Answer Options:
a. True
b. False
Answer: a. True
Question: If a stock’s expected return as seen by the marginal investor exceeds this investor’s required return, then the investor will buy the stock until its price has risen enough to bring the expected return down to equal the required return.
Answer Options:
a. True
b. False
Answer: a. True
Question: The cost of debt is equal to one minus the marginal tax rate multiplied by the average coupon rate on all outstanding debt.
Answer Options:
a. True
b. False
Answer: False
Question: Companies can issue different classes of common stock. Which of the following statements concerning stock classes is CORRECT? a. All common stocks fall into one of three classes: A, B, and C. b. All common stocks, regardless of class, must have the same voting rights. c. All firms have several classes of common stock. d. All common stock, regardless of class, must pay the same dividend. e. Some class or classes of common stock are entitled to more votes per share than other classes.
Answer Options:
a. All common stocks fall into one of three classes: A, B, and C.
b. All common stocks, regardless of class, must have the same voting rights.
c. All firms have several classes of common stock.
d. All common stock, regardless of class, must pay the same dividend.
e. Some class or classes of common stock are entitled to more votes per share than other classes.
Answer: e. Some class or classes of common stock are entitled to more votes per share than other classes.
Question: For capital budgeting and cost of capital purposes, the firm should always consider retained earnings as the first source of capital (i.e., use these funds first) because retained earnings have no cost to the firm.
Answer Options:
a. True
b. False
Answer: False
Question: When estimating the cost of equity by use of the DCF method, the single biggest potential problem is to determine the growth rate that investors use when they estimate a stock’s expected future rate of return. This problem leaves us unsure of the true value of rs.
Answer Options:
a. True
b. False
Answer: True
Question: Funds acquired by the firm through retaining earnings have no cost because there are no dividend or interest payments associated with them, and no flotation costs are required to raise them, but capital raised by selling new stock or bonds does have a cost.
Answer Options:
a. True
b. False
Answer: False
Question: When estimating the cost of equity by use of the bond-yield-plus-risk-premium method, we can generally get a good idea of the interest rate on new long-term debt, but we cannot be sure that the risk premium we add is appropriate. This problem leaves us unsure of the true value of rs.
Answer Options:
a. True
b. False
Answer: True
Question: Which of the following statements is CORRECT?
Answer Options:
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: e
Question: The cost of debt is equal to one minus the marginal tax rate multiplied by the average coupon rate on all outstanding debt.
Answer Options:
a. True
b. False
Answer: b. False
Question: If a typical U.S. company correctly estimates its WACC at a given point in time and then uses that same cost of capital to evaluate all projects for the next 10 years, then the firm will most likely
Answer Options:
a. become riskier over time, but its intrinsic value will be maximized.
b. become less risky over time, and this will maximize its intrinsic value.
c. accept too many low-risk projects and too few high-risk projects.
d. become more risky and also have an increasing WACC. Its intrinsic value will not be maximized.
e. continue as before, because there is no reason to expect its risk position or value to change over time as a result of its use of a single cost of capital.
Answer: c
Question: Preferred stock is a hybrid—a sort of cross between a common stock and a bond—in the sense that it pays dividends that normally increase annually like a stock but its payments are contractually guaranteed like interest on a bond.
Answer Options:
a. True
b. False
Answer: b. False
Question: When working with the CAPM, which of the following factors can be determined with the most precision?
Answer Options:
a. The market risk premium (RPM).
b. The beta coefficient, bi, of a relatively safe stock.
c. The most appropriate risk-free rate, RRF.
d. The expected rate of return on the market, rM.
e. The beta coefficient of “the market,” which is the same as the beta of an average stock.
Answer: e