Understanding Cost of Capital and WACC

chapter 14 Question WACC is used to discount Blank______. The return an investor in a security receives is equal to the cost of the security to the company that issued it. True false question. True The cost of capital is an appropriate name since a project must earn enough to pay those who ______ the capital. The cost of capital depends primarily on the (use/source) of funds. A firm's overall cost of capital will include both its cost of capital and equity capital. What does WACC stand for? Finding a firm's overall cost of equity is difficult because _____. The return an investor in a security receives is ______ the cost of the security to the company that issued it. In addition to CAPM, the cost of equity can be determined using the dividend growth model and the _____ approach. A project should only be accepted if its return is above what is ___. To apply the dividend growth model to a particular stock, you need to assume that the firm's ___ will grow at a constant rate. The cost of capital depends on the _____ of funds, not the _____ of funds. The growth rate of dividends can be found using _____. Which of the following are components used in the construction of the WACC? The underlying key assumption, and oftentimes a key disadvantage, of the dividend growth model is that it assumes the dividend _____. Finding a firm's overall cost of equity is (straightforward/difficult). The cost of can be observed because it is the interest rate the firm must pay on new loans. One method for estimating the cost of equity is based on the ______ model. Preferred stock __ The formula for calculating the cost of equity capital that is based on the dividend discount model is: Select all that apply To estimate the growth rate of a particular stock, we can ___. The most appropriate weights to use in the WACC are the ______ weights. Which of the following methods for calculating the cost of equity ignores risk? Which of the following is true? Select all that apply A firm's cost of debt can be ___. Which of the following are tax-deductible to the firm? Select all that apply What can we say about the dividends paid to common and preferred stockholders? The WACC is the weighted average of the cost of equity and the _____. To apply the dividend growth model to a particular stock, you need to assume that the firm's ___ will grow at a constant rate. Answer Cash Flow true supply use debt Weighted average cost of capital there is no way of directly observing the return that the firm's equity investors require on their investment equal to SML required by investors dividend use; source security analysts' forecasts historical dividend growth rates Cost of common stock Cost of debt Cost of preferred stock grows at a constant rate difficult debt dividend growth pays a constant dividend pays dividends in perpetuity RE = D1/P0 + g use the historical dividend growth rate. use security analysts' forecasts market value The dividend growth model A company can deduct interest paid on debt when computing taxable income. obtained by checking yields on publicly traded bonds estimated easier than its cost of equity obtained by talking to investment bankers Coupon interest paid on bonds Dividends to common stockholders are not fixed. Dividends to preferred stockholders are fixed. aftertax cost of debt dividend MNO preferred stock pays a dividend of $2 per year and has a price of $20. If MNO's tax rate is 21 percent, the required rate of return on its preferred stock is found by which formula? Capital weights can be interpreted just like portfolio weights. The market value cost of debt is often Blank______ the book value cost of debt. Which one of the following is true? Dividends paid to common stockholders ______ be deducted from the payer's taxable income for tax purposes. Projects that have the same risk are said to be in the same _____. B = the market value of a firm's debt S = the market value of that same firm's equity RB = the before-tax yield on the firm's debt TC = the corporate tax rate RS = the cost of equity Given the definitions above, the weighted average cost of capital f Including preferred stock in the WACC adds the term: Economic value added (EVA) is a means of evaluating corporate performance. Which of the following are true? The issuance costs of bonds and stocks are referred to as ______ costs. Which is true of flotation costs in calculating WACC? WACC was used to compute the following project NPVs: Project A = $100, Project B = -$50, Project C = -$10, Project D = $40. Which projects should the firm accept? The most well-known approach to company performance evaluation is the _____ method. In reality, most firms cover the equity portion of their capital spending with ___. Flotation costs are costs incurred to ____. The best way to include flotation costs is to ___. An important advantage to a firm raising equity internally is not having to pay ___. $2/$20 structure similar to Under U.S. tax law, a corporation's interest payments are deductible for tax purposes. cannot risk class [S/(S + B)] × RS + [B/(S + B)] × RB × (1 − Tc) (P/V) × RP True Ideally, we should use market values in the WACC. Book values are often similar to market values for debt. flotation They are relevant cash flows. A and D economic value added internally generated cash flow bring new security issues to the market add them to the initial investment