Question 1

When calculating the WACC it is common to include the estimated cost of accounts payable if a firm does not take the discount for early payment.

Accepted Answer

When calculating the Weighted Average Cost of Capital (WACC), accounts payable are not included because they are considered a spontaneous source of financing and do not have an explicit cost of capital like debt and equity.

Question 2

The ________ is cited by the author as a reason for using just one rate,a long-term yield,as the average cost of debt financing for a firm that has multiple issues of debt with varying maturities.

Accepted Answer

The unbiased expectations theory states that the long-term rate is an unbiased predictor of future short-term rates. Therefore, using just one rate, a long-term yield, as the average cost of debt financing for a firm that has multiple issues of debt with varying maturities is reasonable according to this theory. The other options (A, B, C) are not relevant to the author's argument.

Question 3

Which of the following is NOT a problem with the dividend model approach to estimating the cost of equity?

Accepted Answer

All of the given options are problems with the dividend model approach to estimating the cost of equity.

Question 4

Your firm is considering the issuance of preferred shares for the first time.The average yield on preferred stock for firms in your industry is 6.50%.If you wish to issue preferred stock at par with a face value of $50.00 per share,approximately how large would you need to make your annual preferred dividend?

Accepted Answer

The annual preferred dividend can be calculated by multiplying the face value of the preferred stock ($50) by the average yield for preferred stock in the industry (6.50% or 0.065). Thus, the annual preferred dividend would be $50 x 0.065 = $3.25. Therefore, the best choice is B.

Question 5

If interest rates rise,the price of preferred shares will also rise,other things equal.

Accepted Answer

If interest rates rise, the price of preferred shares will typically fall, not rise. This is because preferred shares are viewed as similar to bonds, and as interest rates rise, the yield on bonds increases, making them a more attractive investment than preferred shares. Therefore, if interest rates rise, investors may sell their preferred shares in favor of bonds, resulting in a decrease in the price of preferred shares.

Question 6

________ on preferred shares are paid ________ taxes and ________ common share dividends.

Accepted Answer

Preferred shares pay dividends, not interest payments, and these dividends are typically paid after any taxes and before common share dividends.

Question 7

Picarello Corporation's next annual dividend is expected to be $4.64 per share,to be issued one year from today.The firm anticipates the growth rate in dividends will be 4% annually for the foreseeable future.If the current price is $51 per share,what is the required rate of return for the firm's equity?

Accepted Answer

The dividend growth model can be used to calculate the required rate of return:

P0 = D1 / (r - g)

Where:
P0 = current price = $51
D1 = next year's dividend = $4.64
g = growth rate in dividends = 4%
r = required rate of return

So, we can rearrange the equation to solve for r:

r = (D1 / P0) + g

r = ($4.64 / $51) + 0.04

r = 0.132 = 13.20%

Therefore, the required rate of return for the firm's equity is approximately 13.10% (Option B).

Question 8

Which of the following is NOT a key component of the CAPM?

Accepted Answer

Diversifiable risk, also known as unsystematic risk, is not a key component of the CAPM. The key components are beta, the risk-free rate, and the market risk premium.

Question 9

The cost of preferred shares reflects the rate that the firm would need to offer if it issued new preferred shares today.

Accepted Answer

The cost of preferred shares is the rate of return required by investors in the market to purchase the firm's preferred stock. It is usually determined by the current market price of existing preferred shares and not the potential issuance of new shares.

Question 10

The ________ is a popular and somewhat intuitive technique for estimating the required return on common equity.

Accepted Answer

The dividend model, also known as the dividend discount model, is a widely used method for determining the required rate of return on a company's common equity. This model relies on the assumption that the stock's intrinsic value is equal to the present value of all its future dividends. It is considered intuitive because higher dividends indicate a higher cash return to the investor, which thus influences the required return on equity. The yield to maturity model is used to calculate the rate of return on a fixed-income investment such as bonds. The future value model is used to determine the value of an investment at a future date based on a set interest rate. The interest model is too broad and vague to be a correct option.

Question 11

To estimate the after-tax cost of preferred stock you must:

Accepted Answer

Preferred dividend payments are not tax deductible for the firm, therefore there is no need to adjust the cost of preferred stock for taxes.

Question 12

Diamond Electronics Inc.has a current price of $18.45 per share for its preferred shares that pay an annual dividend of $0.96.What is the current return on the firm's preferred shares?

Accepted Answer

The current return on the preferred shares can be calculated using the following formula: 
Current Return = Annual Dividend / Current Market Price 
Substituting the given values, 
Current Return = 0.96 / 18.45 
Current Return = 0.0520 or 5.20% 
Therefore, the answer is A) 5.20%.

Question 13

For purposes of pricing,preferred shares are considered a form of perpetuity.

Accepted Answer

Preferred shares are often viewed as a type of perpetuity because they pay a fixed dividend that is unlikely to change, and have no maturity or expiration date.

Question 14

What is the logic behind using just one cost of debt financing rather than estimating the cost of financing with each specific issue of long and short-term debt?

Accepted Answer

The answer of What is the logic behind using just...

Question 15

Freightway Trucking Inc.uses the CAPM to help estimate their cost of equity.Given the following information,what is the firm's estimated cost of equity? The risk-free return in the market is currently 3%,the market risk premium is 8%,the expected return on the market portfolio if 11% and the firm has a beta of 1.50

Accepted Answer

The firm's estimated cost of equity using the CAPM formula is calculated as: Risk-Free Rate + (Beta * Market Risk Premium) = 3% + (1.50 * 8%) = 3% + 12% = 15%.

Question 16

The costs associated with the issuance of debt,or flotation costs,are generally of secondary consideration and are typically ignored in cost of debt estimates.

Accepted Answer

Flotation costs are often considered insignificant relative to the overall cost of debt and are usually ignored when calculating the cost of debt because they represent a one-time expense that can be amortized over the life of the debt, making their impact on the overall cost minimal.

Question 17

Janis Corp.just issued an annual dividend of $2.50 per share.The firm anticipates the growth rate in dividends will be 3% annually for the foreseeable future.If the current price is $61 per share,what is the required rate of return for the firm's equity?

Accepted Answer

The answer of Janis Corp.just issued an annual dividend of...

Question 18

Beta is a/an ________ measure of risk and assumes that investors hold a ________ portfolio

Accepted Answer

Beta is a relative or comparative measure of risk, as it compares the volatility of a stock or portfolio to the broader market. It assumes that investors hold a well-diversified portfolio, as beta measures how a particular asset moves relative to the overall market. Option A and D are incorrect, as beta is not an absolute measure of risk and does not assume investors hold a risk-free portfolio. Option B is partially correct in that beta is a relative measure of risk, but it assumes investors hold a well-diversified portfolio, not a risk-free one.

Question 19

If a firm does not have publicly traded debt and therefore does not have a yield to maturity as an estimate for its cost of debt,a common practice is to estimate the cost of debt by adding a premium to the rate on:

Accepted Answer

Long-term government bonds are often used as a proxy for the risk-free rate, and adding a premium to this rate can provide a reasonable estimate for the cost of debt. This approach is commonly used in industries or companies that do not have publicly traded debt.

Question 20

The cost of debt is measured on an after-tax basis and reflects the rate that the firm would need to offer if it issued new debt today.

Accepted Answer

The cost of debt is typically measured on an after-tax basis because interest payments on debt are tax deductible. Additionally, the cost of debt represents the current rate that the firm would need to pay to issue new debt.

Quiz 10: Assessing the Cost of Capital: What Return Investors Require