Foundations Of Financial Management 11th Canadian Edition By Stanley B. Block – Test Bank
Chapter 11
Cost of Capital
Multiple Choice Questions
- The cost of capital is used as a discount rate because:
A.it is an indication of how much the firm is earning overall.
B. as long as the cost of capital is earned, the common stock value of the firm will be maintained.
C. it is comparable to the prevailing market interest rates.
D. returns below the cost of capital will cover all fixed costs associated with capital and provide an excess return to shareholders.
- The component parts of the cost of capital should be weighted by their proportion in the firm’s:
A.current capital structure.
B. historical capital structure.
C. optimum capital structure.
D. expected capital structure.
- If a firm’s bonds are currently yielding 8% in the marketplace, why would the firm’s cost of debt be lower?
A.Interest rates have changed.
B. Additional debt can be issued more cheaply than the original debt.
C. There should be no difference; cost of debt is the same as the bond’s market yield.
D. Interest is tax-deductible.
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Blooms: Remember
Difficulty: Easy
Learning Objective: 11-03 Construct the cost of capital based on the various valuation techniques from Chapter 10 as applied to bonds; preferred stocks; and common shares.
Topic: 11-02 Cost of Debt
- Although debt financing is usually the cheapest component of capital, it cannot be used to excess because:
A.interest rates may change.
B. the firm’s share price will increase and raise the cost of equity financing.
C. the financial risk of the firm may increase and thus drive up the cost of all sources of financing.
D. underwriting costs may change.
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Blooms: Remember
Difficulty: Medium
Learning Objective: 11-04 Examine how a firm attempts to find a minimum cost of capital by varying the mix of its sources of financing.
Topic: 11-10 Optimal Capital Structure—Weighting Costs
- Each project should be judged against:
A.the specific means of financing used to support its implementation.
B. the going interest rate at that point in time.
C. the cost of new common stock equity.
D. the risk and return to the shareholder.
- For a firm paying 7% for new debt, the higher the firm’s tax rate:
A.the higher the after tax cost of debt.
B. the lower the after tax cost of debt.
C. after tax cost is unchanged.
D. Not enough information to judge.
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Blooms: Understand
Difficulty: Medium
Learning Objective: 11-03 Construct the cost of capital based on the various valuation techniques from Chapter 10 as applied to bonds; preferred stocks; and common shares.
Topic: 11-02 Cost of Debt
- The after tax cost of preferred stock to the issuing corporation:
A.is the same as the before-tax cost.
B. is usually lower than the cost of debt.
C. is dependent on the firm’s tax bracket.
D. is determined by the dividend payment.
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Blooms: Remember
Difficulty: Easy
Learning Objective: 11-03 Construct the cost of capital based on the various valuation techniques from Chapter 10 as applied to bonds; preferred stocks; and common shares.
Topic: 11-03 Cost of Preferred Stock
- A firm in a cyclical industry should use:
A.a large amount of debt to lower the cost of capital.
B. no debt at all.
C. preferred stock in place of debt.
D. a limited amount of debt to lower the cost of capital.
- Use of the marginal cost of capital:
A.acknowledges that when retained earnings is used up as a source of equity the cost of capital lowers as new common stock is sold to support more growth.
B. recognizes that the return from the last dollar of funds generated should be less than the cost of the last dollar of funds raised.
C. acknowledges that when retained earnings is used up as a source of equity the cost of capital rises as new common stock is sold to support more growth.
D. recognizes that the return from the last dollar of funds generated should be more than the cost of the last dollar of funds raised.
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Blooms: Remember
Difficulty: Medium
Learning Objective: 11-05 Apply the marginal cost of capital concept.
Topic: 11-15 The Marginal Cost of Capital
- The overall weighted average cost of capital is used instead of costs for specific sources of funds because:
A.use of the cost for specific sources of capital would make investment decisions consistent.
B. it is the minimum point for the firms cost of capital given the current equity mix.
C. investments funded by low cost debt would have a disadvantage over other investments.
D. a project with the lowest return would always be accepted under the specific cost criteria.
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