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Principles of Finance, 6e
Besley/Brigham
Chapter 12
Cengage Learning Testing, Powered by Cognero
Page 36
© 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license
a.
True
b.
False
ANSWER:
True
POINTS:
1
DIFFICULTY:
Easy
ACCREDITING STANDARDS:
Blooms Taxonomy-5 - Knowledge
Business Program-6 - Reflective Thinking
DISC-FIN-03 - Capital Budgeting and Cost of Capital
Time Estimate-a - 5 min.
TOPICS:
Balance Sheet and Capital
72. The component costs of capital are market-determined variables in as much as they are based on investors' required
returns.
a.
True
b.
False
ANSWER:
True
POINTS:
1
DIFFICULTY:
Easy
ACCREDITING STANDARDS:
Blooms Taxonomy-5 - Knowledge
Business Program-6 - Reflective Thinking
DISC-FIN-03 - Capital Budgeting and Cost of Capital
Time Estimate-a - 5 min.
TOPICS:
Component Cost of Capital
73. The before-tax cost of debt, which is lower than the after-tax cost, is used as the component cost of debt for purposes
of developing the firm's WACC.
a.
True
b.
False
ANSWER:
False
POINTS:
1
DIFFICULTY:
Easy
ACCREDITING STANDARDS:
Blooms Taxonomy-5 - Knowledge
Business Program-6 - Reflective Thinking
DISC-FIN-03 - Capital Budgeting and Cost of Capital
Time Estimate-a - 5 min.
TOPICS:
Cost of Debt
74. The cost of debt is equal to one minus the marginal tax rate multiplied by the coupon rate on outstanding debt.
a.
True
b.
False
ANSWER:
False
POINTS:
1
DIFFICULTY:
Easy
Principles of Finance, 6e
Besley/Brigham
Chapter 12
Cengage Learning Testing, Powered by Cognero
Page 38
78. The cost of equity raised by retaining earnings can be less than, equal to, or greater than the cost of equity raised by
selling new issues of common stock, depending on tax rates, flotation costs, the attitude of investors, and other factors.
a.
True
b.
False
ANSWER:
False
POINTS:
1
DIFFICULTY:
Easy
ACCREDITING STANDARDS:
Blooms Taxonomy-5 - Knowledge
Business Program-6 - Reflective Thinking
DISC-FIN-03 - Capital Budgeting and Cost of Capital
Time Estimate-a - 5 min.
TOPICS:
Cost of Equity
79. The higher the firm's flotation cost for new common equity, the more likely the firm is to use preferred stock that has
no flotation cost and retained earnings whose cost is the average return on assets.
a.
True
b.
False
ANSWER:
False
POINTS:
1
DIFFICULTY:
Easy
ACCREDITING STANDARDS:
Blooms Taxonomy-5 - Knowledge
Business Program-6 - Reflective Thinking
DISC-FIN-03 - Capital Budgeting and Cost of Capital
Time Estimate-a - 5 min.
TOPICS:
Flotation Cost and Capital Choice
80. The cost of equity capital from the sale of new common stock (re) is generally equal to the cost of equity capital from
retention of earnings (rs), divided by one minus the flotation cost as a percentage of sales price (1 − F).
a.
True
b.
False
ANSWER:
False
POINTS:
1
DIFFICULTY:
Easy
ACCREDITING STANDARDS:
Blooms Taxonomy-5 - Knowledge
Business Program-6 - Reflective Thinking
DISC-FIN-03 - Capital Budgeting and Cost of Capital
Time Estimate-a - 5 min.
TOPICS:
Cost of External Equity
81. In capital budgeting and cost of capital analyses, the firm should always consider retained earnings as the first source
of capital, because this is a free source of funding to the firm.
a.
True
b.
False
Principles of Finance, 6e
Besley/Brigham
Chapter 12
Cengage Learning Testing, Powered by Cognero
Page 39
© 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license
ANSWER:
False
POINTS:
1
DIFFICULTY:
Easy
ACCREDITING STANDARDS:
Blooms Taxonomy-5 - Knowledge
Business Program-6 - Reflective Thinking
DISC-FIN-03 - Capital Budgeting and Cost of Capital
Time Estimate-a - 5 min.
TOPICS:
Retained Earnings
82. Funds acquired by the firm through retaining earnings have no cost because there are no dividend or interest payments
associated with them, but capital raised by selling new stock or bonds does have a cost.
a.
True
b.
False
ANSWER:
False
POINTS:
1
DIFFICULTY:
Easy
ACCREDITING STANDARDS:
Blooms Taxonomy-5 - Knowledge
Business Program-6 - Reflective Thinking
DISC-FIN-03 - Capital Budgeting and Cost of Capital
Time Estimate-a - 5 min.
TOPICS:
Retained Earnings
83. The cost of capital should reflect the average cost of the various sources of long-term funds a firm uses to support its
assets.
a.
True
b.
False
ANSWER:
True
POINTS:
1
DIFFICULTY:
Easy
ACCREDITING STANDARDS:
Blooms Taxonomy-5 - Knowledge
Business Program-6 - Reflective Thinking
DISC-FIN-03 - Capital Budgeting and Cost of Capital
Time Estimate-a - 5 min.
TOPICS:
Cost of Capital
84. The weighted average cost of capital increases if the total funds required call for an amount of equity in excess of what
can be obtained as retained earnings.
a.
True
b.
False
ANSWER:
True
POINTS:
1
DIFFICULTY:
Easy
ACCREDITING STANDARDS:
Blooms Taxonomy-5 - Knowledge
Business Program-6 - Reflective Thinking
Principles of Finance, 6e
Besley/Brigham
Chapter 12
Cengage Learning Testing, Powered by Cognero
Page 41
© 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license
particular cost. For example, a firm may use up its 10 percent debt and can then issue more debt only if it offers a higher
rate to investors.
a.
True
b.
False
ANSWER:
True
POINTS:
1
DIFFICULTY:
Easy
ACCREDITING STANDARDS:
Blooms Taxonomy-5 - Knowledge
Business Program-6 - Reflective Thinking
DISC-FIN-03 - Capital Budgeting and Cost of Capital
Time Estimate-a - 5 min.
TOPICS:
Breaks in MCC Schedule
89. A breakpoint will occur in the MCC schedule whenever the cost of one of the capital components rises.
a.
True
b.
False
ANSWER:
True
POINTS:
1
DIFFICULTY:
Easy
ACCREDITING STANDARDS:
Blooms Taxonomy-5 - Knowledge
Business Program-6 - Reflective Thinking
DISC-FIN-03 - Capital Budgeting and Cost of Capital
Time Estimate-a - 5 min.
TOPICS:
Breaks in MCC Schedule
90. The correct discount rate for a firm to use in capital budgeting, assuming that new investments are of the same degree
of risk as the firm's existing assets, is its marginal cost of capital.
a.
True
b.
False
ANSWER:
True
POINTS:
1
DIFFICULTY:
Easy
ACCREDITING STANDARDS:
Blooms Taxonomy-5 - Knowledge
Business Program-6 - Reflective Thinking
DISC-FIN-03 - Capital Budgeting and Cost of Capital
Time Estimate-a - 5 min.
TOPICS:
Appropriate Discount Rate
91. The MCC schedule, as developed from the weighted average cost of capital, has a break point that occurs when
retained earnings are used up.
a.
True
b.
False
ANSWER:
True
POINTS:
1
Principles of Finance, 6e
Besley/Brigham
Chapter 12
Cengage Learning Testing, Powered by Cognero
Page 44
98. In general, it is not possible for re, the cost of new equity, to be lower than rs, the cost of retained earnings. However,
an exception to this rule occurs when the stock price increases just prior to the firm issuing new equity such that it more
than offsets the flotation costs and thus, re becomes less than rs.
a.
True
b.
False
ANSWER:
False
POINTS:
1
DIFFICULTY:
Moderate
ACCREDITING STANDARDS:
Blooms Taxonomy-5 - Knowledge
Business Program-6 - Reflective Thinking
DISC-FIN-03 - Capital Budgeting and Cost of Capital
Time Estimate-a - 5 min.
TOPICS:
Retained Earnings and New Equity
99. The cost of debt, rd, is always less than rs, so rd(1 − T) will certainly be less than rs. Therefore, since a firm cannot be
100% debt financed, the weighted average cost of capital will always be greater than rd(1 − T).
a.
True
b.
False
ANSWER:
True
POINTS:
1
DIFFICULTY:
Moderate
ACCREDITING STANDARDS:
Blooms Taxonomy-5 - Knowledge
Business Program-6 - Reflective Thinking
DISC-FIN-03 - Capital Budgeting and Cost of Capital
Time Estimate-a - 5 min.
TOPICS:
WACC
100. The lower the firm's tax rate, the lower will be the firm's after-tax cost of debt and WACC, other things held
constant.
a.
True
b.
False
ANSWER:
False
POINTS:
1
DIFFICULTY:
Moderate
ACCREDITING STANDARDS:
Blooms Taxonomy-5 - Knowledge
Business Program-6 - Reflective Thinking
DISC-FIN-03 - Capital Budgeting and Cost of Capital
Time Estimate-a - 5 min.
TOPICS:
WACC and Tax Rate
101. Assume that a firm's financial analysts determine that a decrease in the firm's debt-to-assets ratio will cause a
decrease in both the component cost of debt rd(1 − T) and the component cost of equity (rs). This information tells us that
Principles of Finance, 6e
Besley/Brigham
Chapter 12
Cengage Learning Testing, Powered by Cognero
Page 45
© 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license
the firm's present debt-to-assets ratio is above its optimal ratio.
a.
True
b.
False
ANSWER:
False
POINTS:
1
DIFFICULTY:
Moderate
ACCREDITING STANDARDS:
Blooms Taxonomy-5 - Knowledge
Business Program-6 - Reflective Thinking
DISC-FIN-03 - Capital Budgeting and Cost of Capital
Time Estimate-a - 5 min.
TOPICS:
Optimal Level of Debt
102. Firms should use their weighted average cost of capital (WACC) when they are funding their capital projects with a
variety of sources. However, when the firm plans on using only debt or only equity to fund a particular project, it should
use the after-tax cost of the specific source of capital to evaluate that project.
a.
True
b.
False
ANSWER:
False
POINTS:
1
DIFFICULTY:
Moderate
ACCREDITING STANDARDS:
Blooms Taxonomy-5 - Knowledge
Business Program-6 - Reflective Thinking
DISC-FIN-03 - Capital Budgeting and Cost of Capital
Time Estimate-a - 5 min.
TOPICS:
Specific Source of Capital
103. The firm's cost of capital represents the maximum rate of return earned on the firm's investments.
a.
True
b.
False
ANSWER:
False
POINTS:
1
DIFFICULTY:
Easy
ACCREDITING STANDARDS:
Blooms Taxonomy-5 - Knowledge
Business Program-6 - Reflective Thinking
DISC-FIN-03 - Capital Budgeting and Cost of Capital
Time Estimate-a - 5 min.
TOPICS:
Cost of Capital
104. The cost of capital used to evaluate investment opportunities should be calculated as a weighted average of the
various types of funds generally used, regardless of the specific financing used to fund a particular project.
a.
True
b.
False
ANSWER:
True
POINTS:
1
Principles of Finance, 6e
Besley/Brigham
Chapter 12
Cengage Learning Testing, Powered by Cognero
Page 48
© 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license
b.
False
ANSWER:
True
POINTS:
1
DIFFICULTY:
Easy
ACCREDITING STANDARDS:
Blooms Taxonomy-5 - Knowledge
Business Program-6 - Reflective Thinking
DISC-FIN-03 - Capital Budgeting and Cost of Capital
Time Estimate-a - 5 min.
TOPICS:
WACC
112. Flotation costs lower the cost of capital to a firm when issuing new securities.
a.
True
b.
False
ANSWER:
False
POINTS:
1
DIFFICULTY:
Easy
ACCREDITING STANDARDS:
Blooms Taxonomy-5 - Knowledge
Business Program-6 - Reflective Thinking
DISC-FIN-03 - Capital Budgeting and Cost of Capital
Time Estimate-a - 5 min.
TOPICS:
Flotation Costs
113. Retained earnings have no cost since the firm does not have to issue securities to raise retained earnings.
a.
True
b.
False
ANSWER:
False
POINTS:
1
DIFFICULTY:
Easy
ACCREDITING STANDARDS:
Blooms Taxonomy-5 - Knowledge
Business Program-6 - Reflective Thinking
DISC-FIN-03 - Capital Budgeting and Cost of Capital
Time Estimate-a - 5 min.
TOPICS:
Cost of Retained Earnings
114. Retained earnings costs are lower than the costs of newly issued equity since a new issue will have flotation costs.
a.
True
b.
False
ANSWER:
True
POINTS:
1
DIFFICULTY:
Easy
ACCREDITING STANDARDS:
Blooms Taxonomy-5 - Knowledge
Business Program-6 - Reflective Thinking
DISC-FIN-03 - Capital Budgeting and Cost of Capital
Time Estimate-a - 5 min.
