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Weighted average cost of capital

In computing the cost of capital, do we use the historical costs of existing debt and equity or the current costs as determined in the market?
a. Historical costs
b. Current costs

The cost of debt is less than the cost of preferred stock if both securities are priced to yield 10% and the company is in the 35 percent tax bracket.
a. True
b. False

What is the aftertax cost of debt if the yield is 6% and the corporate tax rate is 16%?
a. 3.03%
b. 5.04%
c. 7.07%
d. 8.09%

If a company has preferred stock priced at $80 with annual dividends of $6 and flotation costs of $3, then the effective cost of preferred stock is:
a. 7.79%
b. 7.75
c. 7.23
d. 6.00

According to the capital asset pricing model, if the required market return is 12%, risk-free return is 5.5%, and beta is 1, then the required return on common stock is:
a. 8%
b. 10%
c. 12%
d. 14%

The cost of new common stock is lower than the cost of retained earnings, according to the text.
a. True
b. False

Maximizing the overall cost of capital represents an optimum capital structure.
a. True
b. False

Preferred stock is not a tax-deductible expense for an issuing company.
a. True
b. False

A company has the following capital structure:
? Debt 30% Cost of Debt=7.7%
? Preferred stock 15% Cost of preferred stock=10.81%
? Common stock 55% Cost of common stock=14%

Weighted average cost of capital equals:

a. 9.63%
b. 10.63%
c. 11.63%
d. 12.63%

The marginal cost of capital increases as higher-cost new common stock is substituted for retained earnings.
a. True
b. False

According to the text, stockholders definitively and conclusively prefer dividends over retained earnings.
a. True
b. False

According to the clientele effect, investors in high marginal tax brackets usually prefer companies that reinvest most of their earnings rather than pay out in dividends.
a. True
b. False

If a company pays annual dividends of $1.20 per share and has $2.40 earnings per share, then the dividend payout ratio is:
a. 40%
b. 46%
c. 50%
d. 200%

A stock split significantly increases the value of a company by generating more earnings for the company.
a. True
b. False

Theoretically, a stock repurchase program can be an equivalent alternative to a cash dividend, assuming no tax advantages according to the text.
a. True
b. False

Dividend reinvestment plans allow corporations to raise funds continually from present stockholders.
a. True
b. False

The shares of the Charles Darwin Fitness Centers sell for $60. The firm has a P/E ratio of 20. Forty percent of earnings are paid out in dividends. What is the firm's dividend yield?
a. 8%
b. 6%
c. 4%
d. 2%

A convertible security is a bond or share of preferred stock that can be converted, at the option of the holder, into common stock
a. True
b. False

Interest rates on convertibles are lower than those on straight debt issues.
a. True
b. False

Derivative securities such as options and futures can be used by corporate financial managers for hedging activities.
a. True
b. False

Solution Preview

In computing the cost of capital, do we use the historical costs of existing debt and equity or the current costs as determined in the market?
a. Historical costs
b. Current costs

The cost of debt is less than the cost of preferred stock if both securities are priced to yield 10% and the company is in the 35 percent tax bracket.
a. True
b. False

What is the aftertax cost of debt if the yield is 6% and the corporate tax rate is 16%?
a. 3.03%
b. 5.04%
c. 7.07%
d. 8.09%

If a company has preferred stock priced at $80 with annual dividends of $6 and flotation costs of $3, then the effective cost of preferred stock is:
a. 7.79%
b. 7.75
c. 7.23
d. 6.00

According to the capital asset pricing model, if the required market return is 12%, risk-free return is ...

Solution Summary

This provides the steps to calculate the Weighted average cost of capital

$2.19