Question 1) Even though preferred stock is generally more risky to investors, the before-tax yield on preferred stock is sometimes less than the before-tax yield on the same company's bonds. Why?
Question 2) A company has a capital structure that consists of 50 percent debt and 50 percent equity. Which of the following statements is most correct?
A) The cost of equity financing is greater than or equal to the cost of debt financing. (correct answer)
b) The WACC exceeds the cost of equity financing.
c) The WACC is calculated on a before-tax basis.
d) The WACC represents the cost of capital based on historical averages. In that sense, it does not represent the marginal cost of capital.
e) The cost of retained earnings exceeds the cost of issuing new common stock.
Question 3) Suppose a firm is losing money and thus, is not paying taxes, and that this situation is expected to persist for a few years whether or not the firm uses debt financing. Then the firm's after-tax cost of debt will equal its before-tax cost of debt. Why?