Question

Which of the following is true?

As beta increases the cost of equity increases

As the growth rate increases the cost of equity decreases

As the dividend on preferred stock increases the cost of preferred stock decreases

As the market price of preferred stock increases the cost of preferred stock increases

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Question 10

Which of the following is true?

When calculating the WACC, the appropriate weights are the target market value weights

WACC is calculated by adding the component costs together and dividing by 3

WACC is higher when retained earnings are used compared to issuing new stock

Corporate tax rates always favor the use of common equity as a source of financing

Answer 1

1.

Correct option is > As beta increases the cost of equity increases

The cost of equity increases when the beta of the equity increases.

Beta is multiplier in CAPM = Risk free rate + Beta x (Market rate – Risk free rate)

2.

Correct option is > When calculating the WACC, the appropriate weights are the target market value weights

The market weights are appropriate weights for WACC calculation.

WACC = Cost of equity x Market Weight of equity + Cost of preferred share x Market Weight of preferred share + Cost of debt x Market Weight of debt x (1-Tax rate)