Quiz 2: The cost of capital

A single, overall cost of capital is often used to evaluate projects because

• it is the only way to measure a firm's required return.

• it acknowledges that most new investment projects have about the same degree of risk.

• it avoids the problem of computing the required rate of return for each investment proposal.

• it acknowledges that most new investment projects offer about the same expected return.

The cost of equity capital is all of the following EXCEPT:

• generally lower than the before-tax cost of debt.

• by far the most difficult component cost to estimate.

• the minimum rate that a firm should earn on the equity-financed part of an investment.

• a return on the equity-financed portion of an investment that, at worst, leaves the market price of the stock unchanged.

In calculating the costs of the individual components of a firm's financing, the corporate tax rate is important to which of the following component cost formulas?

• Ordinary Shares

• Preferences Shares

• Long-term Debt

• Short-term Debt

To compute the required rate of return for equity in a company using the CAPM, it is necessary to know all of the following EXCEPT:

• The risk-free rate.

• The beta for the firm.

• The earnings for the next time period.

• The market return expected for the time period.

The common stock of a company must provide a higher expected return than the debt of the same company because:

• There is a market premium required for bonds.

• There is more systematic risk involved for the common stock.

• There is greater demand for stock than for bonds.

• There is less demand for stock than for bonds.

In calculating the proportional amount of equity financing employed by a firm, we should use:

• The current market price per share of common stock times the number of shares outstanding.

• The book value of the firm.

• The sum of common stock and preferred stock on the balance sheet.

• the common stock equity account on the firm's balance sheet.

Love Berhad relies on preferred stock, bonds, and common stock for its long-term financing. Rank in ascending order (i.e., 1 = lowest, while 3 = highest) the likely after-tax component costs of the Love Berhad long-term financing.

• 1 = bonds; 2 = common stock; 3 = preferred stock.

• 1 = bonds; 2 = preferred stock; 3 = common stock.

• 1 = common stock; 2 = preferred stock; 3 = bonds.

• 1 = preferred stock; 2 = common stock; 3 = bonds.

Which of the following methods involves computing the cost of capital by dividing the dividend by market price/net proceeds per share?

• Adjusted price method

• Price earning method

• Dividend yield method

• Adjusted dividend method Adjusted dividend method

Which among the following figures is not relevant while calculating the cost of the redeemable preference shares?

• Earning Per Share (EPS)

• Discount

• Floatation Cost

• None of the above

Which of the following factors affecting the cost of capital can be controlled by the firm?

• Level of interest rates

• Dividend policy

• Tax rates

• None of the above