Managerial Finance Chapter 14 Practice Problems PDF

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Practice problems for quizzes, midterms, exams for managerial finance....

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Chapter 14 Cost of Capital

True / False Questions 1. A firm's overall cost of equity is an estimate only. TRUE

Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 14-01 Basics principles of cost of capital. Topic: 14-04 The Cost of Equity

2. The cost of equity is affected by dividend increases or decreases. TRUE

Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 14-01 Basics principles of cost of capital. Topic: 14-04 The Cost of Equity

3. A firm's overall cost of equity is directly observable in the financial markets. FALSE

Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 14-01 Basics principles of cost of capital. Topic: 14-04 The Cost of Equity

4. A firm's overall cost of equity is highly dependent upon the growth rate and risk level of a firm. TRUE

Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 14-01 Basics principles of cost of capital. Topic: 14-04 The Cost of Equity

5. A firm's overall cost of equity is unaffected by changes in the market risk premium. FALSE

Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 14-01 Basics principles of cost of capital. Topic: 14-04 The Cost of Equity

6. The cost of equity is affected by the growth rate of the firm. TRUE

Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 14-01 Basics principles of cost of capital. Topic: 14-04 The Cost of Equity

7. The cost of equity is affected by the market risk premium. TRUE

Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 14-01 Basics principles of cost of capital. Topic: 14-04 The Cost of Equity

8. The cost of equity is affected by the risk level of the firm. TRUE

Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 14-01 Basics principles of cost of capital. Topic: 14-04 The Cost of Equity

9. Suppose that new information regarding future inflation in Canada causes investors to become less risk averse. The SML approach indicates that, all else equal, firm cost of capital will increase. FALSE

Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Easy Learning Objective: 14-01 Basics principles of cost of capital. Learning Objective: 14-02 How to determine a firm's cost of equity capital. Topic: 14-04 The Cost of Equity Topic: 14-05 The Dividend Growth Model Approach Topic: 14-06 The SML Approach

10. As a means of determining a firm's cost of equity financing for an investment, a weakness in the dividend growth model is that the model is highly sensitive to the growth rate of the firm. TRUE

Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 14-01 Basics principles of cost of capital. Topic: 14-04 The Cost of Equity Topic: 14-05 The Dividend Growth Model Approach

11. Given the following: the risk-free rate is 8% and the market risk premium is 8.5%. Project I should be accepted if the firm's beta is 1.2.

Project I II III

Beta 0.65 0.90 1.40

Expected return 12% 17% 19%

FALSE

Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Easy Learning Objective: 14-01 Basics principles of cost of capital. Learning Objective: 14-02 How to determine a firm's cost of equity capital. Topic: 14-04 The Cost of Equity Topic: 14-05 The Dividend Growth Model Approach Topic: 14-06 The SML Approach

12. Given the following: the risk-free rate is 8% and the market risk premium is 8.5%. Project II should be accepted if the firm's beta is 1.2.

Project I II III

Beta 0.65 0.90 1.40

Expected return 12% 17% 19%

TRUE

Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Easy Learning Objective: 14-01 Basics principles of cost of capital. Learning Objective: 14-02 How to determine a firm's cost of equity capital. Topic: 14-04 The Cost of Equity Topic: 14-05 The Dividend Growth Model Approach Topic: 14-06 The SML Approach

13. Given the following: the risk-free rate is 8% and the market risk premium is 8.5%. Project III should be accepted if the firm's beta is 1.2.

Project I II III

Beta 0.65 0.90 1.40

Expected return 12% 17% 19%

FALSE

Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Easy Learning Objective: 14-01 Basics principles of cost of capital. Learning Objective: 14-02 How to determine a firm's cost of equity capital. Topic: 14-04 The Cost of Equity Topic: 14-05 The Dividend Growth Model Approach Topic: 14-06 The SML Approach

14. In general, for the purpose of estimating the cost of preferred stock, one can ignore the current level of common stock dividends. TRUE

Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 14-01 Basics principles of cost of capital. Topic: 14-04 The Cost of Equity Topic: 14-05 The Dividend Growth Model Approach

15. As a means of determining a firm's cost of equity financing for an investment, a weakness in the dividend growth model is that it fails to specifically address the risk level of the investment. TRUE

Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 14-01 Basics principles of cost of capital. Topic: 14-04 The Cost of Equity Topic: 14-05 The Dividend Growth Model Approach

16. As a means of determining a firm's cost of equity financing for an investment, a weakness in the dividend growth model is that the model can only be used by dividend-paying firms. TRUE

Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 14-01 Basics principles of cost of capital. Topic: 14-04 The Cost of Equity Topic: 14-05 The Dividend Growth Model Approach

17. As a means of determining a firm's cost of equity financing for an investment, a weakness in the dividend growth model is that the model is highly dependent upon the accuracy of the beta assigned to the firm. FALSE

Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 14-01 Basics principles of cost of capital. Topic: 14-04 The Cost of Equity Topic: 14-05 The Dividend Growth Model Approach

18. A potential problem associated with the use of the dividend growth model to compute the cost of equity is that the estimated cost of equity is sensitive to the estimated dividend growth rate. TRUE

Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Medium Learning Objective: 14-01 Basics principles of cost of capital. Topic: 14-04 The Cost of Equity Topic: 14-05 The Dividend Growth Model Approach

19. A potential problem associated with the use of the dividend growth model to compute the cost of equity is that Everything needed for the model is directly observable except the current dividend. FALSE

Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Medium Learning Objective: 14-01 Basics principles of cost of capital. Topic: 14-04 The Cost of Equity Topic: 14-05 The Dividend Growth Model Approach

20. A potential problem associated with the use of the dividend growth model to compute the cost of equity is that the approach explicitly considers risk. FALSE

Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Medium Learning Objective: 14-01 Basics principles of cost of capital. Topic: 14-04 The Cost of Equity Topic: 14-05 The Dividend Growth Model Approach

21. It is considered unlikely that the dividend growth and the SML approaches will result in different estimates of the cost of equity for a given firm FALSE

Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 14-01 Basics principles of cost of capital. Learning Objective: 14-02 How to determine a firm's cost of equity capital. Topic: 14-04 The Cost of Equity Topic: 14-06 The SML Approach

22. The SML approach generally assumes that the reward-to-risk ratio is constant. TRUE

Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 14-01 Basics principles of cost of capital. Learning Objective: 14-02 How to determine a firm's cost of equity capital. Topic: 14-04 The Cost of Equity Topic: 14-06 The SML Approach

23. One variable that the security market line approach depends on to estimate the expected return on a risky asset is the Risk-free rate of return. TRUE

Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 14-01 Basics principles of cost of capital. Learning Objective: 14-02 How to determine a firm's cost of equity capital. Topic: 14-04 The Cost of Equity Topic: 14-06 The SML Approach

24. One variable that the security market line approach depends on to estimate the expected return on a risky asset is the Marginal tax rate. FALSE

Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 14-01 Basics principles of cost of capital. Topic: 14-04 The Cost of Equity Topic: 14-06 The SML Approach

25. One variable that the security market line approach depends on to estimate the expected return on a risky asset is the Market risk premium. TRUE

Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 14-01 Basics principles of cost of capital. Learning Objective: 14-02 How to determine a firm's cost of equity capital. Topic: 14-04 The Cost of Equity Topic: 14-06 The SML Approach

26. One variable that the security market line approach depends on to estimate the expected return on a risky asset is the Systematic risk of the asset. TRUE

Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Medium Learning Objective: 14-01 Basics principles of cost of capital. Learning Objective: 14-02 How to determine a firm's cost of equity capital. Topic: 14-04 The Cost of Equity Topic: 14-06 The SML Approach

27. A decrease in the reward for bearing systematic risk will always decrease a firm's cost of equity, when calculated using the SML approach. TRUE

Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Medium Learning Objective: 14-01 Basics principles of cost of capital. Learning Objective: 14-02 How to determine a firm's cost of equity capital. Topic: 14-04 The Cost of Equity Topic: 14-06 The SML Approach

28. An increase in the firm's beta will always decrease a firm's cost of equity, when calculated using the SML approach. FALSE

Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Medium Learning Objective: 14-01 Basics principles of cost of capital. Learning Objective: 14-02 How to determine a firm's cost of equity capital. Topic: 14-04 The Cost of Equity Topic: 14-06 The SML Approach

29. For the purpose of estimating the firm's cost of capital, one cannot look only at the coupon rate on the firm's existing debt. TRUE

Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 14-03 How to determine a firm's cost of debt. Topic: 14-09 The Cost of Debt

30. For the purpose of estimating the firm's cost of debt for a project, one could observe the yield-to-maturity on recently issued bonds with a similar rating and term-to-maturity. TRUE

Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 14-03 How to determine a firm's cost of debt. Topic: 14-09 The Cost of Debt

31. Ignoring taxes, if a firm issues debt at par, then the YTM cannot be computed. FALSE

Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 14-03 How to determine a firm's cost of debt. Topic: 14-09 The Cost of Debt

32. The after-tax cost of debt generally increases when bond prices decline. TRUE

Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Easy Learning Objective: 14-03 How to determine a firm's cost of debt. Topic: 14-09 The Cost of Debt

33. Ignoring taxes, if a firm issues debt at par, then the cost of debt is equal to its coupon rate. TRUE

Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Medium Learning Objective: 14-03 How to determine a firm's cost of debt. Topic: 14-09 The Cost of Debt

34. Ignoring taxes, if a firm issues debt at par, then the cost of debt is equal to its yield to maturity. TRUE

Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Medium Learning Objective: 14-03 How to determine a firm's cost of debt. Topic: 14-09 The Cost of Debt

35. The after-tax cost of debt generally increases when a firm's bond rating increases. FALSE

Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Medium Learning Objective: 14-03 How to determine a firm's cost of debt. Topic: 14-09 The Cost of Debt

36. The after-tax cost of debt generally increases when tax rates decrease. TRUE

Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Medium Learning Objective: 14-03 How to determine a firm's cost of debt. Topic: 14-09 The Cost of Debt

37. The after-tax cost of debt generally increases when the market rate of interest increases. TRUE

Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Medium Learning Objective: 14-03 How to determine a firm's cost of debt. Topic: 14-09 The Cost of Debt

38. The cost of debt is affected by investors' risk tolerance level. TRUE

Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 14-03 How to determine a firm's cost of debt. Topic: 14-09 The Cost of Debt

39. The cost of debt is affected by marginal tax rate. TRUE

Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 14-03 How to determine a firm's cost of debt. Topic: 14-09 The Cost of Debt

40. The cost of debt is affected by the coupon rate of a firm's outstanding bonds. FALSE

Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 14-03 How to determine a firm's cost of debt. Topic: 14-09 The Cost of Debt

41. The cost of debt is affected by the current yield-to-maturity of the firm's bonds. TRUE

Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 14-03 How to determine a firm's cost of debt. Topic: 14-09 The Cost of Debt

42. The market value of a firm that invests in projects providing a return equal to its WACC will not change over time. TRUE

Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 14-04 How to determine a firm's overall cost of capital. Topic: 14-11 The Weighted Average Cost of Capital Topic: 14-12 The Capital Structure Weights Topic: 14-13 Taxes and the Weighted Average Cost of Capital

43. It is generally better to base estimates of the WACC on book value weights of debt and equity since market values, particularly those for equity, tend to fluctuate widely. FALSE

Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Easy Learning Objective: 14-04 How to determine a firm's overall cost of capital. Topic: 14-11 The Weighted Average Cost of Capital Topic: 14-12 The Capital Structure Weights Topic: 14-13 Taxes and the Weighted Average Cost of Capital

44. The interest rate that should be used when evaluating a capital investment project is sometimes called the cost of capital. TRUE

Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 14-04 How to determine a firm's overall cost of capital. Topic: 14-11 The Weighted Average Cost of Capital Topic: 14-12 The Capital Structure Weights Topic: 14-13 Taxes and the Weighted Average Cost of Capital

45. The BongoBongo Drum Co. uses debt and equity in its capital structure and has positive earnings. An increase in the firm's debt rating from BBB to A would decrease the firm's WACC. TRUE

Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Easy Learning Objective: 14-04 How to determine a firm's overall cost of capital. Topic: 14-11 The Weighted Average Cost of Capital Topic: 14-12 The Capital Structure Weights Topic: 14-13 Taxes and the Weighted Average Cost of Capital

46. If a firm uses its WACC as the discount rate for all of the projects it undertakes, then the firm will tend to become riskier over time. TRUE

Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 14-04 How to determine a firm's overall cost of capital. Topic: 14-11 The Weighted Average Cost of Capital Topic: 14-12 The Capital Structure Weights Topic: 14-13 Taxes and the Weighted Average Cost of Capital

47. A firm may have to rely upon a competitor's cost of capital to ascertain the appropriate required return for a project. TRUE

Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 14-04 How to determine a firm's overall cost of capital. Topic: 14-11 The Weighted Average Cost of Capital Topic: 14-12 The Capital Structure Weights Topic: 14-13 Taxes and the Weighted Average Cost of Capital

48. For a profitable firm, an increase in its marginal tax rate will increase its weighted average cost of capital. FALSE

Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Easy Learning Objective: 14-04 How to determine a firm's overall cost of capital. Topic: 14-11 The Weighted Average Cost of Capital Topic: 14-12 The Capital Structure Weights Topic: 14-13 Taxes and the Weighted Average Cost of Capital

49. The cost of capital is also known as the appropriate discount rate TRUE

Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 14-04 How to determine a firm's overall cost of capital. Topic: 14-11 The Weighted Average Cost of Capital Topic: 14-12 The Capital Structure Weights Topic: 14-13 Taxes and the Weighted Average Cost of Capital

50. The weighted average cost of capital for a firm is dependent upon the firm's level of risk. TRUE

Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 14-04 How to determine a firm's overall cost of capital. Topic: 14-11 The Weighted Average Cost of Capital Topic: 14-12 The Capital Structure Weights Topic: 14-13 Taxes and the Weighted Average Cost of Capital

51. A firm that uses its WACC as a cutoff without considering project risk will likely see its WACC rise over time. TRUE

Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 14-04 How to determine a firm's overall cost of capital. Topic: 14-11 The Weighted Average Cost of Capital Topic: 14-12 The Capital Structure Weights Topic: 14-13 Taxes and the Weighted Average Cost of Capital

52. By using a firm's WACC to analyze all potential investments, we risk incorrectly accepting some unsuitable projects. TRUE

Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 14-04 How to determine a firm's overall cost of capital. Topic: 14-11 The Weighted Average Cost of Capital Topic: 14-12 The Capital Structure Weights Topic: 14-13 Taxes and the Weighted Average Cost of Capital

53. By using a firm's WACC to analyze all potential investments, we risk incorrectly acceptin...