Dr. Sudhakar Raju Financial Statements Analysis (FN 6450) PRACTICE EXAM QUESTIONS ON WACC 1. The return shareholders require on their investment in a firm is called the: a. dividend yield. B. cost of equity. c. capital gains yield. d. cost of capital. e. income return.
2. The cost of capital: a. will decrease as the risk level of a firm increases. b. is primarily dependent upon the source of the funds used for a project. c. implies a project will produce a positive net present value only when the rate of return on the project is less than the predetermined cost of capital. d. remains constant for all projects undertaken by the same firm. E. depends on how the funds are going to be utilized.
3. Which of the following statements are correct concerning the security market line (SML) approach to determining the cost of equity for a firm? I. The SML approach considers the amount of unsystematic risk associated with a firm. II. The SML approach can be applied to more firms than the dividend growth model can. III. The SML approach considers only future information. IV. The SML approach assumes the reward-to-risk ratio is constant. a. I and III only B. II and IV only c. III and IV only d. I, II, and III only e. I, II, III, and IV
4. The pre-tax cost of debt for a firm: A. is based on the yield to maturity on the firm's outstanding bonds. b. is equal to the coupon rate for the latest bond issue. c. is equivalent to the current yield on the outstanding bonds of the firm. d. is based on the yield to maturity that existed when the currently outstanding bonds were originally issued. e. has to be estimated as it cannot be directly observed in the market.
5. The capital structure weights used in computing the weighted average cost of capital: a. are based on the book values of total debt and total equity. B. are based on the market value of the firm's debt and equity securities. c. are computed using the book value of the long-term debt and the book value of equity. d. remain constant over time unless the firm issues new securities. e. are restricted to the firm's debt and common stock.
6. DTK, Inc. uses both preferred and common stock as well as long-term debt to finance its operations. An increase in which one of the following will increase the capital structure weight of debt, all else equal? a. market price of the common stock b. number of shares of preferred stock outstanding c. book value of the outstanding shares of common stock D. number of bonds outstanding e. number of shares of stock outstanding
7. The weighted average cost of capital for a firm is the: a. discount rate which the firm should apply to all of the projects it undertakes. B. rate of return a firm must earn on its existing assets to maintain the current value of its stock. c. coupon rate the firm should expect to pay on its next bond issue. d. maximum rate which the firm should require on any projects it undertakes. e. required rate which every project's internal rate of return must exceed. 8. Which one of the following statements is correct concerning the weighted average cost of capital (WACC)? A. The WACC may decrease as a firm's debt-equity ratio increases. b. When computing the WACC, the weight assigned to the preferred stock is based on the coupon rate multiplied by the par value of the stock. c. A firm's WACC will decrease as the corporate tax rate decreases. d. The weight of the common stock used in the computation of the WACC is based on the number of shares outstanding multiplied by the book value per share. e. The WACC will remain constant unless a firm retires some of its debt.
9. Flotation costs should: a. be ignored when analyzing a project because flotation costs are not an actual cost of the project. b. be averaged over the life of the project thereby reducing the cash flows for each year of the project. c. only be considered when two projects have the same net present value. D. be included in the initial cost of a...
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