Fundamentals of Corporate Finance, 3e (Berk/DeMarzo/Harford)
Chapter 13 The Cost of Capital
13.1 A First Look at the Weighted Average Cost of Capital
1) Financial managers must determine their firm's overall cost of capital based on all
sources of financing.
Answer: TRUE
Diff: 1 Var: 1
Skill: Conceptual
AACSB Objective: Analytic Skills
Author: KB
Question Status: Revised
2) To attract capital from outside investors, a firm must offer potential investors an
expected return that is commensurate with the level of risk that they can bear.
Answer: TRUE
Diff: 1 Var: 1
Skill: Conceptual
AACSB Objective: Analytic Skills
Author: KB
Question Status: Previous Edition
3) One should use accounting-based book values rather than market values of debt and
equity to determine the weights for the different sources of capital.
Answer: FALSE
Diff: 1 Var: 1
Skill: Conceptual
AACSB Objective: Analytic Skills
Author: KB
Question Status: Previous Edition
4) A firm's sources of financing, which usually consists of debt and equity, represent its
________.
A) total assets
B) capital
C) total liabilities
D) current liabilities
Answer: B
Diff: 1 Var: 1
Skill: Definition
AACSB Objective: Analytic Skills
Author: KB
Question Status: Previous Edition
1
Copyright © 2015 Pearson Education, Inc.
,5) The relative proportion of debt, equity, and other securities that a firm has outstanding
constitute its ________.
A) asset ratio
B) current ratio
C) capital structure
D) retained earnings
Answer: C
Diff: 1 Var: 1
Skill: Conceptual
AACSB Objective: Analytic Skills
Author: KB
Question Status: Revised
6) A firm's overall cost of capital that is a blend of the costs of the different sources of
capital is known as the firm's ________.
A) weighted average cost of capital
B) cost of equity infusion
C) cost of debt
D) cost of preferred stock
Answer: A
Diff: 1 Var: 1
Skill: Definition
AACSB Objective: Analytic Skills
Author: KB
Question Status: Revised
7) The book value of a firm's equity is $100 million and its market value of equity is $200
million. The face value of its debt is $50 million and its market value of debt is $60 million.
What is the market value of assets of the firm?
A) $150 million
B) $160 million
C) $260 million
D) $250 million
Answer: C
Explanation: C) Market value of debt plus market value of equity gives market value of
assets.
$200 + $60 = $260 million
Diff: 1 Var: 1
Skill: Analytical
AACSB Objective: Analytic Skills
Author: KB
Question Status: Revised
2
Copyright © 2015 Pearson Education, Inc.
,8) A firm raised all its capital via equity rather than debt. Such a firm is also referred to as
a(n) ________ firm.
A) levered
B) margined
C) risk less
D) unlevered
Answer: D
Diff: 1 Var: 1
Skill: Definition
AACSB Objective: Analytic Skills
Author: KB
Question Status: Revised
9) A levered firm is one that has ________ outstanding.
A) debt
B) equity
C) preferred stock
D) equity options
Answer: A
Diff: 1 Var: 1
Skill: Definition
AACSB Objective: Analytic Skills
Author: KB
Question Status: Previous Edition
10) Leverage is the amount of ________ on a firm's balance sheet.
A) equity
B) debt
C) preferred stock
D) retained earnings
Answer: B
Diff: 1 Var: 1
Skill: Definition
AACSB Objective: Analytic Skills
Author: KB
Question Status: Previous Edition
11) For an unlevered firm, the cost of capital can be determined by using the ________.
A) yield on the traded debt
B) Capital Asset Pricing Model
C) dividend yield
D) preferred stock yield
Answer: B
Diff: 1 Var: 1
Skill: Conceptual
AACSB Objective: Analytic Skills
Author: KB
Question Status: Previous Edition
12) Assume Lavender Corporation has a market value of $4 billion of equity and a market
value of $19.8 billion of debt. What are the weights in equity and debt that are used for
calculating the WACC?
A) 0.10, 0.90
B) 0.832, 0.168
C) 0.168, 0.832
D) 0.90, 0.10
3
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, Answer: C
Explanation: C) Weight in debt equals market value of debt divided by market value of
debt plus equity. Similarly, weight in equity is market value of equity divided by market
value of debt plus equity.
Weight in equity = $4 billion / ($4 + $19.8) billion = 0.168;
Weight in debt = $19.8 billion / ($4 + $19.8) billion = 0.832
Diff: 1 Var: 9
Skill: Analytical
AACSB Objective: Analytic Skills
Author: KB
Question Status: Revised
13) Assume Bismuth Electronics has a book value of $6 billion of equity and a face value of
$19.7 billion of debt. The market values of equity and debt are $2.5 billion and $18.5
billion. A Wall Street financial analyst determines values of equity and debt as $3 billion
and $20 billion. Which of the following values should be used for calculating the firm's
WACC?
A) $6 billion of equity and $19.7 billion of debt
B) $2.5 billion of equity and $20 billion of debt
C) $3 billion of equity and $19.9 billion of debt
D) $2.5 billion of equity and $18.5 billion of debt
Answer: D
Diff: 1 Var: 9
Skill: Conceptual
AACSB Objective: Analytic Skills
Author: KB
Question Status: Revised
14) Assume the total market value of General Motors (GM) is $10 billion. GM has a market
value of $6 billion of equity and a face value of $12 billion of debt. What are the weights in
equity and debt that are used for calculating the WACC?
A) 0.30, 0.70
B) 0.60, 0.40
C) 0.40, 0.60
D) cannot be determined
Answer: B
Explanation: B) Weight in debt equals market value of debt divided by market value of
debt plus equity. Similarly, weight in equity is market value of equity divided by market
value of debt plus equity.
Equity = $6 million / $10 million = 0.60; Debt = ($10 million - $6 million) / $10 million =
0.40
Diff: 1 Var: 47
Skill: Analytical
AACSB Objective: Analytic Skills
Author: KB
Question Status: Previous Edition
15) A firm incurs $40,000 in interest expenses each year. If the tax rate of the firm is 30%,
what is the effective after-tax interest rate expense for the firm?
A) $21,000.00
B) $22,400.00
C) $23,800.00
D) $28,000.00
Answer: D
Explanation: D)
4
Copyright © 2015 Pearson Education, Inc.
Chapter 13 The Cost of Capital
13.1 A First Look at the Weighted Average Cost of Capital
1) Financial managers must determine their firm's overall cost of capital based on all
sources of financing.
Answer: TRUE
Diff: 1 Var: 1
Skill: Conceptual
AACSB Objective: Analytic Skills
Author: KB
Question Status: Revised
2) To attract capital from outside investors, a firm must offer potential investors an
expected return that is commensurate with the level of risk that they can bear.
Answer: TRUE
Diff: 1 Var: 1
Skill: Conceptual
AACSB Objective: Analytic Skills
Author: KB
Question Status: Previous Edition
3) One should use accounting-based book values rather than market values of debt and
equity to determine the weights for the different sources of capital.
Answer: FALSE
Diff: 1 Var: 1
Skill: Conceptual
AACSB Objective: Analytic Skills
Author: KB
Question Status: Previous Edition
4) A firm's sources of financing, which usually consists of debt and equity, represent its
________.
A) total assets
B) capital
C) total liabilities
D) current liabilities
Answer: B
Diff: 1 Var: 1
Skill: Definition
AACSB Objective: Analytic Skills
Author: KB
Question Status: Previous Edition
1
Copyright © 2015 Pearson Education, Inc.
,5) The relative proportion of debt, equity, and other securities that a firm has outstanding
constitute its ________.
A) asset ratio
B) current ratio
C) capital structure
D) retained earnings
Answer: C
Diff: 1 Var: 1
Skill: Conceptual
AACSB Objective: Analytic Skills
Author: KB
Question Status: Revised
6) A firm's overall cost of capital that is a blend of the costs of the different sources of
capital is known as the firm's ________.
A) weighted average cost of capital
B) cost of equity infusion
C) cost of debt
D) cost of preferred stock
Answer: A
Diff: 1 Var: 1
Skill: Definition
AACSB Objective: Analytic Skills
Author: KB
Question Status: Revised
7) The book value of a firm's equity is $100 million and its market value of equity is $200
million. The face value of its debt is $50 million and its market value of debt is $60 million.
What is the market value of assets of the firm?
A) $150 million
B) $160 million
C) $260 million
D) $250 million
Answer: C
Explanation: C) Market value of debt plus market value of equity gives market value of
assets.
$200 + $60 = $260 million
Diff: 1 Var: 1
Skill: Analytical
AACSB Objective: Analytic Skills
Author: KB
Question Status: Revised
2
Copyright © 2015 Pearson Education, Inc.
,8) A firm raised all its capital via equity rather than debt. Such a firm is also referred to as
a(n) ________ firm.
A) levered
B) margined
C) risk less
D) unlevered
Answer: D
Diff: 1 Var: 1
Skill: Definition
AACSB Objective: Analytic Skills
Author: KB
Question Status: Revised
9) A levered firm is one that has ________ outstanding.
A) debt
B) equity
C) preferred stock
D) equity options
Answer: A
Diff: 1 Var: 1
Skill: Definition
AACSB Objective: Analytic Skills
Author: KB
Question Status: Previous Edition
10) Leverage is the amount of ________ on a firm's balance sheet.
A) equity
B) debt
C) preferred stock
D) retained earnings
Answer: B
Diff: 1 Var: 1
Skill: Definition
AACSB Objective: Analytic Skills
Author: KB
Question Status: Previous Edition
11) For an unlevered firm, the cost of capital can be determined by using the ________.
A) yield on the traded debt
B) Capital Asset Pricing Model
C) dividend yield
D) preferred stock yield
Answer: B
Diff: 1 Var: 1
Skill: Conceptual
AACSB Objective: Analytic Skills
Author: KB
Question Status: Previous Edition
12) Assume Lavender Corporation has a market value of $4 billion of equity and a market
value of $19.8 billion of debt. What are the weights in equity and debt that are used for
calculating the WACC?
A) 0.10, 0.90
B) 0.832, 0.168
C) 0.168, 0.832
D) 0.90, 0.10
3
Copyright © 2015 Pearson Education, Inc.
, Answer: C
Explanation: C) Weight in debt equals market value of debt divided by market value of
debt plus equity. Similarly, weight in equity is market value of equity divided by market
value of debt plus equity.
Weight in equity = $4 billion / ($4 + $19.8) billion = 0.168;
Weight in debt = $19.8 billion / ($4 + $19.8) billion = 0.832
Diff: 1 Var: 9
Skill: Analytical
AACSB Objective: Analytic Skills
Author: KB
Question Status: Revised
13) Assume Bismuth Electronics has a book value of $6 billion of equity and a face value of
$19.7 billion of debt. The market values of equity and debt are $2.5 billion and $18.5
billion. A Wall Street financial analyst determines values of equity and debt as $3 billion
and $20 billion. Which of the following values should be used for calculating the firm's
WACC?
A) $6 billion of equity and $19.7 billion of debt
B) $2.5 billion of equity and $20 billion of debt
C) $3 billion of equity and $19.9 billion of debt
D) $2.5 billion of equity and $18.5 billion of debt
Answer: D
Diff: 1 Var: 9
Skill: Conceptual
AACSB Objective: Analytic Skills
Author: KB
Question Status: Revised
14) Assume the total market value of General Motors (GM) is $10 billion. GM has a market
value of $6 billion of equity and a face value of $12 billion of debt. What are the weights in
equity and debt that are used for calculating the WACC?
A) 0.30, 0.70
B) 0.60, 0.40
C) 0.40, 0.60
D) cannot be determined
Answer: B
Explanation: B) Weight in debt equals market value of debt divided by market value of
debt plus equity. Similarly, weight in equity is market value of equity divided by market
value of debt plus equity.
Equity = $6 million / $10 million = 0.60; Debt = ($10 million - $6 million) / $10 million =
0.40
Diff: 1 Var: 47
Skill: Analytical
AACSB Objective: Analytic Skills
Author: KB
Question Status: Previous Edition
15) A firm incurs $40,000 in interest expenses each year. If the tax rate of the firm is 30%,
what is the effective after-tax interest rate expense for the firm?
A) $21,000.00
B) $22,400.00
C) $23,800.00
D) $28,000.00
Answer: D
Explanation: D)
4
Copyright © 2015 Pearson Education, Inc.
