International Financial Management, 8e (Eun)
Chapter 17 International Capital Structure and the Cost of Capital
1) The cost of capital is
A) the minimum rate of return an investment project must generate in order to pay its financing
costs.
B) the minimum rate of return an investment project must generate in order to pay its financing
costs plus a reasonable profit.
C) the maximum rate of return an investment project must generate in order to pay its financing
costs.
D) the maximum rate of return an investment project must generate in order to pay its financing
costs plus a reasonable profit.
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3) In the notation of the book, K = (1 − λ)Kl + λ(1 − τ)i
Which of these is correct?
A) The debt-to–equity ratio is λ
B) The tax rate is τ
C) The after-tax cost of debt capital is i
D) all of the options
Answer: B
Topic: Cost of Capital
4) In the notation of the book, K = (1 − λ)Kl + λ(1 − τ)i ; which of the following is correct?
A) The debt-to–total market value ratio is λ
B) The tax rate is i
C) The after-tax cost of debt capital is i
D) all of the options
Answer: A
Topic: Cost of Capital
5) In the notation of the book, K = (1 − λ)Kl + λ(1 − τ)i ; which of the following is correct?
A) The debt-to–equity ratio is λ
B) The cost of equity capital for a levered firm is K
C) The pre-tax cost of debt capital is i
D) all of the options
Answer: C
Topic: Cost of Capital
6) In the notation of the book, K = (1 − λ)Kl + λ(1 − τ)i ; which of the following is correct?
A) The debt-to–equity ratio is λ
B) The cost of equity capital for a levered firm is Kl
C) The after-tax cost of debt capital is i
D) all of the options
Answer: B
Topic: Cost of Capital
7) In the notation of the book, K = (1 − λ)Kl + λ(1 − τ)i ; which of the following is correct?
A) The weighted average cost of capital for a levered firm is K
B) The tax rate is τ
C) The after-tax cost of debt capital is i
D) all of the options
Answer: A
Topic: Cost of Capital
8) At the optimal capital structure,
A) K = (1 − λ)Kl + λ(1 − τ)i will be minimized.
B) The debt-equity ratio will be equal to the debt-to-value ratio.
C) K = (1 − λ)Kl + λ(1 − τ)i will be maximized.
D) none of the options
Answer: A
Topic: Cost of Capital
9) Solve for the weighted average cost of capital.
10.60
%
=
K1
=
cost of equity capital for a leveraged firm
1/3
=
λ
=
debt-to-total-market-value ratio
8.0
%
=
i
=
before-tax borrowing cost
40.0
%
=
τ
=
marginal corporate income tax rate
A) 8.67 percent
B) 8.00 percent
C) 7.60 percent
D) 7.33 percent
11.20
%
=
K1
=
cost of equity capital for a leveraged firm
1/2
=
λ
=
debt-to-total-market-value ratio
8.0
%
=
i
=
before-tax borrowing cost
40.0
%
=
τ
=
marginal corporate income tax rate
11) Solve for the weighted average cost of capital.
11.80
%
=
K1
=
cost of equity capital for a leveraged firm
3/5
=
λ
=
debt-to-total-market-value ratio
8.0
%
=
i
=
before-tax borrowing cost
40.0
%
=
τ
=
marginal corporate income tax rate
A) 8.67 percent
B) 8.00 percent
C) 7.60 percent
D) 7.33 percent
12.40
%
=
K1
=
cost of equity capital for a leveraged firm
2/3
=
λ
=
debt-to-total-market-value ratio
8.0
%
=
i
=
before-tax borrowing cost
40.0
%
=
τ
=
marginal corporate income tax rate
13.00
%
=
K1
=
cost of equity capital for a leveraged firm
5/7
=
λ
=
debt-to-total-market-value ratio
8.0
%
=
i
=
before-tax borrowing cost
40.0
%
=
τ
=
marginal corporate income tax rate
14) Solve for the weighted average cost of capital.
13.60
%
=
K1
=
cost of equity capital for a leveraged firm
3/4
=
λ
=
debt-to-total-market-value ratio
8.0
%
=
i
=
before-tax borrowing cost
40.0
%
=
τ
=
marginal corporate income tax rate
A) 7.00 percent
B) 6.89 percent
C) 6.73 percent
D) 6.67 percent
14.20
%
=
K1
=
cost of equity capital for a leveraged firm
7/9
=
λ
=
debt-to-total-market-value ratio
8.0
%
=
i
=
before-tax borrowing cost
40.0
%
=
τ
=
marginal corporate income tax rate
15.40
%
=
K1
=
cost of equity capital for a leveraged firm
9/11
=
λ
=
debt-to-total-market-value ratio
8.0
%
=
i
=
before-tax borrowing cost
40.0
%
=
τ
=
marginal corporate income tax rate
17) Solve for the weighted average cost of capital.
16.00
%
=
K1
=
cost of equity capital for a leveraged firm
5/6
=
λ
=
debt-to-total-market-value ratio
8.0
%
=
i
=
before-tax borrowing cost
40.0
%
=
τ
=
marginal corporate income tax rate
A) 7.00 percent
B) 6.89 percent
C) 6.73 percent
D) 6.67 percent
17.20
%
=
K1
=
cost of equity capital for a leveraged firm
6/7
=
λ
=
debt-to-total-market-value ratio
8.0
%
=
i
=
before-tax borrowing cost
40.0
%
=
τ
=
marginal corporate income tax rate
%
%
%
20) Solve for the weighted average cost of capital.
11.20
%
=
K1
1/2
=
λ
8.0
%
=
i
40.0
%
=
τ
A) 8.67 percent
B) 8.00 percent
C) 7.60 percent
D) 7.33 percent
11.80
%
=
K1
3/5
=
λ
8.0
%
=
i
40.0
%
=
τ
12.40
%
=
K1
2/3
=
λ
8.0
%
=
i
40.0
%
=
τ
23) Solve for the weighted average cost of capital.
13.00
%
=
K1
5/7
=
λ
8.0
%
=
i
40.0
%
=
τ
A) 8.67 percent
B) 8.00 percent
C) 7.60 percent
D) 7.14 percent
13.60
%
=
K1
3/4
=
λ
8.0
%
=
i
40.0
%
=
τ
14.20
%
=
K1
7/9
=
λ
8.0
%
=
i
40.0
%
=
τ
26) Solve for the weighted average cost of capital.
15.40
%
=
K1
9/11
=
λ
8.0
%
=
i
40.0
%
=
τ
A) 7.00 percent
B) 6.89 percent
C) 6.73 percent
D) 6.67 percent
16.00
%
=
K1
5/6
=
λ
8.0
%
=
i
40.0
%
=
τ
17.20
%
=
K1
6/7
=
λ
8.0
%
=
i
40.0
%
=
τ
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29) Find the debt-to-value ratio for a firm with a debt-to-equity ratio of 1/2.
A) 1/3
B) 1/2
C) 3/5
D) 2/3
Answer: A
Explanation: DV = 1/(1 + 2) = 1/3
Topic: Cost of Capital
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30) Find the debt-to-value ratio for a firm with a debt-to-equity ratio of 1.
A) 1/3
B) 1/2
C) 3/5
D) 2/3
Answer: B
Explanation: DV = 1/(1 + 1) = 1/2
Topic: Cost of Capital
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31) Find the debt-to-value ratio for a firm with a debt-to-equity ratio of 1½.
A) 1/3
B) 1/2
C) 3/5
D) 2/3
Answer: C
Explanation: DV = 3/(3 + 2) = 3/5
Topic: Cost of Capital
32) Find the debt-to-value ratio for a firm with a debt-to-equity ratio of 2.
A) 1/3
B) 1/2
C) 3/5
D) 2/3
Answer: D
Explanation: DV = 2/(2 + 1) = 2/3
Topic: Cost of Capital
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33) Find the debt-to-value ratio for a firm with a debt-to-equity ratio of 2½.
A) 1/3
B) 1/2
C) 3/5
D) 5/7
Answer: D
Explanation: DV = 5/(5 + 2) = 5/7
Topic: Cost of Capital
34) Find the debt-to-value ratio for a firm with a debt-to-equity ratio of 2½.
A) 1/3
B) 1/2
C) 3/5
D) 5/7
Answer: D
Explanation: DV = 5/(5 + 2) = 5/7
Topic: Cost of Capital
35) Find the debt-to-value ratio for a firm with a debt-to-equity ratio of 3.
A) 3/4
B) 7/9
C) 4/5
D) 9/11
Answer: A
Explanation: DV = 3/(3 + 1) = 3/4
Topic: Cost of Capital
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36) Find the debt-to-value ratio for a firm with a debt-to-equity ratio of 3½.
A) 3/4
B) 7/9
C) 4/5
D) 9/11
Answer: B
Explanation: 7/(7 + 2) = 7/9
Topic: Cost of Capital
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37) Find the debt-to-value ratio for a firm with a debt-to-equity ratio of 4.
A) 3/4
B) 7/9
C) 4/5
D) 9/11
Answer: C
Explanation: DV = 4/(4 + 1) = 4/5
Topic: Cost of Capital
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38) Find the debt-to-value ratio for a firm with a debt-to-equity ratio of 4½.
A) 3/4
B) 7/9
C) 4/5
D) 9/11
Answer: D
Explanation: 9/(9 + 2) = 9/11
Topic: Cost of Capital
39) Find the debt-to-value ratio for a firm with a debt-to-equity ratio of 5.
A) 3/4
B) 7/9
C) 4/5
D) 5/6
Answer: D
Explanation: DV = 5/(5 + 1) = 5/6
Topic: Cost of Capital
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40) Find the debt-to-equity ratio for a firm with a debt-to-total-value ratio of 1/2.
A) 1
B) 2
C) 3
D) 4
Answer: A
Explanation: Solve for equity = 1/(1 + X) = 1/2; X = 1; Thus debt-to-equity = 1/1 = 1
Topic: Cost of Capital
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41) Find the debt-to-equity ratio for a firm with a debt-to-total-value ratio of 2/3.
A) 1
B) 2
C) 3
D) 4
Answer: B
Explanation: Solve for equity = 2/(2 + X) = 2/3; X = 1; Thus debt-to-equity = 2/1 = 2
Topic: Cost of Capital
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42) Find the debt-to-equity ratio for a firm with a debt-to-total-value ratio of 3/4
A) 1
B) 2
C) 3
D) 4
Answer: C
Explanation: Solve for equity = 3/(3 + X) = 3/4; X = 1; Thus debt-to-equity = 3/1 = 3
Topic: Cost of Capital
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43) Find the debt-to-equity ratio for a firm with a debt-to-total-value ratio of 4/5.
A) 1
B) 2
C) 3
D) 4
Answer: D
Explanation: Solve for equity = 4/(4 + X) = 4/5; X = 1; Thus debt-to-equity = 4/1 = 4
Topic: Cost of Capital
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44) Find the debt-to-equity ratio for a firm with a debt-to-total-value ratio of 5/6.
A) 2
B) 3
C) 4
D) 5
Answer: D
Explanation: Solve for equity = 5/(5 + X) = 5/6; X = 1; Thus debt-to-equity = 5/1 = 5
Topic: Cost of Capital
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45) Corporations are becoming multinational not only in the scope of their business activities but
also in their capital structure(.)
A) by raising funds from domestic as well as government sources.
B) by raising funds from foreign as well as domestic sources.
C) This trend reflects not only a conscious effort on the part of firms to raise the cost of capital by
international sourcing of funds but also the ongoing liberalization and deregulation of international
financial markets that make them accessible for many firms.
D) by raising funds from foreign as well as domestic sources. This trend reflects not only a
conscious effort on the part of firms to raise the cost of capital by international sourcing of funds,
but also the ongoing liberalization and deregulation of international financial markets that make
them accessible for many firms.
Answer: B
Topic: Cost of Capital
46) Find the weighted average cost of capital for a firm that has a debt-to-equity ratio of 1½, a tax
rate of 34 percent, a levered cost of equity of 12 percent and an after-tax cost of debt of 8 percent.
A) 9.6 percent
B) 7.968 percent
C) 14 percent
D) none of the options
Answer: A
Explanation: If DE = 3/2, then DV = 3/(3 + 2) = 3/5; 0.0960 = 9.6% = (1 − (3/5)) (0.12) + (3/5)
(0.08)
Topic: Cost of Capital
47) Find the weighted average cost of capital for a firm that has a debt-to-equity ratio of 1½, a tax
rate of 34 percent, a levered cost of equity of 12 percent and a pre-tax cost of debt of 10 percent.
A) 9.6 percent
B) 7.968 percent
C) 8.76 percent
D) none of the options
Answer: C
Explanation: If DE = 3/2, then DV = 3/(3 + 2) = 3/5; 0.0876 = 8.76% = (1 − (3/5)) (0.12) + (3/5)
(1 − 0.34) (0.08)
Topic: Cost of Capital
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48) Find the weighted average cost of capital for a firm that has a debt-to-equity ratio of 2, a tax
rate of 40 percent, a levered cost of equity of 12 percent and an after-tax cost of debt of 9 percent.
A) 7.6 percent
B) 7.968 percent
C) 10 percent
D) none of the options
Answer: C
Explanation: If DE = 2/1, then DV = 2/(2 + 1) = 2/3; 0.1000 = 10% = (1 − (2/3)) (0.12) + (2/3)
(0.09)
Topic: Cost of Capital
49) Find the weighted average cost of capital for a firm that has a debt-to-equity ratio of 2, a tax
rate of 40 percent, a levered cost of equity of 12 percent and a pre-tax cost of debt of 9 percent.
A) 7.6 percent
B) 7.968 percent
C) 10 percent
D) none of the options
Answer: A
Explanation: If DE = 2/1, then DV = 2/(2 + 1) = 2/3; 0.0760 = 7.6% = (1 − (2/3)) (0.12) + (2/3) (1
− 0.40) (0.09)
Topic: Cost of Capital
50) The cost of equity capital is
A) the expected return on the firm’s stock that investors require.
B) frequently estimated by using the Capital Asset Pricing Model (CAPM).
C) generally considered to be a linear function of the systematic risk inherent in the security.
D) all of the options
Answer: D
Topic: Cost of Capital
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51) A reduced cost of equity capital increases the firm’s value
A) through revaluation of the firm’s existing cash flows from existing projects.
B) through increased investment as more projects become positive NPVs.
C) both of the options
D) none of the options
Answer: C
Topic: Cost of Capital
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52) A value-maximizing firm would
A) undertake an investment project as long as the IRR exceeds the NPV.
B) undertake an investment project as long as the IRR is less than the cost of capital.
C) undertake an investment project as long as the IRR exceeds the cost of capital.
D) none of the options
Answer: C
Topic: Cost of Capital
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53) Using the notation of the text, the CAPM states
A) = + ( – )(1 – τ)
B) = λ + ( – )(1 – λ)
C) = + ( – )
D) none of the options
Answer: C
Topic: Cost of Capital
54) The common stock of Kansas City Power and Light has a beta of 0.80. The Treasury bill rate is
4 percent and the market risk premium is 8 percent. What is their cost of equity capital?
A) 12.0 percent
B) 10.4 percent
C) 7.20 percent
D) 6.4 percent
Answer: B
Explanation: 10.4% = 4% + 0.80 × 8%.
Topic: Cost of Capital
55) The market risk premium
A) can be defined by the difference between the expected market return and the risk-free rate.
B) is the reward for bearing nondiversifiable risk.
C) is the slope of the security market line.
D) can be expressed as ( – )
Answer: A
Topic: Cost of Capital