lOMoARcPSD|3720244

The Cost of Capital - testbanks

Bachelor of Science in Accountancy (Polytechnic University of the Philippines)

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 lOMoARcPSD|3720244

Chapt
er11
TheCos
tofCapi
tal

 Lear
ningGoal
s
1. Under
st
andthek
eya s
sump
tions
,theba
sicc
onc
ept
,andt
hes
pec
ifics
our
cesofc
api
tala
ssoc
iat
ed
wit
hthecos
tofcap
ita
l.

2. De
ter
minet
hec
osto
flon
g-t
erm de
bta
ndt
hec
ostofpr
efe
rre
dst
ock.

3. Cal
cul
atet
hecos
tofc
ommonstoc
ke qu
itya
ndc
onv
erti
tint
othec
ostofr
eta
ine
dea
rni
ngsa
ndt
he
cos
tofnewis
sue
sofcommons
tock.

4. Calc
ulat
etheweight
edave
rag
ecos
tofc
api
tal(
WACC)a
ndd
isc
ussa
lt
erna
ti
vewe
ight
ings
che
mes
andeconomicv
alueadde
d(EVA®).

5. Des
cri
bet
hepr
oce
dur
esus
edt
ode
ter
minebr
eakp
oint
sandt
hewe
ight
edma
rgi
nalc
ostofc
api
tal
(
WMCC) .

6. Expl
ainthewei
ght
edmargi
nalcos
tofca
pit
al(WMCC)andi
tsus
ewi
tht
hei
nve
stme
ntoppor
tuni
ti
es
sc
hedule(I
OS)tomak
efina
ncin
g/in
ves
tmentde
cis
ion
s.

 Tr
ue/
Fal
se
1. Bus
ine
ssr
is
kist
her
iskt
oth
efir
mofbe
inguna
blet
oco
verope
rat
ingc
ost
s.
Ans
wer
:TRUE
Leve
lofDiffic
ult
y:1
Lear
nin
gGoa l
:1
Topi
c:Bus
ine ssRi
sk

2. Theta
rgetc
api
tals
truc
tur
eisthede
sir
edopt
ima
lmi
xofde
bta
nde
qui
tyfina
nci
ngt
hatmos
tfir
ms
at
temptt
oachi
eveandmaint
ain.
Ans
wer
:TRUE
Leve
lofDiffic
ult
y:1
Lear
ningGoa l
:1
Topi
c:Tar
getCa pi
talSt
ruc
tur
e

3. Thecos
tofca
pit
ali
sther
ateofr
etur
nafir
mmus
tea
rnoni
nve
stme
ntsi
nor
dert
ole
aves
har
epr
ice
unc
hanged
.
Ans
wer
:TRUE
Leve
lofDiffic
ult
y:1
Lear
nin
gGoa l
:1
Topi
c:Bas
icConc ep
tofCos
tofCa
pit
al

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 lOMoARcPSD|3720244

Cha
pte
r11 TheCos
tofCa
pit
al 438
4. Thecosto
fcapit
ali
suse
dtod e
cidewhe
the
rap
ropos
edc
orpor
atei
nve
stme
ntwi
lli
ncr
eas
eor
de
cre
a s
ethefir
m’ss
toc
kp r
ice
.
Ans
wer
:TRUE
Leve
lofDiffic
ult
y:1
Lear
nin
gGoa l
:1
Topi
c:Bas
icConc ep
tofCos
tofCa
pit
al

5. Thecos
tofcapi
talr
eflec
tsthec
ostoffundso
vert
hel
ongr
unme
asur
eda
tagi
venpo
inti
nti
me,
ba
sedonthebes
tinformati
onavai
lab
le.
Ans
wer
:TRUE
Leve
lofDiffic
ult
y:1
Lear
nin
gGoa l
:1
Topi
c:Bas
icConc ep
tofCos
tofCa
pit
al

6. Thecostofe
achtypeofca
pit
alde
pendsonther
is
k-f
reec
ostoft
hatt
ypeo
ffunds
,thebu
sine
ssr
isk
oft
hefirm,a
ndthefina
nci
alr
iskoft
hefir
m.
Ans
wer
:TRUE
Leve
lofDiffic
ult
y:2
Lear
nin
gGoa l
:1
Topi
c:Bas
icConc ep
tofCos
tofCa
pit
al

7. Th
ec os
tofca
pit
alac
tsasamaj
orli
nkbet
weenthefir
m’sl
ong-
ter
minv
est
mentde
cis
ion
sandt
he
wea
lthoft
heowner
sasdet
ermi
nedbyin
vest
orsi
nthema r
ket
pla
ce.
Ans
wer
:TRUE
Leve
lofDiffic
ult
y:2
Lear
nin
gGoa l
:1
Topi
c:Bas
icConc ep
tofCos
tofCa
pit
al

8. Thecostofc
api
talcanbethoughtofa st
her
ateofr
etur
nre
qui
redb
ythema
rke
tsupp
lie
rsofc
api
tal
i
nordertoat
tr
actthe
irfundst
ot hefir
m.
Ans
wer
:TRUE
Leve
lofDiffic
ult
y:2
Lear
nin
gGoa l
:1
Topi
c:Bas
icConc ep
tofCos
tofCa
pit
al

9. Bus
ine
ssr
is
kist
her
iskt
oth
efir
mofbe
inguna
blet
oco
verr
equi
redfina
nci
alob
lig
ati
ons
.
Ans
wer
:FALSE
Leve
lofDiffic
ult
y:2
Lear
nin
gGoa l
:1
Topi
c:Bus
ine ssRi
sk

10. Holdi
ngri
skcons
tant,t
hei
mplemen
tat
ionofpr
oje
ctswi
thar
ateo
fre
tur
nabo
vet
hec
ostofc
api
tal
wil
ldecr
eas
ethevalueoft
hefir
m,a
ndviceve
rsa.
Ans
wer
:FALSE
Leve
lofDiffic
ult
y:2
Lear
nin
gGoa l
:1
Topi
c:Bas
icConc ep
tofCos
tofCa
pit
al

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 lOMoARcPSD|3720244

Cha
pte
r11 TheCos
tofCa
pit
al 439
11. Thespeci
ficc
osto
feachs ourc
eoffina
nci
ngistheaft
er-
taxc
ostofobt
aini
ngthefina
nci
ngus
ingt
he
hi
st
oric
all
yba s
edcos
treflect
edbyt
hee xi
st
ingfina
nci
ngonthefir
m’sbooks.
Ans
wer
:FALSE
Leve
lofDiffic
ult
y:2
Lear
nin
gGoa l
:1
Topi
c:Bas
icConc ep
tofCos
tofCa
pit
al

12. I
nge
ner
al,
floa
tat
ionc
ost
sinc
lud
etwoc
ompone
nts
,unde
rwr
it
ingc
ost
sanda
dmi
nis
tr
ati
vec
ost
s.
Ans
wer
:TRUE
Leve
lofDifficul
ty:1
Lear
ningGoa l:2
Topi
c:Flo
tationCo s
ts

13. Fl
otat
ioncos
tsredu
cethenetpr
oce
edsf
romt
hes
aleofabondwhe
the
rsol
datapr
emi
um,a
ta
di
scount
,orati
tsparv
a l
ue.
Ans
wer
:TRUE
Leve
lofDifficul
ty:1
Lear
ningGoa l:2
Topi
c:Flo
tationCo s
ts

14. Thene
tpr
oceedsuse
di ncalc
u l
at
ionofthec
ostofl
ong
-te
rmde
bta
ref
undsa
ctua
ll
yre
cei
vedf
rom
t
hesal
eaf
terpayi
ngforflo
tat
ioncost
sandtaxe
s.
Ans
wer
:FALSE
Leve
lofDifficul
ty:1
Lear
ningGoa l:2
Topi
c:Flo
tationCo s
ts

15. Si
ncepr
efe
rre
dst
ocki
saf
ormo
fowne
rsh
ip,
thes
toc
kwi
llne
verma
tur
e.
Ans
wer
:TRUE
Leve
lofDiffic
ult
y:1
Lear
nin
gGoa l
:2
Topi
c:Cos
tofPr ef
err
edSt
ock

16. Pre
ferr
edst
ockr
epres
entsaspeci
altypeofowner
shi
pint
ere
sti
nthefir
ma nd,
thus
,thepr
efe
rre
d
st
ockhol
der
smustrec
eiv
et hei
rst
ate
ddi vi
dend
spri
ortot
hedis
tri
but
ionofanyear
ningst
ocommon
st
ockhol
der
sandbondholder
s.
Ans
wer
:FALSE
Leve
lofDiffic
ult
y:1
Lear
nin
gGoa l
:2
Topi
c:Cos
tofPr ef
err
edSt
ock

17. Whe
nthene
tproc
eedsfr
oms
aleofabonde
qua
lit
spa
rva
lue
,thebe
for
e-t
axc
ostwoul
djus
teq
ual
t
hec
ouponi
nte
res
trat
e.
Ans
wer
:TRUE
Leve
lofDiffic
ult
y:2
Lear
nin
gGoa l
:2
Topi
c:Cos
tofLon g-
Ter
mDe
bt

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 lOMoARcPSD|3720244

Cha
pte
r11 TheCos
tofCa
pit
al 440
18. Thea
mountofpre
fer
redst
ockdivi
dend
stha
tmustbepai
deachye
armaybesta
tedindoll
ars(
i.e
.,
x-
dol
la
rpr
efer
redst
ock)orasaper
cent
ageoft
hefir
m’se
arn
ings(
i.
e.
,x-
per
centpre
fer
redstoc
k).
Ans
wer
:FALSE
Leve
lofDiffic
ult
y:2
Lear
nin
gGoa l
:2
Topi
c:Cos
tofPr ef
err
edSt
ock

19. Thecos
tofpr
efer
redst
ockistyp
ica
ll
yhighe
rthant
hec
ostofl
ong
-te
rmd
ebt(
bonds
)be
caus
ethe
cos
tofl
ong-
ter
md ebt(
int
eres
t)i
staxde
ducti
ble
.
Ans
wer
:TRUE
Leve
lofDiffic
ult
y:2
Lear
nin
gGoa l
:2
Topi
c:Cos
tofPr ef
err
edSt
ockCo
mpa
redt
oLon
g-Te
rmDe
bt

20. Thecos
tofcommonst
ockeq
uit
ymayb
eme
asur
edus
inge
ithe
rthec
ons
tan
tgr
owt
hva
lua
ti
onmode
l
ort
hecapi
tala
sse
tpr
ici
ngmode
l.
Ans
wer
:TRUE
Leve
lofDiffic
ult
y:1
Lear
nin
gGoa l
:3
Topi
c:Cos
tofCo mmonSt
ockEq
uit
y

21. Afir
mc a
nr e
tai
nmoreofit
searni
ngsi
fitc
anc
onvi
ncei
tss
toc
kho
lde
rst
hati
twi
lle
arna
tle
astt
hei
r
r
equir
edre
turnont
herei
nvest
edfunds
.
Ans
wer
:TRUE
Leve
lofDiffic
ult
y:1
Lear
nin
gGoa l
:3
Topi
c:Cos
tofCo mmonSt
ockEq
uit
y

22. Incomput
ingt
hecostofre
tai
nedearni
ngs,
thene
tpr
oce
edsr
epr
ese
ntst
hea
moun
tofmone
yre
tai
ned
netofa
nyunder
pri
ci
n gand/
orflo
tat
ioncos
ts.
Ans
wer
:FALSE
Leve
lofDiffic
ult
y:1
Lear
nin
gGoa l
:3
Topi
c:Cos
tofRe tai
nedEa
rni
ngs

23. Th ec
osto
fc o
mmonstoc
kequi
tyi
sther
atea
twhi
chi
nve
stor
sdi
scountt
hee
xpe
cte
ddi
vide
ndsoft
he
fir
mtodete
rminei
tss
har
eva
lue.
Ans
wer
:TRUE
Leve
lofDiffic
ult
y:1
Lear
nin
gGoa l
:3
Topi
c:Cos
tofCo mmonSt
ockEq
uit
y

24. Thecons
tantgr
owthmode
lus
est
hema r
ketpr
icea
sar
efle
cti
onoft
hee
xpe
cte
dri
sk-
ret
urn
pr
efe
renc
eofi n
ves
tor
sint
hemar
ket
pla
ce.
Ans
wer
:TRUE
Leve
lofDifficul
ty:2
Lear
nin
gGoa l:3
Topi
c:ConstantGr o
wthMode
l

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 lOMoARcPSD|3720244

Cha
pte
r11 TheCos
tofCa
pit
al 441
25. Thecosto
fco
mmonst
ockeq
uityca
pit
alr
epre
sent
stheretur
nrequi
redbyex
ist
ingshar
ehol
der
son
t
heiri
nves
tme
nti
nor
dert
olea
vethemark
etpri
ceofthefir
m’souts
tand
ings
hareuncha
nged.
Ans
wer
:TRUE
Leve
lofDiffic
ult
y:2
Lear
nin
gGoa l
:3
Topi
c:Cos
tofCo mmonSt
ockEq
uit
y

26. Thecosto
fr e
tai
nedear
ning
sisalwaysl
owe
rthant
hecos
tofanewis
sueofc
ommons
toc
kduet
othe
ab
senceofflo
tat
ionc
ostswhenfina
ncin
gpr
oje
ctswi
thre
tai
nede
arni
ngs
.
Ans
wer
:TRUE
Leve
lofDiffic
ult
y:2
Lear
nin
gGoa l
:3
Topi
c:Cos
tofRe tai
nedEa
rni
ngs

27. Sin
c ethene
tproce
edsfr
omsal
eofnewcommonstoc
kwillbel
esst
hant
hec
urr
entma
rke
tpr
ice
,th
e
costofnewiss
ueswil
lal
way
sbeles
stha
nthecos
tofexi
st
ingis
sues
.
Ans
wer
:FALSE
Leve
lofDiffic
ult
y:2
Lear
nin
gGoa l
:3
Topi
c:Cos
tofNe wCommonSt
ockEq
uit
y

28. TheGordonmodeli
sba s
edonthepre
mis
ethatthev al
ueofasha
reofstoc
kise
qua
ltos
umofa
ll
fut
uredi
vide
ndsi
tisexpect
edt
op r
ovi
deove
ra ninfini
tet
imehor
izon.
Ans
wer
:FALSE
Leve
lofDifficul
ty:2
Lear
nin
gGoa l:3
Topi
c:ConstantGr o
wthMode
l

29. Thecostofr
eta
inedear
nin
gst
othefir
mist
hes
amea
sthec
ostofa
neq
uiv
ale
ntf
ull
ysub
scr
ibe
d
i
ssueofaddi
ti
onalco
mmons t
ock
.
Ans
wer
:TRUE
Leve
lofDiffic
ult
y:2
Lear
nin
gGoa l
:3
Topi
c:Cos
tofRe tai
nedEa
rni
ngs

30. Usi
ngtheCa
pit
alAss
etPri
cin
gMode l(CAPM) ,th
ecostofc
ommons t
ockeq
uit
yist
her
etur
n
r
equi
redbyi
nve
sto
rsascompens
ati
onforthefir
m’snondi
ver
si
fia
bler
isk.
Ans
wer
:TRUE
Leve
lofDifficul
ty:3
Lear
nin
gGoa l:3
Topi
c:Capi
ta lAssetPr
ici
ngMode
l

31. UseoftheCapit
alAssetPr
ici
ngModel(CAPM)inmeasur
ingt
hecosto
fcommons to
ckequi
ty
di
ffe
rsfromt
h econs
tantgr
owthva
lua
tionmode
lintha
titdi
rec
tl
yconsi
der
sthefir
m’sri
skas
r
efle
cte
db yb
e t
a.
Ans
wer
:TRUE
Leve
lofDifficul
ty:3
Lear
nin
gGoa l:3
Topi
c:Capi
ta lAssetPr
ici
ngMode
l

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 lOMoARcPSD|3720244

Cha
pte
r11 TheCos
tofCa
pit
al 442
32. Whentheconst
antgro
wt hvaluat
ionmodelisus
edtofindt
hec ostofcommonst
ocke
quit
yca
pit
al,i
t
ca
neasi
lybea d
just
edforflo
tati
oncost
stofindt
hecostofnewc ommons t
ock
;theCa
pit
alAs
set
Pr
ici
ngMode l(
CAPM)doe snotprovi
deasimplea
djustmentme cha
nism.
Ans
wer
:TRUE
Leve
lofDiffic
ult
y:3
Lear
ningGoa l
:3
Topi
c:CAPM a ndCons
tantGr
owt
hMode
l

33. Th
ecos
tofne
wcommons
toc
kisnor
mal
lygr
eat
ert
hana
nyo
the
rlon
g-t
erm fina
nci
ngc
ost
.
Ans
wer
:TRUE
Leve
lofDiffic
ult
y:3
Lear
nin
gGoa l
:3
Topi
c:Cos
tofNe wCommonSt
ockEq
uit
y

34. Thec a
pita
lasse
tprici
ngmodelde
scri
best
herel
at
ions
hipbe
twee nther
equ
iredre
tur
n,ort
hecos
tof
commons toc
ke qui
tycap
ita
l,a
ndthenons
yst
emati
cri
skofthefir
ma smeasur
edbythebe
ta
coeffic
ient
.
Ans
wer
:FALSE
Leve
lofDifficul
ty:3
Lear
nin
gGoa l:3
Topi
c:Capi
ta lAssetPr
ici
ngMode
l

35. Thewe i
ght
edave
ragecos
ttha
tre
fle
ctst
heint
err
ela
ti
onshi
po ffina
nci
ngdec
isi
onscanbeobtai
ned
byweighi
ngthec
ostofeac
hsour
ceoffina
nci
ngbyitst
arge
tproporti
oni
nthefir
m’scapi
tal
st
ruc
ture.
Ans
wer
:TRUE
Leve
lofDiffic
ult
y:1
Lear
ningGoa l
:4
Topi
c:Tar
getMa rke
tVa
lueWe
ight
s

36. I
ncomputi
ngtheweigh
tedav
era
gecostofcap
ital
,thehi
st
ori
cwe i
ght
sar
eei
the
rbookv
alueo
r
mar
ketv
alueweight
sbase
donactua
lcapi
tals
truc
turepr
opor
tions
.
Ans
wer
:TRUE
Leve
lofDi
fficul
ty:1
Lear
nin
gGoa l:4
Topi
c:Mar
ke tVal
uev e
rsusBookVa
lueWe
ight
s

37. I
nc omputi
ngthewei
ght
edaver
agecos
tofc a
p i
tal
,thetar
getwe
ight
sar
eei
the
rbookv
alueo
rma
rke
t
v
alueweight
sbasedona
ctua
lcapi
tals
truc
tureproport
ions
.
Ans
wer
:FALSE
Leve
lofDi
fficul
ty:1
Lear
nin
gGoa l:4
Topi
c:Mar
ke tVal
uev e
rsusBookVa
lueWe
ight
s

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 lOMoARcPSD|3720244

Cha
pte
r11 TheCos
tofCa
pit
al 443
38. Incomput
ingthewe
igh
teda
ver
agecos
tofcapi
tal
,fromastr
ict
lyt
heor
eti
calpo
into
fvi
ew,t
he
pre
fer
redweighi
ngs
chemei
sta
rgetmar
ketv
aluepropor
ti
ons.
Ans
wer
:TRUE
Leve
lofDiffic
ult
y:1
Lear
ningGoa l
:4
Topi
c:Tar
getMa rke
tVa
lueWe
ight
s

39. Thewei
ght
edav
era
gec
ostofc
api
tal(
WACC)r
efle
ctst
hee
xpe
cte
dav
era
gef
utur
ecos
toff
undso
ver
t
helon
grun.
Ans
wer
:TRUE
Leve
lofDi
ffic
ult
y:1
Lear
nin
gGoa l
:4
Topi
c:Wei
ghtedAve
rag
eCo
stofCa
pit
al

40. Si
ncer
eta
ine
dearn
ingsisamoree
xpensi
vesou
rceoffinanc
ingt
hande
btandpref
err
eds
toc
k,t
he
wei
ght
edave
rag
ecostofcap
ita
lwil
lfa
llonc
ereta
ine
de a
rni
ngsha
vebeenexha
ust
ed.
Ans
wer
:FALSE
Leve
lofDi
ffic
ult
y:3
Lear
nin
gGoa l
:4
Topi
c:Wei
ghtedMargi
nalCos
tofCa
pit
al

41. Afir
m ma yf
acei
ncrea
sesinthewei
ght
edave
ragecos
tofca
pita
leit
herwhenr
eta
inedea
rnin
gsh a
ve
be
ene xha
ust
edorduetoincr
ease
sinde
bt,
pref
erre
dstoc
k,andcommone q
uit
ycost
sasaddi
tiona
l
ne
wf undsar
ereq
uire
d.
Ans
wer
:TRUE
Leve
lofDi
ffic
ult
y:3
Lear
nin
gGoa l
:4
Topi
c:Wei
ghtedMargi
nalCos
tofCa
pit
al

42. Thewei
ght
edmar
ginalc ostofc
api
tali
sthefir
m’swe
ight
eda
ver
agec
ostofc
api
tala
ssoc
iat
edwi
th
i
tsne
xtdol
la
roft
otalfinanci
ng.
Ans
wer
:TRUE
Leve
lofDi
ffic
ult
y:1
Lear
nin
gGoa l
:5
Topi
c:Wei
ghtedMargi
nalCos
tofCa
pit
al

43. Thewei
ght
edma r
gina
lcos
tofcapi
tals
chedul
eisagr
apht
hatr
ela
test
hefir
m’swe
ight
eda
ver
age
cos
tofc
api
talt
othelev
eloft
ota
lnewfina
nc i
ng.
Ans
wer
:TRUE
Leve
lofDi
ffic
ult
y:1
Lear
nin
gGoa l
:5
Topi
c:Wei
ghtedMargi
nalCos
tofCa
pit
al

44. Ata nygiv

enti
me,thefir
m’sfinanc
ingc
ost
sandi
nve
stme
ntr
etur
nswi
llbea
ffe
cte
dbyt
hev
olumeof
fina
ncingandi
nve
stmentunder t
ake
n.
Ans
wer
:TRUE
Leve
lofDi
ffic
ult
y:2
Lear
nin
gGoa l
:5
Topi
c:Wei
ghtedMargi
nalCos
tofCa
pit
al

Downloaded by Methly Moreno (methlymoreno16@gmail.com)

 lOMoARcPSD|3720244

Cha
pte
r11 TheCos
tofCa
pit
al 444
45. Ast
hevol
umeoffina
nci
nginc
reas
es,t
hecos
tsofthev
ari
oust
ype
soffina
nci
ngwi
llde
cre
ase
,
r
edu
cin
gthefir
m’swei
ght
edaver
agecos
tofcapi
tal
.
Ans
wer
:FALSE
Leve
lofDi
ffic
ult
y:2
Lear
nin
gGoa l
:5
Topi
c:Wei
ghtedMargi
nalCos
tofCa
pit
al

46. Th
ewe
igh
tedma
rgi
nalc
ostofc
api
tali
sani
ncr
eas
ingf
unc
ti
ono
fthel
eve
loft
ota
lne
wfina
nci
ng.
Ans
wer
:TRUE
Leve
lofDi
ffic
ult
y:2
Lear
nin
gGoa l
:5
Topi
c:Wei
ghtedMargi
nalCos
tofCa
pit
al

47. Thebrea
kingpoi
nti
sthel
eve
loft
ota
lne
wfina
nci
nga
twhi
cht
hec
ostofoneo
fthefina
nci
ng
component
sri
ses
.
Ans
wer
:TRUE
Leve
lofDi
ffic
ult
y:2
Lear
nin
gGoa l
:5
Topi
c:WMCCBr ea
kPoi
nts

48. Afir
m’si
nve
stmentoppor
tuni
ti
ess
che
dul
eisar
anki
ngofi
nve
stme
ntpos
sibi
li
ti
esf
rom be
st(
highe
st
r
etur
n)t
oworst(
lowestr
etur
n).
Ans
wer
:TRUE
Leve
lofDi
ffic
ult
y:1
Lear
nin
gGoa l
:6
Topi
c:I
nve
stmentOppor
tuni
ti
esSc
hedul
e

49. Th
ela
rge
rthev
olumeofne
wfina
nci
ng,t
hegr
eat
ert
her
iska
nd,t
hus
,thehi
ghe
rthefina
nci
ngc
ost
s.
Ans
wer
:TRUE
Leve
lofDi
ffic
ult
y:2
Lear
nin
gGoa l
:6
Topi
c:Wei
ghtedMargi
nalCos
tofCa
pit
al

50. Theinv
est
mentoppor
tuni
tysche
dule(IOS)i
sthegra
pht
hatr
ela
test
hefir
m’swe
ight
eda
ver
agec
ost
ofca
pit
al(WACC)tothele
velofto
talnewfina
nci
ng.
Ans
wer
:FALSE
Leve
lofDi
ffic
ult
y:3
Lear
nin
gGoa l
:6
Topi
c:WMCCa ndI
OS

51. Thea c
cept
anc
eo fpr
oje
ctsbegi
nni
ngwitht
hos
ehavi
ngthegr
eate
stposi
ti
ved
iffe
renc
ebetweenIRR
andthewei
ghte
da ve
rag
ec os
tofca
pit
al
,Ka,do
wntothepoi
ntatwhichI
RRjustequal
skashoul
d
res
ulti
nthemaximum t
otalNPVforal
lind
epe
nde
ntproj
ect
saccept
ed.
Ans
wer
:TRUE
Leve
lofDi
ffic
ult
y:3
Lear
nin
gGoa l
:6
Topi
c:WMCCa ndI
OS

Downloaded by Methly Moreno (methlymoreno16@gmail.com)

 lOMoARcPSD|3720244

Cha
pte
r11 TheCos
tofCa
pit
al 445
52. Asthecumul
a t
iv
eamountofmone
yin
ves
tedi
nafir
m’sc
api
talpr
oje
ctsi
ncr
eas
es,
itsr
etur
nsont
he
pr
ojec
tswil
lincr
eas
e.
Ans
wer
:FALSE
Leve
lofDi
ffic
ult
y:3
Lear
nin
gGoa l
:6
Topi
c:WMCCa ndI
OS

53. Whi
letheretur
nwilli
ncre
asewit
hth
eaccept
anc
eo fmorep
roj
ect
s,t
heweight
edma
rgi
nalc
osto
f
c
api
talwil
lincre
asebec
ausegr
eat
eramount
soffina
nci
ngwil
lbere
quir
ed.
Ans
wer
:FALSE
Leve
lofDi
ffic
ult
y:3
Lear
nin
gGoa l
:6
Topi
c:WMCCa ndI
OS

54. Accor
din
gt ot
hefir
m’sowne rwea
lthmaxi
miza
ti
ongoa
l,t
hefir
mshoul
dac
ceptpro
ject
suptot
he
po
intwhereth
ema rgi
nalr
eturnonit
sin
vest
menti
seq
ualt
oitswei
ght
edmarg
inalcos
tofca
pit
al
.
Ans
wer
:TRUE
Leve
lofDi
ffic
ult
y:3
Lear
nin
gGoa l
:6
Topi
c:WMCCa ndI
OS

55. Thec
osto
fcapi
talc
anbethoughtofasthe“magi
cnumber”thati
suse
dtodec
idewhe
the
ra
pr
opos
edcor
por
ateinv
est
mentwillinc
reaseorde
cre
aset
hefirm’ss
toc
kpri
ce.
Ans
wer
:TRUE
Leve
lofDiffic
ult
y:2
Lear
nin
gGoa l
:1
Topi
c:Bas
icConc ep
tofCos
tofCa
pit
al

56. Thecos
tofcommonst
ockequi
tycanbethou
gh to
fasthe“
ma gi
cnumber”t
hati
sus
edtode
cid
e
whet
herapr
opose
dcor
pora
teinve
stmentwil
lincr
eas
eordecr
easet
hefir
m’ss
toc
kpri
ce.
Ans
wer
:FALSE
Leve
lofDiffic
ult
y:3
Lear
nin
gGoa l
:1
Topi
c:Bas
icConc ep
tofCos
tofCa
pit
al

57. Thecosto
fcapi
talisast
ati
cconc
ept
;iti
sno
taffe
cte
dbye
cono
mica
ndfir
m-s
pec
ificf
act
orss
ucha
s
bus
ines
sris
kandfinanc
ialr
isk
.
Ans
wer
:FALSE
Leve
lofDiffic
ult
y:2
Lear
nin
gGoa l
:1
Topi
c:Bas
icConc ep
tofCos
tofCa
pit
al

58. Thecosto
fcapi
talisadyna
micconc
ept
;iti
saffe
cte
dbye
conomi
candfir
m-s
pec
ificf
act
orss
ucha
s
bus
ines
sris
kandfinanc
ialr
isk
.
Ans
wer
:TRUE
Leve
lofDiffic
ult
y:2
Lear
nin
gGoa l
:1
Topi
c:Bas
icConc ep
tofCos
tofCa
pit
al

Downloaded by Methly Moreno (methlymoreno16@gmail.com)

 lOMoARcPSD|3720244

Cha
pte
r11 TheCos
tofCa
pit
al 446
59. I
nusi
ngt
hec
ostofc
api
tal
,iti
simpor
tantt
hati
tre
fle
ctst
heh
ist
ori
calc
ostofr
ais
ingf
undso
vert
he
l
ongr
un.
Ans
wer
:FALSE
Leve
lofDiffic
ult
y:3
Lear
nin
gGoa l
:1
Topi
c:Bas
icConc ep
tofCos
tofCa
pit
al

60. From abondiss

uer’
sper
spec
ti
ve,
theI
RRonabond’sca
shflo
wsisit
scostt
oma t
uri
ty;f
romt
he
in
vest
or’spe
rspect
iv
e,t
heIRRonabond’
sca
shflo
wsistheyi
eldt
oma t
urit
y(YTM).
Ans
wer
:TRUE
Leve
lofDiffic
ult
y:3
Lear
nin
gGoa l
:2
Topi
c:Cos
tofLon g-
Ter
mDe
bt

61. From abondis

suer
’sp
ers
pect
ive
,theI
RRonabond’sc
ashflo
wsisit
syi
eldt
omatur
it
y(YTM)
;
fr
omt heinv
est
or’
sper
spe
cti
ve,t
heIRRonabond’
scas
hflo
wsi st
hecos
ttomat
uri
ty
.
Ans
wer
:FALSE
Leve
lofDiffic
ult
y:3
Lear
nin
gGoa l
:2
Topi
c:Cos
tofLon g-
Ter
mDe
bt

62. Nic
oTr adi
ngCorporati
onisconsi
der
ingissui
nglon
g -t
e r
mde bt
.Thed e
btwou l
dha v
ea30y e
ar
matur
ityanda10pe r
centcouponrat
e.Inordert
oselltheis
sue,th
ebondsmus tbeunderpri
cedata
di
scountof5per
ce n
toffacevalu
e.Inaddit
ion,t
hefirm wouldhavet
op ayflo
t at
ioncost
sof5
pe
rcentoffac
evalue.Thefir
m’staxrat
eis35perce
nt .Give
nt h
isinf
ormati
on ,theaft
ertaxcostof
de
btforNicoTra
d in
gwou l
dbe7. 26perce
nt.
Ans
wer
:TRUE
Leve
lofDiffic
ult
y:4
Lear
nin
gGoa l
:2
Topi
c:Cos
tofLon g-
Ter
mDe
bt(
Equa
ti
on11.
2)

63. Nic
oTr adi
ngCorporati
onisconsi
deri
ngiss
uinglon
g -t
e r
mde bt
.Thed e
btwou l
dha v
ea30y e
ar
matur
ityanda10pe r
centcouponrat
e.Inorde
rtoselltheis
sue,th
ebondsmus tbeunderpri
cedata
di
scountof5per
ce n
toffacevalu
e.Inaddit
ion,t
hefirm wouldhavet
op ayflo
t at
ioncost
sof5
pe
rcentoffac
evalue.Thefir
m’staxrat
eis35perce
nt .Give
nt h
isinf
ormati
on ,theaft
ertaxcostof
de
btforNicoTra
d in
gwou l
dbe11. 17perc
ent.
Ans
wer
:FALSE
Leve
lofDiffic
ult
y:4
Lear
nin
gGoa l
:2
Topi
c:Cos
tofLon g-
Ter
mDe
bt(
Equa
ti
on11.
2)

64. NicoTradi
ngCorporat
ionisconsi
deri
ngis
suingpr
efer
redst
ock.Thepref
e r
redstockwouldhav
ea
parval
ueof$75a ndapref
e r
reddiv
idendof7.
5percen
tofpar.I
nordertoissuethest
ock,Nic
o
tr
adin
gwou ldhav
et opayflo
tat
ioncos
tsof6perce
ntofparval
ue.Giventhisinf
ormati
on,Nico
Tradi
ng’
scostofpref
err
eds t
ockwouldbe7.98per
cent
.
Ans
wer
:TRUE
Leve
lofDiffic
ult
y:3
Lear
nin
gGoa l
:2
Topi
c:Cos
tofPr ef
err
edSt
ock(
Equ
ati
on11.
3)

Downloaded by Methly Moreno (methlymoreno16@gmail.com)

 lOMoARcPSD|3720244

Cha
pte
r11 TheCos
tofCa
pit
al 447
65. NicoTradi
ngCorporat
ionisconsi
deri
ngis
suin
gprefe
rre
ds t
ock.Thepref
e r
redstockwouldhav
ea
parval
ueof$75a ndapref
e r
reddiv
idendof7.
5perce
ntofpar.I
nordertoissuethest
ock,Nic
o
tr
adin
gwou ldhav
et opayflo
tat
ioncos
tsof6perc
entofparval
ue.Giventhisinf
ormati
on,Nico
Tradi
ng’
scostofpref
err
eds t
ockwouldbe7.5per
cent
.
Ans
wer
:FALSE
Leve
lofDiffic
ult
y:3
Lear
nin
gGoa l
:2
Topi
c:Cos
tofPr ef
err
edSt
ock(
Equ
ati
on11.
3)

66. Th ecos
tofre
tain
e de a
rningsf
orTangsha
nMi ni
ngwoul
dbe16.
64per
centi
fthefir
mj us
tpaida
divid
endof$4.00,thestockpr
iceis$50.
00,
divi
dendsa
ree
xpe
ctedt
ogrowat8pe rc
entind
efini
te
ly,
andflot
ati
oncost
sa re$5.00pershar
e.
Ans
wer
:TRUE
Leve
lofDiffic
ult
y:3
Lear
nin
gGoa l
:3
Topi
c:Cos
tofRe tai
nedEa
rni
ngs(
Equa
ti
on11.
5)

67. Th ecos
tofre
tain
e de a
rningsf
orTangsha
nMi ni
ngwoul
dbe17.
60per
centi
fthefir
mj us
tpaida
divid
endof$4.00,thestockpr
iceis$50.
00,
divi
dendsa
ree
xpe
ctedt
ogrowat8pe rc
entind
efini
te
ly,
andflot
ati
oncost
sa re$5.00pershar
e.
Ans
wer
:FALSE
Leve
lofDiffic
ult
y:3
Lear
nin
gGoa l
:3
Topi
c:Cos
tofRe tai
nedEa
rni
ngs(
Equa
ti
on11.
5)

68. Th ec os
tofnewcommons t
ockequi
tyforTangs
hanMi ni
ngwoul
dbe17.
60per
centift
hefir
mjus
t
paidadi vi
dendof$4.
00,t
hesto
ckpriceis$50.
00,di
vide
ndsar
eexp
ect
edtogr
owa t8per
c e
nt
indefini
tel
y,a
ndflo
tat
ionc
ostsar
e$5.00pershar
e.
Ans
wer
:TRUE
Leve
lofDiffic
ult
y:3
Lear
nin
gGoa l
:3
Topi
c:Cos
tofNe wCommonSt
ockEq
uit
y(Eq
uat
ion11
.8a
ndEq
uat
ion11.
8a)

69. Th ecos
tofre
tai
nedear
nin
gsequi
tyf
orTangs
hanMini
ngwoul
dbe18.
00pe
rce
nti
fthee
xpe
c t
ed
ret
u r
nonU.S.Trea
sur
yBill
sis5.
00per
cent
,thema
rke
tri
skpr
emiu
mis10.
00per
cen
t,a
ndthe
fir
m’sbetai
s1.3
.
Ans
wer
:TRUE
Leve
lofDiffic
ult
y:3
Lear
nin
gGoa l
:3
Topi
c:Cos
tofRe tai
nedEa
rni
ngs(
Equa
ti
on11.
6)

70. Thecos
tofr
etai
nedear
nin
gsequi
tyf
orTangs
hanMini
ngwoul
dbe18.
00per
centift
h ee
xpe c
ted
re
tur
nonU.S.Tre
asur
yBill
sis5.
00per
cent
,thema
rke
tre
tur
nis10
.00pe
rce
nt,andthefir
m’sbeta
i
s1 .
3.
Ans
wer
:FALSE
Leve
lofDiffic
ult
y:3
Lear
nin
gGoa l
:3
Topi
c:Cos
tofRe tai
nedEa
rni
ngs(
Equa
ti
on11.
6)

Downloaded by Methly Moreno (methlymoreno16@gmail.com)

 lOMoARcPSD|3720244

Cha
pte
r11 TheCos
tofCa
pit
al 448
71. We ight
sthatus
ea c
count
ingv
alue
stomeasur
et hepropor
ti
onofe
acht
ypeofc
api
tali
nthefir
m’s
fina
nc i
alst
ruct
urear
ecal
ledmark
etva
lueweights.
Ans
wer
:FALSE
Leve
lofDiffic
ult
y:2
Lear
nin
gGoa l
:4
Topi
c:Alt
ernati
veWeight
ingSc
heme
s

72. We ight
sthatus
ea c
count
ingval
uest
omeas
urethepr
opor
ti
onofe
acht
ypeofc
api
tali
nthefir
m’s
fina
nc i
alst
ruct
urear
ecal
ledbookval
uewe
ight
s.
Ans
wer
:TRUE
Leve
lofDiffic
ult
y:2
Lear
nin
gGoa l
:4
Topi
c:Alt
ernati
veWeight
ingSc
heme
s

73. His
tori
calweight
saree
ithe
rbookv
alueo
rma
rke
tva
luewe
ight
sba
sedont
hea
ctua
lhi
st
ori
cal
ca
pita
lstruc
turepr
opor
ti
ons.
Ans
wer
:TRUE
Leve
lofDiffic
ult
y:2
Lear
nin
gGoa l
:4
Topi
c:Alt
ernati
veWeight
ingSc
heme
s

74. Targ
etwei
ghtsa
reei
the
rbookv
alu
eorma
rke
tva
luewe
ight
sba
sedont
hea
ctua
lhi
st
ori
calc
api
tal
st
ruct
urep
ropor
ti
ons
.
Ans
wer
:FALSE
Leve
lofDiffic
ult
y:2
Lear
nin
gGoa l
:4
Topi
c:Alt
ernati
veWeight
ingSc
heme
s

75. Ta
rgetweight
sar
eei
the
rbookv
alu
eorma
rke
tva
luewe
ight
sba
sedonde
sir
edc
api
tals
truc
tur
e
pr
oport
ions.
Ans
wer
:TRUE
Leve
lofDiffic
ult
y:2
Lear
nin
gGoa l
:4
Topi
c:Alt
ernati
veWeight
ingSc
heme
s

76. Economi cv
aluea
ddedist hediffe
renc
ebetweenaninve
stme nt
’snetope
rat
ingprofita
fte
rtax
esand
t
hec ostoff
undsusedtofinanc
et heinv
est
me nt
,wh i
chi
sf oundbymul t
ipl
yingt
hedo ll
aramountof
t
hef undsuse
dtofina
nceth ei
nv est
mentbythefir
m’sweightedave
ragecostofc
a pit
al
.
Ans
wer
:TRUE
Leve
lofDiffic
ulty
:3
Lear
ningGoa l
:4
Topi
c:Economi cVal
ueAdde
d

77. Theinve
stmentopera
tingscheduleisthedi
ffer
encebet
weenaninv
estment
’snetopera
ti
ngprofitaft
er
t
axesandthecostoffundsusedtofinancetheinve
stme
nt,whic
hisfoundbymultipl
yin
gthedo ll
ar
amountofthefundsusedtofinan
c ethein
ve s
tmentbyt
hefir
m’sweight
edaver
agec os
tofcapi
ta l
.
Ans
wer
:FALSE
Leve
lofDiffic
ulty
:3
Lear
ningGoa l
:4
Topi
c:Economi cVal
ueAdde
d

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 lOMoARcPSD|3720244

Cha
pte
r11 TheCos
tofCa
pit
al 449
78. Thebrea
kpo i
nti
sthelev
eloft
otalne
wfina
nci
ngatwhic
hthec
ostofoneoft
hefina
nci
ng
component
sri
ses
,ther
ebycaus
inganupwar
dshi
fti
nthewei
ght
edma r
gina
lcos
tofcapi
tal
.
Ans
wer
:TRUE
Leve
lofDiffic
ult
y:2
Lear
nin
gGoa l
:5
Topi
c:Bre
aki ngPoi
nts

79. Th einve
stmen
topport
uni
typoi
ntist
hel
eveloft
ota
lnewfina
nci
nga
twhichthecostofoneoft
he
financ
ingcompone
ntsri
ses
,the
reb
ycaus
inganupwards
hifti
nth
eweigh
tedmarginalcos
tofca
pit
al
.
Ans
wer
:FALSE
Leve
lofDiffic
ult
y:2
Lear
nin
gGoa l
:5
Topi
c:Bre
aki ngPoi
nts

80. Thewei
ght
edma r
ginalc
ostofcapi
tali
sthefir
m’swe
ight
eda
ver
agec
ostofc
api
tala
ssoc
iat
edwi
th
t
henex
tdoll
aroft
otalnewfina
ncin
g.
Ans
we:TRUE
r
Leve
lofDi
ffic
ult
y:2
Lear
nin
gGoa :5
l
Topi
c:Wei
ghtedMar
gina
lCos
tofCa
pit
al

 Mul
ti
pleChoi
ceQuest
ions
1. The_________i stherat
eofr
etur
nafir
mmus
tea
rnoni
tsi
nve
stme
ntsi
npr
oje
ctsi
nor
dert
o
mainta
inthema rketval
ueofi
tsst
ock
.
(a)netpresentva l
ue
(b)costofcapi t
al
(c)int
ernalrateo fret
urn
(d)grossprofitma rgi
n
Ans
wer
:B
Leve
lofDiffic
ult
y:1
Lear
nin
gGoa l
:1
Topi
c:Bas
icConc ep
tofCos
tofCa
pit
al

2. The_________i stherat
eofr
etur
nre
qui
redb
ythema
rke
tsuppl
ie
rso
fca
pit
ali
nor
dert
oat
tr
act
t
heirfundstothefirm.
(a)yiel
dt oma turit
y
(b)inter
nalrateo fret
urn
(c)costofcapi t
al
(d)grossprofitma r
gin
Ans
wer
:C
Leve
lofDiffic
ult
y:1
Lear
nin
gGoa l
:1
Topi
c:Bas
icConc ep
tofCos
tofCa
pit
al

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 lOMoARcPSD|3720244

Cha
pte
r11 TheCos
tofCa
pit
al 450
3. _________ist heri
sktot
hefir
m ofbe
inguna
blet
oco
verope
rat
ingc
ost
s.
(a)Totalr
isk
(b)Businessr i
sk
(c)Financi
a lris
k
(d)Divers
ifiableri
sk
Ans
wer
:B
Leve
lofDiffic
ult
y:1
Lear
nin
gGoa l
:1
Topi
c:Bus
ine ssRi
sk

4. _________ist heri
sktot
hefir
m ofbe
inguna
blet
oco
verfina
nci
alobl
ig
ati
ons
.
(a)Totalr
isk
(b)Businessr i
sk
(c)Financi
a lris
k
(d)Divers
ifiableri
sk
Ans
wer
:C
Leve
lofDiffic
ult
y:1
Lear
ningGoa l
:1
Topi
c:Fina
nc i
alRis
k

5. Thecosto
fc api
talre
fle
ctsthecostoff
unds
(a)o
v e
ras hort
-runti
mepe riod
.
(b)a
tagive npointi
ntime.
(c)o
v e
ralon g-
runtimeper i
od.
(d)a
tcurrentbookvalues.
Ans
wer
:C
Leve
lofDiffic
ult
y:1
Lear
nin
gGoa l
:1
Topi
c:Bas
icConc ep
tofCos
tofCa
pit
al

6. Thef
ourbasi
csour
cesofl
ong-t
ermf undsfo
rthebusi
ne s
sfir
ma re
(a)c
urr
entli
abi
li
ti
es,l
ong-
ter
md e
bt,commons t
ock,andpref
e r
redstock.
(b)c
urr
entli
abi
li
ti
es,l
ong-
ter
md e
bt,commons t
ock,andret
ainedea r
ning
s.
(c)l
ong-
ter
m debt
,pai
d-i
ncapit
alinexces
so fpa
r,commons tock,andret
aine
dea
rni
ngs
.
(d)l
ong-
ter
m debt
,commonstock,pref
err
edstoc
k,andretai
nede ar
nings.
Ans
wer
:D
Leve
lofDiffic
ult
y:1
Lear
nin
gGoa l
:1
Topi
c:Compa ri
ngtheCo
stofVa
riousSou
rce
sofCa
pit
al

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 lOMoARcPSD|3720244

Cha
pte
r11 TheCos
tofCa
pit
al 451
7. Fir
mstypical
lyrai
selong-
ter
mf unds
(a)onl
ya tth
ei nc
epti
onofthefir
m.
(b)onac ont
inuousbasi
s.
(c)inlumpsumsa sneeded.
(d)inpropor
tiontot
hec a
pit
almixtur
eoft
het
arg
etc
api
tals
truc
tur
e.
Ans
wer
:C
Leve
lofDiffic
ult
y:1
Lear
nin
gGoa l
:1
Topi
c:Bas
icConc ep
tofCos
tofCa
pit
al

8. Thefir
m’sopti
ma lmixofdebta
nde
qui
tyi
sca
ll
edi
ts
(a)opti
ma lr
ati
o.
(b)tar
getcapi
talst
ruc
tur
e.
(c)ma xi
mumwe al
th.
(d)ma xi
mumbookv al
ue.
Ans
wer
:B
Leve
lofDiffic
ult
y:1
Lear
ningGoa l
:1
Topi
c:Tar
getCa pi
talSt
ruc
tur
e

9. Thec os
to fea
c htypeofc api
taldependsont
he
(a)risk
- f
reecostofthattypeoffunds.
(b)businessr
i s
koft hefirm.
(c)financi
alris
koft hefirm.
(d)
Alloft heabove.
Ans
wer
:D
Leve
lofDiffic
ult
y:2
Lear
nin
gGoa l
:1
Topi
c:Bas
icConc ep
tofCos
tofCa
pit
al

10. Th e_________isawei
ght
eda
ver
ageoft
hec
osto
ffundswhi
chr
efle
ctst
hei
nte
rre
lat
ions
hipof
financi
ngdecisi
ons.
(a)r i
skpremium
(b)no minalcost
(c)c ostofca
pital
(d )ri
sk-f
reerat
e
Ans
wer
:C
Leve
lofDiffic
ult
y:2
Lear
nin
gGoa l
:1
Topi
c:Bas
icConc ep
tofCos
tofCa
pit
al

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 lOMoARcPSD|3720244

Cha
pte
r11 TheCos
tofCa
pit
al 452
11. The_________i st
hefir
m’sde
sir
edop
tima
lmi
xofde
bta
nde
qui
tyfina
nci
ng.
(a)bookv a
lue
(b)marketvalue
(c)costofcapit
al
(d)tar
getcapita
lst
ruc
ture
Ans
wer
:D
Leve
lofDiffic
ult
y:2
Lear
ningGoa l
:1
Topi
c:Tar
getCa pi
talSt
ruc
tur
e

12. Thecos
ttoacorpora
tionofe
a c
htyp eofcap
itali
sdependentupon
(a)t
heris
k-f
reerat
eofbondsplusthebusi
nessri
skofthefirm.
(b)t
heris
k-f
reerat
eofe a
chtypeofc a
pit
alplust
hebusinessri
skofthefir
m.
(c)t
heris
k-f
reerat
eofe a
chtypeofc a
pit
alplust
hefinanc
ialri
skofthefir
m.
(d)t
heris
k-f
reerat
eofe a
chtypeofc a
pit
alplust
hebusinessri
skandthefina
nci
alr
isko
fth
efir
m.
Ans
wer
:D
Leve
lofDiffic
ult
y:3
Lear
nin
gGoa l
:1
Topi
c:Bas
icConc ep
tofCos
tofCa
pit
al

13. Thespeci
ficcostofeac
hs our
ceofl
ong
-te
rmfina
nci
ngi
sba
sedon_________a
nd_________c
ost
s.
(a)bef
ore-ta
x;h i
st
ori
cal
(b)aft
er-
tax;hist
ori
cal
(c)bef
ore-ta
x;bookv al
ue
(d)aft
er-
tax;curr
ent
Ans
wer
:D
Leve
lofDiffic
ult
y:3
Lear
nin
gGoa l
:1
Topi
c:Bas
icConc ep
tofCos
tofCa
pit
al

14. Inordert
ore cognizetheinterr
e la
ti
ons hi
pbe t
we enfina
nci
nga
ndi
nve
stme
nts
,th
efir
mshou
ldus
e
_________whe neva l
uati
nga ni nv
e stme nt
.
(a)thelea
stc ostl
ys ourceoffinanc i
ng
(b)themos tcostl
ys ourceoffinanc i
n g
(c)theweighteda veragecosto fallfinanci
ngs ourc
e s
(d)thecurr
e ntoppor t
unitycost
Ans
wer
:C
Leve
lofDiffic
ult
y:3
Lear
nin
gGoa l
:1
Topi
c:Bas
icConc ep
tofCos
tofCa
pit
al

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 lOMoARcPSD|3720244

more on liability kasi ito.

Cha
pte
r11 TheCos
tofCa
pit
al 453
15. Ac orpora
ti
onhasc oncl
udedthatit
sfinanci
alri
s kpre
miumi st
oohi gh.Inordert
ode
cre
aset
his
,th
e
fir
mc an
(a)increas
etheproport
ionoflong-t
erm debttodecreas
ethecostofc a
pita
l.
(b)increas
eshort
-termdebtt
ode cre
as ethecostofcapi
tal
.
(c)de cr
easet
heproporti
onofc ommons t
ockeq ui
tytodecr
easefinanc
ialri
sk.
(d)increas
etheproport
ionofcommons tockequit
ytode c
reas
efinancialr
isk.
Ans
wer
:D
Leve
lofDiffic
ult
y:4
Lear
ningGoa l
:1
Topi
c:Fina
nc i
alRis
k

16. The_________f ro
mt hesaleofas e
curi
tya
rethefundsact
ual
lyr
ecei
vedf
romthesa
leaf
ter
_________,orthetot
alcostsofis
suinga
ndsel
lin
gt hese
curi
ty
,whic
hhavebee
nsubtr
act
edfr
om t
he
tot
alproce
eds.
(a)grossprocee
ds;theafte
r-ta
xcosts
(b)grossprocee
ds;theflo
tati
oncosts
(c)netproceeds
;theflo
tati
onc os
ts
(d)netproceeds
;theafter
-t
a xcos
ts
Ans
wer
:C
Leve
lofDifficul
ty:1
Lear
ningGoa l:2
Topi
c:Flo
tationCo s
ts

17. Ata
xadjustmentmus tbema
dei
nde
ter
min
ingt
hec
ostof_________.
(
a)lon
g- t
erm debt
(
b)commons to c
k
(
c)pre
ferredstock
(
d)ret
ainedearning
s
Ans
wer
:A
Leve
lofDiffic
ult
y:1
Lear
nin
gGoa l
:2
Topi
c:Cos
tofLon g-
Ter
mDe
bt

18. Thebefor
e -
taxcos
tofdeb
tforafir
mwhi
chha
sa40p
erc
entma
rgi
nalt
axr
atei
s12pe
rce
nt.
The
aft
er-
taxcostofde
btis
(a)4.8percent
.
(b)6.0percent
.
(c)7.2percent
.
(d)12percent.
Ans
wer
:C
Leve
lofDiffic
ult
y:1
Lear
nin
gGoa l
:2
Topi
c:Cos
tofLon g-
Ter
mDe
bt(
Equa
ti
on11.
2)

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 lOMoARcPSD|3720244

Cha
pte
r11 TheCos
tofCa
pit
al 454
19. Wha ti
sthedi
vide
ndona
n8pe
rce
ntpr efe rredst
ockt
hatc
urr
ent
lys
ell
sfor$45a
ndha
saf
acev
alue
of$50persha
re?
50 x 0.08 = 4
(
a)$3 .33
(
b)$3 .60
(
c)$4 .00
(
d )$5.00
Ans
wer
:C
Leve
lofDiffic
ult
y:1
Lear
nin
gGoa l
:2
Topi
c:Cos
tofPr ef
err
edSt
ock(
Equ
ati
on11.
3)

20. Afir
m hasi
ssued10perce
ntpr
efe
rre
ds t
ock,
whi
chsoldfor$100pers
har
eparval
ue.Thecos
tof
i
ssui
ngandsell
ingthes
toc
kwas$2p ers
hare
.Th
efir
m’ smargi
nalt
axrat
eis40pe
rcent
.Thecos
tof
t
hepref
err
edstockis
(
a)3 .
9perce
nt .
(
b)6 .
1perce
nt .
(
c)9 .
8perce
nt .
(
d)10 .
2percent.
Ans
wer
:D
Leve
lofDiffic
ult
y:2
Lear
nin
gGoa l
:2
Topi
c:Cos
tofPr ef
err
edSt
ock(
Equ
ati
on11.
3)

21. Afirm hasis

sue dpref
err
edst
ocka
tit
s$125persha
repa
rval
ue.Thestoc
kwillpaya$15annua
l
divi
dend.Thec ostofi
ssui
ngands
ell
ingt
hest
ockwas$4pe
rshare.Thecos
tofthepr
efe
rred
stoc
kis
(a)7 .
2percent.
(b)12pe rc
ent.
(c)12 .
4percent.
(d)15pe rc
ent.
Ans
wer
:C
Leve
lofDiffic
ult
y:2
Lear
nin
gGoa l
:2
Topi
c:Cos
tofPr ef
err
edSt
ock(
Equ
ati
on11.
3)

22. Whe ndeter

mi ni
ngthea ft
er-
taxcos
tofabond
,thef
acev
alueoft
hei
ssuemus
tbea
djus
tedt
othene
t
proc
eedsamount sbyc onsi
deri
ng
(a)theris
k.
(b)theflo
tat
ionc ost
s.
(c)theapproximateretur
ns.
(d)thetaxes
.
Ans
wer
:B
Leve
lofDiffic
ult
y:2
Lear
nin
gGoa l
:2
Topi
c:Cos
tofLon g-
Ter
mDe
bt

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 lOMoARcPSD|3720244

Cha
pte
r11 TheCos
tofCa
pit
al 455
23. Theappro
ximatebe
for
e-t
axc
ostofd
ebtf
ora15
-ye
ar,
10p
erc
ent
,$1,
000pa
rva
luebonds
ell
inga
t
$950is
(a)10perce
nt.
(b)10.
6pe r
cent
.
(c)12perce
nt.
(d)15.
4pe r
cent
.
Ans
wer
:B
Leve
lofDiffic
ult
y:3
Lear
nin
gGoa l
:2
Topi
c:Cos
tofLon g-
Ter
mDe
bt(
Equa
ti
on11.
1)

24. I
facorpor
ati
onha sa
naver
aget
axrat
eof40p er
cent
,theappro
ximat
e,a
nnua
l,a
fte
r-t
axc
osto
fde
bt
f
ora15-ye
ar,12perc
ent
,$1,
000pa
rvaluebond,s
ell
ingat$950is
(
a)10pe r
cent.
(
b)10.6percent
.
(
c)7.6percent.
(
d)6.0percent.
Ans
wer
:C
Leve
lofDiffic
ult
y:3
Lear
nin
gGoa l
:2
Topi
c:Cos
tofLon g-
Ter
mDe
bt(
Equa
ti
on11.
1andEq
uat
ion11.
2)

25. I
facorpora
ti
onhasanave
raget
axrat
eof40p e
rcent
,theappro
ximat
eannua
l,a
fte
r-t
axc
osto
fde
bt
f
ora10-yea
r,8per
cent
,$1,
000parv
aluebondsel
lin
ga t$1,
150is
(
a)3.6percent
.
(
b)4.8percent
.
(
c)6pe rc
ent.
(
d)8pe rc
ent.
Ans
wer
:A
Leve
lofDiffic
ult
y:3
Lear
nin
gGoa l
:2
Topi
c:Cos
tofLon g-
Ter
mDe
bt(
Equa
ti
on11.
1andEq
uat
ion11.
2)

26. Thea ppr

oxi
ma t
ebe
for
e-t
axc
ostofd
ebtf
ora10
-ye
ar,
8pe
rce
nt,
$1,
000pa
rva
luebonds
ell
inga
t
$1,150is
(a)6pe r
cent
.
(b)8 .
3perce
nt.
(c)8 .
8perce
nt.
(d)9pe r
cent
.
Ans
wer
:A
Leve
lofDiffic
ult
y:3
Lear
nin
gGoa l
:2
Topi
c:Cos
tofLon g-
Ter
mDe
bt(
Equa
ti
on11.
1andEq
uat
ion11.
2)

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 lOMoARcPSD|3720244

Cha
pte
r11 TheCos
tofCa
pit
al 456
27. Theapproxi
ma t
eaft
er-
taxcos
tofde
btfora20-
yea
r,7pe
rce
nt,$1
,000pa
rva
luebonds
ell
inga
t$960
(as
sumeama rgi
nalt
axr at
eof40pe
rce
n t
)is
(a)4.41perc
ent.
(b)5.15perc
ent.
(c)7pe r
cent
.
(d)7.35perc
ent.
Ans
wer
:A
Leve
lofDiffic
ult
y:3
Lear
nin
gGoa l
:2
Topi
c:Cos
tofLon g-
Ter
mDe
bt(
Equa
ti
on11.
1andEq
uat
ion11.
2)

28. Debtisg e
n e
rall
ytheleaste
xpensi
v esourc
eofc a
pit
al.Th
isi
spr
imari
lydueto
(
a)fix edint
e r
estpayments
.
(
b)i tsposit
ionintheprior
it
yofcla i
msona sse
tsandear
nin
gsi
ntheeventofl
iqui
dat
ion
.
(
c)t hetaxde duct
ibi
lit
yofint
erestpayments.
(
d)t hes e
curedna t
ureofadebtobligat
ion.
Ans
wer
:C
Leve
lofDiffic
ult
y:3
Lear
nin
gGoa l
:2
Topi
c:Cos
tofLon g-
Ter
mDe
bt

29. Afirm ha
sde termineditc
anis
suepre
fer
reds
toc
ka t$115pers
har
eparva
lue.
Thest
ockwil
lpa
ya
$12annualdividend.Thecos
tofis
sui
ngandsel
li
ngthestoc
kis$3pe
rshar
e.Thec
ostoft
he
pref
err
edstocki s
(a)6.4percent.
(b)10.4percent.
(c)10.7percent.
(d)12percent.
Ans
wer
:C
Leve
lofDiffic
ult
y:3
Lear
nin
gGoa l
:2
Topi
c:Cos
tofPr ef
err
edSt
ock(
Equ
ati
on11.
3)

30. Thecos
tofco mmons t
oc kequi
tyis
(a)t
hecostofthegua rantee
ds t
ateddividend.
(b)t
herat
ea twhichi nv
e st
orsdis
c ounttheexpect
eddi
vide
ndsoft
hefir
m.
(c)t
heaft
er-t
axc ostoftheintere
stob l
igati
ons.
(d)t
hehis
torica
lc ostoffloat
ingthes t
ockissue
.
Ans
wer
:B
Leve
lofDiffic
ult
y:1
Lear
nin
gGoa l
:3
Topi
c:Cos
tofCo mmonSt
ockEq
uit
y

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 lOMoARcPSD|3720244

Cha
pte
r11 TheCos
tofCa
pit
al 457
31. Thecostofcommons t
ockequi
tyma
ybee
sti
mat
edb
yus
ingt
he
(a)yi
eldcurve.
(b)netpre
sentval
ueme t
hod
.
(c)Gordonmode l
.
(d)DuPontanaly
sis
.
Ans
wer
:C
Leve
lofDifficul
ty:1
Lear
nin
gGoa l:3
Topi
c:ConstantGr o
wthMode
l

32. Thecostofco mmons to

cke q
uit
yma
ybee
sti
mat
edb
yus
ingt
he
(a)yi
e l
dc ur
ve .
(b)capi
talassetpri
cin
gmode l.
(c)i
nternalr
a teofre
turn.
(d)DuPonta nalys
is.
Ans
wer
:B
Leve
lofDifficul
ty:1
Lear
nin
gGoa l:3
Topi
c:Capi
ta lAssetPr
ici
ngMode
l

33. Thecostofret
ain
e dear
ni n
gsi
s
(a)z
e ro
.
(b)e
q ualt
othec osto
fane wissu eofcommonst
ock.
(c)e
q ualt
othec osto
fc ommons t
ockequi
ty
.
(d)i
rrel
evantt
ot heinv
es t
men
t/financi
ngdeci
si
on.
Ans
wer
:C
Leve
lofDiffic
ult
y:1
Lear
nin
gGoa l
:3
Topi
c:Cos
tofRe tai
nedEa
rni
ngs

34. Thec os
tofnewcommons t
ockfinanci
ngishi
ghe
rth
ant
hec
ostofr
eta
ine
dea
rni
ngsduet
o
(a)flot
at
ioncost
sandunder
pric
ing.
(b)flot
at
ioncost
sandover
pri
cing.
(c)flot
at
ioncost
sandcommissi
onc os
ts.
(d)commi s
sioncos
tsa
ndo ve
rpric
ing.
Ans
wer
:A
Leve
lofDiffic
ult
y:2
Lear
nin
gGoa l
:3
Topi
c:Cos
tofNe wCommonSt
ockEq
uit
y

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 lOMoARcPSD|3720244

Cha
pte
r11 TheCos
tofCa
pit
al 458
35. Thec onsta
ntgrowt
hv al
uat
ionmode l
—t heGor donmode l
—i sbas
edont
hepr
emi
set
hatt
hev
alueof
ashareofc ommonstockis
(a)thes um oft
hedivi
dendsandexpect
e dcapitalap
pr e
c i
ati
on.
(b)de te
rminedbas
edona nindust
rysta
nda rdP/Emu lt
ipl
e .
(c)de te
rminedbyusin
game as
ureofrelat
iveris
kc al
ledbe ta
.
(d)eq ualt
othepre
sentvalueofal
lexpectedfuturedivi
de nds.
Ans
wer
:D
Leve
lofDifficul
ty:2
Lear
nin
gGoa l:3
Topi
c:ConstantGr o
wthMode
l

36. I
ncalc
ula t
ingthec ostofcommonst
ocke
qui
ty
,themode
lha
vin
gth
est
ron
gert
heor
eti
cal
f
ounda
tionis
(
a)thec onst
an tgrowthmodel.
(
b)theGor donmode l.
(
c)thev ari
ablegro wthmodel
.
(
d)thec api
tala s
setprici
ngmodel
.
Ans
wer
:D
Leve
lofDiffic
ult
y:2
Lear
ningGoa l
:3
Topi
c:CAPM v er
susCons
tantGr
owt
hMode
l

37. Afir
m hasabe t
aof1.
2.Themar
ketr
etur
ne q
ual
s14per
centa
ndt
her
is
k-f
reer
ateo
fre
tur
neq
ual
s
6per
cent
.Thee st
imat
edcos
tofc
ommons toc
kequi
tyi
s
(
a)6pe rc
ent.
(
b)7 .
2percent.
(
c)14pe rc
ent.
(
d)15 .
6percent.
Ans
wer
:D
Leve
lofDifficul
ty:2
Lear
nin
gGoa l:3
Topi
c:Capi
ta lAssetPr
ici
ngMode
l(Eq
uat
ion11.
6)

38. Onemajorexpens
eassoc
iat
edwi
thi
ssui
ngne
wsh
are
sofc
ommons
toc
kis
(
a)underwriti
ngfee
s.
(
b)lega
lfees.
(
c)regi
stra
tionfe
es.
(
d)underpri
c i
ng.
Ans
wer
:D
Leve
lofDifficul
ty:2
Lear
ningGoa l:3
Topi
c:Flo
tationCo s
ts

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 lOMoARcPSD|3720244

Cha
pte
r11 TheCos
tofCa
pit
al 459
39. Fir
msunde r
pricenewi s
suesofcommons toc
kf orthefollo
wingr e
ason(s)
.
(a)Whe nthema rketisinequil
ibr
ium,addit
ionaldema ndforsharescanbeac
h i
eve
don l
yatalowe
r
pri
ce.
(b)Whe naddit
ionals har
esareiss
ued,eachshare’
spe r
centofowne rshi
pint
hefir
mi sdi
lut
ed,
the
rebyjust
ifyin
gal owershar
ev a
lue
.
(c)Ma nyi
n ve
storsviewt heiss
uanceofaddi
tionalsharesasasignaltha
tmanagementi
susing
commons tockeq uit
yfinanci
ngbecauseitbel
ievesthatth
es har
e sar
ecur
rent
lyover
pric
ed.
(d)Alloftheabove.
Ans
wer
:D
Leve
lofDiffic
ult
y:3
Lear
nin
gGoa l
:3
Topi
c:Underpric
ingNe
wCommonSt
ockEq
uit
y

40. Circ
umstancesinwhichtheconst
antgr
owthva
lua
tionmode
l—t
heGor
donmode
l—f
ore
sti
mat
ing
t
hev al
ueofas har
eofs t
ockshouldbeuse
din
clud
e
(
a )decl
iningdivi
dends.
(b)anerrat
icdivi
dendstre
am.
(
c )thela
ckofdi vi
dends.
(
d )astea
d ygrowthrat
eindivide
nds.
Ans
wer
:D
Leve
lofDifficul
ty:3
Lear
nin
gGoa l:3
Topi
c:ConstantGr o
wthMode
l

41. Afirm ha
sc ommons t
ockwit
hama r
ketp
ric
eof$25pershar
eandane
xpec
teddivi
dendof$2per
sharea
tthee ndoft
hecomingye
ar.
Thegrowthr
atei
ndivide
ndsha
sbee
n5pe r
cent
.Thecostoft
he
fir
m’scommons toc
kequit
yis
(a)5pe r
cent.
(b)8pe r
cent.
(c)10pe r
cent.
(d)13pe r
cent.
Ans
wer
:D
Leve
lofDifficul
ty:3
Lear
nin
gGoa l:3
Topi
c:ConstantGr o
wthMode
l(Eq
uat
ion11.
5)

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 lOMoARcPSD|3720244

Cha
pte
r11 TheCos
tofCa
pit
al 460
42. Afirm hascommonstoc
kwit
hamarke
tpric
eof$55pers
har
ea ndanexpec
teddi
vide
ndof$2
.81
persha
r eatt
heendofth
ecomin
gye
ar.Thediv
ide
ndspai
dontheouts
tand
ingst
ockovert
hep
ast
fiv
eyearsareasf
oll
ows:

Year Divi
dend
1 $2.
00
2 2.14
3 2.29
4 2.45
5 2.62

Thec
os toft
hefir
m’ scommons
toc
keq
uit
yis
(a)4 .
1percent.
(b)5 .
1percent.
(c)12 .
1percent.
(d)15 .
4percent.
Ans
wer
:C
Leve
lofDifficul
ty:3
Lear
nin
gGoa l:3
Topi
c:ConstantGr o
wthMode
l(Eq
uat
ion11.
5)

43. Usi
ngthec a
pitalass
etpr icingmodel
,thec
ostofc
ommons
toc
keq
uit
yist
her
etur
nre
qui
redb
y
i
nves
torsascompe nsati
onf or
(
a)thes pec
ificri
sko fthefirm.
(
b)thefirm’sdivers
ifiabler i
sk.
(
c)pr i
cevolatil
it
yoft hes tock.
(
d)thefirm’snondiversifia
bleris
k.
Ans
wer
:D
Leve
lofDifficul
ty:3
Lear
nin
gGoa l:3
Topi
c:Capi
ta lAssetPr
ici
ngMode
l

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 lOMoARcPSD|3720244

Cha
pte
r11 TheCos
tofCa
pit
al 461
44. Afir
m hasc ommons t
ockwithama r
ketpr
iceof$100p e
rshareandanexpect
eddivide
ndof$5 .
61
pe
rshareattheendofthecomingyear
.Ane wissueofst
ockisexpect
edtobesoldfor$98,with$2
pe
rsharerepres
enti
ngtheunder
pric
ingnece
ssaryinthecompeti
ti
vecapi
talmar
ket.Flot
ati
onc ost
s
ar
eexpect
edt otot
al$1pershar
e.Thediv
idendspaidontheouts
tandi
ngstoc
ko v
erthepastfiv
e
ye
arsar
ea sfoll
ows:

Ye
ar Di
vide
nd
1 $4.
00
2 4.
28
3 4.
58
4 4.
90
5 5.
24

Thec
os toft
hisne
wi s
sueofc
ommons
toc
kis
(a)5 .
8perc
ent.
(b)7 .
7perc
ent.
(c)10 .
8perc
ent.
(d)12 .
8perc
ent.
Ans
wer
:D
Leve
lofDifficul
ty:3
Lear
nin
gGoa l:3
Topi
c:ConstantGr o
wthMode
l(Eq
uat
ion11.
8andEq
uat
ion11.
8a)

45. Sinc
ere t
ainedearni
ng sarevi
e wedasaful
lysubsc
ribedi
ssueo
fadd
iti
ona
lcommons
toc
k,t
hec
ost
ofret
ainedearnin
gsis
(a)les
st hanthecostofne wc ommonstoc
ke qui
ty
.
(b)equaltothecosto fnewc ommons t
ockequit
y.
(c)great
e rt
hanthec ostofnewc ommons t
ockequity
.
(d)notrelat
edtothec ostofne wcommons t
ockequit
y.
Ans
wer
:A
Leve
lofDiffic
ult
y:3
Lear
nin
gGoa l
:3
Topi
c:Cos
tofRe tai
nedEa
rni
ngs

46. I
ncompa ringthec onsta
ntgr o wthmode landt hecapi
talasse
tpric
ingmode l(
CAPM)t oca l
culat
ethe
c
ostofcommons t
oc kequity,
(
a)t heconstantgrowthmode lignoresris
k, whiletheCAPM d ir
ectl
yc onsidersri
skasreflect
edin
thebeta.
(
b)t heCAPM di r
e ct
lycons idersr i
skasreflecte
di nth
ebe ta
,whilethec onst
antgrowthmode lu s
es
thema rke
tpr i
cea sare flecti
ono fthee xpecte
dr i
sk-r
etur
nprefer
e n
c eo fi
nv e
sto
rs.
(
c)t heCAPM di r
e ct
lycons idersr i
skasreflecte
di nth
ebe ta
,whilethec onst
antgrowthmode lu s
es
divi
de ndexpectati
onsa sar efle
cti
ono frisk.
(
d)t heCAPM i ndir
ectl
yc ons idersris
ka sreflect
edinthema rk
etret
urn ,whiletheconst
an tgrowth
mode lusesdividendexpe ctat
ionsasar eflect
ionofris
k.
Ans
wer
:B
Leve
lofDiffic
ult
y:4
Lear
ningGoa l
:3
Topi
c:CAPM v er
susCons
tantGr
owt
hMode
l

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 lOMoARcPSD|3720244

Cha
pte
r11 TheCos
tofCa
pit
al 462
47. I
nca
lculat
ingt hecostofcommons t
ockequit
y
(
a)t
heu s
eo fth ecapi
talass
etpri
cingmodel(CAPM)i soft
enpref
erred,becauset
hedatar
equir
ed
ar
emor ere adi
lyavail
able
.
(
b)t
heu s
eo fth eCAPM i spre
ferr
ed,beca
useitmoredir
ectl
ycal
culatesri
sk.
(
c)t
heu s
eo fth econst
antgrowthvalua
ti
onmode li
softenpre
fer
red,becausethedat
arequi
redare
mor ereadilyavail
able
.
(
d)t
heu s
eo fth econst
antgrowthvalua
ti
onmode li
softenpre
fer
red,becauseithasast
ron
ger
t
he oret
icalfoundati
on.
Ans
wer
:C
Leve
lofDiffic
ult
y:4
Lear
ningGoa l
:3
Topi
c:CAPM v er
susCons
tantGr
owt
hMode
l

48. Gi
ventha
tthecos
tofcommons t
ockis18perc
e nt
,divi
dendsar
e$1.50pers
har
e,a
ndt
hepr
iceo
f
t
hest
ockis$12.
50persha
re,whati
stheannualgro
wt hrat
eofdi
vidends
?
(
a)4pe r
cent
.
(
b)5pe r
cent
.
(
c)6pe r
cent
.
(
d)8pe r
cent
.
Ans
wer:C
Leve
lofDifficul
ty:4
Lear
nin
gGoa l:3
Topi
c:ConstantGr o
wthMode
l(Eq
uat
ion11.
5)

49. Gene ra
ll
y, t
heorderofcost
,from thel e
a s
te xpen
sivetothemos texpe
nsive
,fo
rlon
g-t
ermc
api
talo
fa
corporat
ionis
(
a )ne wc ommons toc
k,ret
ainede arnings,pref
erre
ds t
ock,long-t
ermdebt.
(
b)c ommons tock,pr
efer
reds t
ock,long -
termde bt
,short-
term de
bt.
(
c )pr ef
erre
dstock,re
tai
nede arni
n g
s ,commons to
ck,newc ommons tock.
(
d )lon g
-ter
m deb t
,pr
efer
reds t
ock,r et
ainede a
rnings
,newc ommons t
ock.
Ans
wer
:D
Leve
lofDiffic
ult
y:1
Lear
nin
gGoa l
:4
Topi
c:Compa ri
ngtheCo
stofVa
riousSou
rce
sofCa
pit
al

50. Gene
ral
lytheleastexpens
ives
our
ceo
flon
g-t
ermc
api
tali
s
(
a)reta
inedearnings.
(
b)prefe
rredstock.
(
c)long-t
erm debt.
(
d)short
-ter
m de bt
.
Ans
wer
:C
Leve
lofDiffic
ult
y:1
Lear
nin
gGoa l
:4
Topi
c:Compa ri
ngtheCo
stofVa
riousSou
rce
sofCa
pit
al

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 lOMoARcPSD|3720244

Cha
pte
r11 TheCos
tofCa
pit
al 463
51. We i
ghi
ngs che mesforcal
cul
at
ingt
hewe
ight
eda
ver
agec
ostofc
api
tali
ncl
udea
llo
fthef
oll
owi
ng
EXCEPT
(a)bookva luewe i
ghts.
(b)opti
ma lv alueweight
s.
(c)marketv alueweights
.
(d)tar
getwe ights.
Ans
wer
:B
Leve
lofDiffic
ult
y:1
Lear
nin
gGoa l
:4
Topi
c:Alt
ernati
veWeight
ingSc
heme
s

52. Thepref
erre
dc ap i
tals
truc
tur
ewe
ight
stobeus
edi
nthewe
ight
eda
ver
agec
ostofc
api
tala
re
(a)marketwe i
ghts.
(b)nominalwe ight
s.
(c)hi
stori
cwe ights
.
(d)ta
rgetweights.
Ans
wer
:D
Leve
lofDiffic
ult
y:1
Lear
ningGoa l
:4
Topi
c:Tar
getMa rke
tVa
lueWe
ight
s

53. Whe ndis

cussi
n gweighingsche
mesforc
alcul
ati
ngt
hewei
ghte
daver
agecostofcap
ita
l,t
he
pref
ere
ncescanbes tat
eda s
(a)ma r
ketvalueweightsarepr
efe
rre
doverbookva
luewe
ight
sandta
rgetwei
ghtsar
epref
err
edove
r
hist
ori
cwe ight
s.
(b)bookvaluewe i
ghtsa r
epref
err
edove
rma rke
tva
luewe
ight
sandta
rgetwei
ghtsar
epref
err
edove
r
hist
ori
cwe ight
s.
(c)bookvaluewe i
ghtsa r
epref
err
edove
rma rke
tva
luewe
ight
sandhi
stori
cweight
sarepr
efe
rre
d
overta
rgetwe i
ghts.
(d)ma r
ketvalueweightsarepr
efe
rre
doverbookva
luewe
ight
sandhi
stori
cweight
sarepr
efe
rre
d
overta
rgetwe i
ghts.
Ans
wer
:A
Leve
lofDiffic
ult
y:3
Lear
nin
gGoa l
:4
Topi
c:Alt
ernati
veWeight
ingSc
heme
s

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 lOMoARcPSD|3720244

Cha
pte
r11 TheCos
tofCa
pit
al 464
54. Afir
m ha
sdet
erminedi
tscostofea
chsourc
eofcapi
talandopti
malc a
pit
als
truc
tur
e,whi
chi
s
c
omposedoft
hefoll
owi
n gsourc
esandta
rgetma
rketval
ueproport
ions:

Tar
getMarket
Sourc
eo fCapi
tal Pr
oport
ions Af
ter
-TaxCos
t
Long-
ter
mde bt 40% 6%
Pre
fer
redst
ock 10 11
Commons t
ockequi
ty 50 15

Thewe
ight
edaver
agecostofc
api
tali
s
(
a)6pe r
cent.
(
b)10.7perce
nt.
(
c)11pe r
cent.
(
d)15pe r
cent.
Ans
wer
:C
Leve
lofDi
ffic
ult
y:3
Lear
nin
gGoa l
:4
Topi
c:Wei
ghtedAve
rag
eCo
stofCa
pit
al(
Equa
ti
on1
1.9)
55. Afir
m ha
sdet
erminedi
tscostofea
chsourc
eofcapi
talandopti
malc a
pit
als
truc
tur
e,whi
chi
s
c
omposedoft
hefoll
owi
n gsourc
esandta
rgetma
rketval
ueproport
ions:

Tar
ge tMarket Af
ter
-Tax
Sourc
eo fCapi
tal Pr
opor t
ions Cost
Long-
ter
mde bt 45% 5%
Pre
fer
redst
ock 10 14
Commons t
ockequi
ty 45 22

I
fthefir
mwe r
etos hi
ftt
owardamoreleve
ragedcapi
tals
truc
tur
e(i
.e
.,agr
eat
erpe
rce
nta
geofde
bti
nthe
c
apit
alstr
uct
ure)
,theweight
edave
ragecostofca
pita
lwould
(a)incr
ease.
(b)remainunchange
d.
(c)decre
ase.
(d)notbeabletobedete
rmine
d .
Ans
wer
:C
Leve
lofDi
ffic
ult
y:3
Lear
nin
gGoa l
:4
Topi
c:Wei
ghtedAve
rag
eCo
stofCa
pit
al(
Equa
ti
on1
1.9)

56. Asthev ol
umeoffinanci
nginc
rea
ses
,thecost
softhevar
ioust
ype
soffina
nci
ngwi
ll_________
,
_________thefir
m’sweigh
tedav
era
gec os
tofcap
ital
.
(a)incr
ease,l
owe r
ing
(b)incr
ease,r
aisi
ng
(c)decreas
e,lo
we ri
ng
(d)decreas
e,ra
ising
Answer:B
Leve
lofDi
ffic
ult
y:3
Lear
nin
gGoa l
:4
Topi
c:Wei
ghtedMargi
nalCos
tofCa
pit
al

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 lOMoARcPSD|3720244

Cha
pte
r11 TheCos
tofCa
pit
al 465
Afir
mhasdete
rmine
di t
sop
tima
lca
pit
als
truc
tur
ewhi
chi
scompos
edoft
hef
oll
owi
ngs
our
cesa
ndt
arg
et
mark
etv
aluepr
oport
ions
.

Tabl
e11
.1
Tar
getMarket
Sourc
eofCapital Pr
oport
ions
Long-
ter
m debt 20%
Pre
fer
redst
ock 10
Commons t
ockequi
ty 70

De bt:Thefirmc ansella12-y ear,$1,

000p a rv a
lue,7percentbondf o r$960.Aflotat
ioncostof
2pe rcentofthefacevaluewoul dbere quiredi nadditi
ontot h
edi scounto f$40.
Pre f
erredSt ock:Thefirmha sde t
ermi neditc anissuepref
erredstoc kat$75pe rshar
epa rvalue.
Thes tockwi l
lpaya$10a nnua ldivi
de nd .
Thec ostofiss
u i
nga ndse ll
ingthestockis$3pe rshar
e.
CommonSt ock:Afirm’ sc o
mmons toc kisc urren
tlysel
li
ngf or$18p ershare
.Th edivi
dend
expectedtob epaidatthee ndoft hec omi ngy e a
ris$1.74.It
sdi v
ide ndp aymentshavebeengr o
wi n
g
atac onstan
tr a
tefort
hel astfoury ear
s .Fou ry ear
sa go
,thedividendwa s$1.50.Iti
sexpectedthatto
sel
l,ane wc ommons tocki ss
uemus tbeunde rpri
ced$1pe rshareinfloa t
ati
onc ost
s.Addit
ionall
y,
t
hefir m’sma rgi
nalta
xr ateis40pe r
ce nt.

57. Thefir
m’sbefor
e-t
axc
osto
fde
bti
s(Se
eTa
ble11
.1.
)
(a)7.7per
cent.
(b)10.6pe
rcent
.
(c)11.2per
cent.
(d)12.7per
cent.
Ans
wer
:A
Leve
lofDiffic
ult
y:4
Lear
nin
gGoa l
:4
Topi
c:Cos
tofLon g-
Ter
mDe
bt(
Equa
ti
on11.
1)

58. Thefirm’
sa f
ter
-t
axc
ostofde
bti
s(Se
eTa
ble11.
1.
)
(a)3.25perce
nt.
(b)4.6perce
nt.
(c)8pe r
cent.
(d)8.13perce
nt.
Ans
wer
:B
Leve
lofDiffic
ult
y:4
Lear
nin
gGoa l
:4
Topi
c:Cos
tofLon g-
Ter
mDe
bt(
Equa
ti
on11.
2)

59. Thefir
m’scostofpr
efe
rre
dst
ocki
s(Se
eTa
ble11.
1.
)
(a)7.2per
cent.
(b)8.3per
cent.
(c)13.3per
cent.
(d)13.9per
cent.
Answer:D
Leve
lofDiffic
ult
y:4
Lear
nin
gGoa l
:4
Topi
c:Cos
tofPr ef
err
edSt
ock(
Equ
ati
on11.
3)

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 lOMoARcPSD|3720244

Cha
pte
r11 TheCos
tofCa
pit
al 466
60. Thefirm’
sc os
tofane
wis
sueo
fco
mmons
toc
kis(
SeeTa
ble11.
1.
)
(a)7pe r
cent.
(b)9.08perce
nt.
(c)13.2perce
nt.
(d)14.4perce
nt.
Ans
wer
:C
Leve
lofDiffic
ult
y:4
Lear
nin
gGoa l
:4
Topi
c:Cos
tofNe wCommonSt
ockEq
uit
y(Eq
uat
ion11
.8a
ndEq
uat
ion11.
8a)

61. Thefir
m’scos
tofre
tai
nede
arn
ing
sis(
SeeTa
ble11
.1.
)
(a)10.2pe
rce
nt.
(b)13.9pe
rce
nt.
(c)12.4pe
rce
nt.
(d)13.6pe
rce
nt.
Ans
wer
:C
Leve
lofDiffic
ult
y:4
Lear
nin
gGoa l
:4
Topi
c:Cos
tofRe tai
nedEa
rni
ngs(
Equa
ti
on11.
5)

62. Theweigh
tedaverag
ecos
tofc
api
talupt
othepo
intwhe
nre
tai
nede
arni
ngsa
ree
xha
ust
edi
s(Se
e
Tabl
e11.1
.)
(a)7.
5percent.
(b)8.
65percent
.
(c)10.
4percent.
(d)11.
0percent.
Ans
wer
:D
Leve
lofDi
ffic
ult
y:4
Lear
nin
gGoa l
:4
Topi
c:Wei
ghtedMargi
nalCos
tofCa
pit
al(
Equ
ati
on11.
9)

63. Thewei
ghte
daveragec
ostofc
api
tala
fte
ral
lre
tai
nede
arn
ing
sar
eexha
ust
edi
s(Se
eTa
ble11.
1.
)
(a)13
.6per
cent.
(b)11
.0per
cent.
(c)11
.55per
cent.
(d)10
.4per
cent.
Ans
wer
:C
Leve
lofDi
ffic
ult
y:4
Lear
nin
gGoa l
:4
Topi
c:Wei
ghtedMargi
nalCos
tofCa
pit
al(
Equ
ati
on11.
9)

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 lOMoARcPSD|3720244

Cha
pte
r11 TheCos
tofCa
pit
al 467
Afir
mhasdet
ermine
dit
sop
tima
lst
ruc
tur
ewhi
chi
scompos
edo
fthef
oll
owi
ngs
our
cesa
ndt
arg
etma
rke
t
v
aluepr
opor
ti
ons.

Tabl
e11.
2
Tar
getMarket
Sour
ceofCapi
tal Pr
oport
ions
Long
-te
rmdebt 60%
Commonst
ockequi
ty 40

De :Thefir
bt mc ansella15-year
,$1,000p a
rvalue,8percentbondf or$1,050.Aflot
a t
ioncostof
2pe r
centoft
hefa cevaluewouldbere qui
redinadditi
ontot hepremiumof$50.
CommonSt ock:Afir m’scommons tockiscurr
e n
tlysel
lingfor$75p ershare.Thedividend
expect
edtobepa i
da ttheendoft hecomingy e
aris$5.Itsdivide
ndpa yme ntshavebeengr o
wingata
consta
ntrat
eforthela s
tfiv
eyea r
s.Fi
v eyear
sago,thedividendwa s$3.10.Itisexpec
tedthattose
ll
,
ane wcommons tocki s
suemus tbeunde r
pri
ced$2pe rshareandth efir
m mus tpay$1p ershar
ein
flo
tat
ioncost
s.Addi t
ional
ly,t
hefirmha sama r
ginalta
xr ateof40pe r
c ent
.

64. Thefir
m’sbefor
e-t
axc
osto
fde
bti
s(Se
eTa
ble11
.2.
)
(a)7.7per
cent.
(b)10.6pe
rcent
.
(c)11.2per
cent.
(d)12.7per
cent.
Ans
wer
:A
Leve
lofDiffic
ult
y:4
Lear
nin
gGoa l
:4
Topi
c:Cos
tofLon g-
Ter
mDe
bt(
Equa
ti
on11.
1)

65. Thefir
m’sa f
ter
-t
axc
ostofde
bti
s(Se
eTa
ble11.
2.
)
(a)4.6perce
nt.
(b)6pe r
cent.
(c)7pe r
cent.
(d)7.7perce
nt.
Ans
wer
:A
Leve
lofDiffic
ult
y:4
Lear
nin
gGoa l
:4
Topi
c:Cos
tofLon g-
Ter
mDe
bt(
Equa
ti
on11.
2)

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 lOMoARcPSD|3720244

Cha
pte
r11 TheCos
tofCa
pit
al 468
66. Thefir
m’scos
tofane
wis
sueo
fco
mmons
tocki s( SeeTa
ble11.
2.
)
(a)10.2pe
rce
nt. growth rate:
(b)14.3pe
rce
nt.
(c)16.7pe
rce
nt.
(d)17.0pe
rce
nt.
Ans
wer
:D
Leve
lofDiffic
ult
y:4
Lear
nin
gGoa l
:4
Topi
c:Cos
tofNe wCommonSt
ockEq
uit
y(Eq
uat
ion11
.8a
ndEq
uat
ion11.
8a)

67. Thefir
m’scos
tofre
tai
nede
arn
ing
sis(
SeeTa
ble11
.2.
)
(a)10.2pe
rce
nt.
(b)14.3pe
rce
nt.
(c)16.7pe
rce
nt.
(d)17.0pe
rce
nt.
Ans
wer
:C
Leve
lofDiffic
ult
y:4
Lear
nin
gGoa l
:4
Topi
c:Cos
tofRe tai
nedEa
rni
ngs(
Equa
ti
on11.
5)

68. Theweigh
tedaveragec
ostofc
api
talupt
othepo
intwhe
nre
tai
nede
arni
ngsa
ree
xha
ust
edi
s(Se
e
Tabl
e11.2
.)
(a)6.
8percent.
(b)7.
7percent.
(c)9.
44percent.
(d)11.
29percent.
Ans
wer
:C
Leve
lofDi
ffic
ult
y:4
Lear
nin
gGoa l
:4
Topi
c:Wei
ghtedMargi
nalCos
tofCa
pit
al(
Equ
ati
on11.
9)

69. Assu
mingthefir
mpl a
nstopa
youta
llofi
tse
arn
ing
sasdi
vid
ends
,thewe
igh
teda
ver
agec
ostof
ca
pit
ali
s(SeeTa bl
e11.2.
)
(
a)9 .
6perce
nt.
(
b)10 .
9perce
nt.
(
c)11 .
6perce
nt.
(
d)12 .
1perce
nt.
Ans
wer
:A
Leve
lofDi
ffic
ult
y:4
Lear
nin
gGoa l
:4
Topi
c:Wei
ghtedMargi
nalCos
tofCa
pit
al(
Equ
ati
on11.
9)

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Cha
pte
r11 TheCos
tofCa
pit
al 469
Tabl
e11.
3
BalanceSheet
Ge
neralTalcMi ne
s
Dec
embe r31,2003
Assets
CurrentAsset
s
Cash $25
,000
Acc ount
sRe c
eiva
ble 120
,000
In
v entor
ies 300
,000
To t
alCurre
ntAs s
ets $445
,000
NetFi xe
dAs se
ts $500
,000
To t
alAsset
s $945
,000

Li
abi
li
ti
esandSt
ockhol
der
s’Equi
ty
Curr
e ntLiabil
ities
Acc ountsPaya ble $80
,000
Note sPayable 350
,000
Acc rual
s 50
,000
To ta
lCurr entLiabi
li
ti
es $480
,000
Long-Te r
mDe bts(150bondsi
ssuedat$1,000par
) 150
,000
To ta
lLiabiliti
es $630
,000
St
ockhol ders
’Eq uit
yCommonSt ock(7,200shar
esout
st
andi
ng) $180
,000
RetainedEa rnings 135
,000
To ta
lStockho lder
s’Equi
ty $315
,000
To ta
lLiabiliti
esandStoc
kholde
rs’Eq ui
ty $945
,000
70.

Sour
ceofCapi
tal Af
ter
-TaxCos
t
Long
-te
rmdebt 8%
Commonst
ockequi
ty 19

Gi
vent
hisaft
er-
taxcostofea
chs
ourc
eofcapi t al,thewe i
ght
eda
ver
agec
osto
fca
pit
alus
ingbookwe
ight
s
f
orGene
ralTal
cMi nesis(Se
eTa
ble11.
3.
)
(
a)11 .
6pe r
cent
. CAPITAL STRUCTURE:
LTD : 150,000
(
b)15 .
5pe r
cent
. C/S : 180,000
(
c)16 .
6pe r
cent
. R/E : 135,000
TOTAL : 465,000
(
d)17 .
5pe r
cent
.
Ans
wer
:B to compute WACC:
150/465 x 8% = 2.6%
Leve
lofDi
ffic
ult
y:4 315/465 x 19% = 12.9%
Lear
nin
gGoa l
:4 total : 15.5%
Topi
c:Wei
ghtedAve
rag
eCo
stofCa
pit
al(
Equa
ti
on1
1.9)

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 lOMoARcPSD|3720244

Cha
pte
r11 TheCos
tofCa
pit
al 470
71. GeneralTalcMineshascompi
le
dthef
oll
owi
ngda
tar
ega
rdi
ngt
hema
rke
tva
luea
ndc
ostoft
he
spe
cificsour
cesofca
pita
l.

Sour
ceofCapi
tal Af
ter
-TaxCos
t
Long
-te
rmdebt 8%
Commonst
ockequi
ty 19

Ma r
ketpr
icepersha
reo fcommons to c k$50
Ma r
ketval
ueoflong-
termde b
t$980pe rbond
Thewe i
ght
edaverag
ec ostofcap
italus i
ngma rk etv a luewe
ight
sis(
Se eTa ble11 .3.)
(a)11.7per
cent. LTD : 150 X 980 = 147,000
C/S : 7200 X 50 = 360,000 hindi mo isasama ang RE
(b)13.5per
cent. kapag market value weights
(c)15.8per
cent. TOTAL 507,000 ang pag compute ng WACC.

(d)17.5per
cent. WACC:
Ans
wer
:C LTD : 147/507 X 8% = 2.3
C/S : 360/507 X 19% = 13.5
Leve
lofDi
ffic
ult
y:4 TOTAL : 15.8
Lear
nin
gGoa l
:4
Topi
c:Wei
ghtedAve
rag
eCo
stofCa
pit
al(
Equa
ti
on1
1.9)

72. The_________istheleveloft
ota
lfina
nci
nga
twhi
cht
hec
ostofoneo
fthefina
nci
ngc
ompone
nts
ris
es.
(a)we i
ght
edaveragecostofca
pit
al
(b)we i
ght
edma rgi
nalcostofca
pita
l
(c)tar
getcap
ita
ls t
ruc
ture
(d)breaki
ngpoint
Ans
wer
:D
Leve
lofDi
ffic
ult
y:1
Lear
nin
gGoa l
:5
Topi
c:WMCCBr ea
kin
gPo
int

73. Asasourc
eoffinanc
ing,oncer
eta
ine
de a
rni
ngsha
vebe
ene
xha
ust
ed,
thewe
igh
teda
ver
agec
ostof
ca
pit
alwil
l
(
a)incre
ase.
(
b)remainthesame.
(
c)decreas
e.
(
d)changeinanundete
rmi n
eddir
ect
ion.
Ans
wer
:A
Leve
lofDi
ffic
ult
y:2
Lear
nin
gGoa l
:5
Topi
c:Wei
ghtedMargi
nalCos
tofCa
pit
al

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 lOMoARcPSD|3720244

Cha
pte
r11 TheCos
tofCa
pit
al 471
74. Afirmexpect
stohav
eava
il
able$500,000ofear
ningsinthecomingyea
r,whi
chitwi
llret
ainf
or
rein
ves
tmentpur
pose
s.Gi
venthefol
lowingta
rgetc
ap i
talst
ruct
ure
,atwhatl
eve
lofto
talnew
fina
nci
ngwillr
eta
ine
dear
ning
sbee xhaust
ed?

Tar
getMarket
Sourc
eo fCapi
tal Pr
oport
ions 500,000/50% = 1,000,000
Long-
ter
mde bt 40%
Pre
fer
redst
ock 10
Commons t
ockequi
ty 50

(
a)$500,
000.
(
b)$800
,000.
(
c)$1,
000,000
.
(
d)$1,
500,000
.
Ans
wer
:C
Leve
lofDi
ffic
ult
y:3
Lear
nin
gGoa l
:5
Topi
c:WMCCBr ea
kin
gPo
int(
Equa
ti
on11.
10)

75. Ac orporatione xpe

ctstoha veear
ningsav ai
labl
etocommons ha
rehol
ders(netpr
ofitsminus
pref
erreddi vidends
)of$1 ,
000,
000int hec omingyear
.Thefirmp l
anstop a
y40pe rcentofea
rnin
g s
avai
lableinc a s
hdividends.Ift
hefir
mha satar
getcapi
tals
truct
ureof40pe r
centlong-t
ermdebt,10
percentpreferredst
ock, and50pe r
centc ommons toc
ke qui
ty,whatcapi
talbudgetcouldth
efir
m
supportwi thoutiss
uingne wc o
mmons toc k
?
(a)$2 ,000,000 .
(b)$600, 000 .
(c)$1 ,200,000 .
(d)$800 ,000.
Ans
wer
:C
Leve
lofDi
ffic
ult
y:4
Lear
nin
gGoa l
:5
Topi
c:WMCCBr ea
kin
gPo
int(
Equa
ti
on11.
10)

76. The_________i sascheduleorgra

phre
lat
ingt
hefir
m’swe
ight
eda
ver
agec
ostofc
api
talt
othel
eve
l
ofnewfinanci
ng.
(a)weight
e davera
gec ostofca
pit
al
(b)weight
e dmarginalcostofca
pit
al
(c)ta
rgetcapi
talstr
ucture
(d)bre
a ki
ngpo i
nt
Ans
wer
:B
Leve
lofDi
ffic
ult
y:1
Lear
nin
gGoa l
:6
Topi
c:WMCCa ndI
OS

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 lOMoARcPSD|3720244

Cha
pte
r11 TheCos
tofCa
pit
al 472
77. Theinv
estmentoppor
tunit
yschedule(I
OS)i s
(a)asetofdeci
sioncr
ite
riaf
ordetermini
n gtheacce
ptabi
lit
yofcapit
alproj
ect
s.
(b)adete
rminati
onoftheweightedavera
gec osto
fcapita
latvar
iousincr
ementsoffina
nci
ng.
(c)anint
erna
lrateofret
urnranki
ngofc apit
alproj
ect
sfrom be
sttoworst.
(d)ali
stofin
v e
stmentoppor
tunit
iesavai
labl
et ot
hefir
m.
Ans
wer
:C
Leve
lofDi
ffic
ult
y:1
Lear
nin
gGoa l
:6
Topi
c:WMCCa ndI
OS
78. Afir
m ha
sdet
erminedi
tscostofea
chsourc
eofcapi
talandopti
malc a
pit
als
truc
tur
ewhi
chi
s
c
omposedoft
hefoll
owi
n gsourc
esandta
rgetma
rketval
ueproport
ions.

Tar
getMarket
Sourc
eo fCapit
al Pr
oport
ions Af
ter
-TaxCos
t
Long-
ter
mDe bt 35% 9%
Pre
fer
redStoc
k 10 14
CommonSt oc
kEq ui
ty 55 20

Thefir
mi sconsi
deri
nganinve
stmentoppor
tunit
y,whichhasaninter
nalra
teofretur
nof10pe r
cent
.
Theproje
ct
(a)shoul
dno tbeconsi
der
edbecauseit
sint
ernalr
ateofret
urnisle
ssthanthecos
toflong-
ter
m
debt.
(b)shoul
db econsi
dere
db e
causeit
sint
erna
lr a
teofret
urnisgr
e a
tertha
nthecostofdebt
.
(c)shoul
dno tbeconsi
der
edbecauseit
sint
ernalr
ateofret
urnisle
ssthantheweight
edaver
agecost
ofcapit
al.
(d)shoul
db econsi
dere
db e
causeit
sint
erna
lr a
teofret
urnisgr
e a
tertha
nthewe i
ghtedav
eragecost
ofcapit
al.
Ans
wer
:C
Leve
lofDi
ffic
ult
y:2
Lear
nin
gGoa l
:6
Topi
c:WMCCa ndI
OS(
Equ
ati
on11.
9)

79. Thewe ight

edma r
ginalcostofcapi
tali
s_________functi
onofto
talfina
ncingi
ndol
l a
rs;the
int
ernalra
teofret
urnoni ndivi
dualpro
jec
tsis_________func
ti
onoft heto
talc
api
talinve
s t
menti
n
doll
ars.
(a)a ninc
reas
ing;anincreas
ing
(b)ade cr
easi
ng;anincreasi
n g
(c)ade cr
easi
ng;adec r
easing
(d)a ninc
reas
ing;adecreasi
n g
Ans
wer
:D
Leve
lofDi
ffic
ult
y:3
Lear
nin
gGoa l
:6
Topi
c:WMCCa ndI
OS

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 lOMoARcPSD|3720244

Cha
pte
r11 TheCos
tofCa
pit
al 473
80. Thein
vest
mentopportuni
tyschedulecombi ne
dwiththewei
ghte
dma r
gina
lcos
tofc
api
tali
ndi
cat
es
(a)t
hosepro
ject
sthatafirmshouldselect .
(b)t
hosepro
ject
sthatwillre
sul
tint h
ehi ghes
tcas
hflows.
(c)whic
hproje
ctsar
ea ccept
ablegiventhefirm’scos
tofcapi
tal
.
(d)whic
hcombinati
onofpr oj
ectswillfitwithi
nthefir
m’sca
pit
albu
dget.
Ans
wer
:C
Leve
lofDi
ffic
ult
y:3
Lear
nin
gGoa l
:6
Topi
c:WMCCa ndI
OS

81. Inordert
ore cognizetheinterr
e la
ti
ons hi
pbe t
we enfina
nci
nga
ndi
nve
stme
nts
,th
efir
mshou
ldus
e
_________whe neva l
uati
nga ni nv
e stme nt
.
(a)thelea
stc ostl
ys ourceoffinanc i
ng
(b)themos tcostl
ys ourceoffinanc i
n g
(c)theweighteda veragecosto fallfinanci
ngs ourc
e s
(d)thecurr
e ntoppor t
unitycost
Ans
wer
:C
Leve
lofDi
ffic
ult
y:3
Lear
nin
gGoa l
:6
Topi
c:WMCCa ndI
OS

82. Apr
ojec
t’
sr ateofret
urns
houldbe_________t
hant
hewei
ght
edma r
ginalcos
toffina
nci
ng.
The
c
umula
ti
vea ccepta
nceofpro
ject
s_________th
ewei
ght
edmargi
nalcostofca
pit
al
.
(
a)le
ss;increas
es
(
b)le
ss;decreases
(
c)gre
ater;incr
eases
(
d)gre
ater;decrea
ses
Ans
wer
:C
Leve
lofDi
ffic
ult
y:3
Lear
nin
gGoa l
:6
Topi
c:WMCCa ndI
OS

83. Acc
ordingtotheinves
tmentoppor
tunit
ysc
hedul
e(IOS),
asthec
umu
lat
iv
eamountofmone
y
i
nves
tedinapr oj
ecti
ncre
ases,t
heretur
nonthepr
ojec
tswil
l
(
a)de cr
ease.
(
b)increas
e.
(
c)rema i
nunc hange
d.
(
d)no tbeafactor
.
Ans
wer
:A
Leve
lofDi
ffic
ult
y:3
Lear
nin
gGoa l
:6
Topi
c:WMCCa ndI
OS

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 lOMoARcPSD|3720244

Cha
pte
r11 TheCos
tofCa
pit
al 474
84. Thewea
lth-maxi
mi zi
ngin v
estmentdecisi
onforafirmoccurswhen
(a)t
hecostofcapit
alequalst
her e
turnont heproj
ect.
(b)t
hewe i
ghte
dma rginalcostofcap
italisle
ssthantheinve
stmentopport
uni
tyschedu
le.
(c)t
hewe i
ghte
dc ostofcapit
alexcee
d sthema r
ginalcos
tofcapi
tal.
(d)t
hewe i
ghte
dma rginalcostofcap
italequal
stheinvest
mentopportuni
tysc
hedule
.
Ans
wer
:D
Leve
lofDi
ffic
ult
y:3
Lear
nin
gGoa l
:6
Topi
c:WMCCa ndI
OS

85. Inuti
li
zingtheinves
tme ntopport
unit
yschedul
eandtheweighte
dma rginalcos
tofc api
tal
,acapit
al
proj
ectwil
lbe
(a)accept
ab l
easlonga sthema r
ginalr
etur
nequal
sorexceedstheave ragecos
to fcapi
talove
rall
leve
lsofne e
dedf unding
.
(b)unacceptab
leifthema rgi
nalret
urnequal
sthewei
ghte
dma r
g ina
lc ostofcapi
tal.
(c)unacceptabl
eifthema rgi
nalret
urnequal
sorexce
edsthewe ight
edma rgi
nalcostofcapi
tal
.
(d)accept
ab l
easlonga sthema r
ginalr
etur
nequal
sorexceedsthewe ightedma r
ginalcosto
f
capit
al.
Ans
wer
:D
Leve
lofDi
ffic
ult
y:4
Lear
nin
gGoa l
:6
Topi
c:WMCCa ndI
OS

86. Thecos
tuti
li
zedinmakin
gc ap
italbudg e
tingdecisi
onsgi
v e
na ninvestmentoppor
tuni
tys
che
dul
eis
(a)t
hewe i
ghte
davera
gecostofallneededfina
nc i
ngforfundi
ng .
(b)t
hesimpleave
rag
eofthecostofthel as
tincrement
alamoun toffinanci
ng.
(c)t
hewe i
ghte
davera
gecostofthelastincr
eme nta
lamountoffinanc i
ng.
(d)t
hewe i
ghte
davera
gecostofallbondsissuedthatar
erelat
edtothec api
talbud
g e
t.
Ans
wer
:C
Leve
lofDi
ffic
ult
y:4
Lear
nin
gGoa l
:6
Topi
c:WMCCa ndI
OS

87. Ani
nvest
men topportuni
ty/
c ostsche
du l
e
(
a)ra
nksc a
pi t
alpro
je c
tsbyn etpresentval
ue,fr
omhi ghes
ttolowest,a
ndt h e
nc ompa r
esthe
dis
countratetothema rginalcos
tofc api
tal
.
(
b)ra
nksc a
pi t
alpro
je c
tsbyi nter
nalrateofr
eturnfromthehighes
tt ol
owe standma rgin
alcostf
rom
lo
we s
ttohighest
, andthe ncompar e
sthema rgi
nalret
urnt
ot hema r
gina lcos
t.
(
c)ra
nksc a
pi t
alpro
je c
tsbyi nter
nalrateofr
eturnfromlowesttohighe
sta ndma rgi
nalcostfr
om
hi
ghesttolowest
, andthe ncompar e
sthema rgi
nalret
urnt
ot hema r
gina lcos
t.
(
d)ra
nksc a
pi t
alpro
je c
tsbyn etpresentval
ue,andthencompa r
esthema rginalr
e t
urntothecost
.
Ans
wer
:B
Leve
lofDi
ffic
ult
y:4
Lear
nin
gGoa l
:6
Topi
c:WMCCa ndI
OS

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 lOMoARcPSD|3720244

Cha
pte
r11 TheCos
tofCa
pit
al 475
88. Afir
m’scur
renti
nve
stme
ntoppor
tuni
tys
che
dul
eandt
hewe
ight
edma
rgi
nalc
ostofc
api
tals
che
dul
e
a
reshownbel
o w.

I
nves
tment I
nit
ial
Opport
uni
tySchedul
e I
RR I
nvest
ment
A 15% 200,
000
B 12 300,
000
C 19 100,
000
D 10 400,
000
E 16 300,
000

We ight edMarginalCos
tofCapit
al
RangeofTota lNe wFinancing WMCC
$0–$250 ,000 7.
5%
250,
001–500 ,000 8.
9
500,
001–1,
000, 000 10.
0
1,
000,
001–1,500, 000 12.
0

Thei
nvest
mentopport
uni
ti
eswhi
chs
hou
ldb
ese
lec
teda
re
(a)A,B,C, andD.
(b)A,B,C, andE.
(c)A,B,D,a ndE.
(d)B,C,D,a ndE.
Ans
wer
:B
Leve
lofDi
ffic
ult
y:4
Lear
nin
gGoa l
:6
Topi
c:WMCCa ndI
OS(
Equ
ati
on11.
9andEq
uat
ion11.
10)

89. NicoTr adi

ngCorporati
onisconsi
der
ingiss
uinglon
g -t
e r
mde bt
.Thed e
btwou l
dha v
ea30y e
ar
ma t
urityanda10pe r
centcouponrat
e.Inorde
rtoselltheis
sue,th
ebondsmus tbeunderpri
cedata
dis
countof5pe r
ce n
toffacevalu
e.Inaddit
ion,t
hefirm wouldhavet
op ayflo
t at
ioncost
sof5
perce
n toffac
evalue.Thefir
m’staxrat
eis35perce
nt .Give
nt h
isinf
ormati
on ,theaft
ertaxcostof
debtforNicoTra
d in
gwou l
dbe
(a)7.26%.
(b)11 .17%.
(c)10 .00%.
(d)noneoft hea
bo ve
Ans
wer
:A
Leve
lofDiffic
ult
y:3
Lear
nin
gGoa l
:2
Topi
c:Cos
tofLon g-
Ter
mDe
bt(
Equa
ti
on11.
1andEq
uat
ion11.
2)

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 lOMoARcPSD|3720244

Cha
pte
r11 TheCos
tofCa
pit
al 476
90. TangshanMi ningisconsi
deri
ngissui
ngl ong-
termd ebt
.Thedebtwouldhavea30y earmaturi
tyand
a12p ercentc
ouponr ateandma kesemiannualcouponpayment
s.Inordertosellt
heiss
ue,thebonds
mustbeunde rpri
c e
da tadis
countof2.5p er
centoffaceval
ue.I
na ddi
ti
on,thefirmwouldha v
eto
payflot
ationcostsof2.5per
centoffacev a
lue.Thefirm’
staxra
teis33pe r
cent
. Give
nthis
inf
ormation,t
h eaft
ertaxcostofdebtforNicoTradingwouldbe
(a)6 .
38%.
(b)12 .
76%.
(c)4 .
98%.
(d)8 .
55%.
Ans
wer
:D
Leve
lofDiffic
ult
y:4
Lear
nin
gGoa l
:2
Topi
c:Cos
tofLon g-
Ter
mDe
bt(
Equa
ti
on11.
1andEq
uat
ion11.
2)

91. Tangs
ha nMin
ingiscons
ideri
ngissui
ngpre
fer
redst
ock.Thepref
err
edst
ockwoul
dhaveaparval
ue
of$75,anda5.50pe
rcentdi
vidend.Whati
sthecos
to fpr
efe
rre
ds t
ockf
orTan
gsha
nifflo
tat
ionc
ost
s
wouldamountto5.
5pe r
centofparval
ue?
(a)5.50%.
(b)5.27%.
(c)7.73%.
(d)5.82%.
Ans
wer
:D
Leve
lofDiffic
ult
y:3
Lear
nin
gGoa l
:2
Topi
c:Cos
tofPr ef
err
edSt
ock(
Equ
ati
on11.
3)

92. Wha twouldbethecostofne

wc ommons t
ockequit
yforTa
ngs
hanMini
ngi
fthefir
mjustp
aida
divi
dendof$4.25,t
hes t
ockpri
ceis$55.
00,di
vid
endsaree
xpe
cte
dtogr
owat8.5perc
ent
inde
fini
tel
y,a
ndflotat
ioncos
tsare$6.
25persha
re?
(a)17 .
96%.
(b)16 .
88%.
(c)9 .
46%.
(d)noneofthea bo
ve
Answe r
:A
Leve
lofDiffic
ult
y:3
Lear
nin
gGoa l
:3
Topi
c:Cos
tofNe wCommonSt
ockEq
uit
y(Eq
uat
ion11
.8a
ndEq
uat
ion11.
8a)

93. Whatwouldbet
hecostofre
tai
nedearn
ing
se q
uit
yforTa
ngs
hanMini
ngiftheexpe
cte
dr et
urnon
U.
S.Trea
suryBi
llsi
s5.00perc
ent
,themarke
tris
kpremi
umis10
.00per
cent,a
ndthefir
m’sbetai
s
1.
3?
(
a)11.5%
(
b)18.0%
(
c)10.0%
(
d)noneoftheabov
e
Answe
r:B
Leve
lofDiffic
ult
y:3
Lear
nin
gGoa l
:3
Topi
c:Cos
tofRe tai
nedEa
rni
ngs(
Equa
ti
on11.
6)

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 lOMoARcPSD|3720244

Cha
pte
r11 TheCos
tofCa
pit
al 477

 EssayQuest
ions
1. Afir
m ha
sdete
rmine
di t
sop t
imalc
api
tals
truc
tur
e,whi
chi
scompos
edoft
hef
oll
owi
ngs
our
cesa
nd
t
arge
tmarke
tval
ueproport
ions:

Tar
getMarket
Sourc
eo fCapi
tal Pr
oporti
ons
Long-
ter
mde bt 30%
Pre
fer
redst
ock 5
Commons t
ockequi
ty 65

De bt:Thefirmc ansella20-y ear

,$1,000parvalue,9pe r
centbondf or$980 .Aflo ta
tionc ostof2
percentofthef acev a
luewou ldber equir
edinadditiont othediscountof$20.
Pre f
erredSt ock:Th efirmha sdet
ermineditcanissuepr efe
rredstocka t$65pe rshar
epa rv al
ue.
Thes tockwi l
lpa yan$8. 00a nnualdi
vidend.Thec osto fis
suinga ndselli
ngt hes t
ocki s$3pe rsha
re.
CommonSt oc k:Th efirm’sc ommons toc
kiscur r
entlys el
li
ngfor$40pe rsh are.Thedi vi
de nd
expectedtob epa i
da ttheendoft hec omingyearis$5. 07.It
sdividendp ayme ntsha vebe engrowing
atac onst
antr ateforthelastfiveyear
s.Fiveyea
rsa go,thedi vi
dendwa s$3.45 .Iti
sexp ectedthatt
o
sel
l,ane wc ommons tockissuemus tbeunde r
priceda t$1pe rshareandt hefir mmus tpa y$1pe r
shareinflot
a t
ionc ost
s .Additiona
ll
y,thefir
m’sma rgina lt
axrateis40pe r
cent .

Cal
cul
at
ethefir
m’swe
ight
eda
ver
agec
osto
fca
pit
ala
ssumi
ngt
hefir
mha
sexha
ust
eda
llr
eta
ine
d
ea
rni
ngs.
Ans
we: ki 5.
r 6%
kp 12.
9%
kn 21.
34%
ka (
0.3)
(5.
6) (
0.05)
(12.
9) (
0.65)
(21.
34) 16
.20%
Leve
lofDi
ffic
ult
y:3
Lear
nin
gGoa l
:4
Topi
c:Wei
ghtedMargi
nalCos
tofCa
pit
al(
Equ
ati
on11.
9)
2. Pr
omoPa
kha
scompi
ledt
hef
oll
owi
ngfina
nci
alda
ta:

Sourc
eo fCapi
tal BookValue MarketVal
ue Cost
Long-
ter
mde bt $10,
000
,000 $8,
500,
000 5.
0%
Pre
fer
redst
ock 1,
000
,000 1,
500,
000 14.
0
Commons t
ockequi
ty 9,
000
,000 15,
000,
000 20.
0
$20,
000
,000 $25,
000,
000

(
a)Ca
lcul
at
ethewe
ight
eda
ver
agec
ostofc
api
talus
ingbookval
uewe i
ght
s.
(
b)Ca
lcul
at
ethewe
ight
eda
ver
agec
ostofc
api
talus
ingmarke
tvaluewei
ghts
.

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 lOMoARcPSD|3720244

Cha
pte
r11 TheCos
tofCa
pit
al 478
Ans
wer
s:
(
a)
Long-
ter
mde bt 50%
Pre
fer
redst
ock 5
Commons t
ockequi
ty 45
100%

ka (0.
5)(
5) (
0.05)(
14) (0
.45)
(20
) 2
.5 0
.7 9 12.
2%
(
b)
Long-
ter
mde bt 34%
Pre
fer
redst
ock 6
Commons to
ckequity 60
100%
ka (
0.34)
(5) (
0.06)
(14) (
0.60)
(20
) 1
.7 0
.84 12 14.
5%
Leve
lofDi
ffic
ult
y:4
Lear
nin
gGoa l
:4
Topi
c:WACCUnde rAl
te
rna
ti
veWe
ight
ingSc
heme
s(Eq
uat
ion11.
9)
Nort
hSeaOilhasc
ompil
edthefol
lowi
ngdat
arel
at
iv
etocurr
entcos
tsofi
tsbas
icsour
ceso fe
xte
rna
l
ca
pit
al—lon
g-t
ermdebt
,pre
fer
redst
ock,a
ndcommonstoc
kequit
y—f orv
ari
antr
angesoffina
nci
ng.

Tabl
e11.
4
Sour
ceofCapit
al Cos t Ra ngeofTo talNe wFi nanci
ng
Long
-te
rm de
bt 7% $0–$2 ,000,000
8 $2,000,
001–$3 ,
000,000
10 $3,000,001a nda bove
Pref
err
edstoc
k 19% $0–$960, 000
21 $960,001a nda bove
Commons tock 20% $0–$700, 000
24 $700,001–$1 ,600,000
26 $1,600,
001–$2 ,200,000
30 $2,200,001a nda bove
Thefirmexpect
stohave$350,
000ofc urr
e ntret
a i
nede arni
n gsinthecomi
ngy earatacostof20per
cent
;
oncethes
ereta
inedear
ningsar
ee xhaus
ted,thefirm wi l
liss
uene wcommons t
ock.Thec ompany’
sta
rget
cap
italst
ruc
tur
eproport
ionsareusedincalculat
ingthewe i
ghteda ve
ragec
ostofcapit
alfoll
ow.

Sourc
eofCapital Tar
getCapi
talSt
ruc
tur
e
Long-
ter
m debt 0.
25
Pre
fer
redst
ock 0.
25
Commons t
ockequi
ty 0.
50

3. Calc
ula
tethefir
m’scos
tofcap
ita
lpriort
oexha
usti
ngthefir
m’sa
vai
la
blec
urr
entr
eta
ine
dea
rni
ngs
.
(Se
eTable11.
4 .
)
Answer:ka (7)(
0.25
) (
19)(
0.25) (
20)
(0.
50) 16.
5%.
Leve
lofDi
ffic
ult
y:4
Lear
nin
gGoa l
:6
Topi
c:WMCCa ndBre
aki
ngPoi
nts(
Equ
ati
on11.
9andEq
uat
ion11.
10)

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 lOMoARcPSD|3720244

Cha
pte
r11 TheCos
tofCa
pit
al 479
4. Ca
lcul
at
ethefir
m’sc
osto
fca
pit
alf
or$2
,000,
000oft
ota
lne
wfina
nci
ng.
(Se
eTa
ble11
.4.
)
Ans
we:ka (
r 7)(
0.25
) (
21)
(0.
25) (
26)
(0.
50) 20
%.
Leve
lofDi
ffic
ult
y:4
Lear
nin
gGoa l
:6
Topi
c:WMCCa ndBre
aki
ngPoi
nts(
Equ
ati
on11.
9andEq
uat
ion11.
10)
5. Gi
venthefol
lowi
nginf
ormat
iononth
eavai
la
blei
nve
stme
ntoppor
tun
iti
esbe
low,
det
ermi
newhi
ch
pr
oje
ctsshou
ldbese
lect
ed.(
SeeTabl
e11.
4.
)

Inve
stment I
nit
ial Int
ernalRat
e
Opport
unit
y I
nvest
ment ofRe t
urn
A 400,
000 22%
B 500,
000 21
C 400,
000 19
D 400,
000 17
E 600,
000 16
F 700,
000 16

Ans
we:Pr
r oje
ctsA,
B,a
ndC.
Leve
lofDi
ffic
ult
y:4
Lear
nin
gGoa l
:6
Topi
c:WMCCa ndI
OS

6. Ac
orpor
ati
oni
scons
ide
rin
gac
api
talpr
oje
ctf
ort
hec
omi
ngy
ear
.
The project has an internal rate of return of 14 percent. If the firm has the following target capital
structure and costs, what should their decision be and why?

Sourc
eo fCapi
tal Pr
oport
ion Af
ter
-TaxCos
t
Long-
ter
mde bt 0.
40 10%
Pre
fer
redst
ock 0.
10 15%
Commons t
ockequi
ty 0.
50 20%
Ans
wer
s:ka (
0.40)
(10%) (
0.10)
(15
%) (
0.50)
(20%) 15.
5%
Theyshoul
dre
jec
tthi
spr
oje
ct,be
caus
ethewe
ight
eda
ver
agec
ostofc
api
tali
s15.
5pe
rce
nta
ndt
hei
nte
rna
l
ra
teofret
urni
s14per
cen
t.
Leve
lofDi
ffic
ult
y:4
Lear
nin
gGoa l
:6
Topi
c:WMCCa ndI
OS(
Equ
ati
on11.
9)

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