Q1. For a typical corporation, which of the following capital structures will result in the lowest
weighted average cost of capital?
a. 40% debt, 20% preferred stock, 40% common equity
b. 50% debt, 10% preferred stock, 40% common equity
c. 60% debt, 10% preferred stock, 30% common equity
d. 60% debt, 15% preferred stock, 25% common equity
Q2. Why should firms that own and operate multiple businesses that have different risk
characteristics use business-specific, or divisional costs of capital?
a. Not all divisions have equal risk and the firm might accept projects whose returns are
higher than are deemed appropriate.
b. Not all business divisions have equal risk and the firm will likely become less risky in
the future.
c. Not all lines of business have equal risk and it is likely that the firm will accept projects
whose returns are unacceptably low in relation to the risk involved.
d. Use of the same weighted average cost of capital for all divisions may result in too much
money being allocated to the least risky division.
Q3. Due to changes in regulatory requirements, the transactions costs associated with selling
corporate securities increased by $1 per share. This change will
a. cause the cost of capital to decrease.
b. cause the cost of capital to increase.
c. have no effect on the cost of capital because transactions costs are expensed
immediately.
, d. cause the cost of capital to decrease only if investors may be billed for part of the
increase in transactions costs.
Q4. Other things equal, management should retain profits only if the company's investments
within the firm are at least as attractive as the stockholders' other investment opportunities.
a. True
b. False
Q5. GHJ Inc. is investing in a major capital budgeting project that will require the expenditure of
$16 million. The money will be raised by issuing $2 million of bonds, $4 million of preferred
stock, and $10 million of new common stock. The company estimates is after-tax cost of debt to
be 7%, its cost of preferred stock to be 9%, the cost of retained earnings to be 14%, and the cost
of new common stock to be 17%. What is the weighted average cost of capital for this project?
a. 12.20%
b. 13.12%
c. 13.75%
d. 14.23%
Q6. A corporate bond has a face value of $1,000 and a coupon rate of 5%. The bond matures in
15 years and has a current market price of $925. If the corporation sells more bonds it will incur
flotation costs of $25 per bond. If the corporate tax rate is 35%, what is the after-tax cost of debt
capital?
a. 3.74%
b. 4.45%
c. 5.29%
, d. 6.78%
Q7. Sentry Manufacturing paid a dividend yesterday of $5 per share. The dividend is expected to
grow at a constant rate of 8% per year. The price of Sentry Manufacturing's stock today is $29
per share. If Sentry Manufacturing decides to issue new common stock, flotation costs will equal
$2.50 per share. Sentry Manufacturing's marginal tax rate is 35%. Based on the above
information, the cost of new common stock is
a. 28.38%.
b. 24.12%.
c. 26.62%.
d. 31.40%.
Q8. Financing with new common stock is generally more costly than financing with retained
earnings due to increasing tax rates.
a. True
b. False
Q9. In general, the least expensive source of capital is
a. debt.
b. new common stock.
c. preferred stock
d. retained earnings.
Q10. WineCellars Inc. currently has a weighted average cost of capital of 12%. WineCellars has
weighted average cost of capital?
a. 40% debt, 20% preferred stock, 40% common equity
b. 50% debt, 10% preferred stock, 40% common equity
c. 60% debt, 10% preferred stock, 30% common equity
d. 60% debt, 15% preferred stock, 25% common equity
Q2. Why should firms that own and operate multiple businesses that have different risk
characteristics use business-specific, or divisional costs of capital?
a. Not all divisions have equal risk and the firm might accept projects whose returns are
higher than are deemed appropriate.
b. Not all business divisions have equal risk and the firm will likely become less risky in
the future.
c. Not all lines of business have equal risk and it is likely that the firm will accept projects
whose returns are unacceptably low in relation to the risk involved.
d. Use of the same weighted average cost of capital for all divisions may result in too much
money being allocated to the least risky division.
Q3. Due to changes in regulatory requirements, the transactions costs associated with selling
corporate securities increased by $1 per share. This change will
a. cause the cost of capital to decrease.
b. cause the cost of capital to increase.
c. have no effect on the cost of capital because transactions costs are expensed
immediately.
, d. cause the cost of capital to decrease only if investors may be billed for part of the
increase in transactions costs.
Q4. Other things equal, management should retain profits only if the company's investments
within the firm are at least as attractive as the stockholders' other investment opportunities.
a. True
b. False
Q5. GHJ Inc. is investing in a major capital budgeting project that will require the expenditure of
$16 million. The money will be raised by issuing $2 million of bonds, $4 million of preferred
stock, and $10 million of new common stock. The company estimates is after-tax cost of debt to
be 7%, its cost of preferred stock to be 9%, the cost of retained earnings to be 14%, and the cost
of new common stock to be 17%. What is the weighted average cost of capital for this project?
a. 12.20%
b. 13.12%
c. 13.75%
d. 14.23%
Q6. A corporate bond has a face value of $1,000 and a coupon rate of 5%. The bond matures in
15 years and has a current market price of $925. If the corporation sells more bonds it will incur
flotation costs of $25 per bond. If the corporate tax rate is 35%, what is the after-tax cost of debt
capital?
a. 3.74%
b. 4.45%
c. 5.29%
, d. 6.78%
Q7. Sentry Manufacturing paid a dividend yesterday of $5 per share. The dividend is expected to
grow at a constant rate of 8% per year. The price of Sentry Manufacturing's stock today is $29
per share. If Sentry Manufacturing decides to issue new common stock, flotation costs will equal
$2.50 per share. Sentry Manufacturing's marginal tax rate is 35%. Based on the above
information, the cost of new common stock is
a. 28.38%.
b. 24.12%.
c. 26.62%.
d. 31.40%.
Q8. Financing with new common stock is generally more costly than financing with retained
earnings due to increasing tax rates.
a. True
b. False
Q9. In general, the least expensive source of capital is
a. debt.
b. new common stock.
c. preferred stock
d. retained earnings.
Q10. WineCellars Inc. currently has a weighted average cost of capital of 12%. WineCellars has
