Chapter 9 The Cost of Capital (with Questions Answers)

Principles of Managerial Finance, Brief Ed., 8e (Zutter/Smart)
Chapter 9 The Cost of Capital

9.1 Overview of the cost of capital

1) 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.
Answer: FALSE
Diff: 1
Topic: Overview of the Cost of Capital
Learning Obj.: LG 1
Learning Outcome: F-13
AACSB: Analytical Thinking

2) The cost of common stock equity refers to the cost of the next dollar of financing necessary to
finance a new investment opportunity.
Answer: FALSE
Diff: 1
Topic: Overview of the Cost of Capital
Learning Obj.: LG 1
Learning Outcome: F-13
AACSB: Analytical Thinking

3) The target capital structure is the desired optimal mix of debt and equity financing that firms
attempt to achieve and maintain.
Answer: TRUE
Diff: 1
Topic: The Basic Concept
Learning Obj.: LG 1
Learning Outcome: F-14
AACSB: Analytical Thinking

4) The cost of capital is the rate of return a firm must meet or exceed on investments to increase
the firm's value.
Answer: TRUE
Diff: 1
Topic: The Basic Concept
Learning Obj.: LG 1
Learning Outcome: F-13
AACSB: Analytical Thinking




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,5) The cost of capital is used to decide whether a proposed corporate investment will increase or
decrease a firm's stock price.
Answer: TRUE
Diff: 1
Topic: The Basic Concept
Learning Obj.: LG 1
Learning Outcome: F-13
AACSB: Analytical Thinking

6) The cost of capital reflects the cost of financing and is the minimum rate of return that a
project must earn to increase firm value.
Answer: TRUE
Diff: 1
Topic: The Basic Concept
Learning Obj.: LG 1
Learning Outcome: F-13
AACSB: Analytical Thinking

7) 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.
Answer: TRUE
Diff: 1
Topic: The Basic Concept
Learning Obj.: LG 1
Learning Outcome: F-13
AACSB: Analytical Thinking

8) 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.
Answer: FALSE
Diff: 1
Topic: The Basic Concept
Learning Obj.: LG 1
Learning Outcome: F-13
AACSB: Analytical Thinking

9) 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.
Answer: FALSE
Diff: 1
Topic: The Basic Concept
Learning Obj.: LG 1
Learning Outcome: F-13
AACSB: Analytical Thinking




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,10) 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.
Answer: FALSE
Diff: 1
Topic: The Basic Concept
Learning Obj.: LG 1
Learning Outcome: F-13
AACSB: Analytical Thinking

11) 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.
Answer: TRUE
Diff: 1
Topic: The Basic Concept
Learning Obj.: LG 1
Learning Outcome: F-13
AACSB: Analytical Thinking

12) In using the cost of capital, it is important that it reflects the historical cost of raising funds
over the long run.
Answer: FALSE
Diff: 1
Topic: The Basic Concept
Learning Obj.: LG 1
Learning Outcome: F-13
AACSB: Reflective Thinking

13) The ________ is the rate of return that a firm must earn on its investments in order to
maintain the market value of its stock.
A) yield to maturity
B) cost of capital
C) internal rate of return
D) modified internal rate of return
Answer: B
Diff: 1
Topic: The Basic Concept
Learning Obj.: LG 1
Learning Outcome: F-13
AACSB: Analytical Thinking




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, 14) The ________ is the rate of return required by the market suppliers of capital in order to
attract their funds to the firm.
A) yield to maturity
B) internal rate of return
C) cost of capital
D) modified internal rate of return
Answer: C
Diff: 1
Topic: The Basic Concept
Learning Obj.: LG 1
Learning Outcome: F-13
AACSB: Analytical Thinking

15) Although a firm's existing mix of financing sources may reflect its target capital structure, it
is ultimately ________.
A) the internal rate of return that is relevant for evaluating the firm's future investment
opportunities
B) the marginal cost of capital that is relevant for evaluating the firm's future investment
opportunities
C) the risk-free rate of return that is relevant for evaluating the firm's future investment
opportunities
D) the risk-free rate of return that is relevant for evaluating the firm's future financing
opportunities
Answer: B
Diff: 1
Topic: The Basic Concept
Learning Obj.: LG 1
Learning Outcome: F-14
AACSB: Reflective Thinking

16) The ________ is a weighted average of the cost of funds which reflects the interrelationship
of financing decisions.
A) internal rate of return
B) sunk cost
C) cost of capital
D) risk-free rate
Answer: C
Diff: 1
Topic: The Basic Concept
Learning Obj.: LG 1
Learning Outcome: F-13
AACSB: Reflective Thinking




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Copyright © 2019 Pearson Education, Inc.