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Fin 701 Module 5 Exam Questions with Correct AnswersFin 701 Module 5 Exam Questions with Correct Answers
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Capital - Answer-funds used to finance a firm's assets and operations cost of capital - Answer-average cost of raising new capital for the firm minimum (or hurdle rate) rate of return - Answer-firm must earn on its investments to provide a return to the providers of the funds based on the ris...

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  • 23 augustus 2024
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Fin 701 Module 5 Exam Questions with
Correct Answers
Capital - Answer-funds used to finance a firm's assets and operations

cost of capital - Answer-average cost of raising new capital for the firm

minimum (or hurdle rate) rate of return - Answer-firm must earn on its investments to
provide a return to the providers of the funds based on the risk of the assets

The firm's cost of capital indicates - Answer-how the market views the risk of the firm's
assets, and how they are used

If investors are compensated for their financing, - Answer-the firm must earn a return
higher than the cost of financing

In order to create value, a corporation must earn a rate of return on its invested capital
that is - Answer-higher than the market's required rate of return on that invested capital.

A company's weighted average cost of capital (WACC) is - Answer-the required return
on the overall firm

WACC is also known as - Answer-rate appropriate of cash flows

The cost of capital is - Answer-the rate that must be earned on an investment project if
the project is to increase the value of the common shareholders' investment

The cost of capital is referred to as - Answer-the firm's opportunity cost of capital

The firm financed completely with equity capital has - Answer-a cost of capital equal to
the required return on common stock

If a firm were to earn exactly its cost of capital, - Answer-we would expect the price of its
common stock to remain unchanged

Investor's point of view - Answer-required rate of return

Firm's point of view - Answer-Cost of capital

Cost of equity is return required by ____________________ and based on the
_____________________________ - Answer-investors; risk of the firm's cash flows

Two key methods of Determining Cost of Equity - Answer-Dividend discount model and
SLM or CAPM

, This method is good when the firm pays dividends, and those dividends are expected to
grow at a constant rate - Answer-dividend discount model (DDM)

CAPM uses the - Answer-stock's beta or degree of market risk to estimate a required
rate of return

DDM model advantage: - Answer-easy to understand and use

DDM disadvantage: - Answer-o It only works if the firm pays dividend
o If the dividends are not growing at a consistent rate (as in the prior example), it may
not be applicable
o The estimated cost of equity is very sensitive to the estimated firm's estimated growth
rate
o Risk is not specifically considered

Pros of SLM/CAPM - Answer-o Specifically adjusts for the stock's systematic risk
o As long as beta is available, applicable to all companies

Cons of SLM/CAPM - Answer-o The expected market risk premium must be estimated,
and yet the MPR varies over time
o Beta must be estimated, and it also varies over time
o The assumption is that past risk (beta) will predict future returns

Cost of debt - Answer-the required return on a company's debt

Cost of debt is calculated by - Answer-the yield of maturity on a firm's existing debt or
use estimates of current rates based on bond rating expected

When corps receive a tax break on interest paid on debt their after-tax cost is - Answer-
reduced

The cost of debt is equal to the yield to maturity because - Answer-it is the market rate
of interest that would be required on new debt issues.

Preferred stock - Answer-pays a fixed dividend every period

preferred stock is a - Answer-perpetuity

The WACC is - Answer-the minimum return a company needs to earn to satisfy all its
investors, including stockholders, bondholders, and preferred stockholders

WACC is the rate of return a firm must earn on its existing assets to - Answer-maintain
the current value of its stock

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