Question 1

In calculating the cost of common stock equity,the model which describes the relationship between the required return and the nondiversifiable risk of the firm is ________.

Accepted Answer

The capital asset pricing model (CAPM) describes the relationship between the required return of a stock and the nondiversifiable risk (measured by beta) of the firm. The other models listed are not directly related to this relationship.

Question 2

The cost of common stock equity may be estimated by using the ________.

Accepted Answer

The capital asset pricing model, or CAPM, is a widely used method for estimating the cost of equity. It takes into account the risk-free rate, market risk premium, and the systematic risk of a company's stock, as measured by its beta. The yield curve helps in estimating the cost of debt, break-even analysis is used to determine the point at which a company makes neither a profit nor a loss, and DuPont analysis is a method for analyzing a company's return on equity.

Question 3

What would be the cost of new common stock equity for Tangshan Mining if the firm just paid a dividend of $4.25,the stock price is $55.00,dividends are expected to grow at 8.5 percent indefinitely,and flotation costs are $6.25 per share?

Accepted Answer

The cost of new common stock equity can be calculated using the formula: Cost of Equity = (D1 / (P0 - F)) + g, where D1 is the expected dividend next year, P0 is the current stock price, F is the flotation cost, and g is the growth rate. D1 = $4.25 * (1 + 0.085) = $4.61. Thus, Cost of Equity = ($4.61 / ($55.00 - $6.25)) + 0.085 = 17.96%.

Question 4

One major expense associated with issuing new shares of common stock is ________.

Accepted Answer

Underpricing refers to the practice of selling shares for less than their market value in order to entice investors to purchase them. This can be a major expense for a company as it results in the company receiving less money for each share sold.

Question 5

The cost of new common stock financing is higher than the cost of retained earnings due to ________.

Accepted Answer

Flotation costs and underpricing typically increase the cost of new common stock financing compared to retained earnings. Flotation costs refer to the expenses associated with issuing new securities, such as underwriting fees, legal fees, and printing costs. Underpricing occurs when an initial public offering (IPO) of stock is priced below its market value, which can lead to a loss for the company. Both of these factors increase the cost of new common stock financing.

Question 6

One of the circumstances in which the Gordon growth valuation model for estimating the value of a share of stock should be used is ________.

Accepted Answer

The Gordon growth model is most suitable for stocks with a steady growth rate in dividends that can be projected into the future. It assumes that the dividend will grow at a constant rate indefinitely, which may not hold true for stocks with declining or erratic dividend streams or a lack of data on dividend payments.

Question 7

Given that the cost of common stock is 9 percent,dividends are $0.75 per share and the price of the stock is $12.50 per share,what is the annual growth rate of dividends?

Accepted Answer

We can use the Gordon Growth Model to calculate the annual growth rate of dividends:

Cost of common stock = 9%

Dividends = $0.75 per share

Price of the stock = $12.50 per share

Using the formula 
9% = (0.75 / 12.50) + g

Solving the equation for g, we get:

g = 3%

Therefore, the annual growth rate of dividends is 3%.

Question 8

The constant-growth valuation model is based on the premise that the value of a share of common stock is ________.

Accepted Answer

The constant-growth valuation model, also known as the Gordon growth model, assumes that the value of a share of common stock is equal to the present value of all expected future dividends, discounted at the investor's required rate of return. This means that the value of the stock is based solely on the dividends it is expected to pay in the future, and not on any industry standard P/E multiple or relative risk measure like correlation coefficient. Therefore, option D is the correct choice.

Question 9

In comparing the constant-growth model and the capital asset pricing model (CAPM)to calculate the cost of common stock equity,________.

Accepted Answer

The constant-growth model uses dividend expectations to calculate the cost of equity, while the CAPM uses beta to directly consider the risk of the stock. The CAPM's beta coefficient measures the volatility or risk of a stock in relation to the market as a whole. Meanwhile, the constant-growth model assumes that the market price of a stock reflects investors' expected risk-return preferences, which is often not the case, especially for newer companies with high growth potential or high uncertainty. Therefore, the CAPM is a more reliable method of calculating the cost of common stock equity.

Question 10

Using the capital asset pricing model,the cost of common stock equity is the return required by investors as compensation for ________.

Accepted Answer

The capital asset pricing model (CAPM) is used to determine the expected return on an investment. It does so by taking into consideration the risk-free rate, the beta (systematic risk) of the investment, and the expected market return. The cost of common stock equity, which is a component of the CAPM, is the return required by investors as compensation for the nondiversifiable (systematic) risk of the investment. Therefore, choice D is the best answer as it refers to a firm's nondiversifiable risk, which is the type of risk that is measured by beta and is relevant in the CAPM. The other choices (A, B, and C) are related to specific, unsystematic, or idiosyncratic risks that can be diversified by investors and are not relevant for the CAPM.

Question 11

A firm has common stock with a market price of $25 per share and an expected dividend of $2 per share at the end of the coming year.The growth rate in dividends has been 5 percent.The cost of the firm's common stock equity is ________.

Accepted Answer

The answer of A firm has common stock with a...

Question 12

The weighted average cost of capital (WACC)reflects the expected average cost of the different forms of capital that a firm uses.

Accepted Answer

WACC takes into account the cost of debt, cost of equity, and other types of capital that a firm uses, and weights them by their respective proportions in the capital structure. Therefore, it reflects the expected average cost of all types of capital.

Question 13

Since retained earnings are viewed as a fully subscribed issue of additional common stock,the cost of retained earnings is ________.

Accepted Answer

Retained earnings are the portion of the company's profits that are not paid out as dividends but rather are reinvested back into the business. Since retained earnings are already owned by existing shareholders and no new shares are issued, the cost of using retained earnings is lower than issuing new common stock equity. Hence, the cost of retained earnings is lower than the cost of new common stock equity.

Question 14

A firm has common stock with a market price of $55 per share and an expected dividend of $2.81 per share at the end of the coming year.The dividends paid on the outstanding stock over the past five years are as follows:  The cost of the firm's common stock equity is ________.

Accepted Answer

The answer of A firm has common stock with a...

Question 15

The cost of retained earnings is ________.

Accepted Answer

Retained earnings represent the cost of common stock equity since they are the portion of earnings that have been reinvested in the company rather than paid out to shareholders as dividends. As a result, the cost of retained earnings is the same as the cost of common stock equity.

Question 16

A corporation that uses both debt and equity in its capital structure has concluded that the risk premium it must pay on its common stock is too high.To decrease this,the firm can ________.

Accepted Answer

The risk premium on common stock is directly related to financial risk, which is the risk inherent in a company's capital structure. As such, decreasing the proportion of common stock equity (by increasing the proportion of debt) will decrease the financial risk and ultimately lower the risk premium on the common stock. Therefore, the best choice is to increase the proportion of common stock equity to decrease financial risk.

Question 17

What would be the cost of retained earnings equity for Tangshan Mining if the expected return on U.S.Treasury Bills is 5.00%,the market risk premium is 10.00 percent,and the firm's beta is 1.3?

Accepted Answer

The cost of retained earnings equity can be calculated using the Capital Asset Pricing Model (CAPM):
Cost of Retained Earnings Equity = Risk-Free Rate + Beta*(Market Risk Premium)
= 5.00% + 1.3*(10.00%) = 18.0%

Question 18

The weighted average cost that reflects the interrelationship of financing decisions can be obtained by weighing the cost of each source of financing by the target proportion in a firm's capital structure.

Accepted Answer

This statement accurately describes the calculation for a weighted average cost of capital (WACC) which takes into account the proportion of each source of financing in a company's capital structure.

Question 19

A firm has common stock with a market price of $100 per share and an expected dividend of $5.61 per share at the end of the coming year.A new issue of stock is expected to be sold for $98,with $2 per share representing the underpricing necessary in the competitive capital market.Flotation costs are expected to total $1 per share.The dividends paid on the outstanding stock over the past five years are as follows:  The cost of this new issue of common stock is ________.

Accepted Answer

The answer of A firm has common stock with a...

Question 20

A firm has a beta of 1.2.The market return equals 14 percent and the risk-free rate of return equals 6 percent.The estimated cost of common stock equity is ________.

Accepted Answer

The estimated cost of common stock equity is equal to the risk-free rate plus the product of beta and the market risk premium (i.e., the difference between the market return and the risk-free rate). So, the estimated cost of common stock equity is 6% + (1.2 × (14% - 6%)) = 15.6%. Therefore, the correct answer is D).

Quiz 9: The Cost of Capital

In calculating the cost of common stock equity,the model which describes the relationship between the required return and the nondiversifiable risk of the firm is ________.

The cost of common stock equity may be estimated by using the ________.

What would be the cost of new common stock equity for Tangshan Mining if the firm just paid a dividend of $4.25,the stock price is $55.00,dividends are expected to grow at 8.5 percent indefinitely,and flotation costs are $6.25 per share?

One major expense associated with issuing new shares of common stock is ________.

The cost of new common stock financing is higher than the cost of retained earnings due to ________.

One of the circumstances in which the Gordon growth valuation model for estimating the value of a share of stock should be used is ________.

Given that the cost of common stock is 9 percent,dividends are $0.75 per share and the price of the stock is $12.50 per share,what is the annual growth rate of dividends?

The constant-growth valuation model is based on the premise that the value of a share of common stock is ________.

In comparing the constant-growth model and the capital asset pricing model (CAPM) to calculate the cost of common stock equity,________.

Using the capital asset pricing model,the cost of common stock equity is the return required by investors as compensation for ________.

A firm has common stock with a market price of $25 per share and an expected dividend of $2 per share at the end of the coming year.The growth rate in dividends has been 5 percent.The cost of the firm's common stock equity is ________.

The weighted average cost of capital (WACC)reflects the expected average cost of the different forms of capital that a firm uses.

Since retained earnings are viewed as a fully subscribed issue of additional common stock,the cost of retained earnings is ________.

A firm has common stock with a market price of $55 per share and an expected dividend of $2.81 per share at the end of the coming year.The dividends paid on the outstanding stock over the past five years are as follows: The cost of the firm's common stock equity is ________.

The cost of retained earnings is ________.

A corporation that uses both debt and equity in its capital structure has concluded that the risk premium it must pay on its common stock is too high.To decrease this,the firm can ________.

What would be the cost of retained earnings equity for Tangshan Mining if the expected return on U.S.Treasury Bills is 5.00%,the market risk premium is 10.00 percent,and the firm's beta is 1.3?

The weighted average cost that reflects the interrelationship of financing decisions can be obtained by weighing the cost of each source of financing by the target proportion in a firm's capital structure.

A firm has a beta of 1.2.The market return equals 14 percent and the risk-free rate of return equals 6 percent.The estimated cost of common stock equity is ________.