1**.**

Coupon rate = 7 percent

Average tax rate = 32%

Price of common stock = $80

Price of preferred stock = $50

Bond yield risk premium = 7%

Return of the market = 12%

Marginal tax rate = 35%

Common stock dividend (Do) = $6

Preferred stock dividend (Do) = $4

Growth rate of common stock dividend = 6%

Risk-free rate of return = 6%

Beta = 1.2

According to the information given, what is the cost of equity using the *capital asset pricing model?*

- 14.4 percent

- 12 percent

- 13.95 percent

- 13.2 percent

** **

- A firm should reject an investment if the
*internal rate of return*on the investment is

- less than the interest rate.

- greater than the interest rate.

- less than the cost of capital.

- greater than the cost of capital.

** **

- Which of the following statements about retained earnings is
*correct?*

- Retained earnings are the firm’s cheapest source of funds.

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

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

- Retained earnings have no cost.

** **

- The internal rate of return and net present value methods of capital budgeting assume that the cash flows are reinvested at the

- cost of capital for NPV and the internal rate of return for IRR.

- cost of capital for IRR and the internal rate of return for NPV.

- internal rate of return.

- cost of capital.

** **

- NPV may be preferred to IRR because

- NPV excludes salvage value.

- IRR makes more conservative assumptions concerning reinvesting.

- NPV makes more conservative assumptions concerning reinvesting.

- IRR excludes salvage value.

** **

- A firm has two investment opportunities. Each investment costs $2,000, and the firm’s cost of capital is

8 percent. The cash flows of each investment are as follows:

**Cash Flow of Investment A**

Year 1: $1800

Year 2: $600

Year 3: $500

Year 4: $400

**Cash Flow of Investment B**

Year 1: $900

Year 2: $900

Year 3: $900

Year 4: $900

According to the information, the NPV for Investment B is

- $1,600.

- $2,980.

- $980.

- $3,600.

** **

- Which of the following statements about the cost of debt is
*correct?*

- The cost of debt is greater than the cost of preferred stock.

- The cost of debt is greater than the cost of equity.

- The cost of debt is less than the cost of equity.

- The cost of debt is equal to the firm’s interest rate.

** **

**8.**

Coupon rate = 7 percent

Average tax rate = 32%

Price of common stock = $80

Price of preferred stock = $50

Bond yield risk premium = 7%

Return of the market = 12%

Marginal tax rate = 35%

Common stock dividend (Do) = $6

Preferred stock dividend (Do) = $4

Growth rate of common stock dividend = 6%

Risk-free rate of return = 6%

Beta = 1.2

According to the information given, what is the cost of preferred stock?

- 8 percent

- 12 percent

- 9 percent

- 10 percent

** **

**9.**

Coupon rate = 7 percent

Average tax rate = 32%

Price of common stock = $80

Price of preferred stock = $50

Bond yield risk premium = 7%

Return of the market = 12%

Marginal tax rate = 35%

Common stock dividend (Do) = $6

Preferred stock dividend (Do) = $4

Growth rate of common stock dividend = 6%

Risk-free rate of return = 6%

Beta = 1.2

According to the information given, what is the cost of equity using the bond yield plus risk premium

method?

- 13.2 percent

- 12 percent

- 13.95 percent

- 14 percent

** **

- Which of the following statements about the marginal cost of capital is
*correct?*

- The marginal cost of capital is a firm’s cost of debt and equity finance.

- The marginal cost of capital refers to the cost of additional funds.

- The marginal cost of capital declines as flotation costs alter equity financing.

- The marginal cost of capital is constant once the optimal capital structure is determined.

** **

- The lower the debt ratio, the

- lower is the use of financial leverage.

- higher is the use of financial leverage.

- higher are the firm’s total assets.

- lower are the firm’s total assets.

** **

- If the net present values of two mutually exclusive investments are positive, a firm should select

- both investments.

- the investment with the higher net present value.

- the investment with the higher present value.

- neither investment.

** **

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

- greater than zero.

- less than zero.

- greater than the cost of the investment.

- less than the cost of the investment.

** **

- If the internal rates of return of two mutually exclusive investments exceed the firm’s cost of capital,

the firm should make

- both investments.

- the investment with the higher IRR.

- the investment with the lower IRR.

- neither investment.

** **

**15.**

Coupon rate = 7 percent

Average tax rate = 32%

Price of common stock = $80

Price of preferred stock = $50

Bond yield risk premium = 7%

Return of the market = 12%

Marginal tax rate = 35%

Common stock dividend (Do) = $6

Preferred stock dividend (Do) = $4

Growth rate of common stock dividend = 6%

Risk-free rate of return = 6%

Beta = 1.2

According to the information given, what is the cost of equity using the expected growth method?

- 13.95 percent

- 14.4 percent

- 12 percent

- 13.2 percent

** **

- An increase of cost of capital will

- increase an investment’s IRR.

- Increase an investment’s NPV.

- decrease an investment’s NPV.

- decrease an investment’s IRR.

** **

- The net present value of an investment will be higher if

- the cost of capital is higher.

- there’s no salvage value.

- the cost of the investment is lower.

- a firm uses straight-line depreciation.

** **

**18.**

Coupon rate = 7 percent

Average tax rate = 32%

Price of common stock = $80

Price of preferred stock = $50

Bond yield risk premium = 7%

Return of the market = 12%

Marginal tax rate = 35%

Common stock dividend (Do) = $6

Preferred stock dividend (Do) = $4

Growth rate of common stock dividend = 6%

Risk-free rate of return = 6%

Beta = 1.2

According to the information given, what is the cost of debt?

- 2.45 percent

- 7.0 percent

- 4.55 percent

- 6.25 percent

** **

- A firm has two investment opportunities. Each investment costs $2,000, and the firm’s cost of capital is

8 percent. The cash flows of each investment are as follows:

**Cash Flow of Investment A**

Year 1: $1800

Year 2: $600

Year 3: $500

Year 4: $400

**Cash Flow of Investment B**

Year 1: $900

Year 2: $900

Year 3: $900

Year 4: $900

Based on the information, if the investments are independent, the firm should select

- all investments with an IRR that’s less than 8 percent.

- all investments with an IRR that’s greater than 8 percent.

- only one investment if the IRR is greater than 8 percent.

- the higher IRR investment.

** **

- Which of the following statements
*best*explains why a rising ratio of debt-to-total assets increases the

cost of debt?

- As total assets decline in relation to a stable debt level, equity declines.

- If debt remains constant while the ratio increases, rising assets must be finance with more expensive equity financing.

- As the ratio increases, creditors require higher interest rates to compensate them for higher default risk.

- As debt increases, the contribution of more expensive equity financing decreases.