Question 1

The cost of capital reflects the cost of funds ________.

Accepted Answer

C

Question 2

A firm's flotation cost can be calculated by weighting the cost of each source of financing by its relative proportion in a firm's target capital structure.

Accepted Answer

False

Question 3

The cost of capital reflects the cost of funds over the long run measured at a given point in time, based on the best information available.

Accepted Answer

The cost of capital reflects the cost of funds over the long run based on the best information available at a given point in time.

Question 4

The cost of capital is the rate of return a firm must earn on investments in order to increase the firm's value.

Accepted Answer

The cost of capital is the minimum rate of return that a company must generate in order to be able to satisfy its investors and maintain its market position. By earning this rate of return, a company can reinvest its earnings in new projects and continue to grow.

Question 5

The ________ is the firm's desired optimal mix of debt and equity financing.

Accepted Answer

The target capital structure is the firm's desired optimal mix of debt and equity financing. The other options, book value, market value, and cost of capital, are important financial concepts but do not specifically refer to the optimal mix of debt and equity financing.

Question 6

The cost of capital is a static concept and it is not affected by economic and firm-specific factors such as business risk and financial risk.

Accepted Answer

The cost of capital is affected by economic and firm-specific factors such as business risk and financial risk. These factors can influence the return that investors require for their investment, which in turn affects the cost of capital for the firm.

Question 7

The cost of capital is a dynamic concept and it is affected by economic and firm-specific factors such as business risk and financial risk.

Accepted Answer

The cost of capital is not a static concept and it can change due to various factors such as economic conditions, changes in interest rates, and changes in the risk profile of the firm. Business risk, financial risk, and other factors can also impact the cost of capital. Therefore, the statement is true that the cost of capital is a dynamic concept that is affected by economic and firm-specific factors.

Question 8

The ________ is the rate of return required by the market suppliers of capital in order to attract their funds to the firm.

Accepted Answer

The cost of capital is the rate of return required by the market suppliers of capital (i.e. investors, lenders, etc.) in order to provide funds to a firm. It represents the opportunity cost of investing in one asset instead of another with comparable risk. The cost of capital is a critical input in many financial decisions, such as determining whether to pursue a new investment, how to fund it, and whether it will generate adequate returns for stakeholders.

Question 9

The cost to a firm of each type of capital is dependent upon ________.

Accepted Answer

The cost to a firm of each type of capital is dependent upon the risk-free rate of each type of capital plus the business risk and the financial risk of the firm. This encompasses the basic cost of borrowing (risk-free rate) and the additional risks associated with the firm's operations (business risk) and its capital structure (financial risk).

Question 10

In using the cost of capital, it is important that it reflects the historical cost of raising funds over the long run.

Accepted Answer

The cost of capital should reflect the current or expected cost of raising funds, which may not necessarily be the same as the historical cost. The historical cost may be used as a reference point, but it is not always the most accurate reflection of the current cost of capital.

Question 11

Holding risk constant, the implementation of projects with a rate of return above the cost of capital will decrease the value of a firm, and vice versa.

Accepted Answer

This statement is incorrect. The implementation of projects with a rate of return above the cost of capital will increase the value of a firm, as it generates positive net present value (NPV) and increases shareholders' wealth. Conversely, projects with a rate of return below the cost of capital will decrease the value of a firm, as they generate negative NPV and destroy shareholders' wealth. Holding risk constant, the relationship between the net present value and the cost of capital is inverse; that is, as the cost of capital increases, the net present value decreases, and vice versa.

Question 12

The target capital structure is the desired optimal mix of debt and equity financing that most firms attempt to achieve and maintain.

Accepted Answer

The target capital structure is the ideal blend of debt and equity financing used by a firm to maximize its value and minimize its cost of capital. Many firms strive to achieve and sustain this financing mix through various financial policies and strategies.

Question 13

The cost of common stock equity refers to the cost of the next dollar of financing necessary to finance a new investment opportunity.

Accepted Answer

The cost of common stock equity refers to the return a company must offer investors to entice them to invest in the company's stock, not specifically to the cost of financing a new investment opportunity. It represents the cost of obtaining equity financing, reflecting the expected return demanded by investors.

Question 14

The cost of capital is used to decide whether a proposed corporate investment will increase or decrease a firm's stock price.

Accepted Answer

The cost of capital is an important factor in determining the feasibility of a proposed investment as it measures the cost of funding and the expected rate of return. By comparing the cost of capital to the potential returns from the investment, a firm can determine whether the investment is likely to increase or decrease its stock price. Therefore, the statement is true.

Question 15

Although a firm's existing mix of financing sources may reflect its target capital structure, it is ultimately ________.

Accepted Answer

The mix of financing sources of a firm may reflect its target capital structure, but the relevant factor for evaluating the firm's future investment opportunities is the marginal cost of capital. The marginal cost of capital considers the cost of each additional dollar of funding and reflects the firm's current market conditions, including the cost of debt and equity. Therefore, it is ultimately the marginal cost of capital that the firm should consider when evaluating investment opportunities, rather than simply relying on their current financing mix.

Question 16

The ________ is the rate of return that a firm must earn on its investments in order to maintain the market value of its stock.

Accepted Answer

The cost of capital is the rate of return that a firm must earn on its investments in order to maintain the market value of its stock. This includes both the cost of equity and the cost of debt. Yield to maturity, internal rate of return, and modified internal rate of return are all used in financial analysis, but they do not specifically address the cost of capital.

Question 17

The ________ is a weighted average of the cost of funds which reflects the interrelationship of financing decisions.

Accepted Answer

The cost of capital is the weighted average cost of funds and considers the interrelationship of financing decisions, like debt and equity, whereas the internal rate of return is the discount rate that makes net present value zero, the sunk cost is a cost that has already been incurred and cannot be recovered, and the risk-free rate is the rate of return on a risk-free investment.

Question 18

The cost of capital is described as the rate of return required by the market suppliers of capital in order to attract their funds to the firm.

Accepted Answer

The answer of The cost of capital is described as...

Question 19

The cost of capital of each source of financing is the after-tax cost of obtaining the financing using the historically based cost reflected by the existing financing on the firm's books.

Accepted Answer

The statement is not entirely accurate. The cost of each source of financing should be determined based on the current market conditions, not just the historical cost reflected on the firm's books. Additionally, the after-tax cost should take into account any tax deductions or credits associated with the financing.

Question 20

The cost of capital acts as a major link between a firm's long-term investment decisions and the wealth of the firm's owners as determined by the market value of their shares.

Accepted Answer

The cost of capital is important in determining whether or not a project or investment is financially feasible and will generate returns that are greater than the cost of acquiring the necessary capital. If the cost of capital is too high, then it may not be worth pursuing the investment, as it could end up being a drain on the firm's resources and negatively impact the market value of the firm's shares. Therefore, the cost of capital is a key factor in linking a firm's investment decisions to the wealth of its owners.

Quiz 9: The Cost of Capital