Question 1

The firm's cost of capital represents the maximum rate of return that a firm can earn from its capital budgeting projects to ensure that the value of the firm increases.

Accepted Answer

False

Question 2

Each component cost of particular types of capital is identical for each source of funds found in a firm's capital structure.

Accepted Answer

The cost of capital components (such as the cost of debt or the cost of equity) may vary depending on the source of funds. For example, the cost of debt may differ if the funds are raised through bank loans versus issuing bonds. Similarly, the cost of equity may differ if the funds are raised through private equity investors versus issuing shares in the public market.

Question 3

The weighted average cost of capital increases if the total funds required call for an amount of equity in excess of what can be obtained as retained earnings.

Accepted Answer

If the desired funds require more equity financing than can be obtained through retained earnings, the company will have to issue new equity, which typically has a higher cost of capital than retained earnings. This increased cost of equity will raise the weighted average cost of capital.

Question 4

The cost of issuing preferred stock by a corporation must be adjusted to an after-tax figure because of the 70 percent dividend exclusion provision for corporations holding other corporations' preferred stock.

Accepted Answer

The answer of The cost of issuing preferred stock by...

Question 5

A firm's capital structure has no impact on the firm's weighted average cost of capital.

Accepted Answer

A firm's capital structure does have an impact on the firm's weighted average cost of capital (WACC). The WACC takes into account the cost of equity and cost of debt, and the proportion of each in the firm's capital structure will affect the overall WACC. As a firm takes on more debt, for example, its cost of debt may increase, which would in turn increase its WACC.

Question 6

The cost of debt is equal to one minus the marginal tax rate multiplied by the coupon rate on outstanding debt.

Accepted Answer

The answer of The cost of debt is equal to...

Question 7

Tax adjustments to the cost of preferred stock must be made when determining the cost of capital since dividend expenses on preferred stocks are tax deductible.

Accepted Answer

The answer of Tax adjustments to the cost of preferred...

Question 8

There is a jump,or break,in a firm's MCC schedule each time the firm runs out of a particular source of capital at a particular cost.For example,a firm may use up its 10 percent debt and can then issue more debt only if it offers a higher rate to investors.

Accepted Answer

This is true because when a firm exhausts a particular source of capital at a particular cost, it must offer a higher rate to investors for more funds which results in a jump or break in the firm's MCC schedule.

Question 9

The component costs of capital are market-determined variables in as much as they are based on investors' required returns.

Accepted Answer

The component costs of capital, such as cost of debt and cost of equity, are based on the required returns of investors in the market. These required returns are influenced by various market factors such as interest rates, inflation, and risk perceptions, making the component costs of capital market-determined variables.

Question 10

Capital refers to items on the right-hand side of a firm's balance sheet.

Accepted Answer

Capital refers to the funds that a business owner invests in the company, as well as any profits that are retained in the business rather than paid out as dividends to shareholders. These funds are listed on the right-hand side of a company's balance sheet under the "liabilities and equity" section.

Question 11

The firm's cost of external equity capital is the same as the required rate of return on the firm's outstanding common stock.

Accepted Answer

The answer of The firm's cost of external equity capital...

Question 12

The correct discount rate for a firm to use in capital budgeting,assuming that new investments are of the same degree of risk as the firm's existing assets,is its marginal cost of capital.

Accepted Answer

The marginal cost of capital represents the cost of obtaining new funds for the firm, and taking into account the risk associated with those funds. It reflects the opportunity cost of using those funds in new investments instead of paying out dividends or repurchasing shares. Since it takes into account the risk of the firm's existing assets, it is the appropriate discount rate to use in capital budgeting for new investments of similar risk.

Question 13

Funds acquired by the firm through retaining earnings have no cost because there are no dividend or interest payments associated with them,but capital raised by selling new stock or bonds does have a cost.

Accepted Answer

The answer of Funds acquired by the firm through retaining...

Question 14

The cost of capital used in capital budgeting must be determined using the specific financing used to fund that particular project.

Accepted Answer

The cost of capital used in capital budgeting should reflect the company's overall cost of capital, which incorporates the cost of all sources of financing used by the company. It is not necessarily determined by the financing used for a specific project.

Question 15

The cost of capital is the firm's average cost funds given what the market demands be paid to attract the funds.

Accepted Answer

The cost of capital is indeed the average cost of funds that a firm must pay to attract the money it needs to operate. This includes both debt and equity financing, and is determined by what the market expects in terms of returns for taking on the risk of investing in the company.

Question 16

The cost of equity capital from the sale of new common stock (ke)is generally equal to the cost of equity capital from retention of earnings (rs),divided by one minus the flotation cost as a percentage of sales price (1 - F).

Accepted Answer

The formula for cost of equity capital from the sale of new common stock is ke = (D1/P0) + g + f, where D1 is the expected dividend per share next year, P0 is the current market price per share, g is the expected growth rate of dividends, and f is the flotation cost. This formula does not involve the cost of equity capital from retention of earnings.

Question 17

The after tax cost of debt is used to calculate the weighted average cost of capital since we are concerned with the after-tax cash flows of the firm.

Accepted Answer

This statement is true. The after-tax cost of debt reflects the actual cost of debt that the firm incurs after considering the tax savings from deducting interest payments on their income tax returns. Since we are interested in the actual cash flows of the firm after all expenses, including taxes, the after-tax cost of debt is used to calculate the weighted average cost of capital (WACC).

Question 18

Even if a firm obtains all of its common equity from retained earnings,its MCC schedule might still increase if very large amounts of new capital are needed.

Accepted Answer

This is true because if a firm needs to raise very large amounts of new capital, it may have to issue new debt or preferred stock, which will increase the cost of capital (MCC) for the firm. Even if the firm only uses retained earnings for common equity, its overall MCC schedule will still be impacted by the cost of other sources of capital.

Question 19

The marginal cost of capital (MCC)is the cost of the last dollar of new capital that the firm raises,and the marginal cost declines as more and more of a specific type of capital is raised during a given period.

Accepted Answer

The marginal cost of capital (MCC) typically increases as more and more of a specific type of capital is raised during a given period, reflecting the principle that the cost to the firm of raising additional capital increases as the amount of capital already raised increases.

Question 20

The cost of equity raised by retaining earnings can be less than,equal to,or greater than the cost of equity raised by selling new issues of common stock,depending on tax rates,flotation costs,the attitude of investors,and other factors.

Accepted Answer

The answer of The cost of equity raised by retaining...

Quiz 11: The Cost of Capital