FUNDAMENTALS OF FINANCIAL MANAGEMENT
09 – The Cost of Capital
Test Bank
Page 1 of 11
CAPITAL COMPONENTS
1. Which of the following is not considered a capital component for the purpose of calculating the
weighted average cost of capital (WACC) as it applies to capital budgeting? (E)
A. Long-term debt.
C. Accounts payable and accruals.
B. Common stock.
D. Preferred stock.
2. For a typical firm with a given capital structure, which of the following is correct? (Note: All rates are
after taxes.) (E)
A. kd > ke > ks > WACC.
D. ke > ks > WACC > kD.
B. ks > ke > kd > WACC.
E. None of the statements above is correct.
C. WACC > ke > ks > kD.
3. Which of the following statements is most correct? (E)
A.
If a company’s tax rate increases but the yield to maturity of its noncallable bonds remains the
same, the company’s marginal cost of debt capital used to calculate its weighted average cost
of capital will fall.
B. All else equal, an increase in a company’s stock price will increase the marginal cost of
retained earnings, ks.
C. All else equal, an increase in a company’s stock price will increase the marginal cost of issuing
new common equity, kE.
D. Statements a and b are correct.
E. Statements b and c are correct.
4. Which of the following statements is most correct? (E)
A. Since the money is readily available, the cost of retained earnings is usually a lot cheaper than
the cost of debt financing.
B. When calculating the cost of preferred stock, a company needs to adjust for taxes, because
preferred stock dividends are tax deductible.
C. When calculating the cost of debt, a company needs to adjust for taxes, because interest
payments are tax deductible.
D. Statements a and b are correct.
E. Statements b and c are correct.
5. Which of the following statements is most correct?
A.
In the weighted average cost of capital calculation, we must adjust the cost of preferred stock
for the tax exclusion of 70 percent of dividend income.
B. We ideally would like to use historic