Question 1

In determining the cost of debt, a firm could use its yields and prices of outstanding bonds.

Accepted Answer

By looking at the yields and prices of outstanding bonds, a firm can calculate the cost of debt as the interest rate paid on those bonds.

Question 2

A firm's cost of preferred stock is equal to the preferred dividend divided by market price plus the dividend growth rate (K_p = D/P₀ + g).

Accepted Answer

The cost of preferred stock is calculated as the preferred dividend divided by the market price (Kp = D/P0), without considering a growth rate, as preferred dividends are typically fixed.

Question 3

Regardless of the particular source of funds utilized for a project, the required rate of return, or discount rate, will be the weighted average cost of capital.

Accepted Answer

The weighted average cost of capital (WACC) is the required rate of return for a project, and it is calculated based on the weighted average of the costs of various sources of funds (e.g. debt, equity, etc.). Therefore, regardless of the particular source of funds utilized for a project, the WACC will be the discount rate used to evaluate the project's potential returns.

Question 4

The measurement of common stock equity in weighted average cost of capital uses the cost of retained earnings (K_e) ,but not the cost of new common stock (K_n). Either or both may be used; it is situation-dependent.

Accepted Answer

The answer of The measurement of common stock equity in...

Question 5

It is standard practice to evaluate investment decisions using the cost of the specific financing method involved.

Accepted Answer

Standard practice involves using the weighted average cost of capital (WACC) for evaluating investment decisions, which considers the cost of all financing sources, not just the cost of a specific financing method.

Question 6

The out-of-pocket cost of common stock is a good approximation of the cost of common stock equity.
Flotation costs for new stock issues must be considered in the valuation, unlike existing stock.

Accepted Answer

The answer of The out-of-pocket cost of common stock is...

Question 7

The cost of new common stock is greater than the cost of outstanding common stock.

Accepted Answer

The cost of new common stock, also known as the cost of equity, is typically higher than the cost of outstanding common stock because new equity issuances often require the payment of flotation costs and may also dilute the ownership and earnings of existing shareholders.

Question 8

The cost of debt is equal to the current bond yield on bonds of similar risk class, adjusted for the corporate tax rate.

Accepted Answer

The cost of debt is calculated using the current bond yield on bonds of similar risk class, adjusted for the corporate tax rate. This is because interest payments on debt are tax deductible, which lowers the effective cost of debt to the company.

Question 9

The cost of capital for each source of funds is dependent on current market conditions and expected rates of return.

Accepted Answer

This is true because market conditions and expected rates of return affect the risk associated with each source of funds, which in turn affects the cost of capital. For example, if interest rates in the market are high, the cost of debt financing will be higher, while if investors have lower expected returns, the cost of equity financing may be lower.

Question 10

The cost of capital refers to the cost that a company takes on to purchase a big project.

Accepted Answer

The answer of The cost of capital refers to the...

Question 11

Retained earnings represent an internal source of funds that is raised without the payment of interest or cost to the firm's stockholders.
"Opportunity cost" must be considered since earnings could be issued to shareholders in the form of dividends.

Accepted Answer

The answer of Retained earnings represent an internal source of...

Question 12

The cost of retained earnings is considered to be equal to the required rate of return on a firm's outstanding common stock.

Accepted Answer

Retained earnings refer to profits that a company reinvests back into itself instead of distributing as dividends. The cost of retained earnings is the opportunity cost of not distributing those profits as dividends to shareholders. This opportunity cost is equal to the required rate of return that shareholders could earn if they had received those profits as dividends and invested them elsewhere. Therefore, the cost of retained earnings is considered to be equal to the required rate of return on a firm's outstanding common stock.

Question 13

The calculation of the cost of capital depends upon the historical cost of funds.
Each project must be evaluated by the current cost of funds.

Accepted Answer

The calculation of the cost of capital depends upon the current cost of funds, not the historical cost of funds. Therefore, each project must be evaluated based on the current cost of funds, not historical cost.

Question 14

The amount of debt capital used by a corporation is not related to the availability of equity funds from retained earnings and new common stock.

Accepted Answer

The amount of debt capital used by a corporation can be affected by the availability of equity funds from retained earnings and new common stock. If a corporation has a strong financial position with ample retained earnings and the potential for future profits, they may be able to rely less on debt financing and more on equity financing. On the other hand, if a corporation has limited or no access to equity funds, they may have to rely more on debt financing to fund their operations and growth.

Question 15

A firm's cost of preferred stock is equal to the preferred dividend divided by the net price after flotation costs.

Accepted Answer

The formula for the cost of preferred stock is (preferred dividend/net price after flotation costs).

Question 16

The cost of debt needs to consider tax, while the cost of stock does not need to consider tax.

Accepted Answer

The cost of debt needs to consider tax because interest paid on debt is tax-deductible, which reduces the after-tax cost of borrowing. On the other hand, the cost of stock does not need to consider tax as it represents ownership in the company and does not involve any interest payments or tax deductions.

Question 17

The discount rate that equates a future stream of expected dividends to the current price is a good approximation of the cost of common stock.

Accepted Answer

The discount rate, also known as the required rate of return, represents the return that investors expect to receive on their investment in the common stock. By equating this rate to the present value of future expected dividends, we can estimate the current price of the stock. Therefore, this is a good approximation of the cost of common stock.

Question 18

In determining the cost of preferred stock, the earnings on outstanding preferred stock may be used as a proxy.

Accepted Answer

The cost of preferred stock is typically calculated using the dividend approach, which involves dividing the annual preferred dividend by the current market price of the preferred stock, not by using the earnings on outstanding preferred stock.

Question 19

The only difference in the cost of retained earnings (K_e) and the cost of new common stock (K_n₎is the flotation cost on new common stock.

Accepted Answer

The statement is true, as the only difference between the cost of retained earnings and the cost of new common stock is the flotation cost associated with issuing new stock.

Question 20

K_e represents an expected return to stockholders as well as a cost to the firm.

Accepted Answer

K_e represents the expected return to stockholders through dividends and capital gains, which is a cost to the firm as it reduces the firm's retained earnings and available funds for other investments.

Quiz 11: Cost of Capital