Midterm Makeup for Week 6 – Taken in Week 8

Name: __Iago Oliveira _________________ Date: _________________________

1. 1) In order to create value, a corporation must earn a rate of return on its invested capital
that is higher than the market’s required rate of return on that invested capital.

2. 4) The cost of debt increases relative to the investor’s required return due to flotation
costs, but decreases relative to the investor’s required return due to the tax deductibility of

interest.

3. 3) The cost of debt capital is obtained by substituting the net proceeds per bond for the
bond price in the bond valuation equation and solving for the required return.

4. 4) The cost of preferred stock is equal to the preferred stock dividend divided by the net
proceeds per preferred share.

5. 7) The Capital Asset Pricing Model may be used to estimate the cost of retained earnings.

6. 10) The after-tax cost of equity equals one minus the marginal tax rate times the required
rate of return on common stock.

7. 11) If preferred stock pays a $5 annual dividend and sells for $50, the cost of preferred
stock financing is 10% since dividends are not tax deductible and preferred stock is sold

without flotation costs.

8. 14) The required return of a preferred stockholder, rps, is higher than the cost of preferred

stock for the corporation because stockholders must pay federal taxes on their dividend

income.

9. 15) A security with a reasonably stable price will have a lower required rate of return
than a security with an unstable price.

10. 17) A short-term T-bill’s rate of return should be used in the CAPM formula to determine
the cost of equity capital regardless of the length of the project under consideration.

11. 19) The cost of debt measures the cost of a bank loan, while the cost of preferred stock is
used as a proxy for the cost of a new bond issue.

12. 2) A corporation may lower its cost of capital by shifting a portion of its total financing
from a higher cost source of capital, such as common equity, to a lower cost source of

capital, such as debt.

13. 5) The average cost of capital is the appropriate rate to use when evaluating new
investments, even though the new investments may be in a higher risk class.

14. 7) The mixture of financing sources used by a firm will vary from year to year, so many
firms use target capital structure proportions when calculating the firm’s weighted

average cost of capital.

15. 11) A firm’s weighted average cost of capital is a function of (1) the individual costs of
capital, (2) the capital structure mix, and (3) the level of financing necessary to make the

investment.

16. 3) The firm’s overall cost of capital is important when evaluating the firm’s value, but it
should not be used to evaluate individual projects which have their own unique

characteristics.

17. 2) Advantages of the payback period inc




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