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Practice MC Questions CH 14

The document contains 8 multiple choice practice questions related to concepts in corporate finance including capital structure, weighted average cost of capital (WACC), cost of equity, cost of debt, and project risk assessment. The questions cover determining a firm's capital structure weights, approaches for calculating WACC, characteristics of cost of capital, considerations for a project's cost of capital, implications of using WACC without adjusting for project risk, calculating cash needed for a project based on financing mix and flotation costs, deriving cost of equity based on a competitor's beta, and calculating WACC given inputs like debt ratio, costs of equity and debt, and tax rate.

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161 views

Practice MC Questions CH 14

The document contains 8 multiple choice practice questions related to concepts in corporate finance including capital structure, weighted average cost of capital (WACC), cost of equity, cost of debt, and project risk assessment. The questions cover determining a firm's capital structure weights, approaches for calculating WACC, characteristics of cost of capital, considerations for a project's cost of capital, implications of using WACC without adjusting for project risk, calculating cash needed for a project based on financing mix and flotation costs, deriving cost of equity based on a competitor's beta, and calculating WACC given inputs like debt ratio, costs of equity and debt, and tax rate.

Uploaded by

business doc
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
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Practice MC Questions Ch 14

1. The proportions of the market value of the firm's assets financed via debt, common stock, and
preferred stock are called the firm's _____________________.
A. financing costs
B. portfolio weights
C. beta coefficients
D. capital structure weights
E. costs of capital

2. When firms develop a WACC for individual projects based on the cost of capital for other
firms in similar lines of business as the project, the firm is utilizing a ____________________.
A. subjective risk approach
B. pure play approach
C. divisional cost of capital approach
D. capital adjustment approach
E. security market line approach

3. Which of the following is/are true: The cost of capital _______________________.

I. is an opportunity cost that depends on the use of the funds, not the source
II. is the same thing as the required rate of return
III. is the same as the WACC for projects with equal risk to the firm as a whole
IV. is also known as the appropriate discount rate
A. II and III only
B. I, II, and IV only
C. II, III, and IV only
D. I, III, and IV only
E. I, II, III, and IV

4. Which of the following statements are correct concerning the cost of capital for a project?

I. Ignoring the risk level of a project can cause a firm to reject a profitable project.
II. The cost of capital for a project should exclude any tax considerations.
III. The use of the funds is more important than the source of funds in determining the cost of
capital.
IV. A firm may have to rely upon a competitor's cost of capital to ascertain the appropriate
required return for a project.
A. I and III only
B. II and IV only
C. I, II, and III only
D. I, III, and IV only
E. I, II, III, and IV
5. A firm that uses its WACC as a cutoff without considering project risk:

I. Tends to become less risky over time.


II. Tends to accept negative NPV projects over time.
III. Likely will see its WACC rise over time.
A. II only
B. I and II only
C. I and III only
D. II and III only
E. I, II, and III

6. A firm needs to raise $165 million for a project. If external financing is used, the firm faces
flotation costs of 8% for equity and 2.5% for debt. If the project is to be financed 60% with
equity and 40% with debt, how much cash must the firm raise in order to finance the project?
A. $128.6 million
B. $142.2 million
C. $161.7 million
D. $171.6 million
E. $175.2 million

7. The Delta Co. owns retail stores that market home building supplies. Largo, Inc. builds single
family homes in residential developments. Delta has a beta of 1.22 and Largo has a beta of 1.34.
The risk-free rate of return is 4 percent and the market risk premium is 6.5 percent. What should
Delta use as its cost of equity if it decides to purchase some land and create a new residential
community?
A. 11.93 percent
B. 12.32 percent
C. 12.43 percent
D. 12.57 percent
E. 12.71 percent

8. Kottinger’s Kamp Supplies has a debt/equity ratio of 25%, its cost of equity is 14%, and its
pretax cost of debt is 7%. The firm’s tax rate is 40%. What is Kottinger's weighted average cost
of capital?
A. 8.91%
B. 9.99%
C. 10.86%
D. 11.14%
E. 12.04%
Solutions

1. The proportions of the market value of the firm's assets financed via debt, common stock, and
preferred stock are called the firm's _____________________.
A. financing costs
B. portfolio weights
C. beta coefficients
D. capital structure weights
E. costs of capital

2. When firms develop a WACC for individual projects based on the cost of capital for other
firms in similar lines of business as the project, the firm is utilizing a ____________________.
A. subjective risk approach
B. pure play approach
C. divisional cost of capital approach
D. capital adjustment approach
E. security market line approach

3. Which of the following is/are true: The cost of capital _______________________.

I. is an opportunity cost that depends on the use of the funds, not the source
II. is the same thing as the required rate of return
III. is the same as the WACC for projects with equal risk to the firm as a whole
IV. is also known as the appropriate discount rate
A. II and III only
B. I, II, and IV only
C. II, III, and IV only
D. I, III, and IV only
E. I, II, III, and IV

4. Which of the following statements are correct concerning the cost of capital for a project?

I. Ignoring the risk level of a project can cause a firm to reject a profitable project.
II. The cost of capital for a project should exclude any tax considerations.
III. The use of the funds is more important than the source of funds in determining the cost of
capital.
IV. A firm may have to rely upon a competitor's cost of capital to ascertain the appropriate
required return for a project.
A. I and III only
B. II and IV only
C. I, II, and III only
D. I, III, and IV only
E. I, II, III, and IV
5. A firm that uses its WACC as a cutoff without considering project risk:

I. Tends to become less risky over time.


II. Tends to accept negative NPV projects over time.
III. Likely will see its WACC rise over time.
A. II only
B. I and II only
C. I and III only
D. II and III only
E. I, II, and III

6. A firm needs to raise $165 million for a project. If external financing is used, the firm faces
flotation costs of 8% for equity and 2.5% for debt. If the project is to be financed 60% with
equity and 40% with debt, how much cash must the firm raise in order to finance the project?
A. $128.6 million
B. $142.2 million
C. $161.7 million
D. $171.6 million
E. $175.2 million

7. The Delta Co. owns retail stores that market home building supplies. Largo, Inc. builds single
family homes in residential developments. Delta has a beta of 1.22 and Largo has a beta of 1.34.
The risk-free rate of return is 4 percent and the market risk premium is 6.5 percent. What should
Delta use as its cost of equity if it decides to purchase some land and create a new residential
community?
A. 11.93 percent
B. 12.32 percent
C. 12.43 percent
D. 12.57 percent
E. 12.71 percent

8. Kottinger’s Kamp Supplies has a debt/equity ratio of 25%, its cost of equity is 14%, and its
pretax cost of debt is 7%. The firm’s tax rate is 40%. What is Kottinger's weighted average cost
of capital?
A. 8.91%
B. 9.99%
C. 10.86%
D. 11.14%
E. 12.04%

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