Answer Choices:
a. Long-term debt.
b. Accounts payable.
c. Retained earnings.
d. Common stock.
e. Preferred stock.
Answer:
b. Accounts payable
Question: The higher the firm’s flotation cost for new common equity, the more likely the firm is to use preferred stock, which has no flotation cost, and retained earnings, whose cost is the average return on the assets that are acquired.
Answer Choices:
a. True
b. False
Answer:
b. False
Question: A detachable warrant is a warrant that can be removed from the security with which it was issued and traded separately from it. Most traded warrants are originally attached to bonds or preferred stocks.
Answer:
Options:
Question: Other things held constant, the higher a firm’s total debt to total capital ratio (measured as (Short-term debt + Long-term debt)/(Debt + Preferred stock + common equity)), the higher its TIE ratio will be.
Answer:
Options
Question: Which of the following statements is CORRECT?
Answer Choices:
a. In the WACC calculation, we must adjust the cost of preferred stock (the market yield) to reflect the fact that 70% of the dividends received by corporate investors are excluded from their taxable income.
b. We should use historical measures of the component costs from prior financings that are still outstanding when estimating a company’s WACC for capital budgeting purposes.
c. The cost of new equity (rₑ) could possibly be lower than the cost of retained earnings (rₛ) if the market risk premium, risk-free rate, and the company’s beta all decline by a sufficiently large amount.
d. Its cost of retained earnings is the rate of return stockholders require on a firm’s common stock.
e. The component cost of preferred stock is expressed as rₚ(1 − T), because preferred stock dividends are treated as fixed charges, similar to the treatment of interest on debt.
Answer:
Options:
Question: The “preferred” feature of preferred stock means that it normally will provide a higher expected return than will common stock.
Answer:
Options:
Question: Which of the following statements is CORRECT?
Answer Choices:
a. Since the costs of internal and external equity are related, an increase in the flotation cost required to sell a new issue of stock will increase the cost of retained earnings.
b. Since its stockholders are not directly responsible for paying a corporation’s income taxes, corporations should focus on before-tax cash flows when calculating the WACC.
c. An increase in a firm’s tax rate will increase the component cost of debt, provided the YTM on the firm’s bonds is not affected by the change in the tax rate.
d. When the WACC is calculated, it should reflect the costs of new common stock, retained earnings, preferred stock, long-term debt, short-term bank loans if the firm normally finances with bank debt, and accounts payable if the firm normally has accounts payable on its balance sheet.
e. If a firm has been suffering accounting losses that are expected to continue into the foreseeable future, and therefore its tax rate is zero, then it is possible for the after-tax cost of preferred stock to be less than the after-tax cost of debt.
Answer:
Options:
Question: Preferred stock typically has a par value, and the dividend is often stated as a percentage of par. The par value is also important in the event of liquidation, as the preferred stockholders are generally entitled to receive the par value before anything is given to the common stockholders.
Answer:
Options:
Question: Suppose you are analyzing two firms in the same industry. Firm A has a profit margin of 10% versus a profit margin of 8% for Firm B. Firm A’s total debt to total capital ratio (measured as (Short-term debt + Long-term debt)/(Debt + Preferred stock + Common equity)) is 70% versus one of 20% for Firm B. Based only on these two facts, you cannot reach a conclusion as to which firm is better managed, because the difference in debt, not better management, could be the cause of Firm A’s higher profit margin.
Answer:
Options
Question: The constant growth DCF model used to evaluate the prices of common stocks is conceptually similar to the model used to find the price of perpetual preferred stock or other perpetuities.
Answer:
Options for Question 10: