11 Finance - Cost of Capital

In order to maximize firm value, management should invest in new assets when cash flows from the assets are discounted at the firm's ________ and result in a positive NPV.

• cost of capital
• cost of debt used to finance the project
• rate of return on equity
• internal rate of return

The investor's required rate of return differs from the firm's cost of capital due to the

• firm's beta.
• tax deductibility of interest.
• CAPM.
• time value of money.

The weights used to determine the relative importance of the firm's sources of capital should reflect

• book values in accord with generally accepted accounting principles.
• current market values for bonds, common stock, and preferred stock and book values for retained earnings.
• current market values.
• subjective adjustments for firm risk.

Which of the following best describes a firm's cost of capital?

• The average yield to maturity on debt
• The average cost of the firm's assets
• The rate of return that must be earned on its investments in order to satisfy the firm's investors
• The coupon rate on preferred stock

Which of the following reasons causes investors to require a lower rate of return on the firm's bonds than on its stock?

• Bondholders bear less risk than common stockholders bear.
• Bondholders have prior voting rights over common stockholders.
• Bondholders receive greater returns than common stockholders.
• Investors pay a lower tax rate on bond interest

When Starbuck's decided to acquire Seattle's Best Coffee Company, it presumably concluded that the

• the rate of return they would earn on Seattle's Best equaled or exceeded the risk-free rate.
• the rate of return they would earn on Seattle's Best equaled or exceeded Starbucks overall cost of capital.
• the rate of return they would earn on Seattle's Best would be equal to or higher than the rate of return they could earn on other investments of equal risk.
• the rate of return they would earn on Seattle's Best equaled or exceeded what Seattle's best was earning prior to the acquisition.

Which of the following is a correct formula for calculating the weighted average cost of capital?

• WACC = weighted after-tax cost of debt + weighted cost of preferred stock + weighted cost of common stock
• WACC = weighted after-tax cost of debt + weighted after-tax cost of preferred stock + weighted after-tax cost of common stock
• WACC = (after-tax cost of debt + cost of preferred stock + cost of common stock )/3
• WACC = weighted cost of debt + weighted cost of preferred stock + weighted cost of common stock

The cost of preferred stock is equal to

• the preferred stock dividend divided by market price.
• the preferred stock dividend divided by its par value.
• (1 - tax rate) times the preferred stock dividend divided by net price.
• the preferred stock dividend divided by the net market price.

Which of the following is NOT used to calculate the cost of debt?

• Market price of the debt
• Number of years to maturity
• Risk-free rate
• Face value of the debt

Many corporate finance professionals favor the CAPM for determining the cost of equity. Which of the following is a reason for this preference?

• The data is less expensive.
• The variables in the model that apply to public corporations are readily available from public sources.
• Because the CAPM gives better treatment to flotation costs.
• The CAPM uses data from the firm's financial statements.