Cost of Capital

The cost of capital is:

a. used as an evaluation tool
b. based on the present cost obligation's of the firm
c. the cost of long-term investment
d. the cost of maintaining the bureaucrats in Ottawa
a. used as an evaluation tool
One assumption underlying the use of the cost of capital to analyze capital projects is that:

a. current costs will remain the same
b. capital structure will vary with the type of financing
c. different risk projects are required to diversify the firm
d. the analyzed projects are of comparable risk to existing projects
d. the analyzed projects are of comparable risk to existing projects
The cost of debt is measured by:

a. the yield to maturity on the firm's bonds
b. the coupon rate on the firm's bonds
c. the weighted average cost of capital
d. the marginal cost of capital
a. the yield to maturity on the firm's bonds
The aftertax cost of debt is expressed:

a. Kd = Y/k(1-T)
b. Kd = Y(1-T)
c. K = (1-t)/Y
d. K = Y
b. Kd = Y(1-T)
The cost of new preferred stock is determined:

a. by the cost of debt because they are similar
b. by the cost of common stock
c. Dp/Kp = P- F
d. Dp/Kp = Pp
c. Dp/Kp = P- F
The formula for the Capital Asset Pricing Model (CAPM) is:

a. Kj = Rf + b (Rf – Rm)
b. Kj = Rf + b (Rm – Rf)
c. K = R + b (R – M)
d. K = R + b (R – R)
b. Kj = Rf + b (Rm – Rf)
The beta coefficient measures:

a. the return relative to the risk-free rate
b. the return relative to the market return
c. the historical volatility relative to the market's volatility
d. the required return on a financial asset
c. the historical volatility relative to the market's volatility
The cost of retained earnings is equal to:

a. the return on new common stock
b. the return on preferred stock
c. the return on existing common stock
d. It does not have a cost.
c. the return on existing common stock
The least expensive form of financing for the firm is:

a. existing common stock
b. preferred stock
c. debt
d. new common stock
c. debt
A growth firm in a stable industry can normally afford to absorb how much debt relative to a firm in a cyclical industry:

a. more debt
b. less debt
c. about the same amount of debt
d. cannot be determined
a. more debt
In determining the appropriate capital mix, the starting point for the firm is:

a. the cost of common equity
b. the optimum capital structure
c. the present capital structure
d. the after-tax cost of debt
c. the present capital structure
The cost of capital is best calculated with:

a. market value weightings
b. book value weightings
c. Modigliani and Miller weightings
d. It doesn't matter.
a. market value weightings
Financial capital:

a. appears under liabilities and equity on the corporate income statement
b. and the optimum capital structure are the same
c. consists of common stock, preferred stock and retained earnings only
d. consists of stocks, bonds and retained earnings
d. consists of stocks, bonds and retained earnings
Regardless of the type of asset being acquired, the appropriate discount rate is:

a. the aftertax cost of debt
b. the required rate of return
c. the weighted average cost of capital
d. the cost of equity capital
c. the weighted average cost of capital
As more and more funds are required by the firm, the cost of each component of the capital structure may increase. These incremental changes are most correctly referred to as:

a. the weighted average cost of capital
b. the marginal cost of capital
c. the cost of capital
d. the incremental cost of capital
b. the marginal cost of capital
capital asset pricing model (CAPM):
A model that relates the risk-return trade-offs of individual assets to market returns. A security is presumed to receive a risk-free rate of return plus a premium for risk.
capital structure:
The combination or weightings of the different liabilities and equities used to finance a corporation.
common equity:
The common stock or ownership capital of the firm. Common equity may be supplied through retained earnings or the sale of new common stock.
cost of capital:
The cost of alternative sources of financing to the firm. (See also weighted average cost of capital: The computed cost of capital determined by multiplying the cost of each item in the optimal capital structure by its weighted representation in the overall capital structure and summing up the results.)
dividend valuation model:
A model for determining the value of a share of stock by taking the present value of an expected stream of future dividends.
flotation cost:
The distribution cost of selling securities to the public. The cost includes the underwriter's spread and any associated fees.
marginal cost of capital:
The cost of the last dollar of funds raised. It is assumed that each dollar is financed in proportion to the firm's optimum capital structure.
optimum capital structure:
A capital structure that has the best possible mix of debt, preferred stock, and common equity. The optimum mix should provide the lowest possible cost of capital to the firm.
weighted average cost of capital:
The computed cost of capital determined by multiplying the cost of each item in the optimal capital structure by its weighted representation in the overall capital structure and summing up the results.