is based on the dividend growth model. Refer to section 14.2 |
| The dividend growth model can be used to compute the cost of equity for a firm in which of the following situations? | II. firms that pay a constant dividend III. firms that pay an increasing dividend IV. firms that pay a decreasing dividend |
| The dividend growth model: | is only as reliable as the estimated rate of growth. Refer to section 14.2 |
| Which one of the following statements related to the SML approach to equity valuation is correct? Assume the firm uses debt in its capital structure. | The model is dependent upon a reliable estimate of the market risk premium. Refer to section 14.2 |
| Which of the following statements are correct? | II. The SML approach can be applied to firms that retain all of their earnings. III. The SML approach assumes a firm's future risks are similar to its past risks. IV. The SML approach assumes the reward-to-risk ratio is constant. Refer to section 14.2 |
| The pre-tax cost of debt: | is based on the current yield to maturity of the firm's outstanding bonds.Refer to section 14.3 |
| The aftertax cost of debt generally increases when: | II. the market rate of interest increases. III. tax rates decrease. Refer to section 14.3 |
| The cost of preferred stock is computed the same as the: | return on a perpetuity. Refer to section 14.3 |
| The cost of preferred stock: | is equal to the dividend yield. Refer to section 14.3 |
| The capital structure weights used in computing the weighted average cost of capital: | are based on the market value of the firm's debt and equity securities.Refer to section 14.4 |
| Morris Industries has a capital structure of 55% common stock, 10% preferred stock, and 45% debt. firm has a 60% dividend payout ratio, a beta of 0.89, & a tax rate of 38%. Given this, which one of the following statements is correct? | The firm's cost of equity is unaffected by a change in the firm's tax rate. Refer to section 14.4 |
| The aftertax cost of debt: | has a greater effect on a firm's cost of capital when the debt-equity ratio increases.Refer to section 14.3 |
| The weighted average cost of capital for a firm may be dependent upon the firm's: | I. rate of growth. II. debt-equity ratio. III. preferred dividend payment. IV. retention ratio. Refer to section 14.4 |
| The weighted average cost of capital for a firm is the: | rate of return a firm must earn on its existing assets to maintain the current value of its stock.Refer to section 14.4 |
| Which one of the following statements is correct for a firm that uses debt in its capital structure? | The WACC should decrease as the firm's debt-equity ratio increases. Refer to section 14.4 |
| If a firm uses its WACC as the discount rate for all of the projects it undertakes then the firm will tend to: | reject some positive net present value projects. II. accept some negative net present value projects. III. favor high risk projects over low risk projects. IV. increase its overall level of risk over time. Refer to section 14.4 |
| Markley & Stearns is a multi-divisional firm that uses its WACC as the discount rate for all proposed projects. Each division is in a separate line of business and each presents risks unique to those lines. A division within the firm will tend to | prefer higher risk projects over lower risk projects. Refer to section 14.5 |
| The discount rate assigned to an individual project should be based on: | the risks associated with the use of the funds required by the project. Refer to section 14.5 |
| Assigning discount rates to individual projects based on the risk level of each project: | may cause the firm's overall weighted average cost of capital to either increase or decrease over time. Refer to section 14.5 |
| Which one of the following statements is correct? | A project that is unacceptable today might be acceptable tomorrow given a change in market returns.Refer to section 14.5 |
| The subjective approach to project analysis: | assigns discount rates to projects based on the discretion of the senior managers of a firm.Refer to section 14.5 |
| Which one of the following statements is correct? | Overall, a firm makes better decisions when it uses the subjective approach than when it uses its WACC as the discount rate for all projects.Refer to section 14.5 |
| When a firm has flotation costs equal to 7 percent of the funding need, project analysts should: | increase the initial project cost by dividing that cost by (1 - 0.07). Refer to section 14.6 |
| The flotation cost for a firm is computed as: | the weighted average of the flotation costs associated with each form of financing.Refer to section 14.6 |
| Incorporating flotation costs into the analysis of a project will: | increase the initial cash outflow of the project. Refer to section 14.6 |
| Flotation costs for a levered firm should: | be weighted and included in the initial cash flow.Refer to section 14.6 |
| All else equal, a higher corporate tax rate will | decrease the WACC of a firm with debt and equity in its capital structure. |
| Which one of the following is a disadvantage of the dividend growth model presented in the text for estimating the cost of equity? | The estimated cost of equity computed using the dividend growth model is highly sensitive to the estimated rate. |
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annette1816
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