FIN 6406 Chapter 14 Quiz || Well-Enlightened.
The cost of capital for a new project: correct answers depends upon how the funds raised for
that project are going to be spent.
A company's current cost of capital is based on: correct answers both the returns currently
required by its debtholders and stockholders.
All else constant, which one of the following will increase a company's cost of equity if the
company computes that cost using the security market line approach? Assume the firm
currently pays an annual dividend of $1 a share and has a beta of 1.2. correct answers A
reduction in the risk-free rate
The primary advantage of using the dividend growth model to estimate a company's cost of
equity is: correct answers the simplicity of the model.
The dividend growth model: correct answers is only as reliable as the estimated rate of
growth.
A group of individuals got together and purchased all of the outstanding shares of common
stock of ZenGen Inc. What is the return that these individuals require on this investment
called? correct answers Cost of equity
What are the advantages of using the DCF model for determining the cost of equity capital?
What are the disadvantages? What specific piece of information do you need to find the cost
of equity using this model? What are some ways which you could get this estmate? correct
answers The primary advantage of the DCF model is its simplicity. The method is
disadvantaged in that (a) the model is applicable only to firms that actually pay dividends;
many do not; (b) even if a firm does pay dividends, the DCF model requires a constant
dividend growth rate forever; (c) the estimated cost of equity from this method is very
sensitive to changes in the growth rate, which is a very uncertain parameter; and (d) the
model does not explicitly consider risk, although risk is implicitly considered to the extent
that the market has impounded the relevant risk of the stock into its market price. While the
share price and most recent dividend can be observed in the market, the dividend growth rate
must be estimated. Two common methods of estimating the growth rate are to use analysts'
earnings and payout forecasts or to determine some appropriate average historical growth rate
from the firm's available data.
The Comic Book Store of Pasadena borrows money at a rate of 8.7 percent. This interest rate
is referred to as the: correct answers cost of debt.
Which one of these will increase a company's aftertax cost of debt? correct answers A
decrease in the company's tax rate
Under what circumstances would it be appropriate for a firm to use different costs of capital
forits different operating divisions? If the overall firm WACC was used as the hurdle rate for
all divisions, would the riskier divisions or the more conservative divisions tend to get most
of the investment projects? Why? If you were to try to estimate the appropriate cost of capital
for different divisions, what problems might you encounter? What are two techniques you
could use to develop a rough estimate for each division's cost of capital? correct answers If
The cost of capital for a new project: correct answers depends upon how the funds raised for
that project are going to be spent.
A company's current cost of capital is based on: correct answers both the returns currently
required by its debtholders and stockholders.
All else constant, which one of the following will increase a company's cost of equity if the
company computes that cost using the security market line approach? Assume the firm
currently pays an annual dividend of $1 a share and has a beta of 1.2. correct answers A
reduction in the risk-free rate
The primary advantage of using the dividend growth model to estimate a company's cost of
equity is: correct answers the simplicity of the model.
The dividend growth model: correct answers is only as reliable as the estimated rate of
growth.
A group of individuals got together and purchased all of the outstanding shares of common
stock of ZenGen Inc. What is the return that these individuals require on this investment
called? correct answers Cost of equity
What are the advantages of using the DCF model for determining the cost of equity capital?
What are the disadvantages? What specific piece of information do you need to find the cost
of equity using this model? What are some ways which you could get this estmate? correct
answers The primary advantage of the DCF model is its simplicity. The method is
disadvantaged in that (a) the model is applicable only to firms that actually pay dividends;
many do not; (b) even if a firm does pay dividends, the DCF model requires a constant
dividend growth rate forever; (c) the estimated cost of equity from this method is very
sensitive to changes in the growth rate, which is a very uncertain parameter; and (d) the
model does not explicitly consider risk, although risk is implicitly considered to the extent
that the market has impounded the relevant risk of the stock into its market price. While the
share price and most recent dividend can be observed in the market, the dividend growth rate
must be estimated. Two common methods of estimating the growth rate are to use analysts'
earnings and payout forecasts or to determine some appropriate average historical growth rate
from the firm's available data.
The Comic Book Store of Pasadena borrows money at a rate of 8.7 percent. This interest rate
is referred to as the: correct answers cost of debt.
Which one of these will increase a company's aftertax cost of debt? correct answers A
decrease in the company's tax rate
Under what circumstances would it be appropriate for a firm to use different costs of capital
forits different operating divisions? If the overall firm WACC was used as the hurdle rate for
all divisions, would the riskier divisions or the more conservative divisions tend to get most
of the investment projects? Why? If you were to try to estimate the appropriate cost of capital
for different divisions, what problems might you encounter? What are two techniques you
could use to develop a rough estimate for each division's cost of capital? correct answers If
