Cost of Capital Practice Exam Quiz
Which of the following best defines the “cost of capital”?
A) The interest rate a company pays on its short-term debts
B) The return required by investors to compensate for the risk of an investment
C) The price of acquiring new capital assets
D) The cost incurred in purchasing capital equipment
The cost of debt is calculated after adjusting for:
A) Inflation
B) Taxes
C) Dividends
D) Profit margins
Which of the following would typically increase the cost of equity?
A) Higher dividends
B) Lower stock price volatility
C) Increased risk premium
D) Decreased interest rates
The Weighted Average Cost of Capital (WACC) is used to:
A) Calculate the return on equity investments
B) Determine the optimal capital structure
C) Evaluate investment project returns
D) Estimate future stock prices
What is the formula for the cost of equity using the Capital Asset Pricing Model (CAPM)?
A) Risk-Free Rate + Beta × Market Return
B) Risk-Free Rate + Market Return
C) Dividend Yield + Growth Rate
D) Debt Rate + Risk Premium
If a company’s WACC is 10% and the company is considering a new project, the project’s return must be:
A) Less than 10%
B) Equal to 10%
C) Greater than 10%
D) Any value depending on the capital structure
What effect does increasing the debt-to-equity ratio have on a company’s cost of capital, assuming the cost of debt remains constant?
A) It increases the cost of capital
B) It decreases the cost of capital
C) It has no effect
D) It causes the cost of equity to decrease
A company with high business risk is likely to have:
A) A low cost of equity
B) A low cost of debt
C) A high cost of equity
D) A low WACC
The cost of capital for a firm is influenced by:
A) Market interest rates
B) The firm’s capital structure
C) The firm’s business risk
D) All of the above
In calculating WACC, the weight of debt is based on:
A) The book value of debt
B) The market value of debt
C) The total number of shares outstanding
D) The retained earnings
If a firm uses retained earnings as its source of equity financing, the cost of equity will be:
A) Higher than the cost of debt
B) Equal to the cost of debt
C) Equal to the dividend rate
D) Lower than if new equity is issued
The cost of debt is typically lower than the cost of equity because:
A) Debt is tax-deductible
B) Debt is riskier than equity
C) Equity investors require a higher return
D) Debt interest rates are fixed
The “marginal cost of capital” refers to:
A) The weighted average cost of all capital sources
B) The cost of acquiring an additional dollar of capital
C) The cost of equity capital only
D) The rate of return on a company’s investment
Which of the following is NOT typically included in the calculation of WACC?
A) Cost of debt
B) Cost of equity
C) Cost of preferred stock
D) Tax rates
What is the primary advantage of using the weighted average cost of capital (WACC)?
A) It accounts for market risk
B) It helps determine the most expensive source of capital
C) It provides a benchmark for investment project decisions
D) It increases the firm’s debt financing
If a company’s debt-to-equity ratio increases, the firm’s cost of equity is likely to:
A) Decrease
B) Increase
C) Stay the same
D) Be unaffected
In calculating the WACC, which of the following would increase the company’s overall cost of capital?
A) Decreased business risk
B) Increased market interest rates
C) Increased dividend payouts
D) Increased profitability
Which of the following is a key assumption in the use of the Modigliani-Miller theorem regarding capital structure?
A) No taxes exist
B) Markets are inefficient
C) Debt financing increases the cost of equity
D) Firms always have access to equity financing
The cost of equity is generally higher than the cost of debt because:
A) Equity holders bear more risk than debt holders
B) Debt holders have higher returns
C) Debt is riskier than equity
D) Equity financing has no associated costs
A firm that uses more debt in its capital structure is likely to experience:
A) A higher WACC
B) A lower WACC
C) A higher cost of equity
D) No change in WACC
The “tax shield” on debt refers to:
A) The reduction in taxes due to interest payments on debt
B) The interest rate paid on debt
C) The risk of bankruptcy associated with debt
D) The cost of issuing new debt
Which of the following is most likely to result in a higher cost of capital?
A) Low inflation rates
B) High risk-free interest rates
C) Increased debt levels
D) Strong corporate governance
In the WACC calculation, the cost of equity is generally calculated using:
A) The dividend discount model
B) The market risk premium
C) The cost of new equity issued
D) The yield on government bonds
What is the cost of equity for a firm that has a 7% risk-free rate, a market return of 12%, and a beta of 1.2?
A) 11.4%
B) 14.0%
C) 12.0%
D) 10.2%
A firm should continue with an investment project if the expected return is:
A) Greater than the WACC
B) Equal to the WACC
C) Less than the WACC
D) Independent of the WACC
The cost of preferred stock is calculated by:
A) Dividends per share / Price of preferred stock
B) Dividends per share / Market return
C) Interest rate on preferred shares
D) Price per share / Dividends
What does a high beta indicate about the cost of equity?
A) Lower risk and lower cost of equity
B) Higher risk and higher cost of equity
C) No risk and no cost of equity
D) Lower risk and higher cost of equity
Which of the following sources of capital is least likely to be included in the WACC calculation for most companies?
A) Debt
B) Preferred stock
C) Retained earnings
D) Common stock
A company with a high level of debt is most likely to have:
A) A higher WACC
B) A lower cost of debt
C) A higher cost of equity
D) A lower cost of equity
The cost of capital is primarily used in:
A) Project evaluation
B) Marketing strategies
C) Hiring decisions
D) Tax planning
Which of the following represents a firm’s cost of capital from debt?
A) The coupon rate on debt
B) The dividend yield on preferred stock
C) The rate of return on equity
D) The net present value of debt
If the market risk premium increases, the cost of equity will:
A) Decrease
B) Stay the same
C) Increase
D) Be unaffected
A firm with a high level of debt financing is at a greater risk of:
A) Bankruptcy
B) Reducing the cost of equity
C) Reducing its WACC
D) Reducing business risk
What is the main reason why a firm might issue new debt instead of equity to finance a project?
A) Debt financing is generally cheaper due to the tax shield
B) Debt does not require periodic payments
C) Debt increases the risk of the firm and reduces its WACC
D) Debt is more flexible than equity financing
The cost of retained earnings is generally considered:
A) Equal to the cost of debt
B) Lower than the cost of debt
C) Higher than the cost of new equity
D) Equal to the cost of new equity
When calculating WACC, the weight of equity is determined by:
A) The book value of equity
B) The market value of equity
C) The company’s earnings before tax
D) The total number of shares outstanding
If a company’s WACC is higher than the required return on a project, the project should:
A) Be accepted
B) Be rejected
C) Be evaluated for higher returns
D) Be delayed
The cost of preferred stock is typically higher than the cost of debt because:
A) Preferred stock dividends are not tax-deductible
B) Preferred stockholders take on more risk than bondholders
C) Preferred stock dividends are fixed
D) Debt financing is more flexible than equity financing
The CAPM model assumes that investors:
A) Prefer higher risk
B) Are risk-averse
C) Are indifferent to risk
D) Only consider short-term returns
In a firm with no debt, the WACC is:
A) Equal to the cost of debt
B) Equal to the cost of equity
C) A weighted average of the cost of debt and equity
D) Zero
Which of the following does NOT directly affect a firm’s cost of equity?
A) The firm’s beta
B) The risk-free rate
C) The firm’s debt ratio
D) The market risk premium
A project should be accepted if its internal rate of return (IRR) is:
A) Less than the WACC
B) Equal to the WACC
C) Greater than the WACC
D) Greater than the market risk premium
When using the dividend discount model (DDM) to calculate the cost of equity, which of the following is required?
A) The market price of the stock
B) The growth rate of dividends
C) The risk-free rate
D) The coupon rate on debt
The weighted average cost of capital is the weighted average of:
A) The cost of debt and equity
B) The cost of debt and dividends
C) The cost of equity and dividends
D) The cost of debt and preferred stock
The primary advantage of using retained earnings instead of issuing new stock is:
A) The cost of retained earnings is generally lower
B) Retained earnings are tax-deductible
C) Issuing new stock dilutes existing shareholders
D) Retained earnings do not require a return
Which of the following is the most expensive source of financing for a firm?
A) Debt
B) Preferred stock
C) Retained earnings
D) Common equity
The cost of capital for a firm with a high risk of bankruptcy is likely to be:
A) Lower than that of a firm with low bankruptcy risk
B) Equal to that of a firm with low bankruptcy risk
C) Higher than that of a firm with low bankruptcy risk
D) Unaffected by bankruptcy risk
The cost of equity for a company can be calculated using the:
A) Dividend discount model (DDM)
B) Return on assets (ROA)
C) Capital asset pricing model (CAPM)
D) All of the above
What is the cost of debt for a firm that has a bond yield of 6% and is in the 30% tax bracket?
A) 6%
B) 4.2%
C) 10%
D) 8%
A firm can lower its WACC by:
A) Issuing more debt
B) Issuing more equity
C) Increasing dividends
D) Decreasing its capital budget
Which of the following best describes the relationship between business risk and cost of capital?
A) Higher business risk leads to a higher cost of capital
B) Higher business risk leads to a lower cost of capital
C) Business risk has no effect on the cost of capital
D) Business risk reduces the required return on equity
The risk-free rate used in CAPM is generally based on:
A) The return on corporate bonds
B) The return on government bonds
C) The market return
D) The dividend yield of a stock
The firm’s capital structure affects the:
A) Cost of debt only
B) Cost of equity only
C) WACC
D) Market value of the firm
The use of debt in a firm’s capital structure can lead to:
A) Increased financial leverage
B) Decreased business risk
C) Lower cost of debt
D) Lower cost of equity
Which of the following is a characteristic of a firm’s cost of debt?
A) It is tax-adjusted to reflect the tax shield
B) It is based on the company’s current stock price
C) It does not depend on the firm’s bond rating
D) It is unaffected by changes in interest rates
If a company’s beta is 1.5, this indicates that the company is:
A) Less volatile than the market
B) More volatile than the market
C) Unaffected by market movements
D) Equal in volatility to the market
A firm’s cost of capital increases when:
A) The firm’s debt rating improves
B) The market risk premium decreases
C) The firm’s risk increases
D) The interest rates decrease
The cost of equity can be estimated by which of the following methods?
A) Dividend discount model (DDM)
B) Capital Asset Pricing Model (CAPM)
C) Earnings capitalization model
D) All of the above
Which of the following would cause the cost of capital to decrease?
A) Increase in interest rates
B) Higher levels of debt in the capital structure
C) Increased risk associated with the firm
D) A decrease in the market risk premium
A company can reduce its WACC by:
A) Increasing its debt-to-equity ratio
B) Reducing the use of debt
C) Lowering its equity dividend payout
D) Increasing its business risk
What does the weighted average cost of capital (WACC) represent?
A) The average return the company must earn on its existing assets
B) The rate of return required by the company’s investors (debt and equity holders)
C) The cost of equity only
D) The risk-free rate of return
A firm’s cost of equity is influenced by:
A) The risk-free rate
B) The firm’s beta
C) The market risk premium
D) All of the above
The market value of debt is important in determining the WACC because:
A) It affects the cost of equity
B) It helps to calculate the weight of debt in the capital structure
C) It determines the cost of debt
D) It has no effect on the cost of capital
The cost of debt is typically lower than the cost of equity because:
A) Debt carries more risk for the investor
B) Debt interest is tax-deductible
C) Debt has no risk for the investor
D) Debt does not require periodic payments
If a company has a lower level of debt, its cost of equity is likely to:
A) Increase
B) Decrease
C) Stay the same
D) Become irrelevant
If the cost of equity is 12%, and the company’s debt has an interest rate of 5%, the WACC will be:
A) Higher if the company has more equity than debt
B) Higher if the company has more debt than equity
C) The same regardless of the capital structure
D) Dependent on the market risk premium
What is the main purpose of calculating the cost of capital?
A) To determine how much capital a company should raise
B) To measure the risk of investing in a company
C) To evaluate the return required by investors to support the business
D) To estimate the future earnings of the company
The cost of retained earnings is typically:
A) The same as the cost of debt
B) The same as the cost of new equity
C) Lower than the cost of new equity
D) Higher than the cost of debt
When calculating WACC, the cost of preferred stock is:
A) The dividend rate on preferred stock
B) The coupon rate on debt
C) The rate of return required by equity holders
D) The rate of return required by bondholders
What happens to the cost of capital when a firm takes on more debt in its capital structure?
A) It always increases
B) It always decreases
C) It may decrease at first but then increase after a certain point
D) It is unaffected by the amount of debt
The formula to calculate the cost of equity using CAPM is:
A) Risk-free rate + (Market rate – Risk-free rate) * Beta
B) Dividend yield + Growth rate
C) (Dividend / Price) + Growth rate
D) Market rate * Beta
A higher beta coefficient indicates:
A) Lower risk compared to the market
B) Higher risk compared to the market
C) No risk compared to the market
D) The same risk as the market
The tax shield of debt financing is most significant when:
A) The company has a high tax rate
B) The company has no income
C) The company has high interest payments on its debt
D) The company has low risk
A decrease in the market risk premium leads to:
A) An increase in the cost of equity
B) A decrease in the cost of equity
C) No change in the cost of equity
D) An increase in the cost of debt
Which of the following is NOT a method to calculate the cost of equity?
A) Dividend discount model (DDM)
B) Capital asset pricing model (CAPM)
C) Earnings yield approach
D) Discounted cash flow model
The cost of debt is adjusted for taxes because:
A) Interest payments are tax-deductible
B) Taxes affect the risk level of debt
C) The market value of debt is affected by taxes
D) All of the above
A company’s WACC is most influenced by:
A) The interest rate on its debt
B) The growth rate of dividends
C) The market risk premium
D) The company’s capital structure
If a firm’s cost of capital is higher than its return on a new project, the project should:
A) Be accepted
B) Be rejected
C) Be re-evaluated with more favorable assumptions
D) Be delayed
The optimal capital structure for a company is the one that:
A) Maximizes the WACC
B) Minimizes the WACC
C) Maximizes the cost of equity
D) Minimizes business risk
A firm with a debt-to-equity ratio of 1:1 will likely have:
A) A higher WACC compared to a firm with no debt
B) A lower WACC compared to a firm with no debt
C) A WACC equal to the cost of debt
D) A WACC equal to the cost of equity
A company’s weighted average cost of capital (WACC) is a weighted average of:
A) The cost of debt, preferred stock, and retained earnings
B) The cost of debt, equity, and preferred stock
C) The risk-free rate, the cost of equity, and the cost of debt
D) The cost of debt and common stock dividends
The cost of capital will be the same regardless of the capital structure when:
A) The company has no debt
B) The company is in a perfectly competitive market
C) The company is facing no business risk
D) The company is in equilibrium between risk and return
When calculating WACC, the weight of debt is calculated based on:
A) The book value of debt
B) The market value of debt
C) The debt’s coupon rate
D) The debt’s maturity period
The cost of debt is calculated using:
A) The yield to maturity on debt securities
B) The coupon rate of the debt
C) The risk-free rate
D) The return on equity
When calculating WACC, the cost of equity is influenced by:
A) The risk-free rate and the market risk premium
B) The company’s dividend policy
C) The company’s operating risk
D) Both A and B
If a company has preferred stock, the cost of preferred stock is calculated as:
A) The dividend on preferred stock divided by the stock price
B) The dividend on preferred stock divided by the book value
C) The dividend on preferred stock multiplied by the number of shares
D) The interest rate on preferred stock
If a company increases its debt ratio, the cost of debt is likely to:
A) Increase
B) Decrease
C) Stay the same
D) Become irrelevant
A higher level of debt financing in a company’s capital structure leads to:
A) Higher interest payments, but lower equity costs
B) Higher equity costs and lower interest payments
C) A higher WACC
D) A lower WACC
Which of the following is true regarding the cost of capital?
A) It is the required return for all investors in the company
B) It is the return the company must earn to satisfy its equity investors only
C) It only includes the return required by debt holders
D) It is only relevant when making investment decisions
In the weighted average cost of capital, the weight of equity is determined by:
A) The market value of equity divided by the total market value of capital
B) The market price of the stock
C) The book value of equity divided by the total book value of capital
D) The dividend yield on common stock
When calculating WACC, the cost of debt is usually adjusted for taxes because:
A) The interest payments on debt are tax-deductible
B) The cost of debt is fixed over time
C) Debt is a form of equity
D) Interest payments on debt are not taxable
A decrease in the risk-free rate would likely cause:
A) An increase in the cost of equity
B) A decrease in the cost of debt
C) A decrease in the cost of equity
D) No effect on the cost of capital
The cost of capital for a project is generally:
A) The same as the company’s WACC
B) The cost of equity for the company
C) The risk-free rate of return
D) Based on the specific risk of the project
The cost of capital for a high-risk project should be:
A) The same as the company’s WACC
B) Lower than the company’s WACC
C) Higher than the company’s WACC
D) Based solely on the debt financing used
The cost of equity capital can be estimated using which of the following?
A) Dividend Discount Model
B) Capital Asset Pricing Model (CAPM)
C) Both A and B
D) Bond Yield Plus Risk Premium Model
A project with an uncertain cash flow stream would likely have:
A) A lower cost of capital than a stable cash flow project
B) A higher cost of capital than a stable cash flow project
C) The same cost of capital as a stable cash flow project
D) No cost of capital
The cost of debt is typically lower than the cost of equity because:
A) Debt holders are more likely to take on risk
B) Debt has tax benefits (tax shield)
C) Debt does not require any periodic payments
D) Debt holders do not require any return
The company’s WACC is 8%. If the company accepts a project with a return of 6%, it is likely that:
A) The project will increase the value of the company
B) The project will decrease the value of the company
C) The project will have no effect on the value of the company
D) The company will be able to raise more capital
The market risk premium is:
A) The difference between the expected return on the market and the risk-free rate
B) The risk-free rate
C) The expected return on the market
D) The return on a risk-free asset
Which of the following would typically increase a company’s WACC?
A) Issuing more debt at a lower interest rate
B) Increasing the company’s dividend payouts
C) Increasing the company’s debt ratio without reducing equity
D) Lowering the market risk premium
The cost of retained earnings is:
A) The same as the cost of new equity
B) Lower than the cost of new equity
C) Higher than the cost of new equity
D) Equal to the market risk premium
When calculating WACC, the weight of debt is influenced by:
A) The total debt on the company’s balance sheet
B) The coupon rate of debt
C) The market value of debt
D) The risk-free rate
The company’s cost of capital is primarily determined by:
A) The required returns of investors
B) The company’s tax rate
C) The company’s cost of debt
D) The company’s risk profile
The cost of equity can be estimated using the CAPM formula. Which of the following is a component of the CAPM formula?
A) Beta
B) Interest rate on debt
C) The company’s dividend payout
D) The company’s market value
What is the effect of an increase in interest rates on the cost of capital for a company?
A) The cost of debt decreases
B) The cost of equity decreases
C) The WACC increases
D) The cost of equity increases but the cost of debt decreases
A company with a high level of financial leverage (debt) will likely have:
A) A higher cost of equity
B) A lower cost of equity
C) The same cost of equity
D) A higher tax rate
The optimal capital structure is the one that:
A) Minimizes the risk of bankruptcy
B) Maximizes the company’s equity
C) Maximizes the company’s WACC
D) Minimizes the company’s WACC
The marginal cost of capital is:
A) The cost of retaining earnings
B) The cost of capital for the last unit of financing
C) The cost of equity for a new project
D) The weighted average cost of debt and equity
Which of the following is true about the cost of debt?
A) It is always equal to the coupon rate of the debt
B) It is the same as the yield to maturity on the debt
C) It is unaffected by the company’s tax rate
D) It is irrelevant in the calculation of WACC
If the debt ratio of a company increases, the cost of equity will likely:
A) Decrease
B) Increase
C) Stay the same
D) Become irrelevant
Which of the following is true regarding the dividend discount model (DDM)?
A) It is used to calculate the cost of debt
B) It is used to calculate the cost of equity for firms with constant dividends
C) It cannot be used for companies that do not pay dividends
D) It is used to calculate the cost of preferred stock
Which of the following would lead to a decrease in the cost of capital?
A) Increasing the level of debt financing
B) Decreasing the risk-free rate
C) Increasing the dividend payout ratio
D) Increasing the firm’s beta
If a company’s return on a new project is greater than its WACC, then the:
A) Project will decrease the firm’s value
B) Project will increase the firm’s value
C) WACC will increase
D) Project will be considered too risky to accept
Which of the following factors would NOT influence a company’s cost of capital?
A) The risk of the company’s existing operations
B) The cost of the company’s debt
C) The overall market interest rates
D) The specific characteristics of the project being undertaken
In general, a company should raise capital using debt rather than equity if:
A) The company’s debt capacity is low
B) The cost of debt is lower than the cost of equity
C) The cost of debt is higher than the cost of equity
D) The company has a high dividend payout ratio
If a company has no debt, its WACC is simply:
A) The cost of equity
B) The average cost of all its capital
C) The cost of debt
D) The risk-free rate
Which of the following would increase the cost of capital for a firm?
A) Increasing the debt-to-equity ratio
B) Decreasing the level of risk in the company’s operations
C) Reducing the cost of debt financing
D) Increasing the company’s beta
The cost of debt is usually calculated using:
A) The coupon rate of the debt
B) The yield to maturity on debt securities
C) The current market price of the debt
D) The risk-free rate
The weighted average cost of capital (WACC) is an important tool for:
A) Deciding whether to increase debt financing
B) Determining the company’s optimal capital structure
C) Setting a project’s internal rate of return (IRR)
D) Determining the company’s tax rate
The risk associated with debt financing is:
A) The possibility of default due to failure to make payments
B) The tax benefits associated with debt
C) The fluctuations in the stock price
D) The potential for company growth
Which of the following statements is true regarding the cost of equity?
A) It is calculated as the interest rate on debt
B) It is typically higher than the cost of debt
C) It includes tax adjustments
D) It is fixed over time
When the required rate of return on equity is equal to the cost of debt, the WACC will:
A) Be at its minimum
B) Increase
C) Be at its maximum
D) Remain constant
Which of the following is a characteristic of a company with a high cost of equity?
A) Low risk and high debt ratio
B) High risk and low debt ratio
C) High risk and high debt ratio
D) Low risk and low debt ratio
The marginal cost of capital reflects:
A) The cost of capital for the last dollar raised
B) The cost of equity only
C) The average cost of capital for the company
D) The debt ratio of the company
If a company’s beta increases, the cost of equity will likely:
A) Decrease
B) Stay the same
C) Increase
D) Be unaffected by changes in beta
A decrease in the company’s cost of debt will likely result in:
A) A higher WACC
B) A lower WACC
C) A higher cost of equity
D) No change in the WACC
The capital asset pricing model (CAPM) is used to calculate:
A) The cost of debt
B) The cost of equity
C) The cost of retained earnings
D) The WACC
In calculating the WACC, the weights of debt and equity are determined by:
A) The market values of debt and equity
B) The historical cost of debt and equity
C) The company’s tax rate
D) The dividend payouts of the company
The cost of debt is usually lower than the cost of equity because:
A) Equity holders take on more risk
B) Debt is tax-deductible
C) Debt holders are paid before equity holders in case of liquidation
D) All of the above
If the cost of capital is greater than the internal rate of return (IRR) on a project, the project will:
A) Increase the firm’s value
B) Decrease the firm’s value
C) Have no impact on the firm’s value
D) Increase the firm’s cost of capital
If a company has a WACC of 10%, and a new project is expected to generate a return of 12%, what should the company do?
A) Reject the project
B) Accept the project
C) Increase the WACC
D) Increase the cost of equity
When a company is in the growth phase and the risk is high, it is likely that:
A) The cost of debt is higher than the cost of equity
B) The cost of equity is higher than the cost of debt
C) The WACC will be lower than the cost of equity
D) The WACC will be the same as the cost of debt
The cost of retained earnings is typically calculated as:
A) The risk-free rate
B) The return required by investors for holding the company’s stock
C) The market value of the company’s equity
D) The coupon rate on debt
Which of the following would most likely decrease the company’s WACC?
A) Issuing more debt at a higher interest rate
B) Increasing the company’s equity value without issuing new debt
C) Reducing the debt-to-equity ratio
D) Increasing the company’s beta
If a company issues new equity instead of debt, the impact on the WACC will likely be:
A) An increase in the WACC
B) A decrease in the WACC
C) No change in the WACC
D) An increase in the cost of equity only
A company’s weighted average cost of capital (WACC) represents:
A) The cost of debt plus equity
B) The required return on the company’s assets
C) The average return required by investors for holding the company’s securities
D) The interest rate paid on all of the company’s debt
The risk-free rate used in the CAPM model is typically the return on:
A) Treasury bonds
B) Corporate bonds
C) Stock market index
D) Preferred stock
If the company’s cost of equity decreases, the overall WACC will:
A) Increase
B) Decrease
C) Stay the same
D) Become negative
When estimating the cost of capital for a multinational company, one must consider:
A) The risk-free rate in the country of operation
B) The tax rate of the home country
C) The cost of equity in each country the company operates in
D) All of the above
The market risk premium in the CAPM model is calculated as:
A) The expected return on the market minus the risk-free rate
B) The return on the risk-free asset
C) The company’s beta times the expected return on the market
D) The cost of debt minus the cost of equity
The cost of capital for a project should be adjusted for its risk because:
A) Higher risk projects require higher returns to compensate investors
B) Lower risk projects are more likely to succeed
C) It is easier to finance high-risk projects
D) Investors are indifferent to risk
If a company is highly leveraged, it will likely experience:
A) Lower cost of capital
B) Higher cost of equity
C) Lower cost of equity
D) No effect on the cost of capital
When calculating the WACC for a company with no debt, the WACC is equal to:
A) The cost of equity
B) The average cost of debt and equity
C) The risk-free rate
D) The company’s market value
Which of the following would most likely increase the cost of capital?
A) An increase in the company’s dividend payouts
B) A reduction in the company’s debt ratio
C) An increase in the company’s market risk premium
D) A decrease in the interest rate on debt
A company has a higher WACC than its industry average. This could indicate:
A) The company is in a lower risk industry
B) The company has a higher risk profile
C) The company has more retained earnings
D) The company’s debt ratio is lower
The weighted average cost of capital (WACC) is primarily used by companies to:
A) Set the required rate of return for new projects
B) Set the interest rate for new debt issuance
C) Determine the total equity value of the company
D) Calculate the company’s dividend payout ratio
If a company has an increasing cost of equity, this could be a signal that:
A) The company is less risky
B) The company is taking on more debt
C) The company’s stock is becoming less attractive to investors
D) The company’s profitability is increasing
Which of the following is NOT a typical component in calculating the cost of equity using the dividend discount model (DDM)?
A) The expected dividend growth rate
B) The dividend paid per share
C) The market price of the stock
D) The cost of debt
The beta coefficient in the CAPM model reflects:
A) The risk-free rate of return
B) The sensitivity of a company’s stock return to changes in the market return
C) The cost of equity for the company
D) The company’s market value
If a company’s risk premium increases, the cost of equity will:
A) Decrease
B) Increase
C) Stay the same
D) Become negative
What is the primary reason for using the weighted average cost of capital (WACC) in investment decisions?
A) To calculate the company’s net income
B) To determine the minimum return required for investments
C) To calculate the market value of the firm
D) To determine the value of dividends
In calculating the WACC, which of the following is used to determine the cost of debt?
A) The coupon rate of the company’s bonds
B) The risk-free rate
C) The return on equity
D) The company’s market risk premium
The cost of equity is higher than the cost of debt primarily because:
A) Debt is more flexible than equity
B) Equity holders take on more risk than debt holders
C) Equity payments are tax-deductible
D) Debt holders have a higher required return
Which of the following is NOT a factor affecting the cost of capital?
A) The company’s tax rate
B) The risk-free rate of return
C) The company’s dividend payout ratio
D) The company’s capital structure
If a company issues more debt, what will most likely happen to its WACC?
A) It will increase
B) It will decrease
C) It will remain unchanged
D) It will fluctuate depending on market conditions
The cost of capital for a project is determined by:
A) The overall market interest rate
B) The riskiness of the project relative to the company’s overall risk
C) The company’s historical cost of equity
D) The company’s tax rate
A company’s cost of debt is typically lower than its cost of equity because:
A) Debt has no tax advantage
B) Debt is less risky to investors
C) Equity investors are guaranteed higher returns
D) Debt holders do not have voting rights
When a company has no debt, its WACC is equal to:
A) The risk-free rate
B) The cost of equity
C) The cost of debt
D) The company’s dividend yield
Which of the following would most likely increase the cost of capital for a company?
A) A decrease in the company’s debt-to-equity ratio
B) A decrease in the company’s equity risk premium
C) An increase in the company’s beta
D) An increase in the company’s dividend payout ratio
Which of the following best describes the concept of a “marginal cost of capital”?
A) The average cost of capital across all sources
B) The cost of raising the first dollar of capital
C) The cost of obtaining additional capital for new projects
D) The cost of capital used in mergers and acquisitions
The cost of debt is typically calculated by:
A) Using the interest rate on a company’s bonds
B) Taking the bond’s yield to maturity
C) Subtracting the risk-free rate from the company’s debt rate
D) Both A and B
If a company issues bonds at a higher interest rate than its existing debt, the company’s WACC will likely:
A) Increase
B) Decrease
C) Stay the same
D) Fluctuate based on market conditions
The cost of capital can be affected by changes in which of the following?
A) Market interest rates
B) The company’s tax rate
C) The company’s risk profile
D) All of the above
The formula for calculating the cost of equity using the dividend discount model (DDM) is:
A) Cost of equity = Risk-free rate + Beta * (Market return – Risk-free rate)
B) Cost of equity = (Dividends per share / Price per share) + Dividend growth rate
C) Cost of equity = (Market return – Risk-free rate) * Beta
D) Cost of equity = Earnings per share / Price per share
A company with a higher debt ratio will likely experience:
A) A higher cost of capital due to increased risk
B) A lower cost of debt
C) A lower cost of equity
D) A lower beta coefficient
In the Capital Asset Pricing Model (CAPM), which of the following represents the market risk premium?
A) The risk-free rate
B) The expected return on the market minus the risk-free rate
C) The return on the company’s stock
D) The return on government bonds
The cost of equity using the CAPM model is calculated by:
A) Adding the risk-free rate to the market risk premium
B) Subtracting the cost of debt from the market return
C) Multiplying the beta by the risk-free rate
D) Adding the risk-free rate to the product of the beta and the market risk premium
If a company’s tax rate decreases, what is the most likely effect on its WACC?
A) WACC will increase
B) WACC will decrease
C) WACC will remain unchanged
D) WACC will be more volatile
In which scenario is the cost of debt likely to be higher than the cost of equity?
A) When the company is highly leveraged
B) When the company has a very low risk profile
C) When the company has a high tax rate
D) When the company has a low beta coefficient
A decrease in the market risk premium will likely result in:
A) A higher cost of equity
B) A lower cost of equity
C) An increase in the WACC
D) A decrease in the company’s debt cost
What is the tax shield on debt?
A) The interest on debt is tax-deductible
B) The principal payments on debt are tax-deductible
C) The dividends on equity are tax-deductible
D) The market risk premium is tax-deductible
A company with a higher level of debt relative to equity is said to have:
A) A higher cost of capital
B) A higher cost of debt
C) A lower beta coefficient
D) A higher tax rate
A firm’s cost of equity is influenced by:
A) The firm’s dividend payout
B) The risk-free rate
C) The firm’s stock volatility compared to the market
D) All of the above
In determining the cost of capital, which of the following is generally considered the most important factor for equity investors?
A) The company’s earnings stability
B) The company’s stock price
C) The market risk premium
D) The company’s tax rate
The weighted average cost of capital (WACC) is the:
A) Minimum return a company must earn to satisfy investors
B) Return on equity for the company
C) Rate at which a company can borrow capital
D) Average return on the company’s investments
A higher beta coefficient indicates:
A) Lower risk and lower return
B) Higher risk and higher return
C) Lower risk and higher return
D) No effect on the cost of equity
A company’s WACC is most likely to decrease if:
A) The market risk premium increases
B) The cost of debt increases
C) The debt-to-equity ratio increases
D) The tax rate decreases
In which situation will the weighted average cost of capital (WACC) be most useful?
A) When deciding whether to fund a new project
B) When determining dividend payout levels
C) When calculating earnings per share
D) When setting executive compensation
What effect does an increase in a company’s cost of equity have on its WACC?
A) It decreases the WACC
B) It increases the WACC
C) It has no effect on the WACC
D) It causes the WACC to become negative
What is the relationship between the cost of debt and the tax rate?
A) The cost of debt increases as the tax rate increases
B) The cost of debt decreases as the tax rate increases
C) The cost of debt is unaffected by changes in tax rates
D) The cost of debt is equal to the tax rate
Which of the following factors will generally lower a company’s cost of capital?
A) An increase in the company’s debt-to-equity ratio
B) A higher risk premium
C) A lower credit rating
D) A reduction in the risk-free rate
The cost of capital for a project is affected by:
A) The company’s overall capital structure
B) The project’s risk relative to the company’s overall risk
C) The tax rate of the company
D) All of the above
In the Capital Asset Pricing Model (CAPM), which of the following represents the return required by equity investors?
A) Risk-free rate
B) Risk-free rate + Beta * Market risk premium
C) The dividend yield
D) The expected return on the company’s stock
If a company has a higher proportion of debt in its capital structure, the company’s WACC will likely:
A) Increase
B) Decrease
C) Remain unchanged
D) Become more volatile
Which of the following is true regarding the cost of debt?
A) It is always higher than the cost of equity
B) It is the return that the company must offer to its debt holders
C) It is always the same as the coupon rate on bonds
D) It is unaffected by tax rates
When calculating the WACC, the cost of equity is usually based on:
A) The company’s earnings per share
B) The dividends paid out to shareholders
C) The dividend discount model (DDM) or the CAPM
D) The company’s long-term debt
The debt tax shield refers to the:
A) Reduction in taxable income due to interest payments on debt
B) Increase in the cost of capital due to debt
C) Decrease in the company’s equity costs
D) Higher tax rate associated with debt financing
A company’s WACC is most affected by which of the following?
A) The interest rate on its debt
B) The amount of its cash reserves
C) The company’s capital expenditures
D) The number of employees
In determining the cost of debt, the effective interest rate is used because it:
A) Reflects the after-tax cost of debt
B) Represents the coupon rate of the debt
C) Includes any flotation costs associated with issuing bonds
D) Is calculated using the company’s equity risk premium
When using the Dividend Discount Model (DDM) to calculate the cost of equity, the dividend growth rate represents:
A) The risk-free rate
B) The company’s expected future dividend growth rate
C) The return required by debt investors
D) The rate at which the company’s earnings are growing
A decrease in the company’s equity risk premium will lead to:
A) A decrease in the cost of equity
B) An increase in the cost of debt
C) A decrease in the company’s dividend payments
D) An increase in the WACC
Which of the following is an advantage of using debt financing?
A) Debt financing does not require equity dilution
B) Debt financing always results in lower costs than equity financing
C) Debt financing is risk-free
D) Debt financing always lowers the company’s WACC
The capital structure of a company is defined as:
A) The total amount of debt in the company’s balance sheet
B) The mix of debt and equity financing used by the company
C) The total value of a company’s stock
D) The company’s market value of capital assets
A company’s WACC will likely be higher when:
A) It has a lower proportion of debt financing
B) It has a higher proportion of debt financing
C) It uses more equity in its capital structure
D) It reduces its tax rate
Which of the following would decrease the cost of equity?
A) An increase in the company’s beta
B) A reduction in the market risk premium
C) An increase in the risk-free rate
D) A decrease in the company’s dividend payout ratio
Which of the following best describes the relationship between the cost of capital and investment decisions?
A) The cost of capital is the return that must be earned on an investment to satisfy investors
B) The cost of capital is the same for all projects within a company
C) The cost of capital is irrelevant for investment decisions
D) The cost of capital is always set by the company’s management
When considering the cost of debt, which of the following must be factored in to account for the tax shield?
A) The company’s earnings before interest and taxes
B) The tax rate
C) The coupon rate of debt
D) The market risk premium
The company’s capital structure is a mix of:
A) Debt, equity, and retained earnings
B) Short-term and long-term liabilities
C) Fixed and variable costs
D) Fixed and floating rates of debt
A firm with a higher risk profile will generally have:
A) A higher cost of capital
B) A lower cost of equity
C) A lower cost of debt
D) A lower beta coefficient
The Weighted Average Cost of Capital (WACC) reflects:
A) The return that must be earned to satisfy both debt and equity holders
B) The return required only by equity holders
C) The tax shield on debt
D) The market value of the company’s debt
The cost of capital is used by companies to:
A) Determine the level of dividends to pay
B) Evaluate investment opportunities and projects
C) Set the executive compensation plan
D) Calculate earnings per share
Which of the following would be the most significant factor in increasing a company’s WACC?
A) A decrease in the company’s debt-to-equity ratio
B) A lower market risk premium
C) A decrease in the company’s beta
D) A lower tax rate
What is the most important factor in determining the cost of equity?
A) The market risk premium
B) The company’s dividend payout
C) The risk-free rate
D) The beta coefficient of the company
The capital structure decision involves choosing between:
A) Equity and debt financing
B) Bonds and preferred stock
C) Short-term and long-term financing
D) Debt financing and retained earnings
The cost of capital reflects:
A) The company’s return on its existing investments
B) The minimum required return on new investments to satisfy investors
C) The average return on the company’s stock
D) The rate of return for the company’s bonds
If the cost of debt is 5%, the cost of equity is 10%, and the company is financed 60% with debt and 40% with equity, what is the WACC?
A) 7%
B) 8%
C) 6%
D) 9%
A company’s WACC is primarily used by:
A) Investors to determine the return on their investments
B) Management to evaluate new projects
C) Financial analysts to determine market value
D) Government agencies to regulate company performance
A higher beta coefficient indicates that a company’s equity is:
A) Less risky and has lower returns
B) More risky and has higher returns
C) Less risky and has higher returns
D) More risky with lower returns
In calculating WACC, the weights for debt and equity are determined by:
A) The company’s current market value of debt and equity
B) The company’s historical cost of debt and equity
C) The company’s debt-to-equity ratio
D) The company’s tax rate
If the company’s risk-free rate increases, the cost of equity will:
A) Decrease
B) Increase
C) Remain unchanged
D) Fluctuate depending on the market
If a firm uses more debt in its capital structure, it will likely experience:
A) A higher cost of equity
B) A lower tax shield
C) A higher WACC
D) A lower WACC
Which of the following is a disadvantage of using equity financing?
A) It increases the company’s debt-to-equity ratio
B) It dilutes the control of existing shareholders
C) It creates fixed financial obligations
D) It increases the risk of bankruptcy
Which of the following factors is most likely to increase the cost of capital for a firm?
A) An increase in the market risk premium
B) A decrease in the corporate tax rate
C) A lower debt-to-equity ratio
D) A decrease in the risk-free rate
A company with a beta greater than 1 is:
A) Less volatile than the market
B) More volatile than the market
C) Unaffected by market movements
D) Likely to have a lower cost of equity
The cost of debt in the WACC calculation is based on:
A) The coupon rate of the bonds
B) The market value of debt
C) The after-tax interest rate
D) The company’s debt-to-equity ratio
The weighted average cost of capital is used to:
A) Determine the cost of debt
B) Evaluate the total cost of financing a company
C) Assess the risk of individual projects
D) Calculate the return on equity
Which of the following is the best method to estimate the cost of equity for a publicly traded company?
A) Dividend Discount Model (DDM)
B) Weighted Average Cost of Capital (WACC)
C) Capital Asset Pricing Model (CAPM)
D) Cost of Debt Model
A company’s weighted average cost of capital (WACC) is the weighted average of:
A) Debt, equity, and retained earnings
B) Debt, equity, and tax rate
C) Debt, preferred stock, and common equity
D) Debt and preferred stock only
If the firm’s capital structure is made up entirely of equity, then its WACC is equal to:
A) The risk-free rate
B) The cost of equity
C) The cost of debt
D) The company’s earnings yield
When using the Dividend Discount Model (DDM), which factor most affects the estimated cost of equity?
A) The dividend payout ratio
B) The current market price of the stock
C) The expected dividend growth rate
D) The company’s tax rate
A company is considering a project with an expected return of 12%. If its WACC is 10%, the company should:
A) Accept the project because the return exceeds the WACC
B) Reject the project because the return is too low
C) Accept the project because the return is lower than the WACC
D) Reject the project because the return equals the WACC
The cost of debt is generally lower than the cost of equity because:
A) Debt holders take on more risk than equity investors
B) Equity investors have a priority claim on the company’s assets
C) Interest payments on debt are tax-deductible
D) Debt does not require a return on investment
The required rate of return for an investment can be determined using the:
A) Weighted Average Cost of Capital (WACC)
B) Internal Rate of Return (IRR)
C) Net Present Value (NPV)
D) Capital Asset Pricing Model (CAPM)
If a company has a higher proportion of equity in its capital structure, it will likely:
A) Have a higher cost of capital
B) Have a lower cost of debt
C) Have a lower cost of capital
D) Have a higher tax rate
Which of the following is true about the cost of equity?
A) It is the same as the cost of debt
B) It is usually lower than the cost of debt
C) It reflects the return required by equity investors
D) It is not relevant for the company’s capital budgeting decisions
The dividend discount model assumes that:
A) The company’s dividends will grow at a constant rate
B) The cost of capital is the same for all companies
C) The company will not issue new shares of stock
D) Dividends are only paid out in the first year
Which of the following is a key assumption of the Modigliani-Miller Proposition on capital structure?
A) There are no taxes in the economy
B) Debt financing is always less expensive than equity financing
C) Companies can only finance using debt or equity
D) The company’s capital structure affects its overall value
Which of the following represents the equity beta in the Capital Asset Pricing Model (CAPM)?
A) The return on the stock market
B) The company’s risk relative to the market
C) The return required by debt holders
D) The overall market risk premium
In practice, the cost of debt is often estimated using:
A) The company’s coupon rate on existing bonds
B) The company’s earnings yield
C) The current yield on the company’s common stock
D) The company’s long-term dividend growth rate
If the cost of debt is 6% and the cost of equity is 10%, with 50% of debt and 50% of equity in the capital structure, what is the WACC?
A) 6%
B) 8%
C) 7%
D) 10%
Which of the following is a method used to calculate the cost of equity?
A) Dividend Discount Model (DDM)
B) Weighted Average Cost of Capital (WACC)
C) Internal Rate of Return (IRR)
D) Cost of Debt Model
A company’s WACC increases when:
A) It increases its debt ratio
B) It decreases its debt ratio
C) It reduces its equity financing
D) It issues more debt and less equity
A firm with a lower risk profile will likely experience:
A) A higher cost of equity
B) A higher cost of capital
C) A lower cost of capital
D) A higher cost of debt
The tax shield on debt refers to:
A) The reduction in tax liability due to interest expense
B) The ability to deduct dividends from taxable income
C) The reduction in equity cost due to debt financing
D) The increase in risk due to high leverage
Which of the following is most likely to decrease a company’s cost of capital?
A) An increase in the corporate tax rate
B) A decrease in the risk-free rate
C) An increase in the firm’s debt-to-equity ratio
D) A higher beta coefficient
Which of the following is not a source of financing included in the WACC calculation?
A) Debt
B) Preferred stock
C) Common equity
D) Accounts payable
The Capital Asset Pricing Model (CAPM) calculates the expected return of an asset based on:
A) The asset’s beta and the market’s expected return
B) The asset’s earnings yield
C) The historical average return of the asset
D) The company’s dividend payout ratio
If the company’s cost of capital exceeds the return on a new investment, the investment should:
A) Be accepted because it generates positive cash flow
B) Be rejected because it does not meet the company’s required return
C) Be delayed until market conditions improve
D) Be accepted if it offers long-term benefits
A company’s cost of equity can be estimated using the:
A) Dividend Discount Model (DDM) or Capital Asset Pricing Model (CAPM)
B) Risk-free rate
C) Return on investment (ROI)
D) Earnings per share
Which of the following is most likely to increase the company’s WACC?
A) An increase in the company’s tax rate
B) A decrease in the market risk premium
C) A higher proportion of debt in the capital structure
D) An increase in the risk-free rate
Which of the following best describes the relationship between risk and the cost of equity?
A) Higher risk leads to a lower cost of equity
B) Higher risk leads to a higher cost of equity
C) Lower risk leads to a lower cost of equity
D) Risk has no impact on the cost of equity
If a company increases its debt ratio, its cost of capital will likely:
A) Decrease
B) Increase
C) Stay the same
D) Become uncertain
The weighted average cost of capital (WACC) is most relevant for:
A) Short-term financial decisions
B) Determining the return on equity
C) Investment projects that are similar to the company’s current operations
D) Debt repayment schedules
If the market risk premium decreases, the cost of equity will likely:
A) Increase
B) Decrease
C) Stay the same
D) Become unpredictable
The capital structure of a firm affects its:
A) Operating efficiency
B) Profitability ratio
C) Cost of capital
D) Total revenue
The use of debt in capital structure is beneficial because it:
A) Increases the company’s financial leverage
B) Increases the company’s equity base
C) Reduces the company’s risk of bankruptcy
D) Eliminates the need for equity financing
The cost of debt is calculated as:
A) The coupon rate on the bonds issued by the company
B) The interest rate on loans and bonds, adjusted for tax deductions
C) The return required by equity investors
D) The risk-free rate plus the market risk premium
The Dividend Discount Model (DDM) is used to calculate:
A) The cost of equity for a firm with stable dividends
B) The cost of capital for a company with fluctuating stock prices
C) The after-tax cost of debt
D) The required return on risky assets
Which of the following components is not typically included in the WACC formula?
A) Cost of debt
B) Cost of equity
C) Cost of preferred stock
D) Depreciation expense
If a firm has no debt in its capital structure, the firm’s WACC will equal:
A) The cost of equity
B) The cost of debt
C) The tax rate
D) The risk-free rate
In the Capital Asset Pricing Model (CAPM), which factor is used to measure the sensitivity of the stock to the market?
A) Risk-free rate
B) Market risk premium
C) Beta coefficient
D) Equity risk premium
When using CAPM, the cost of equity increases if:
A) The risk-free rate decreases
B) The market risk premium decreases
C) The company’s beta increases
D) The company’s beta decreases
A firm’s WACC is most useful in:
A) Estimating the cost of debt
B) Determining the minimum return a company must earn on its investments
C) Setting dividend payout ratios
D) Calculating capital gains
A higher debt-to-equity ratio is likely to:
A) Increase a firm’s cost of capital
B) Decrease a firm’s cost of capital
C) Have no effect on the cost of capital
D) Decrease the firm’s risk premium
In the WACC formula, the weight assigned to each component (debt, equity, etc.) is determined by:
A) The cost of each component
B) The market value of each component
C) The book value of each component
D) The proportion of dividends paid to shareholders
If a company issues new shares of stock, its cost of equity may:
A) Increase due to dilution of control
B) Decrease because of a larger equity base
C) Remain unchanged
D) Increase due to a lower stock price
The risk-free rate is:
A) The expected return on the company’s stock
B) The return on government bonds with no default risk
C) The return on corporate bonds with high credit risk
D) The return on the company’s preferred stock
A company’s cost of equity can be directly influenced by:
A) The company’s dividend policy
B) The interest rates set by central banks
C) The company’s tax rate
D) The firm’s capital structure
The Modigliani-Miller Proposition assumes that:
A) Firms with high debt have a lower cost of capital
B) The tax shield of debt financing is irrelevant in determining value
C) The cost of equity increases with financial leverage
D) There are no market imperfections, such as taxes or transaction costs
The optimal capital structure is the one that:
A) Maximizes the company’s debt ratio
B) Minimizes the firm’s cost of equity
C) Maximizes the firm’s value by minimizing the WACC
D) Increases the company’s stock price without increasing debt
A company’s cost of capital is determined by:
A) The firm’s total assets
B) The weighted average of the costs of debt and equity
C) The dividends paid to shareholders
D) The cost of capital for its industry
When a company uses more debt, the cost of debt generally:
A) Increases due to higher risk of bankruptcy
B) Decreases because debt is cheaper than equity
C) Remains constant regardless of the amount of debt
D) Decreases because of the interest tax shield
A company’s beta coefficient in the Capital Asset Pricing Model (CAPM) measures:
A) The firm’s overall cost of equity
B) The sensitivity of the firm’s returns to market returns
C) The total market risk
D) The firm’s total debt load
If a company’s capital structure becomes more equity-heavy, the WACC is likely to:
A) Increase due to a higher cost of equity
B) Decrease due to a lower cost of debt
C) Remain unchanged
D) Decrease due to a higher tax shield on debt
The market risk premium is:
A) The risk-free rate minus the beta coefficient
B) The return required by investors for bearing market risk
C) The cost of debt for the firm
D) The risk-adjusted return on the firm’s stock
In terms of capital budgeting, the WACC is used as:
A) The discount rate for evaluating investment projects
B) The return expected on equity financing
C) The rate of return for debt investors
D) The minimum required return for equity investors
The Capital Asset Pricing Model (CAPM) uses the risk-free rate, beta, and market risk premium to calculate:
A) The required return on equity
B) The required return on debt
C) The WACC
D) The cost of capital for a project
If the expected return on a project is higher than the company’s WACC, the project will:
A) Increase the company’s overall value
B) Decrease the company’s overall value
C) Have no effect on the company’s value
D) Increase the company’s tax liability
The effect of the tax shield on debt financing is that it:
A) Decreases the cost of debt
B) Increases the firm’s risk
C) Increases the WACC
D) Decreases the WACC
Which of the following is true about the risk-free rate?
A) It is the return on debt with no risk of default
B) It is always equal to the cost of equity
C) It is determined by the company’s capital structure
D) It reflects the return expected on high-risk investments
The cost of capital for a project should be based on:
A) The company’s historical cost of capital
B) The market risk premium
C) The required rate of return for the project’s specific risk
D) The company’s average cost of debt
If a company decides to increase its debt financing, it is likely to:
A) Increase its cost of equity
B) Decrease its overall cost of capital
C) Keep its WACC unchanged
D) Decrease its cost of debt
A firm with high business risk will likely have a:
A) Lower cost of equity
B) Higher cost of equity
C) Lower cost of debt
D) Lower WACC
Which of the following is a key factor in determining the cost of equity using the Dividend Discount Model (DDM)?
A) The company’s cost of debt
B) The company’s expected future dividends
C) The company’s tax rate
D) The market risk premium
The cost of preferred stock is calculated as:
A) The dividend yield on the preferred stock
B) The coupon rate of the company’s debt
C) The market risk premium plus the risk-free rate
D) The return required by equity investors
The cost of debt is usually lower than the cost of equity because:
A) Debt holders have a higher claim on assets in case of liquidation
B) Debt financing has no risk
C) Debt financing is not affected by changes in interest rates
D) Debt financing does not require equity compensation
Which of the following describes the relationship between the cost of debt and the tax rate?
A) The cost of debt increases as the tax rate increases
B) The cost of debt decreases as the tax rate increases
C) The tax rate has no effect on the cost of debt
D) The cost of debt remains constant regardless of tax rate changes
A company’s cost of equity capital is:
A) The same as the cost of debt
B) Always higher than the cost of debt
C) Less sensitive to changes in market conditions than the cost of debt
D) Equal to the dividend yield on the company’s stock
In the WACC formula, which of the following represents the cost of debt?
A) The return on equity
B) The coupon rate of bonds
C) The after-tax return on debt
D) The weighted average dividend yield
A company’s debt ratio impacts its WACC because:
A) A higher debt ratio typically reduces the cost of equity
B) A higher debt ratio increases the cost of equity
C) A higher debt ratio reduces the firm’s overall risk
D) A higher debt ratio always reduces the WACC
The formula for the cost of equity using the Capital Asset Pricing Model (CAPM) is:
A) Risk-free rate + Beta × Market risk premium
B) Risk-free rate + Debt × Market risk premium
C) Beta × Risk-free rate + Equity
D) Risk-free rate + Cost of debt × Equity
Which of the following best defines financial leverage?
A) The use of debt to increase the return on equity
B) The use of equity to reduce the return on debt
C) The use of short-term debt to finance long-term projects
D) The use of retained earnings to reduce capital costs
The concept of the optimal capital structure suggests that:
A) The more debt a company uses, the higher its cost of capital
B) The optimal capital structure minimizes the company’s cost of capital
C) A company should have no debt to minimize risk
D) There is no relationship between capital structure and cost of capital
If the cost of debt increases, the WACC will likely:
A) Increase
B) Decrease
C) Remain unchanged
D) Become negative
If a company uses a high percentage of debt financing, it will:
A) Likely have a lower cost of equity
B) Likely have a higher cost of equity
C) Have no impact on the cost of equity
D) Likely have a higher WACC
The Modigliani-Miller theory of capital structure states that:
A) The cost of capital is irrelevant in determining the value of the firm
B) Debt financing increases a firm’s cost of capital
C) A company should finance all its projects with equity
D) The optimal capital structure involves using no debt
The market risk premium is the:
A) Return on equity minus the risk-free rate
B) Difference between the return on the market and the risk-free rate
C) Return on debt minus the equity return
D) Return on government bonds
When a company’s debt-to-equity ratio increases, its WACC will generally:
A) Stay the same
B) Decrease
C) Increase
D) Become less predictable
A company with a lower business risk will typically have:
A) A higher cost of equity
B) A lower cost of equity
C) A higher WACC
D) A higher debt ratio
The cost of debt can be lower than the cost of equity because:
A) Debt is more volatile than equity
B) Debt holders have senior claims in case of liquidation
C) Debt is less risky than equity
D) Debt provides no tax benefits
In a company’s WACC calculation, the weight assigned to equity represents:
A) The percentage of debt financing
B) The percentage of total capital funded by shareholders’ equity
C) The percentage of total capital funded by preferred stock
D) The total cost of equity divided by the total capital
A firm’s WACC is most useful when evaluating:
A) The profitability of specific products
B) The risk-free rate for debt investment
C) Investment projects that are similar to the firm’s existing operations
D) The firm’s debt-to-equity ratio
Which of the following is a disadvantage of using debt financing in capital structure?
A) Debt increases the cost of capital
B) Debt does not offer tax benefits
C) Debt increases the firm’s financial risk
D) Debt reduces the overall leverage of the firm
Which of the following is NOT a factor that affects the cost of capital?
A) The tax rate
B) The company’s size
C) The market risk premium
D) The firm’s capital structure
In the weighted average cost of capital formula, the weight of debt is:
A) The market value of debt divided by total market value of the company
B) The book value of debt divided by total book value of the company
C) The total debt divided by total capital
D) The total capital divided by total debt
If the risk-free rate decreases, the cost of equity will:
A) Increase
B) Decrease
C) Stay the same
D) Become negative
If a company’s cost of debt is 5%, and its tax rate is 30%, what is the after-tax cost of debt?
A) 5%
B) 3.5%
C) 6.5%
D) 7%
The cost of equity is generally higher than the cost of debt because:
A) Equity holders are paid before debt holders in case of liquidation
B) Debt has no associated risk
C) Equity investors require a higher return to compensate for higher risk
D) Debt financing is cheaper due to the tax shield
Which of the following best describes the relationship between the cost of equity and the firm’s beta?
A) The cost of equity increases as beta decreases
B) The cost of equity decreases as beta decreases
C) The cost of equity is unaffected by changes in beta
D) Beta and cost of equity are not related
The weighted average cost of capital (WACC) can be used to evaluate:
A) Only equity investments
B) Investment projects with risks similar to the firm’s overall risk
C) Projects that are unrelated to the firm’s core business
D) The firm’s tax liability