1. The best explanation of why CFOs use the after-tax cost of Debt when deriving their company’s WACC is:
a) corporations always owe taxes,
b) tax-affecting interest expense creates a lower WACC,
c) after-tax cash flows are used to project the returns of an investment,
d) tax rates often change.
2. The best explanation of why CFOs do not tax-affect the dividends paid on Preferred Stock when deriving their WACC is:
a) Preferred stock isn’t a component of the WACC formula,
b) Preferred stock is a perpetual instrument, so it doesn’t mature,
c) Preferred stock is rarely used by corporations,
d) Dividends paid by Preferred stock are not tax deductible to the company.
7. Which of these statements is true?
a) Debt is always cheaper than Common Stock
b) The CFO wants to find the mix of Debt, Preferred, and Common stock in his capital structure which will minimize his WACC.
c) Too much leverage (Debt/Equity) will ultimately raise the company’s WACC (vs. a low leverage position),
d) All of the above are true
9. A firm that does not earn its Cost of Capital when investing in new projects (i.e. the PV of the projected cash flows turns out to be negative) will end up not maximizing the company’s shareholder value (stock price x # of shares outstanding).
O True
O False
10. If a firm borrows $20M of debt to build a new factory, the after-tax interest rate of that debt should be used as the discount rate when computing the Net Present Value of the factory’s cash flows.
O True
O False