Explore BrainMass
Share

Multiple choice questions relating to cost of capital

This content was STOLEN from BrainMass.com - View the original, and get the already-completed solution here!

Which of the following component costs is expressed on an after-tax basis in the calculation of a firm's cost of capital?

a.
cost of debt

b.
cost of preferred stock

c.
cost of common equity

d.
b and c

e.
all of the above

The component cost of a firm's preferred stock consists of

a.
the current dividend yield.

b.
the expected growth rate of dividends.

c.
dividends expressed as a percent of par value.

d.
a and b

Which of the following would increase the WACC?

a.
an increase in flotation costs

b.
a decrease in tax rates

c.
a decrease in preferred dividends

d.
Both a & b

e.
All of the above

8. If a project comes with its own funding offered at a rate lower than the cost of capital, the capital budgeting analysis should be conducted using

a.
the offered rate because it is appropriate to match sources and uses of funding whenever possible.

b.
the cost of capital because to do otherwise would be unfair to departments whose projects don't happen to have separate funding

c.
the cost of capital because doing otherwise leads to irrational capital budgeting decisions

d.
an average of the offered rate and the cost of capital because that gives the best measure of the effect of the offer on the firm

Show solution and answer to this question below

15. A firm's correctly computed capital structure is 30% debt, 20% preferred stock, and 50% equity. If retained earnings of $1 million are expected, how much capital will have been raised when retained earnings are exhausted and new common equity must be issued?

a.
$1,428,571

b.
$1,000,000

c.
$2,000,000

d.
$3,333,333

Show solution and answer to this question below

If a firm's EBIT changes by 20% and it has a degree of financial leverage (DFL) of 2.0, what is the expected change in earnings per share (EPS)?

a.
20%

b.
40%

c.
50%

d.
60%

According to the MM model of capital structure, the present value of the tax shield is offset by potential __________, resulting in an optimal capital structure.

a.
bankruptcy costs

b.
interest expense

c.
operating costs

d.
a and b

Show solution and answer to this question below

Assume the following facts about a company:

Capital (000s)

EBIT (000s)
$1,000

Debt
-
Less Interest Expense
-

Equity
$3,000
EBT
$1,000

Total Capital
$3,000
Taxes @ 40%
400

Shares @ $10 = 300

Earnings after Tax
$ 600

What will be the company's new EPS if it borrows money at 10% interest and uses it to retire stock until capital is 40% debt? The stock can be purchased at its book value of $10 per share.

a.
$3.33

b.
$4.89

c.
$2.93

d.
none of the above

Show solution and answer to this question below

Khandker Motors finances 40% of its total capital with debt. The cost of debt is 11%. The firm is in the 37% tax bracket and earned an operating profit of $2.5 million dollars. If the Khandker's total capital amounts to $22 million and its book value per share is $20, what is the firm's earnings per share?

a.
$0.85

b.
$0.88

c.
$1.43

d.
$1.46

Show solution and answer to this question below

Zahn Enterprises pays $3 million annually to its bondholders and $7.5 million annual to its stockholders. The required rates of return are 9 percent and 15 percent, respectively, by the bondholders and stockholders. What is the value of Zahn Enterprises?

a.
$1.40 million

b.
$10.50 million

c.
$16.66 million

d.
$83.33 million

Shareholder needs or preferences that may influence the dividend decision include:

a.
the need for current income support oneself

b.
a preference for price appreciation because current income isn't needed

c.
a preference for capital gains over ordinary income.

d.
all of the above

Various management actions provide investors with clues as to the future prospects for the firm. Which of the following actions by management contains the most important economic information for common stock investors?

a.
A 20 percent increase in cash dividends per share.

b.
A 100 percent stock dividend

c.
A 2-for-1 stock split.

d.
a, b, and c are equally important.

Which statement related to the signaling effect of dividends is true?

a.
The signaling effect can explain why an increase in the dividend is often followed by an increase in stock price.

b.
The signaling effect is a reason a firm may follow a constant or steadily increasing dividend policy.

c.
Changes in dividends can be interpreted as a signal from management about changes in the company's future earnings.

d.
all of the above.

Show solution and answer to this question below

A firm's balance sheet discloses cash of $300,000, other assets of $700,000, liabilities of $500,000, preferred stock of $100,000, common stock of $200,000, and retained earnings of $200,000. What is the maximum cash dividend the firm can pay?

a.
$100,000

b.
$300,000

c.
$200,000

d.
$500,000

In dividend reinvestment plans, stockholders receive additional shares instead of cash dividends. Shareholders

a.
are not taxed at the time of the dividend because they received no cash

b.
must pay tax on the full value of the new shares at the time they are sold

c.
must pay tax in the year of the dividend on the value used to buy the new shares

d.
must pay tax on the dividend amount when the shares are sold.

© BrainMass Inc. brainmass.com October 24, 2018, 6:40 pm ad1c9bdddf
https://brainmass.com/business/capital-budgeting/multiple-choice-questions-relating-to-cost-of-capital-45849

Solution Preview

1. Which of the following component costs is expressed on an after-tax basis in the calculation of a firm's cost of capital?

a. cost of debt
b. cost of preferred stock
c. cost of common equity
d. b and c
e. all of the above

Since interest is tax deductible, there fore cost of debt is expressed on an after tax basis.
Answer a.

2.The component cost of a firm's preferred stock consists of
a. the current dividend yield.
b. the expected growth rate of dividends.
c. dividends expressed as a percent of par value.
d. a and b

Answer c. Since the dividends are fixed and are expressed as a percent of par value.

3. Which of the following would increase the WACC?
a. an increase in flotation costs
b. a decrease in tax rates
c. a decrease in preferred dividends
d. Both a & b
e. All of the above

Answer d. An increase in floatation cost would reduce the amount of money collected and hence would increase the cost. Debt cost is after tax cost and a reduction in tax rate would increase the after tax cost since the multiplying factor is (1-tax rate).

8. If a project comes with its own funding offered at a rate lower than the cost of capital, the capital budgeting analysis should be conducted using
a. the offered rate because it is appropriate to match sources and uses of funding whenever possible.
b. the cost of capital because to do otherwise would be unfair to departments whose projects don't happen to have separate funding
c. the cost of capital because doing otherwise leads to irrational capital budgeting decisions
d. an average of the offered rate and the cost of capital because that gives the best measure of the effect of the offer on the firm

Answer d. Since the WACC would change when the new capital is raised in a different proportion and at a different rate

Show solution and ...

Solution Summary

The solution has explanations for various mulitple choice questions relating to finance

$2.19
See Also This Related BrainMass Solution

A Survey of Multiple Choice and True/False Questions Related to Business

1. Two companies are contemplating a merger. In the new entity is expected to require an initial investment of $20 million which will then result in expense savings of $2.7 million for 15 years. The weighted average cost of capital is 8%. The firm just issued bonds at 6.5%. The company would expect the following financial results from the new company:
a. IRR=10.5%, NPV=$5.4 MILLION
b. IRR=10.5%, NPV=$3.1 MILLION
c. IRR=8.0%, NPV=$20.5 MILLION
d. Not enough information to tell

2. Which of the following statements is correct about a company's balance sheet?
a. It displays sources and uses of cash for the period.
b. It is an expansion of the basic accounting equation: Assets = Liabilities + Owners' Equity.
c. It provides a detailed list of revenues and expenses including income tax for a given period.
d. It is unnecessary if both an income statement and statement of cash flows are available.

3. A firm had on its balance sheet the following items: Cash $0.75 million, Accounts Receivable $2.25 million, Inventories $3.00 million, Fixed Assets $4.00 million, Owner's Equity $4.50 million, Accounts Payable $2.00 million, Long-Term Debt $2.00 million and Accrued Liabilities $1.50 million. The company's Working Capital Ratio (Current Ratio) was:
a. .86
b. 1.7
c. 3
d. 1.1

4. Lizpaz Inc. is a levered firm with a debt-to-equity ratio of 0.25. The beta of the common stock is 1.15, while the beta of the debt is 0.3.The market-risk premium is 10 percent and the risk-free rate is 6 percent.The corporate tax rate is 35 percent.
If a new company project has the same risk as the overall firm, what is the weighted average cost of capital for the project?
Choose from the following:
A. 9%
B. 15.2%
C. 15.4%
D. 15.8%

Answer the following true or false:
5. There is unlimited liability in a general partnership.

6. A limited partnership limits the profits partners may receive.

7. Capital Stock refers to high quality beef based broth.

8. The three types of acquisition are: Horizontal Acquisition, Vertical Acquisition and Progressive Acquisition.

9. There are three basic legal procedures that one firm can use to acquire another firm: (1) merger or consolidation, (2) acquisition of stock, and (3) acquisition of assets.

10. You purchased the Microsoft July $85 Call Option in April when the stock was trading at 29.75. On July 24 of the same year the stock shot up to $69.75. Your payoff was $40 per contract.

11. Indus Limousine Company has $1,000 par value bonds outstanding at 10 percent interest. The bonds will mature in 50 years. The percent yield to maturity is 5 percent and the current price of the bonds is $986.24.

12. If a company has promised to pay interest on debt, it must pay the interest even if it shows no profit for the year.

13. The general rule for using the weighted average cost of capital (WACC) in capital budgeting decisions is to accept all projects with rates of return greater than or equal to the WACC.

14. The interests of the key managers should be superior to the interests of the shareholders and employees of two merging companies.

15. An heir will receive $175,000 in 50 years from an estate. If the funds are discounted back at a rate of 14 percent, the present value of this gift is $101,376.

16. A company's Net Cash Flow from Operations must be reported quarterly on the Income Statement and is a component of the stock PE ratio.

View Full Posting Details