Business Finance
CHAPTER 9
THE COST OF CAPITAL (Difficulty: E = Easy, M = Medium, and T = Tough)
Multiple Choice: Conceptual
Easy:
Capital components Answer: c Diff: E
[i]. Which of the following is not considered a capital component for the purpose of calculating the weighted average cost of capital (WACC) as it applies to capital budgeting?
a. Long-term debt. b. Common stock. c. Accounts payable and accruals. d. Preferred stock.
Capital components Answer: d Diff: E
[ii]. For a typical firm with a given capital structure, which of the following is correct? (Note: All rates are after taxes.)
a. kd > ke > ks > WACC. b. ks > ke > kd > WACC. c. WACC > ke > ks > kd. d. ke > ks > WACC > kd. e. None of the statements above is correct.
Capital components Answer: a Diff: E
[iii]. Which of the following statements is most correct?
a. If a company’s tax rate increases but the yield to maturity of its noncallable bonds remains the same, the company’s marginal cost of debt capital used to calculate its weighted average cost of capital will fall. b. All else equal, an increase in a company’s stock price will increase the marginal cost of retained earnings, ks. c. All else equal, an increase in a company’s stock price will increase the marginal cost of issuing new common equity, ke. d. Statements a and b are correct. e. Statements b and c are correct.
Capital components Answer: c Diff: E
[iv]. Which of the following statements is most correct?
a. Since the money is readily available, the cost of retained earnings is usually a lot cheaper than the cost of debt financing. b. When calculating the cost of preferred stock, a company needs to adjust for taxes, because preferred stock dividends are tax deductible. c. When calculating the cost of debt, a company needs to adjust for taxes, because interest payments are tax deductible. d.
THE COST OF CAPITAL (Difficulty: E = Easy, M = Medium, and T = Tough)
Multiple Choice: Conceptual
Easy:
Capital components Answer: c Diff: E
[i]. Which of the following is not considered a capital component for the purpose of calculating the weighted average cost of capital (WACC) as it applies to capital budgeting?
a. Long-term debt. b. Common stock. c. Accounts payable and accruals. d. Preferred stock.
Capital components Answer: d Diff: E
[ii]. For a typical firm with a given capital structure, which of the following is correct? (Note: All rates are after taxes.)
a. kd > ke > ks > WACC. b. ks > ke > kd > WACC. c. WACC > ke > ks > kd. d. ke > ks > WACC > kd. e. None of the statements above is correct.
Capital components Answer: a Diff: E
[iii]. Which of the following statements is most correct?
a. If a company’s tax rate increases but the yield to maturity of its noncallable bonds remains the same, the company’s marginal cost of debt capital used to calculate its weighted average cost of capital will fall. b. All else equal, an increase in a company’s stock price will increase the marginal cost of retained earnings, ks. c. All else equal, an increase in a company’s stock price will increase the marginal cost of issuing new common equity, ke. d. Statements a and b are correct. e. Statements b and c are correct.
Capital components Answer: c Diff: E
[iv]. Which of the following statements is most correct?
a. Since the money is readily available, the cost of retained earnings is usually a lot cheaper than the cost of debt financing. b. When calculating the cost of preferred stock, a company needs to adjust for taxes, because preferred stock dividends are tax deductible. c. When calculating the cost of debt, a company needs to adjust for taxes, because interest payments are tax deductible. d.