Ch.10-11-14-15 Sample Exam

When estimating the WACC, the firm's capital structure weights should ideally be based on:

• Book values of debt and equity

• Target capital structure based on market values

• Historical cost of capital allocations

• Net working capital ratios

• Par values of securities

If a firm's debt-to-equity ratio increases, assuming the cost of debt is lower than equity and taxes are constant, the WACC will:

• Always increase

• Always decrease

• Initially decrease, then increase

• Remain unchanged

• Be equal to the cost of equity

Which method incorporates both business risk and financial risk into the cost of equity estimation?

• Pure-play method

• CAPM

• WACC

• Bond-yield-plus-risk-premium

• Dividend-discount model

If flotation costs are ignored in the DCF method, then the estimated cost of new common equity:

• Will be too low

• Will be too high

• Will remain accurate

• Will equal the WACC

• Cannot be estimated

The WACC is most appropriate when evaluating:

• Projects with varying risk profiles

• Projects of similar risk to the firm's existing assets

• Projects with negative NPV

• Projects funded entirely with debt

• Speculative investments

When calculating the after-tax cost of debt for WACC purposes, analysts should use:

• The yield to maturity on new debt

• The average coupon on outstanding debt

• The cost of equity times debt beta

• The marginal tax rate divided by interest expense

• The prime rate plus credit risk spread

A firm's stock just paid a dividend of $2.50. If the dividend is expected to grow at 6% and the current price is $62, what's the cost of equity using the Gordon Growth Model?

• 10.0%

• 10.3%

• 10.5%

• 11.1%

• 11.4%

All else constant, increasing a firm's debt in the capital structure typically:

• Raises the cost of equity due to increased financial risk

• Lowers the cost of equity due to higher leverage

• Decreases WACC indefinitely

• Eliminates default risk

• Has no impact on value

Which of the following is least likely to affect a firm's WACC?

• Risk-free rate

• Tax rate

• Capital structure

• Dividend payout ratio

• Market risk premium

The cost of retained earnings is:

• Lower than debt

• Free of cost since no flotation is involved

• Equal to the cost of new equity

• Equal to the opportunity cost to shareholders

• Ignored in capital budgeting