Cost of Capital Quiz

What is the cost of capital?

• The interest rate paid on loans

• The minimum return that a company must earn to satisfy its investors

• The rate at which dividends are paid

• The rate of corporate tax

Which of the following is NOT a component of the cost of capital?

• Cost of debt

• Cost of retained earnings

• Cost of preference shares

• Depreciation cost

The weighted average cost of capital (WACC) is:

• The average interest rate a company pays on its loans

• The company's overall cost of funds from all sources

• The cost of equity only

• None of the above

The formula for calculating the cost of debt (before tax) is:

• Interest expense / Total debt

• (Interest expense + Taxes) / Total debt

• Total debt / Interest expense

• Interest expense / Equity capital

If the tax rate increases, the after-tax cost of debt will:

• Increase

• Decrease

• Remain unchanged

• Increase and then decrease

Which of the following sources of capital usually has the highest cost?

• Debt

• Preferred stock

• Common equity

• Retained earnings

The cost of equity can be calculated using which model?

• Dividend discount model (DDM)

• Capital asset pricing model (CAPM)

• Earnings capitalization method

• All of the above

Which of the following is the formula for the dividend discount model (DDM)?

• Cost of equity = Dividend / Price + Growth rate

• Cost of equity = Earnings / Price

• Cost of equity = Growth rate / Dividend

• Cost of equity = Price / Dividend + Growth rate

The cost of retained earnings is typically considered to be:

• Zero, as no external funds are raised

• The same as the cost of new equity

• The same as the cost of debt

• None of the above

What is the relationship between the cost of debt and the cost of equity in most firms?

• The cost of debt is higher than the cost of equity

• The cost of equity is higher than the cost of debt

• Both are equal

• None of the above