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Fundamentals of Corporate Finance, 4/c/e

Fundamentals of Corporate Finance, 4/e

Stephen A. Ross, Massachusetts Institute of Technology
Randolph W. Westerfield, University of Southern California
Bradford D. Jordan, University of Kentucky
Gordon S. Roberts, York University

Cost of Capital

Quick Quiz 1

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1	The interest rate that should be used when evaluating a capital investment project is sometimes called the. I. internal rate of return II. appropriate discount rate III. cost of capital
		A)	I only
		B)	II only
		C)	III only
		D)	I, II, and III
		E)	II and III only


2	You need to calculate the cost of equity capital for a firm that is traded on the Toronto Stock Exchange. Which of the following would likely be least helpful to you?
		A)	Knowledge of the stock's price six months ago.
		B)	The rate of return on stocks of similar risk.
		C)	An investment publication that provides an estimate of the firm's beta.
		D)	An investment survey that projects future dividend growth rates for the firm.
		E)	A data set containing dividends paid for the past ten years.


3	All else the same, a higher corporate tax rate __________.
		A)	will increase the WACC of a firm with debt and equity in its capital structure
		B)	will decrease the WACC of a firm with equity in its capital structure only
		C)	will not affect the WACC of a firm with debt in its capital structure
		D)	will decrease the WACC of a firm with some debt in its capital structure
		E)	will change the WACC of a firm with debt in its capital structure, but the direction is unknown.


4	The cost of capital in a firm that has both debt and equity __________.
		A)	is equal to the cost of debt or equity, depending on which type of financing the firm uses more
		B)	depends on the source of the funds for a project
		C)	is what a firm must earn on a project to compensate investors for the use of their funds
		D)	is also known as the internal rate of return
		E)	will be the same for its different divisions


5	Which of the following is NOT generally considered to be a problem when estimating the cost of equity?
		A)	We must estimate beta using historical information.
		B)	We must estimate the risk-free rate of interest.
		C)	We must estimate the market risk premium.
		D)	We must estimate a dividend growth rate.
		E)	If we use the dividend growth model, we cannot adjust for differences in risk.


6	Topstone Industries' preferred stock pays an annual dividend of $4.00 per share. When issued, the shares sold for their par value of $100 per share. What is the cost of preferred stock if the current price is $125 per share?
		A)	31.3%
		B)	3.7%
		C)	4.0%
		D)	4.7%
		E)	3.2%


7	Treasury bills currently have a return of 3.5% and the market risk premium is 8%. If a firm has a beta of 1.6, what is its cost of equity?
		A)	18.8%
		B)	16.3%
		C)	12.8%
		D)	10.7%
		E)	8.8%


8	Given the following information, what is JEM Inc.'s weighted average cost of capital? Market value of equity = $50 million; market value of debt = $30 million; cost of equity = 16%; cost of debt = 8%; equity beta = 1.25; tax rate = 34%.
		A)	11.29%
		B)	11.45%
		C)	11.98%
		D)	12.32%
		E)	13.00%


9	Your firm is considering a project which requires an initial investment of $5 million. Your target D/E ratio is 0.67. Flotation costs for equity are 8% and flotation costs for debt are 2%. What is the true cost (in dollars) of the project when you consider flotation costs?
		A)	$5.10 million
		B)	$5.28 million
		C)	$5.00 million
		D)	$5.61 million
		E)	$5.40 million


10	A proposed project lasts 3 years and has an initial investment of $200,000. The aftertax cash flows are estimated at $60,000 for year 1, $120,000 for year 2, and $135,000 for year 3. The firm has a target debt/equity ratio of 1.2. The firm's cost of equity is 14% and its cost of debt is 9%. The tax rate is 34%. What is the NPV of this project?
		A)	-$12,370
		B)	$37,723
		C)	$13,687
		D)	$57,185
		E)	$46,120

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