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Fin 701 5-1 and 5-2 Exam Questions with Complete Solutions
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1. A company's current cost of capital is based on: A. Only the return required by the company's current shareholders. B. The current market rate of return on equity shares C. The weighted costs of all future funding sources D. Both the returns currently required by its debt holders and stockho...

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  • August 23, 2024
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  • 2024/2025
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  • fin 701 5 1 and 5 2 exam questions with complete s
  • 1 a companys current cost of capital is based o

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Fin 701 5-1 and 5-2 Exam Questions with
Complete Solutions
1. A company's current cost of capital is based on:
A. Only the return required by the company's current shareholders.
B. The current market rate of return on equity shares
C. The weighted costs of all future funding sources
D. Both the returns currently required by its debt holders and stockholders
E. The company's original debt-equity ratio - Answer-D. Both the returns currently
required by its debt holders and stockholders

2. All else constant, which one of the following will increase a company's cost of equity if
the company computes that cost using the security market line approach? Assume the
firm currently pays an annual dividend of $1 a share and has a beta of 1.2.
A. A reduction in the dividend amount
B. An increase in the dividend amount
C. A reduction in the market rate of return
D. A reduction in the firm's beta
E. A reduction in the risk-free rate - Answer-E. A reduction in the risk-free rate

3. Assume Russo's has a debt equity ratio of .4 and uses the capital asset pricing model
(CAPM) to determine its cost of equity. As a result, the company's cost of equity:
A. Is affected by the firm's rate of growth projections
B. Implies that the firm pays out all of its earnings to its shareholders
C. Is dependent upon a reliable estimate of the market risk premium
D. Would be unaffected if the dividend discount model were applied instead
E. Will be unaffected by changes in overall market risks - Answer-C. Is dependent upon
a reliable estimate of the market risk premium

4. A group of individuals got together and purchased all of the outstanding shares of
common stock of DL Smith Inc. What is the return that these individuals require on this
investment called?
A. Dividend yield
B. Cost of equity
C. Capital gains yield
D. Cost of capital
E. Income return - Answer-B. Cost of equity

5. Textile Mills borrows money at a rate of 8.7 percent. This interest rate is referred to
as the :
A. Compound rate
B. Current yield
C. Cost of debt
D. Capital gains yield

, E. Cost of capital - Answer-C. Cost of debt

6. Which one of these will increase a company's aftertax cost of debt?
A. A decrease in the company's debt-equity ratio
B. A decrease in the company's tax rate
C. An increase in the credit rating of the company's bonds
D. An increase in the company's beta
E. A decrease in the market rate of interest. - Answer-B. A decrease in the company's
tax rate

7. The cost of preferred stock is computed the same as the:
A. Pretax cost of debt
B. Rate of return on an annuity
C. Aftertax cost of debt
D. Rate of return on a perpetuity
E. Cost of an irregular growth common stock - Answer-D. Rate of return on a perpetuity

8. A company's weighted average cost of capital:
A. Is equivalent to the after tax cost of the outstanding liabilities
B. Should be used as the required return when analyzing any new project
C. Is the return investors require on the total assets of the firm.
D. Remains constant when the debt-equity ratio changes
E. Is unaffected by changes in corporate tax rates. - Answer-C. Is the return investors
require on the total assets of the firm.

9. The average of a company's cost of equity, cost of preferred, and aftertax cost of debt
that is weighted based on the company's capital structure is called the:

A. Reward-to-risk ratio
B. Weighted capital gains rate
C. Structured cost of capital
D. Subjective cost of capital
E. Weighted average cost of capital - Answer-E. Weighted average cost of capital

10. If a company usues its WACC as the discount rate for all of the projects it
undertakes then the company will tend to:

A. Accept all positive net present value projects
B. Increase the average risk level of the company over time
C. Reject all high-risk projects
D. Reject all negative net present value projects
E. Favor low-risk project over high-risk projects - Answer-B. Increase the average risk
level of the company over time

11. The subjective approach to project analysis:
A. is used only when a firm has an all-equity capital structure.

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