FIN 101 Mid Term-Financial Management Notes Questions And Answers

1. "Capital" is sometimes defined as funds supplied to a firm by investors. T   2. The cost of capital used in capital budgeting should reflect the average cost of the various sources of long -term funds a firm uses to acquire assets. T   3. The component costs of capital are market-determined variables in the sense that they are based on investors' required returns. T   4. Suppose you are the president of a small, publicly-traded corporation. Since you believe that your firm's stock price is temporarily depressed, all additional capital funds required during the current year will be raised using debt. In this case, the appropriate marginal cost of capital for use in capital budgeting during the current year is the after-tax cost of debt. F   5. The before-tax cost of debt, which is lower than the after-tax cost, is used as the component cost of debt for purposes of developing the firm's WACC. F   6. The cost of debt is equal to one minus the marginal tax rate multiplied by the average coupon rate on all outstanding debt. F   7. The cost of debt is equal to one minus the marginal tax rate multiplied by the interest rate on new debt. T   8. The cost of preferred stock to a firm must be adjusted to an after-tax figure because 70% of dividends received by a corporation may be excluded from the receiving corporation's taxable income. F   9. The cost of perpetual preferred stock is found as the preferred's annual dividend divided by the market price of the preferred stock. No adjustment is needed for taxes because preferred dividends, unlike interest on debt, is not deductible by the issuing firm. T   10. The cost of common equity obtained by retaining earnings is the rate of return the marginal stockholder requires on the firm's common stock. T   11. For capital budgeting and cost of capital purposes, the firm should always consider reinvested earnings as the first source of capital⎯i.e., use these funds first⎯because reinvested earnings have no cost to the firm. F   12. Funds acquired by the firm through retaining earnings have no cost because there are no dividend or interest payments associated with them, and no flotation costs are required to raise them, but capital raised by selling new stock or bonds does have a cost. F  