Professional Documents
Culture Documents
(2B2-LS16)
Question 2:
(2B2-LS18)
Credit rating services may adjust ratings up or down during the life of a
bond. A downgraded rating means that future issues will need to offer
higher interest rates to attract buyers.
Question 3:
(2B2-LS11)
Cash dividends do not result in any taxable gain or loss; stock splits
are taxable.
Stock splits do not result in any taxable gain or loss; cash dividends
are taxable.
Question 4:
(2B2-CQ14)
13.9%.
11.9%.
13.1%.
14.1%.
Question 5:
(2B2-AT08)
Debentures are:
bonds backed by the full faith and credit of the issuing firm.
subordinated debt and rank behind convertible bonds.
income bonds that require interest payments only when earnings
permit.
mortgage bonds secured by a lien on specific assets of the firm.
Debentures are unsecured bonds. They are backed by the full faith and
credit of the issuing firm.
Question 6:
(2B2-LS62)
The underlying logic of the dividend growth model is that market price of
a stock equals the cash flow of expected future incomes (both dividends
and market price appreciation) discounted to their present value. This
means that when the present value of the future cash flows equals the
market price, the discount rate equals the cost of equity capital. An
underlying assumption is that cash flows will grow at a constant
compound rate.
Question 7:
(2B2-LS55)
Preferred stock may be retired through the use of any one of the following
except a:
Question 8:
(2B2-LS60)
Question 9:
(2B2-LS34)
Question 10:
(2B2-LS63)
Question 11:
(2B2-CQ12)
An accountant for Stability Inc. must calculate the weighted average cost of
capital (WACC) of the corporation using the following information.
17%.
13.4%.
10.36%.
11.5%.
Question 12:
(2B2-LS57)
Question 13:
(2B2-AT02)
The beta of Wheeling Inc. common stock is greater than 1. This means that:
The Wheeling stock and the market portfolio have the same
systematic risk.
Returns for the Wheeling stock vary more widely than market returns.
The Wheeling stock has the same risk as other stocks with the same
credit rating.
The unsystematic risk for the Wheeling stock varies more widely than
market returns.
The beta for a common stock is the ratio of the variability in its returns to
the variability in the overall stock market. A common stock with a beta of
1 tracks the market. A common stock with a beta greater than 1 has
returns that are more variable than the overall stock market. A common
stock with a beta less than 1 has returns that are less variable than the
overall stock market. Therefore, the returns for the stock of Wheeling, Inc.
will vary more widely than market returns.
Question 14:
(2B2-LS49)
put option.
protective covenant.
warrant.
call provision.
Question 15:
(2B2-LS37)
Question 16:
(2B2-LS28)
Question 17:
(2B2-LS53)
A financial lease.
A chattel mortgage.
A bond.
A treasury note.
Question 18:
(2B2-AT09)
Question 19:
(2B2-AT04)
A pension fund manager utilizes the Capital Asset Pricing Model (CAPM) to
guide the decision process. The manager has been presented with the
following three investment options by the fund advisor, all of which are
large, fully diversified investment funds.
Which one of the following is correct with regard to the returns for these
portfolios?
Portfolio C can be expected to earn the lowest return.
Portfolios A and C can be expected to earn similar returns.
Portfolio B has more risk than Portfolio C and less risk than Portfolio
A.
Portfolio A can be expected to earn the highest return.
Ke = Rf + (Km - Rf)
Where:
Ke = required rate of return
Rf = risk-free rate (such as the return on U.S. T-bill or T-bonds)
= beta coefficient for the company
Km = return on a market portfolio
Since the betas for portfolios A and C are the same, the required rates of
return would be the same.
Question 20:
(2B2-AT16)
DQZ Telecom is considering a project for the coming year that will cost $50
million. DQZ plans to use the following combination of debt and equity to
finance the investment.
Issue $15 million of 20-year bonds at a price of 101, with a coupon
rate of 8%, and flotation costs of 2% of par.
Use $35 million of funds generated from earnings.
The equity market is expected to earn 12%. U.S. treasury bonds are
currently yielding 5%. The beta coefficient for DQZ is estimated to be .60.
DQZ is subject to an effective corporate income tax rate of 40%.
Assume that the after-tax cost of debt is 7% and the cost of equity is 12%.
Determine the weighted average cost of capital (WACC).
10.5%.
9.5%.
8.5%.
15.8%.
Ka = p1k1+p2k2+ . . . pnkn
Where:
The WACC (Ka) is the weighted average costs of debt, preferred stock,
retained earnings, and common stock sales. The cost of retained earnings
is the cost of internal equity while the cost of common stock is the cost of
external equity.
The sum of the weighted average cost of debt and the weighted average
cost of equity is then: 0.021 + 0.084 = 0.105 (10.5%).
Question 21:
(2B2-CQ10)
55%.
34%.
45%.
66%.
This amount can then be substituted into the WACC formula and
rearranged to solve for wi as:
Question 22:
(2B2-LS66)
Joint Products Inc., a corporation with a 40% marginal tax rate, plans to
issue $1,000,000 of 8% preferred stock in exchange for $1,000,000 of its 8%
bonds currently outstanding. The firm's total liabilities and equity are equal
to $10,000,000. The effect of this exchange on the firm's weighted average
cost of capital is likely to be:
This effect would increase the firm's weighted average cost of capital
since the portion of debt payments are tax deductible. Preferred stock
dividends are not tax deductible.
Question 23:
(2B2-AT20)
Question 24:
(2B2-LS59)
What is the weighted average cost of capital (WACC) for a firm given the
information in the chart?
8%.
12%.
9%.
8.8%.
Where:
Question 25:
(2B2-LS27)
Question 26:
(2B2-LS65)
The firm paying off its only outstanding debt and the Treasury Bond yield
increasing would cause the firm's cost of capital to increase. The cost of
capital is the weighted average cost of debt (after-tax), preferred stock,
retained earnings, and common stock. Paying off the debt reduces the
debt portion which has the lowest cost while leaving the more expensive
portions intact. Therefore, the cost of capital would increase.
Question 27:
(2B2-LS03)
Question 28:
(2B2-CQ06)
Cox Company has sold 1,000 shares of $100 par, 8% preferred stock at an
issue price of $92 per share. Stock issue costs were $5 per share. Cox pays
taxes at the rate of 40%. What is Cox's cost of preferred stock capital?
8%.
8.7%.
9.2%.
8.25%.
Question 29:
(2B2-LS26)
Question 30:
(2B2-LS20)
Question 31:
(2B2-LS25)
Where:
kd = interest rate
t = firm's applicable tax rate.
Question 32:
(2B2-LS10)
A floating bond interest rate pays an interest rate that varies from time to
time (generally based on some benchmark interest rate). Such a bond is
attractive because the rate should go up and reset at higher levels as
rates rise. That is, bond prices move inversely with changes in interest
rates.
Question 33:
(2B2-LS29)
Question 34:
(2B2-LS17)
A corporate bond trades on the secondary market. The return now required
by investors for this bond exceeds its coupon rate. Thus, the bond will:
pay a lump sum of interest and principal at maturity.
be sold below par value.
pay additional interest at maturity.
be sold above par value
After the initial issue, bonds are bought and sold through brokers in the
secondary market (similar to how stocks are traded). In the secondary
market, a bond's price fluctuates inversely with interest rates. If interest
rates fall, the price will be sold above par value. But in this case, the
interest rates are higher than the bond's stated interest (coupon) rate and
the bond will be sold below par value (at a discount).
Question 35:
(2B2-AT17)
Williams Inc. is interested in measuring its overall cost of capital and has
gathered the following data. Under the terms described below, the
company can sell unlimited amounts of all instruments.
Williams can raise cash by selling $1,000, 8%, 20-year bonds with
annual interest payments. In selling the issue, an average premium of
$30 per bond would be received, and the firm must pay flotation
costs of $30 per bond. The after-tax cost of funds is estimated to be
4.8%.
Williams can sell 8% preferred stock at par value, $105 per share. The
cost of issuing and selling the preferred stock is expected to be $5 per
share.
Williams' common stock is currently selling for $100 per share. The
firm expects to pay cash dividends of $7 per share next year, and the
dividends are expected to remain constant. The stock will have to be
underpriced by $3 per share, and flotation costs are expected to
amount to $5 per share.
Williams expects to have available $100,000 of retained earnings in
the coming year; once these retained earnings are exhausted, the
firm will use new common stock as the form of common stock equity
financing.
Williams preferred capital structure is
The cost of funds from the sale of common stock for Williams Inc. is:
7.4%.
7%.
8.1%.
7.6%.
Using the constant dividend growth model (Gordon's model), the cost of
the sale of common stock (Ke) is calculated by taking the next dividend
payment and dividing it by the net price (price less discount, less flotation
costs) plus the constant dividend growth rate. There is no dividend
growth rate for Williams.
Question 36:
(2B2-LS31)
Question 37:
(2B2-AT14)
Williams Inc. is interested in measuring its overall cost of capital and has
gathered the following data. Under the terms described below, the
company can sell unlimited amounts of all instruments.
Williams can raise cash by selling $1,000, 8%, 20-year bonds with
annual interest payments. In selling the issue, an average premium of
$30 per bond would be received, and the firm must pay flotation
costs of $30 per bond. The after-tax cost of funds is estimated to be
4.8%.
Williams can sell 8 percent preferred stock at par value, $105 per
share. The cost of issuing and selling the preferred stock is expected
to be $5 per share.
Williams' common stock is currently selling for $100 per share. The
firm expects to pay cash dividends of $7 per share next year, and the
dividends are expected to remain constant. The stock will have to be
underpriced by $3 per share, and flotation costs are expected to
amount to $5 per share.
Williams expects to have available $100,000 of retained earnings in
the coming year; once these retained earnings are exhausted, the
firm will use new common stock as the form of common stock equity
financing.
Williams preferred capital structure is
If Williams Inc. needs a total of $1,000,000, the firm's weighted average cost
of capital (WACC) would be:
9.1%.
4.8%.
6.5%.
6.9%.
Where:
The WACC (Ka) is the weighted average costs of debt, preferred stock,
retained earnings, and common stock sales.
Using the constant dividend growth model (Gordon's model), the cost of
external equity (Ke) is calculated by taking the next dividend payment
and dividing it by the net price (price less underpricing and flotation
costs) plus the constant dividend growth rate. There is no dividend
growth rate for Williams.
Question 38:
(2B2-LS15)
Question 39:
(2B2-LS12)
Question 40:
(2B2-LS09)
Question 41:
(2B2-LS46)
The after-tax cost of common stock using the dividend growth model is ke
= D1/P0 + g or [$2.00(1.08)]/$50(1 0.10) + 0.08 = $2.16/$45 + 0.08 = 0.1280
or 12.80%. Common stock dividends are not a tax-deductible expense so
taxes are irrelevant in this computation.
Question 42:
(2B2-LS19)
U.S. Treasury bonds are rated AAA since they are backed by the full faith
and credit of the federal government.
Question 43:
(2B2-LS52)
Which one of the following situations would prompt a firm to issue debt, as
opposed to equity, the next time it raises external capital?
If a firm is faced with a high effective tax rate, it would prompt a firm to
issue debt, as opposed to equity the next time it raises capital as the cost
of debt is reduced by that effective tax rate.
Question 44:
(2B2-LS67)
Question 45:
(2B2-LS32)
A put option is a type of option contract giving the holder the right but not
the obligation to sell the underlying asset to the writer. Option holders
have the opportunity for unlimited gain with limited possible losses.
Option writers may experience unlimited potential losses (unless the
contract is covered, which means that the writer already owns the
underlying asset).
Question 46:
(2B2-LS02)
Question 47:
(2B2-LS01)
Question 48:
(2B2-AT12)
The purpose of a safety or buffer stock is to minimize the sum of the cost
of stock-outs and the costs of carrying the buffer. Its level is independent
of ordering costs.
Question 49:
(2B2-LS38)
Question 50:
(2B2-LS35)
Question 51:
(2B2-LS48)
requirements.
covenants.
addenda.
provisions.
Question 52:
(2B2-LS61)
A firm plans to use the historical rate of return to determine the cost of
equity capital. In order to use the historical rate, all of the following
conditions should exist except which of the following?
The firm's performance will hold steady.
Interest rates will not significantly change.
Investor attitude toward risk will not change.
Expected future cash flows will be discounted to present values.
The historical method implies that (1) the firm's performance will not
significantly change in the future, (2) no significant changes in interest
rates will occur, and (3) investor attitude toward risk will not change. The
historical method is relatively easy to calculate, but the limitation is that
the future rarely remains the same as the past.
Question 53:
(2B2-AT10)
A call provision allows the issuer of the bonds to buy back the bonds at a
set price (the call price) after some specified date. Calls are used to
redeem bonds when interest rates drop significantly or to force the
conversion of convertible bonds. When the bonds are called for
redemption, the holder (investor) must sell them back to the issuer. The
holder, however, may want to hold the bonds to earn interest to improve
the conversion gain.
Question 54:
(2B2-LS45)
The after-tax cost of common stock using the dividend growth model is:
ke = D1/P0 + g
or
[$1.50(1.06)]/$60 + 0.06 = $1.59/$60 + 0.06 = 0.0865 or 8.65%.
Common stock dividends are not a tax-deductible expense, so taxes are
irrelevant in this computation.
Question 55:
(2B2-CQ07)
Bull & Bear Investment Banking is working with the management of Clark
Inc. in order to take the company public in an initial public offering.
Selected financial information for Clark is as follows.
$24.00.
$12.00.
$15.00.
$9.00.
Question 56:
(2B2-LS21)
A stock undergoes a 3-for-1 stock split. What is the most likely outcome for
a stockholder currently holding 3,000 shares trading at $30 per share?
The holder will have 9,000 shares at $10 per share.
There will be a decrease in total market value of the shares.
The holder will have 1,000 shares at $90 per share.
There will be an increase in total market value of the shares.
In a 3-for-1 stock split, 3,000 shares would receive another 6,000 shares.
At $30 a share, the price should drop down to about $10 a share. The total
market value should remain the same (9,000 shares at $10 a share versus
the original 3,000 shares at $30; both equal $90,000). While the total
market value initially remains the same, stockholders may profit if the
price eventually goes up.
Question 57:
(2B2-LS08)
The purchaser would receive the principal and interest equal to 8%.
However, since the market rate for such an investment is 9%, the 1%
difference will be deducted as a discount from the amount of cash the
purchaser pays the current owner so that the effective rate of return will
become 9%.
Question 58:
(2B2-AT19)
Williams Inc. is interested in measuring its overall cost of capital and has
gathered the following data. Under the terms described below, the
company can sell unlimited amounts of all instruments.
Williams can raise cash by selling $1,000, 8%, 20-year bonds with
annual interest payments. In selling the issue, an average premium of
$30 per bond would be received, and the firm must pay flotation
costs of $30 per bond. The after-tax cost of funds is estimated to be
4.8%.
Williams can sell 8% preferred stock at par value, $105 per share. The
cost of issuing and selling the preferred stock is expected to be $5 per
share.
Williams' common stock is currently selling for $100 per share. The
firm expects to pay cash dividends of $7 per share next year, and the
dividends are expected to remain constant. The stock will have to be
underpriced by $3 per share, and flotation costs are expected to
amount to $5 per share.
Williams expects to have available $100,000 of retained earnings in
the coming year; once these retained earnings are exhausted, the
firm will use new common stock as the form of common stock equity
financing.
Williams preferred capital structure is
If Williams Inc. needs a total of $200,000, the firm's weighted average cost
of capital(WACC) would be closest to:
6.6%.
4.8%.
7.3%.
6.8%.
Where:
The WACC (Ka) is the weighted average costs of debt, preferred stock and
retained earnings.
The cost of debt is 4.8% and its weight is 0.3 (or 30%).
The cost of preferred stock is the preferred stock dividend divided by its
net price (price less flotation costs) which is [0.08 ($105)] / ($105$5) =
(8.4/100) = .084 (or 8.4%).
Using the constant dividend growth model (Gordon's model), the cost of
retained earnings (Ke) is calculated by taking the next dividend payment
and dividing it by the price plus the constant dividend growth rate. There
is no dividend growth rate for Williams.
Question 59:
(2B2-LS23)
Question 60:
(2B2-CQ09)
The Hatch Sausage Company is projecting an annual growth rate for the
foreseeable future of 9%. The most recent dividend paid was $3.00 per
share. New common stock can be issued at $36 per share. Using the
constant growth model, what is the approximate cost of capital for retained
earnings?
19.88%.
18.08%.
9.08%.
17.33%.
The cost of capital for retained earnings, using the Constant Dividend
Growth Model (Gordon's Model) is calculated as:
In this case, the next dividend is calculated by taking the current dividend
of $3.00 per share and multiplying it by one plus the constant growth rate,
as:
Therefore, the cost of capital for retained earnings can be calculated as:
Question 61:
(2B2-LS50)
Question 62:
(2B2-LS41)
An indenture defines the details of the bond issue, including sinking fund
terms that the borrower pays to a separate custodial account and assures
creditors that adequate funds are available.
Question 63:
(2B2-LS39)
Question 64:
(2B2-LS54)
Which one of the following best describes the record date as it pertains to
common stock?
The date chosen by the issuer of the common stock (which ultimately
determines who the owners of the outstanding shares are on that date).
Question 65:
(2B2-LS56)
Question 66:
(2B2-AT15)
Hi-Tech Inc. has determined that it can minimize its weighted average cost
of capital (WACC) by using a debt to equity ratio of 2:3. If the firm's cost of
debt is 9% before taxes, the cost of equity is estimated to be 12% before
taxes, and the tax rate is 40%, what is the firm's WACC?
6.48%.
9.36%.
7.92%.
10.80%.
Where:
wi = proportion of total permanent capital represented by debt
ki = after-tax cost of debt component
wj = proportion of total permanent capital represented by equity
kj = after-tax cost of equity component
Question 67:
(2B2-LS47)
A call provision grants the right to buy back (or call) all or part of an issue
at the call price rather than attempting to retire the issue by more
expensive methods.
Question 68:
(2B2-LS30)
Which of the following statements is true about using preferred stock issues
as a source of equity capital?
The cost of preferred stock is a function of the stock's market price
and the firm's tax rate.
Dividends are not tax deductible to the issuer.
A firm can deduct taxes on dividends payments, so the after-tax costs
are reduced when determining taxable income.
The cost of preferred stock is a function of the stock's beta.
Because preferred stock dividends are not tax deductible, they represent
an outflow of after-tax funds. A preferred stock dividend costs the firm in
after-tax earnings, so the firm must earn additional capital before taxes
for each dividend dollar paid.
Question 69:
(2B2-AT03)
If three stocks are in a portfolio, the expected return on the portfolio is the:
weighted average of the expected returns multiplied by the beta of
each security.
sum of the expected returns multiplied by the variance of each
security.
sum of the expected returns multiplied by the standard deviation of
each security.
weighted average of the expected returns of the three securities.
Question 70:
(2B2-LS51)
Question 71:
(2B2-LS44)
A company's $100, 10% preferred stock is currently selling for $90. If the
company issues new shares, the flotation costs will be 7%. The company's
tax rate is 40%. What is the company's after-tax cost of new preferred
stock?
6%.
11.95%.
7.17%.
9%.
Question 72:
(2B2-AT13)
A preferred stock is sold for $101 per share, has a face value of $100 per
share, underwriting fees of $5 per share, and annual dividends of $10 per
share. If the tax rate is 40%, the cost of funds (capital) for the preferred
stock is:
5.2%.
6.2%.
10%.
10.4%.
Question 73:
(2B2-LS40)
A $1,000 bond that costs $500 when issued and pays the full par value at
maturity best describes a:
junk bond.
zero coupon bond.
fixed interest rate bond.
floating rate bond.
Zero coupon bonds have no ongoing interest payments. The bond is sold
at a deep discount and redeemed at full value as compound interest
accrues to par value.
Question 74:
(2B2-AT01)
Stanley Company uses the Capital Asset Pricing Model (CAPM) to estimate
the rate of return demanded by the market on its common stock. If the beta
coefficient is 1.75 for Stanley, the risk-free rate of return in the stock market
is 4.6%, and the current rate of return for the market as measured by an
appropriate index is 7%, what is the market's required rate of return on
Stanley's common stock?
8.05%.
11.2%.
8.8%.
12.25%.
Using the CAPM formula, the required rate of return on a common stock is
calculated as:
Ke = Rf + (Km - Rf)
Where:
Ke = required rate of return
Rf = risk-free rate (such as the return on U.S. T-bill or T-bonds)
= beta coefficient for the company
Km = return on a market portfolio
Question 75:
(2B2-AT18)
Williams Inc. is interested in measuring its overall cost of capital and has
gathered the following data. Under the terms described below, the
company can sell unlimited amounts of all instruments.
Williams can raise cash by selling $1,000, 8%, 20-year bonds with
annual interest payments. In selling the issue, an average premium of
$30 per bond would be received, and the firm must pay flotation
costs of $30 per bond. The after-tax cost of funds is estimated to be
4.8%.
Williams can sell 8% preferred stock at par value, $105 per share. The
cost of issuing and selling the preferred stock is expected to be $5 per
share.
Williams' common stock is currently selling for $100 per share. The
firm expects to pay cash dividends of $7 per share next year, and the
dividends are expected to remain constant. The stock will have to be
underpriced by $3 per share, and flotation costs are expected to
amount to $5 per share.
Williams expects to have available $100,000 of retained earnings in
the coming year; once these retained earnings are exhausted, the
firm will use new common stock as the form of common stock equity
financing.
Williams preferred capital structure is
The cost of funds from retained earnings for Williams Inc. is:
7.6%.
8.1%.
7%.
7.4%.
Using the constant dividend growth model (Gordon's model), the cost of
retained earnings (Ke) is calculated by taking the next dividend payment
and dividing it by the price plus the constant dividend growth rate. There
is no dividend growth rate for Williams.
Question 76:
(2B2-AT11)
If a $1,000 bond sells for $1,125, which of the following statements are
correct?
I. The market rate of interest is greater than the coupon rate on the bond.
II. The coupon rate on the bond is greater than the market rate of interest.
III. The coupon rate and the market rate are equal.
IV. The bond sells at a premium.
V. The bond sells at a discount.
I and V.
II and V.
II and IV.
I and IV.
If the coupon (stated) rate on a bond is greater than the market rate of
interest, the price of the bond will be greater than its maturity value and
the bonds will sell at a premium (price is greater than the maturity value).
The market rate of interest is the rate required by the market. If the
coupon rate is greater than the market rate, the market will bid up the
price to obtain the higher rate (the coupon).
Question 77:
(2B2-LS22)
Question 78:
(2B2-LS04)
Question 79:
(2B2-LS43)
A company has $50 million in debt outstanding with a coupon rate of 10%.
Currently, the yield to maturity on these bonds is 8%. If the firm's tax rate is
40%, what is the company's after-tax cost of debt?
10%.
6%.
8%.
4.8%.
Time Spent: 8:35 97 Answered Score 21% Restart End
0 Unanswered
The after-tax cost of debt is kd(1 t) = (0.08)(1 0.40) = 0.048 or 4.8%.
Question 80:
(2B2-LS42)
A 15-year, 8% annual-pay bond has a par value of $1,000. What should this
bond be trading for if it were being priced to yield 9% on an annual rate?
1,000.00.
$935.61.
$919.39.
$1085.60.
The value of the bond should be $919.39. The bond will sell at a discount
because the required rate of return exceeds the coupon rate of the bond.
Question 81:
(2B2-CQ15)
If Thomas pays taxes at the rate of 40%, what is the company's after-tax
weighted average cost of capital (WACC)?
11.9%.
9.84%.
10.94%.
7.14%.
Question 82:
(2B2-LS13)
Question 83:
(2B2-LS07)
Question 84:
(2B2-AT05)
If Barnes wants to outperform the market next year, while minimizing the
risk, which one of the following portfolios will be the most appropriate
portfolio in this situation?
$5 million in Security II, and $5 million in Security I.
$10 million in Security II.
$7 million in Security I, and $1 million each in Securities II, III, and IV.
$4.5 million in Security I, $2.5 million in Security II, and $1.5 million
each in Securities III and IV.
Where:
Ke = required rate of return
Rf = risk-free rate (such as the return on U.S. T-bill or T-bonds)
= beta coefficient for the company
Km = return on a market portfolio
Using the CAPM formula, the portfolio with the highest average beta
would have the highest expected rate of return. The beta values of each
portfolio are calculated below.
Option: $4.5 million in Security I, $2.5 million in Security II, and $1.5
million each in Securities III and IV
= (45% 0.70) + (25% 1.00) + (15% 1.50) + (15% 2.50) = 1.17
Option: $7 million in Security I, and $1 million each in Securities II, III, and
IV
= (70% 0.70) + (10% 1.00) + (10% 1.50) + (10% 2.50) = 0.99
Question 85:
(2B2-LS24)
How does a firm's tax rate influence its after-tax cost of debt?
The higher the tax rate, the greater the after-tax cost of debt.
The sooner the debt is paid off, the lower the tax rate.
The higher the tax rate, the lower the after-tax cost of debt.
The longer the debt is carried, the lower the tax rate.
By definition, the cost of debt represents the interest rate a company pays
on all of its capital debt (e.g., loans and bonds). The stated interest rate is
greater than the after-tax cost of debt because a firm can deduct interest
payments when determining taxable income. The higher the tax rate, the
lower the after-tax cost of debt.
Question 86:
(2B2-AT07)
Question 87:
(2B2-CQ13)
Additional data:
Question 88:
(2B2-LS14)
Although there are many types of bonds, the principal amount of most
bonds is $1,000.
Question 89:
(2B2-LS58)
What is the weighted average cost of capital (WACC) for a firm given the
information in the chart?
29%.
10%.
9.7%.
9%.
Where:
Question 90:
(2B2-LS06)
A firm wants to hedge the risk that market value of a corporate bond may
fall. Which of the following actions should the firm take?
Sell a forward contract on a Treasury bond.
Buy a call option on a Treasury bond.
Sell a put option on a Treasury bond.
Buy a forward contract on a Treasury bond.
Question 91:
(2B2-LS05)
If a firm's goal is to keep portfolio risk low, the best strategy would be to
include:
diversified investments with low betas.
diversified investments with high betas.
investments with high betas and low correlated returns.
investments with low betas and highly correlated returns.
If the aim is to keep portfolio risk low, diversified investments having low
betas should be included. Diversification reduces portfolio risk as long as
the different investments are unlikely to all move in the same direction
(that they are not perfectly, positively correlated). Relative to beta
measures, the higher the beta above 1.0, the greater the volatility in
relation to market activity.
Question 92:
(2B2-CQ11)
The management of Old Fenske Company (OFC) has been reviewing the
company's financing arrangements. The current financing mix is $750,000
of common stock, $200,000 of preferred stock ($50 par) and $300,000 of
debt. OFC currently pays a common stock cash dividend of $2. The
common stock sells for $38, and dividends have been growing at about 10%
per year. Debt currently provides a yield to maturity to the investor of 12%,
and preferred stock pays a dividend of 9% to yield 11%. Any new issue of
securities will have a flotation cost of approximately 3%. OFC has retained
earnings available for the equity requirement. The company's effective
income tax rate is 40%. Based on this information, the cost of capital for
retained earnings is:
16%.
15.8%.
14.2%.
9.5%.
The cost of capital for retained earnings using the Constant Dividend
Growth Model (Gordon's Model) is calculated as follows:
The next dividend is calculated by taking the current dividend per share
and multiplying it by one plus the constant growth rate.
Question 93:
(2B2-AT06)
If a bond sells for more than its face value, it is sold at a premium. Buyers
are willing to pay higher price for the bond expecting higher returns.
Thus, the stated rate must be higher than the market rate.
Question 94:
(2B2-LS64)
Question 95:
(2B2-LS33)
Question 96:
(2B2-CQ08)
$16.50.
$27.50.
$13.50.
$21.50.
Book value per share, common stock = (common stock equity) / (number
of shares of common stock outstanding)
Therefore, book value per share of common stock can be calculated as:
Book value per share, common stock = ($3,000,000 + $24,000,000 +
$6,000,000) / (3,000,000 shares)
Book value per share, common stock = ($33,000,000) / (3,000,000 shares)
Book value per share, common stock = $11 per share
Question 97:
(2B2-LS36)