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Questions and Answers
The Institutional Brokers' Estimate Service (IBES) summarizes analysts'
The Institutional Brokers' Estimate Service (IBES) summarizes analysts'
Studies analyzing the historical returns earned by common stock investors have found that the returns from average risk common stock investments over the years have averaged (arithmetically) ___ percentage points ___ than the returns on Treasury bills.
Studies analyzing the historical returns earned by common stock investors have found that the returns from average risk common stock investments over the years have averaged (arithmetically) ___ percentage points ___ than the returns on Treasury bills.
The cost of equity capital for non-dividend paying stocks can be determined by
The cost of equity capital for non-dividend paying stocks can be determined by
For a company that is not planning to change its target capital structure, the proportions of debt and equity used in calculating the weighted cost of capital should be based on the current ___ weights of the individual components.
For a company that is not planning to change its target capital structure, the proportions of debt and equity used in calculating the weighted cost of capital should be based on the current ___ weights of the individual components.
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The cost of capital is
The cost of capital is
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A firm can raise up to $700 million for investment from a mixture of debt, preferred stock and retained equity. Above $700 million, the firm must issue new common stock. Assuming that debt costs and preferred stock costs remain unchanged, the marginal cost of capital for amounts up to $700 million will __ the marginal cost of capital for amounts over $700 million.
A firm can raise up to $700 million for investment from a mixture of debt, preferred stock and retained equity. Above $700 million, the firm must issue new common stock. Assuming that debt costs and preferred stock costs remain unchanged, the marginal cost of capital for amounts up to $700 million will __ the marginal cost of capital for amounts over $700 million.
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The CAPM assumes that the only risk of concern to the investor is ____, which is measured by ____.
The CAPM assumes that the only risk of concern to the investor is ____, which is measured by ____.
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If a firm adopts a large proportion of above-average-risk investment projects that are not offset by below-average-risk investment projects
If a firm adopts a large proportion of above-average-risk investment projects that are not offset by below-average-risk investment projects
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The most appropriate weights to use in calculating a firm's cost of capital are the proportions of the ___ components in the firm's ___ capital structure.
The most appropriate weights to use in calculating a firm's cost of capital are the proportions of the ___ components in the firm's ___ capital structure.
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For firms subject to the 34% marginal tax rate, the after-tax cost of ___ is roughly two-thirds the cost of preferred stock.
For firms subject to the 34% marginal tax rate, the after-tax cost of ___ is roughly two-thirds the cost of preferred stock.
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There are four major components that determine the risk premium. They include all the following except
There are four major components that determine the risk premium. They include all the following except
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The required rate of return on any security consists of
The required rate of return on any security consists of
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All of the following are true EXCEPT:
All of the following are true EXCEPT:
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Break points can be determined by dividing the amount of funds available from each financing source at a fixed cost by the ____ proportion for that financing source.
Break points can be determined by dividing the amount of funds available from each financing source at a fixed cost by the ____ proportion for that financing source.
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If a preferred stock is callable, then the calculation of the cost of preferred stock financing is
If a preferred stock is callable, then the calculation of the cost of preferred stock financing is
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The constant growth valuation model approach to calculating the cost of equity assumes that
The constant growth valuation model approach to calculating the cost of equity assumes that
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The total return to stockholders, ke, is composed of the
The total return to stockholders, ke, is composed of the
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If a firm is losing money then the after-tax cost of debt is
If a firm is losing money then the after-tax cost of debt is
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The historic beta of a firm is of little use as a forecast of the firm's future systematic risk characteristics when
The historic beta of a firm is of little use as a forecast of the firm's future systematic risk characteristics when
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All of the following methods may be used to determine the cost of equity capital (ke) for a non-dividend-paying stock except
All of the following methods may be used to determine the cost of equity capital (ke) for a non-dividend-paying stock except
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The cost of external equity is greater than the cost of internal equity because
The cost of external equity is greater than the cost of internal equity because
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Retained earnings are a cheaper source of funds than the sale of new equity because
Retained earnings are a cheaper source of funds than the sale of new equity because
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Historic average capital costs are ___ new (marginal) resource allocation decisions.
Historic average capital costs are ___ new (marginal) resource allocation decisions.
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Which of the following is not a typical source of debt funds for a small firm?
Which of the following is not a typical source of debt funds for a small firm?
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If a firm will use only equity funds during the current capital budgeting period then the ___ is the correct capital cost to use for computing the cost of funds for the firm.
If a firm will use only equity funds during the current capital budgeting period then the ___ is the correct capital cost to use for computing the cost of funds for the firm.
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The optimal capital budget is determined by comparing the expected project returns to the company's
The optimal capital budget is determined by comparing the expected project returns to the company's
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The cost of depreciation-generated funds is equal to
The cost of depreciation-generated funds is equal to
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___ refers to the variability in the firm's operating earnings
___ refers to the variability in the firm's operating earnings
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The major components that determine the risk premium on a specific security at any point in time include all of the following except
The major components that determine the risk premium on a specific security at any point in time include all of the following except
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Rank in ascending order (lowest to highest) the relative riskiness of the various types of corporate and government securities.
Rank in ascending order (lowest to highest) the relative riskiness of the various types of corporate and government securities.
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Rank in ascending order (lowest to highest) investors' required rates of return on the various types of corporate securities.
Rank in ascending order (lowest to highest) investors' required rates of return on the various types of corporate securities.
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Which of the following statements (if any) is (are) true concerning companies that do not pay dividends?
Which of the following statements (if any) is (are) true concerning companies that do not pay dividends?
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The optimal capital budget is indicated by the point at which the ___ and the ___ intersect.
The optimal capital budget is indicated by the point at which the ___ and the ___ intersect.
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During the 1980s, the cost of capital for U.S. firms averaged about 3.3 percentage points higher than Japanese firms. During 1990 this disadvantage may have disappeared due to:
During the 1980s, the cost of capital for U.S. firms averaged about 3.3 percentage points higher than Japanese firms. During 1990 this disadvantage may have disappeared due to:
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If a firm sells assets, generating cash flows, the cost of these funds is
If a firm sells assets, generating cash flows, the cost of these funds is
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Small firms are reluctant to obtain capital through the sale of common stock because of:
Small firms are reluctant to obtain capital through the sale of common stock because of:
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Study Notes
Cost of Capital, Capital Structure, and Dividend Policy
- Institutional Brokers' Estimate Service (IBES) summarizes analyst short-term earnings forecasts and long-term earnings growth rates.
- Historical returns from average risk common stocks have averaged 6 to 9 percentage points higher than Treasury bill returns.
- The cost of equity for non-dividend paying stocks can be calculated using the Capital Asset Pricing Model (CAPM) and by estimating the cost of comparable dividend-paying stocks in the same industry.
- For a firm not changing its capital structure, the weighted cost of capital should reflect the current market value of debt and equity components.
- The cost of capital is the minimum rate of return required by investors for a firm's securities, and it should reflect the risk of each type of investment.
Important Formulas and Concepts
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CAPM (Capital Asset Pricing Model): Used to calculate the cost of equity, ke = rf + β(rm - rf), where:
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ke = cost of equity
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rf = risk-free rate
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β = beta (a measure of systematic risk)
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rm = expected market return
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Weighted Average Cost of Capital (WACC): A calculation of the average cost of all capital sources. WACC = wdkd(1-Tc) + wsks + wp*kp, where:
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wd = weight of debt
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kd = cost of debt
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Tc = corporate tax rate
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ws = weight of stock
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ks = cost of equity
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wp = weight of preferred stock
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kp= cost of preferred stock
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Dividend Capitalization Model: Method for computing the cost of equity, ke = (D₁/P₀) + g, where:
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D₁ = expected dividend per share next year
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P₀ = current market price per share
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g = constant growth rate of dividends.
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Break Points in capital budgeting indicate the point where the firm switches from using one type of financing to another, thereby requiring a change in the cost of capital.
Dividends and Financial Risk
- Systematic Risk: Relevant risk measure for investors in the CAPM.
- Unsystematic Risk is not relevant for investors in the CAPM.
- A firm's cost of capital will increase if it takes on more above-average risk investment projects.
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Description
Test your knowledge on the cost of capital, capital structure, and dividend policy. This quiz covers important concepts such as CAPM, historical returns, and the implications of capital structure changes on a firm's weighted cost of capital. Dive into the essential formulas and analyze the risks associated with different types of investments.
