Fundamentals of Corporate Finance 3e Test Bank
Chapter 13: The Cost of Capital
1.
Systematic risk is the only risk that investors require compensation for
bearing.
A)
True
B)
False
Ans:
A
2.
Using a firm’s overall cost of capital to evaluate a project’s cash flows is problematic in that
the firm is a collection of projects, with the possibility that each project has a different level
of risk than the other projects currently working for the firm.
A)
True
B)
False
Ans:
3.
The finance balance sheet is based on market values, just like the
accounting balance sheet.
A)
True
B)
False
Ans:
B
Fundamentals of Corporate Finance 3e Test Bank
4.
If the market value of a firm’s assets is greater than the book value of its
assets then the book value of the firm’s liabilities and equity must be less
than the market value of the firm’s liabilities and equity.
A)
True
B)
False
5.
The beta of a firm is equal to the weighted-average sum of the betas of the
individual projects that the firm is currently operating.
A)
True
B)
False
Ans:
A
6.
Due to the magic of diversification, the risk associated with the assets of a
firm must be less than the risk associated with the financing, or debt and
equity that a firm is utilizing for its assets.
A)
True
B)
False
Ans:
B
AICPA: Industry/Sector Perspective
Fundamentals of Corporate Finance 3e Test Bank
7.
A firm is currently taking on two projects with an individual cost of capital
of 10 percent and 12 percent for each of the projects. This means that the
before-tax cost of capital for the firm must be between 10 and 12 percent.
A)
True
B)
False
8.
If a firm finances the purchase of an asset with cash, then it has zero financial cost to the firm.
A)
True
B)
False
Ans:
B
9.
If one observes the market quoted price of a debt security where the expected cash flows of
that security are known, then one can calculate the current cost of that security to the firm.
A)
True
B)
False
Ans:
A
10.
Long-term debt typically describes debt that will mature in two years or more.
A)
True
B)
False
AICPA: Industry/Sector Perspective
Fundamentals of Corporate Finance 3e Test Bank
11.
Long-term debt is generally viewed as a permanent financing source for a firm.
A)
True
B)
False
Ans:
A
12.
With respect to the cost of capital, we are generally interested in the cost of a source of
financing on a particular date.
A)
True
B)
False
Ans:
A
13.
The historic cost of long-term debt is the appropriate cost of debt for WACC calculations.
A)
True
B)
False
Ans:
B
14.
Milton Corp. issued bonds 10 years ago with a coupon rate of 10 percent at a price of $1,000.
The current price of the bonds is $980. The before-tax cost of the debt to the firm is still 10
percent.
A)
True
B)
False
AICPA: Industry/Sector Perspective
Fundamentals of Corporate Finance 3e Test Bank
15.
The yield to maturity for an annual coupon paying bond will always be equal to the coupon
rate.
A)
True
B)
False
Ans:
B
16.
The yield to maturity is the discount rate that makes the present value of coupon and principal
payments equal to the price of the bond.
A)
True
B)
False
Ans:
A
17.
The current cost of bank debt of a firm can be determined by asking the firm’s banker.
A)
True
B)
False
Ans:
A
18.
If a firm is subject to income taxes, then the after-tax cost of debt for the firm will be less than
the before-tax cost of debt.
A)
True
B)
False
AICPA: Industry/Sector Perspective
Fundamentals of Corporate Finance 3e Test Bank
19.
The issuance costs of new debt securities can be ignored since those costs will not be reflected
in the yield to maturity of the debt in the future.
A)
True
B)
False
Ans:
B
20.
Utilizing the CAPM to estimate the cost of capital for a project is difficult in practice because
analysts do not have the stock returns from individual projects that are necessary to use in a
regression analysis for estimating a project’s beta.
A)
True
B)
False
Ans:
B
21.
Estimates of expected returns based on market security prices will be reliable in all types of
markets, including those deemed less efficient than others.
A)
True
B)
False
Ans:
B
AICPA: Industry/Sector Perspective
Fundamentals of Corporate Finance 3e Test Bank
22.
The cost of equity for a firm must take the cost of preferred stock (if any has been issued) that
the firm has outstanding into account.
A)
True
B)
False
Ans:
A
23.
The correct Treasury rate to use in calculating the cost of equity (when using the CAPM) for a
firm is a short-term rate.
A)
True
B)
False
Ans:
B
24.
When trying to estimate the cost of equity for a firm using the CAPM, it is possible to find the
beta of a comparable, publicly traded firm whose primary business is closely related to the firm.
A)
True
B)
False
Ans:
A
25.
The market risk premium for the future is always perfectly known, and it is 6.51 percent.
A)
True
B)
False
AICPA: Industry/Sector Perspective
Fundamentals of Corporate Finance 3e Test Bank
26.
If a firm is currently paying common share dividends to investors and those dividends are
expected to grow at a low but steady rate in the future, then the cost of common equity for the
firm can be determined by also using the current price of the firm’s common shares.
A)
True
B)
False
Ans:
A
27.
The current cost of preferred equity can be found by taking the ratio of the annual dividend on
the preferred stock to the current price of preferred shares.
A)
True
B)
False
Ans:
A
28.
The CAPM can only be used to determine the cost of common equity.
A)
True
B)
False
Ans:
B
AICPA: Industry/Sector Perspective
29.
The proportions of debt and equity used to determine the weighted average cost of capital for a
firm is based on the market value of debt and equity outstanding.
A)
True
B)
False
Ans:
A
AICPA: Industry/Sector Perspective
Fundamentals of Corporate Finance 3e Test Bank
30.
The correctly calculated weighted average cost of capital for a firm can be used to discount the
cash flows for any new project that the firm may undertake in the future.
A)
True
B)
False
Ans:
B
31.
The estimated cost of capital the financial manager use for efficiency projects tends to be
higher than the cost of capital used to evaluate new projects.
A)
True
B)
False
Ans:
B
32.
When using a single rate, such as the WACC, to discount cash flows for all projects of a
particular company, the discount rate could lead to accepting projects that will actually have a
negative NPV.
A)
True
B)
False
Ans:
A
Fundamentals of Corporate Finance 3e Test Bank
33.
If a company’s weighted average cost of capital is less than the required return on equity, then
the firm
A)
is financed with more than 50% debt.
B)
is perceived to be safe.
C)
has debt in its capital structure.
D)
must have preferred stock in its capital structure.
Ans:
C
34.
Firms have no way to directly estimate the discount rate that reflects the risk of
A)
B)
C)
D)
35.
A firm’s overall cost of capital is
A)
less than its cost of debt.
B)
a weighted average of the costs of capital for the collection of individual projects that
the firm is working on.
C)
best measured by the cost of capital of the riskiest projects that the firm is working
on.
D)
None of the above
AICPA: Industry/Sector Perspective
Fundamentals of Corporate Finance 3e Test Bank
36.
The finance balance sheet is
A)
the same as the accounting balance sheet, but it is based on market values.
B)
the same as the accounting balance sheet, but it does not have to balance.
C)
based on cash rather than accrual accounting.
D)
the same as the accounting balance sheet, but it is based on historical values.
Ans:
A
37.
The value of the cash flows that the assets of a firm are expected to generate must equal
A)
the value of the cash flows claimed by the equity investors.
B)
the value of the cash flows claimed by the debt investors.
C)
the value of the cash flows claimed by both the equity and debt investors.
D)
the revenue produced by the firm.
Ans:
C
38.
The beta for a firm can be estimated by
A)
adding up the betas of the individual projects of the firm.
B)
taking the weighted average of the beta for the individual projects of the firm.
C)
taking the simple average of the beta for the individual projects of the firm.
D)
None of the above
Fundamentals of Corporate Finance 3e Test Bank
39.
A firm can be viewed as
A)
a portfolio of individual projects, each with its own risks, cost of capital, and returns.
B)
a collection of equity shares comprising it.
C)
a collection of debt instruments financing it.
D)
a portfolio of all individual projects in the industry, each with its own risks, cost of
capital, and returns.
40.
In order for a firm to estimate its cost of debt capital by observing the price of its debt
instruments,
A)
the firm must depend on markets being reasonably efficient.
B)
the debt must be privately held by the firm.
C)
the beta of the debt must be greater than the beta of the firm’s equity.
D)
None of the above
Ans:
A
41.
If markets are not reasonably efficient, then
A)
the estimates of expected returns are not needed.
B)
the need for a discount rate to analyze project cash flows is not needed.
C)
estimates of expected returns based on security prices will not be reliable.
D)
None of the above
Ans:
C
AICPA: Industry/Sector Perspective
Fundamentals of Corporate Finance 3e Test Bank
42.
When estimating the cost of debt capital for a firm, we are primarily interested in
A)
the weighted average cost of capital.
B)
the cost of long-term debt.
C)
the coupon rate of the debt.
D)
None of the above
Ans:
B
43.
Long-term debt typically describes
A)
debt with a maturity greater than one year.
B)
only coupon debt.
C)
publicly traded debt.
D)
None of the above
Ans:
A
44.
Which of the following need to be excluded from the calculation of a firm’s amount of
permanent debt?
A)
Long-term debt
B)
Revolving lines of credit
C)
Mortgage debt
D)
None of the above
Ans:
B
AICPA: Industry/Sector Perspective
Fundamentals of Corporate Finance 3e Test Bank
45.
When analyzing a firm’s cost of debt, we are typically interested in
A)
the cost of the debt on the date that the analysis is being completed.
B)
the coupon rate on the firm’s bonds.
C)
the cost of the debt and cost of preferred stock on the date that the analysis is being
completed.
D)
None of the above
Ans:
A
46.
If a firm has bonds outstanding and the firm would like to calculate the current cost of debt for
the bonds, then the firm would
A)
use the coupon rate of the bonds to estimate the cost.
B)
use the current yield to maturity of the bonds to estimate the cost.
C)
use the current coupon yield of the bonds to estimate the cost.
D)
None of the above
Ans:
B
47.
A bond has a coupon rate of 6 percent and the bond makes semiannual coupon payments. The
dollar amount of coupon interest received every six months is
A)
$60.
B)
$30.
C)
$30 plus or minus the prorate portion of the discount or premium that the bond was
purchased for.
D)
$60 plus or minus the prorate portion of the discount or premium that the bond was
purchased for.
Ans:
B
AICPA: Industry/Sector Perspective
Fundamentals of Corporate Finance 3e Test Bank
48.
Bond issuance costs include
A)
investment banking fees.
B)
legal fees.
C)
accountant fees.
D)
All of the above
Ans:
D
49.
Income taxes have the effect of
A)
increasing the cost of debt for a firm.
B)
decreasing the cost of debt for a firm.
C)
decreasing the cost of equity for a firm.
D)
Both B and C are correct
Ans:
B
50.
Bellamee, Inc. has semiannual bonds outstanding with five years to maturity, and the bonds are
priced at $920.87. If the bonds have a coupon rate of 7 percent, then what is the YTM for the
bonds? Round your final percentage answer to two decimal places.
A)
4.5%
B)
7.0%
C)
9.0%
D)
9.2%
Ans:
C
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AICPA: Industry/Sector Perspective
Fundamentals of Corporate Finance 3e Test Bank
51.
Dynamo Corporation has semiannual bonds outstanding with 12 years to maturity, and the
bonds are currently priced at $1,080.29. If the bonds have a coupon rate of 8 percent, then
what is the equivalent annual return (EAR) to the investor for purchasing the bonds at the
described price? Round your final percentage answer to two decimal places.
A)
3.5%
B)
7.00%
C)
7.12%
D)
8.00%
Ans:
C
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AICPA: Industry/Sector Perspective
Fundamentals of Corporate Finance 3e Test Bank
AICPA: Industry/Sector Perspective
52.
Beckham Corporation has semiannual bonds outstanding with 13 years to maturity and the
bonds are currently priced at $746.16. If the bonds have a coupon rate of 8.5 percent, then
what is the after-tax cost of debt for Beckham if its marginal tax rate is 35%? Round your
intermediate calculation to two decimal places & final percentage answer to three decimal
places.
A)
6.250%
B)
8.125%
C)
12.500%
D)
12.890%
Ans:
B
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