WorksheetsFFM_Ch.10 (WACC)
Total questions: 60
Worksheet time: 30mins
The Weighted Average Cost of Capital (WACC) represents:
The cost of debt only
The cost of equity only
The average rate a firm must earn on its investments to maintain value
The firm’s operating cost
The firm’s dividend growth rate
Which of the following costs is adjusted for taxes when calculating WACC?
Cost of equity
Cost of debt
Cost of preferred stock
Cost of retained earnings
Flotation cost
The after-tax cost of debt is calculated as:
Kd (1+T)
Kd (1-T)
Kd/(1-T)
Ks+T
Kd-T
The component cost of equity can be estimated using all of the following EXCEPT:
CAPM approach
Dividend discount model
Bond yield + risk premium
Historical cost method
None of the above
In the WACC formula, weights are based on:
Book values
Market values
Historical costs
Depreciated costs
Replacement costs
The CAPM formula for cost of equity is:
Ke=Rf+(Rm-Rf)/β
Ke=Rf+β(Rm-Rf)
Ke=(Rm-Rf)+β
Ke=Rf+Rm/β
Ke=Rm-Rf+β
Which of the following is NOT a component of capital structure?
Long-term debt
Common equity
Preferred stock
Accounts payable
Retained earnings
Flotation costs:
Increase the cost of new equity
Decrease the cost of new equity
Do not affect WACC
Apply only to retained earnings
Are tax deductible
If a firm’s WACC increases, the firm’s NPV for a project will:
Increase
Decrease
Stay the same
Become zero
Be unaffected by WACC
The cost of preferred stock is computed as:
Dp/Pp
Dp/(Pp-F)
Dp(1-T)/Pp
(Dp+g)/Pp
Dp/(Pp+g)
If retained earnings are exhausted, the firm must issue:
Common stock
Bonds
Preferred stock
Convertible debt
Treasury bills
The marginal cost of capital (MCC) refers to:
The historical average of past capital costs
The cost of additional capital raised today
The book value of debt
The weighted average cost of assets
The cost of sunk capital
A firm’s WACC will decrease if:
Interest rates rise
The firm increases debt financing
The corporate tax rate decreases
Which source of financing is usually the cheapest?
Common equity
Preferred stock
Debt
Retained earnings
New equity
The cost of retained earnings is:
Zero
Equal to cost of equity
Lower than cost of equity
Equal to WACC
Higher than cost of equity
If Rf = 5%, Rm = 11%, and β = 1.5, then cost of equity =
10%
13%
14%
15%
16%
If tax rate = 30%, and before-tax cost of debt = 10%, after-tax cost of debt =
7%
10%
13%
3%
8%
A higher WACC implies:
Lower firm value
Higher firm value
More efficient financing
Lower risk
Higher leverage benefit
WACC is appropriate for evaluating:
Projects of the same risk as the firm’s average risk
All projects
Only equity-financed projects
Only debt-financed projects
Tax-free investments
If a company uses more debt in its capital structure, WACC typically:
Increases indefinitely
Decreases indefinitely
Decreases initially, then increases after a certain point
Remains constant
Is unaffected
The WACC should reflect:
Past average financing costs
The marginal cost of raising new capital
The average cost of existing capital
The risk-free rate
Historical debt yield
A company’s cost of equity capital increases when:
Beta decreases
Market risk premium decreases
Risk-free rate increases
Tax rate increases
Debt ratio increases moderately
The cost of newly issued common stock is higher than retained earnings because of:
Taxes
Inflation
Flotation costs
Risk-free rate
Depreciation
If the dividend is expected to grow at a constant rate, the DCF method for cost of equity is:
Ke = (D1 / P0) + g
Ke = (P0 / D1) + g
Ke = D1 / (P0 + g)
Ke = g / (P0 – D1)
Ke = D0 / P0 + g
Which of the following increases the cost of equity, other things constant?
Lower beta
Lower expected inflation
Higher dividend growth rate
Higher tax rate
Lower market risk premium
A firm’s cost of debt is determined by:
Historical coupon rates
Yield to maturity on current debt
Risk-free rate
Book value of bonds
Market risk premium
The cost of preferred stock is unaffected by:
Dividend level
Market price
Flotation cost
Corporate tax rate
Par value
If the company’s beta doubles, the cost of equity under CAPM will:
Stay the same
Decrease by half
Double
Increase, but not necessarily double
Fall to zero
The WACC assumes that:
The firm’s risk changes with each project
The capital structure remains constant
Debt is risk-free
Taxes are ignored
Dividend policy is irrelevant
If a project’s risk is lower than the firm’s average, it should be evaluated using a:
Higher discount rate
Lower discount rate
Equal discount rate
Market return rate
Beta of 1.0
The “break point” in the marginal cost of capital schedule occurs when:
The firm changes its capital structure
Retained earnings are exhausted
Tax rates change
Dividend policy changes
Beta changes
When computing WACC, the target capital structure weights are:
The firm’s historical proportions
The firm’s desired long-term proportions of financing
The book value of equity and debt
The previous year’s ratios
The industry averages only
An increase in flotation costs for new equity will:
Decrease WACC
Increase WACC
Leave WACC unchanged
Affect only cost of debt
Affect only retained earnings
Which is TRUE about the bond yield + risk premium approach?
It is based purely on historical data
It estimates equity cost using debt yield plus a risk spread
It is more precise than CAPM
It ignores firm-specific risk
It is independent of market conditions
If debt increases beyond the optimal point, WACC:
Decreases continuously
Increases due to rising financial risk
Remains constant
Decreases due to tax shield
Becomes irrelevant
The WACC is mainly used as:
A tax rate estimator
The minimum required return on firm assets
A historical performance measure
A dividend growth indicator
A liquidity ratio
If the cost of equity is 14%, after-tax cost of debt is 7%, and weights are 40% debt and 60% equity, WACC =
9.8%
10%
10.6%
11%
12%
For a firm financed entirely by equity, WACC equals:
Cost of equity
Cost of debt
Zero
Cost of preferred stock
Risk-free rate
A firm’s weighted average cost of capital will be affected by:
Dividend policy
Capital structure
Tax rate
Interest rates
All of the above
When using market value weights, the value of common equity is:
Par value × shares
Market price per share × shares outstanding
Book value of equity
Retained earnings balance
Historical issue price
The cost of debt should be based on:
The coupon rate
The current market yield
The book value interest expense
The prime lending rate
The risk-free rate
If inflation expectations increase, then the WACC will likely:
Increase
Decrease
Stay constant
Turn negative
Be unaffected
The risk premium in CAPM is:
Rm − Rf
Rf − Rm
Rm/β
βRf
Rm + Rf
The cost of capital for a project should be:
The same as WACC regardless of risk
Adjusted for the project’s specific risk level
Equal to the market rate
Based only on debt
Ignored for internal projects
The market value of a company’s financing mix is:
Assets + Liabilities
Equity + Debt (at market prices)
Retained earnings only
Book value of capital
Net working capital
The “hurdle rate” for new projects is typically:
Below WACC
Equal to WACC
Higher than WACC
Based on book value
A higher corporate tax rate makes debt:
More attractive due to tax shield
Less attractive due to risk
Irrelevant to WACC
Costlier than equity
More volatile
The WACC of a firm that has no debt equals:
Cost of equity
Cost of preferred stock
Cost of retained earnings
Market risk premium
Beta
A project with an IRR greater than the firm’s WACC will:
Reduce shareholder value
Increase shareholder value
Have NPV = 0
Be rejected
Have a negative cash flow
If a company’s debt is risk-free and tax rate = 0, then WACC:
Equals cost of debt
Equals cost of equity
Equals weighted average of both
Equals zero
Is undefined
The firm’s WACC should be used as a discount rate for:
All projects
Projects with average risk
Only high-risk projects
Only debt-financed projects
Projects with zero NPV
Which of the following is a limitation of WACC?
Assumes constant risk
Assumes all projects have same financing
May not apply to divisions with different risk
Relies on market estimates
All of the above
The term "marginal" in marginal cost of capital means:
Incremental
Historical
Average
When the firm raises capital in large amounts, WACC:
May increase due to higher flotation and risk
Always decreases
Is unaffected
Equals tax rate
Becomes zero
The WACC formula is:
WACC = Wd Kd (1-T) + Wp Kp + We Ke
WACC = Wd + Wp + We
WACC = (Kd + Kp + Ke)/3
WACC = Kd (1-T) + Ke
WACC = Kd + T + Wp
When preferred stock dividends are not tax-deductible, the cost of preferred stock:
Increases relative to debt
Decreases relative to debt
Equals cost of debt
Equals cost of equity
Becomes negative
The book value weights will differ from market value weights when:
The market price of securities changes
The firm pays dividends
The firm issues new debt
Interest rates are constant
The firm is unprofitable
If a firm has zero-growth dividends, the cost of equity using DCF is:
D0 / P0
(D1 / P0) + g
g / (D1 - P0)
P0 / D1
(D1 + g) / P0
A firm's WACC is least likely to be affected by:
Change in capital structure
Change in tax rate
Change in beta
Change in depreciation method
Change in interest rates
The optimal capital structure is one that:
Maximizes WACC
Minimizes WACC and maximizes firm value
Minimizes debt
Maximizes equity issuance
Minimizes taxes only
