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Which of the following is FALSE?

Select one:

a. The cost to maturity that a firm pays on its existing bonds equals the rate of return required by the market.

b. The cost of retained earnings is generally higher than both the cost of debt and cost of preferred stock.

c. The net proceeds used in calculation of the cost of long-term debt are funds actually received from the sale after paying for flotation costs and taxes.

d. The cost of retained earnings is always lower than the cost of a new issue of common stock due to the absence of flotation costs when financing projects with retained earnings.

The Bigelow Company has a cost of equity of 13 percent, a pre-tax cost of debt of 8 percent, and a tax rate of 35 percent. What is the firm's weighted average cost of capital if the market value of debt is $6m and equity is $1m?

Select one:

a. 10.08 percent

b. 10.24 percent

c. 9.21 percent

d. 6.58 percent

Which of the following is TRUE?

Select one:

a. In computing the cost of retained earnings, the net proceeds represents the amount of money retained net of any underpricing and/or flotation costs.

b. From a bond issuer's perspective, the IRR on a bond's cash flows is its yield to maturity (YTM); from the investor's perspective, the IRR on a bond's cash flows is the cost to maturity.

c. If you purchased the same percentage of each type of security that a firm issued, the expected return on that portfolio of securities would equal the firm's weighted average cost of capital.

d. Holding risk constant, the implementation of projects with a rate of return above the cost of capital will decrease the value of a firm, and vice versa.

The cost of common stock equity may be estimated by using the ________.

Select one:

a. DuPont analysis

b. Gordon model

c. break-even analysis

d. yield curve

Generally the least expensive source of long-term capital is ________.

Select one:

a. preferred stock

b. long-term debt

c. common stock

d. retained earnings

Answer 1

Q1:

Option A; All other options are correct and cost to maturity paid by a firm might not be same as that demanded by market.

Q2:

value of company= debt+ equity= 6+1=7

wacc =(equity/value)* cost of equity + (debt/value)*cost of debt*(1-tx rate)

=(6/7)*.13+ (1/7)*.08(1-.35) =11.88% --- not in the option

Q3:

option B ; From a bond issuer's perspective, the IRR on a bond's cash flows is its yield to maturity (YTM); from the investor's perspective, the IRR on a bond's cash flows is the cost to maturity.

All the others are not correct

Q4:

option b; Gordon model also called as Dividend discount model used to estimate cost of equity

Q5:

optiob B; Generally debt is considered as least expensive source of capital. It also has tax benefits.