Chapter 9 The Cost of Capital

9) Using the weighted cost of capital as a cutoff rate assumes that the riskiness of the project being evaluated is similar to the riskiness of the company's existing assets.

10) Using the weighted cost of capital as a cutoff rate assumes that future investments will be financed so as to maintain the firm's target degree of financial leverage.

11) The market value weights are preferred when calculating a firm's weighted average cost of capital.

12) 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.

13) A company's capital structure mix is based on the proportion of fixed versus variable costs in its optimal production process.

14) A firm's weighted average cost of capital is determined using all of the following inputs EXCEPT

A) the firm's capital structure.

B) the amount of capital necessary to make the investment.

C) the firm's after tax cost of debt.

D) the probability distribution of expected returns.

15) Cost of capital is

A) the coupon rate of debt.

B) a hurdle rate set by the board of directors.

C) the rate of return that must be earned on additional investment if firm value is to remain unchanged.

D) the average cost of the firm's assets.

16) Cost of capital is commonly used interchangeably with all of the following terms EXCEPT

A) the firm's required rate of return.

B) the hurdle rate for new investments.

C) the internal rate of return for new investments.

D) the firm's opportunity cost of funds.

17) Baxter Inc. has a target capital structure of 30% debt, 15% preferred stock, and 55% common equity. The company's after-tax cost of debt is 7%, its cost of preferred stock is 11%, its cost of retained earnings is 15%, and its cost of new common stock is 16%. The company stock has a beta of 1.5 and the company's marginal tax rate is 35%. What is the company's weighted average cost of capital if retained earnings are used to fund the common equity portion?

A) 11.20%

B) 12.00%

C) 13.80%

D) 14.45%

18) GHJ Inc. is investing in a major capital budgeting project that will require the expenditure of $16 million. The money will be raised by issuing $2 million of bonds, $4 million of preferred stock, and $10 million of new common stock. The company estimates is after-tax cost of debt to be 7%, its cost of preferred stock to be 9%, the cost of retained earnings to be 14%, and the cost of new common stock to be 17%. What is the weighted average cost of capital for this project?

A) 12.20%

B) 13.12%

C) 13.75%

D) 14.23%