Chapter 11

It is standard practice to evaluate investment decisions using the cost of the specific financing method involved.

• True

• False

The calculation of the cost of capital depends upon the historical cost of funds.

• True

• False

The cost of capital for each source of funds is dependent on current market conditions and expected rates of return.

• True

• False

Financial capital does not include

• stocks

• bonds

• preferred stocks

• working capital

For a firm paying 5% for new debt, the higher the firm's tax rate

• the higher the after-tax cost of debt

• the lower the after-tax cost of debt

• the after-tax cost is unchanged

• Not enough information to judge

The cost of a firm's debt is determined by taking the

• present value of the interest payments and principal times one minus the tax rate

• coupon rate on bonds times one minus the tax rate

• yield on bonds issued minus the corporation’s marginal tax rate

• None of these options are true

The pre-tax cost of debt for a new issue of debt is determined by

• the investor's required rate of return on issued stock

• the coupon rate of existing debt

• the yield to maturity of outstanding or comparable bonds

• All of these options are true

The after-tax cost of preferred stock to the issuing corporation

• is the same as the before-tax cost

• is usually lower than the cost of debt

• is dependent on the firm's tax bracket

• None of these options are true

If the flotation cost goes up, the cost of retained earnings will

• go up

• go down

• stay the same

• slowly increase

Why is the cost of debt normally lower than the cost of preferred stock?

• Preferred stock dividends are tax deductions

• Interest on debt is tax deductible

• Preferred stock dividends must be paid before common stock dividends

• Common stock dividends are not tax-deductible