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Cost of equity using the capital asset pricing model

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Reference no: EM131323717

1. Which of the following statements about equity is correct?

A. If equity is negative, debt exceeds total assets B. If equity is negative, total assets exceed debt

C. If equity is negative, equity exceeds assets D. If equity is negative, equity exceeds debt


2. The flotation costs of issuing new securities

A. Decrease the cost of capital B. Encourage the retention of earnings

C. Encourage external financing D. Don't affect the cost of capital


3. If the nest present values of two mutually exclusive investments are positive, a firm should select

A. Both investments B. Neither investment

C. The investment with the higher present value D. The investment with the higher net present value


4. Which of the following statements about cost of debt is correct?

A. Cost of debt is less than cost of equity B. Cost of debt is greater than cost of equity

C. Cost of debt is equal to the firm's interest rate D. Cost of debt is greater than the cost of preferred stock

5. The internal rate of return & net present value methods of capital budgeting assume that the cash flows are reinvested at the

A. Cost of capital

B. Internal rate of return

C. Cost of capital for IRR and the internal rate for NPV

D. Cost of capital for NPV and the internal rate of return for IRR


6. The optimal capital structure involves

A. minimizing the cost of all funds

B. maximizing the cost of all funds

C. minimizing the weighted average of the cost of funds

D. minimizing the weighted average of the cost of funds


Use the information in the following table to answer Questions 7, 8, 9, and 10

Coupon rate = 7% Marginal tax rate = 35%

Average tax rate = 32% Common Stock dividend (D) = 6%

Price of common stock = $80 Preferred stock dividend = $4

Price of preferred stock = $50 Growth rate of common stock divided = 6%

Bond yield risk premium =7% Risk-free rate of return = 6%

Return on the market = 12% Beta = 1.2


7. According to the information provided in the table what is the cost of debt?

A. 2.45% B. 4.55% C. 6.25% D. 7.0%


8. According to the information provided in the table what is the cost of preferred stock?

A. 8% B.&nb sp; 9% C. 10% D. 12%

9. According to the information provided in the table what is the cost of equity using the capital asset pricing model

(CAPM)?

A. 12% B. 13.2% C. 13.95% D. 14.4%

10. According to the information provided in the table what is the cost of equity using the bond yield plus risk premium method?

A. 12% B 13.2% C. 13.95% D. 14.4%

11. According to the information provided in the table what is the cost of equity using the expected growth method?

A. 12% B 13.2% C. 13.95% D. 14.4%

12. A firm should make an investment if the present value of the cash inflows on the investment is

A. Less than zero B. greater than zero

C. less than the cost of the investment D. greater than the cost of the investment


13. Which of the following statements about retained earnings is correct?

A. Retained earnings have no cost

B. Retained earnings are the firm's cheapest source of funds

C. Retained earnings have the same cost as new shares of stock

D. Retained earnings are cheaper than the cost of new shares


Use the information in the following table to answer Questions 14, 15, 16 and 17

A firm has two investment opportunities. Each investment costs $2,000, and the firm's cost of capital is 8%. The cash flows of each investment are shown in the following table:

Cash Flow of

Investment A Cash Flow of

Investment B


Year 1 $1,800 $900

Year 2 $600 $900

Year 3 $500 $900

Year 4 $400 $900


14. According to the information in the table, the NPV for Investment A is

A. $871 B. $1,300 C. $2,871 D. $3,300


15. According to the information in the table, the NPV for Investment B is

A. $980 B. $1,600 C. $2,980 D. $3,600


16. Based on the information in the table, if the investments are mutually exclusive, the firm should select

A. the higher NPV investment B. both investments

C. neither investments D. the higher payback investment


17. Based on the information in the table, if the investments are independent, the firm should select

A. the higher IRR investment B. all investments with an IRR that's greater than 8%

C. all investments with an IRR that's less than 8% D. only one investment if the IRR is greater than 8%


18. A firm should reject an investment if the internal rate of return (IRR) on the investment is

A. Greater than the cost of capital

B. less than the cost of capital

C. greater than the interest rate

D. less than the interest rate


19. The net present value of an investment will be higher if

A. The cost of capital is higher

B. There's no salvage value

C. The cost of the investment is lower

D. A firm uses straight-line depreciation


20. Which of the following statements about the marginal cost of capital is correct?

A. the Marginal cost of capital is a firm's cost of debt & equity finance

B. the Marginal cost of capital is constant once the optimal capital structure is determined

C. the Marginal cost of capital declines as flotation costs alter equity financing

D. the Marginal cost of capital refers to the cost of additional funds

Reference no: EM131323717

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