1. Weights used in calculating the WACC should:
sum to 1.00.
always include Wd.
be based on the book value of each source of financing.
be calculated according to the price of each security-so if the price of a bond is $1,000, and the price of common stock is $50, then the weight of debt would be .20.
Question 2. 2. One reason why we are not concerned with idiosyncratic risk (also called firm-specific risk) is that:
most risk is not firm-specific, so we can ignore it.
through hedging and insurance, investors may now invest in stocks with almost no risk exposure of any kind.
it is easy and almost costless to diversify one's portfolio and eliminate idiosyncratic risk.
investing in bonds can offset the idiosyncratic risks of shares of stock.
Question 3. 3. The weighted average cost of capital is:
the average return for the company's stock over the past several years.
the average cost, including commissions, for raising capital for the firm.
an average required return for each of the sources of capital used by the firm to finance its projects, weighted by the amount contributed by each source.
interest payments and dividends, divided by the price of bonds and stock, respectively.
Question 4. 4. Which of the following statements regarding the cost of debt is true?
The cost of debt for bonds equals the coupon rate of outstanding bonds.
The cost of debt for bonds is found by dividing the price by the annual coupon.
The cost of debt for bonds is found by calculating their yield to maturity.
The cost of debt equals the flotation costs charged by investment bankers who advise the firm.
Question 5. 5. We assume investors are risk averse, and therefore they:
are equally concerned with upside potential and downside risk.
expect a higher return for bearing more risk.
will pay more for an investment with higher risk.
have very high required rates of return.
Question 6. 6. Beta is estimated as the slope of a regression line fit to pairs of periodic returns, (rx, ry), where:
rx is the return for a market index such as the S&P 500 Index.
rx is the return for the stock being analyzed-for example, IBM's return if we are estimating IBM's beta.
the slope measures the average return for the market portfolio for each percentage change in the value of the security of interest.
ry is the return for the market index such as the S&P 500 Index.
Question 7. 7. Which of the following statements regarding the cost of preferred stock is true?
It is typically found by solving for an annuity's discount rate.
It is typically found by solving for an annuity due's discount rate.
It is found similarly to a perpetuity's discount rate but with irregular spacing of the dividends.
It is typically found by solving for a perpetuity's discount rate.
Question 8. 8. Investors will make an investment if:
the historical rate of return exceeds the expected rate of return.
the required rate of return exceeds the expected rate of return.
the expected rate of return exceeds the actual rate of return.
the expected rate of return exceeds the required rate of return.
Question 9. 9. In order to find the cost of equity using the firm's cost of debt, the rule of thumb is to:
multiply Kd by one plus the tax rate.
multiply Kd by one minus the tax rate.
add 3% to 6% to Kd.
multiply Kd by the firm's beta.
Question 10. 10. If a firm just paid a dividend equal to $4.00 a share, then for the WACC, in order to find the cost of equity, $4 should be:
divided by the current price of the stock, and the quotient should be added to the dividend growth rate.
divided by the current price of the stock.
multiplied by one minus the tax rate, and the difference divided by the current price of the stock.
multiplied by the sum of one plus the growth rate, and then divided by the current price of the stock; this quotient should be added to the dividend growth rate.