1**.**

Coupon rate = 7 percent

Average tax rate = 32%

Price of common stock = $80

Price of preferred stock = $50

Bond yield risk premium = 7%

Return of the market = 12%

Marginal tax rate = 35%

Common stock dividend (Do) = $6

Preferred stock dividend (Do) = $4

Growth rate of common stock dividend = 6%

Risk-free rate of return = 6%

Beta = 1.2

According to the information given, what is the cost of equity using the *capital asset pricing model?*

**A. **14.4 percent

**B. **12 percent

**C. **13.95 percent

**D. **13.2 percent

** **

**2. **A firm should reject an investment if the *internal rate of return *on the investment is

**A. **less than the interest rate.

**B. **greater than the interest rate.

**C. **less than the cost of capital.

**D. **greater than the cost of capital.

** **

**3. **Which of the following statements about retained earnings is *correct?*

**A. **Retained earnings are the firm’s cheapest source of funds.

**B. **Retained earnings have the same cost as new shares of stock.

**C. **Retained earnings are cheaper than the cost of new shares.

**D. **Retained earnings have no cost.

** **

**4. **The internal rate of return and net present value methods of capital budgeting assume that the cash flows are reinvested at the

**A. **cost of capital for NPV and the internal rate of return for IRR.

**B. **cost of capital for IRR and the internal rate of return for NPV.

**C. **internal rate of return.

**D. **cost of capital.

** **

**5. **NPV may be preferred to IRR because

**A. **NPV excludes salvage value.

**B. **IRR makes more conservative assumptions concerning reinvesting.

**C. **NPV makes more conservative assumptions concerning reinvesting.

**D. **IRR excludes salvage value.

** **

**6. **A firm has two investment opportunities. Each investment costs $2,000, and the firm’s cost of capital is

8 percent. The cash flows of each investment are as follows:

**Cash Flow of Investment A**

Year 1: $1800

Year 2: $600

Year 3: $500

Year 4: $400

**Cash Flow of Investment B**

Year 1: $900

Year 2: $900

Year 3: $900

Year 4: $900

According to the information, the NPV for Investment B is

**A. **$1,600.

**B. **$2,980.

**C. **$980.

**D. **$3,600.

** **

**7. **Which of the following statements about the cost of debt is *correct?*

**A. **The cost of debt is greater than the cost of preferred stock.

**B. **The cost of debt is greater than the cost of equity.

**C. **The cost of debt is less than the cost of equity.

**D. **The cost of debt is equal to the firm’s interest rate.

** **

**8.**

Coupon rate = 7 percent

Average tax rate = 32%

Price of common stock = $80

Price of preferred stock = $50

Bond yield risk premium = 7%

Return of the market = 12%

Marginal tax rate = 35%

Common stock dividend (Do) = $6

Preferred stock dividend (Do) = $4

Growth rate of common stock dividend = 6%

Risk-free rate of return = 6%

Beta = 1.2

According to the information given, what is the cost of preferred stock?

**A. **8 percent

**B. **12 percent

**C. **9 percent

**D. **10 percent

** **

**9.**

Coupon rate = 7 percent

Average tax rate = 32%

Price of common stock = $80

Price of preferred stock = $50

Bond yield risk premium = 7%

Return of the market = 12%

Marginal tax rate = 35%

Common stock dividend (Do) = $6

Preferred stock dividend (Do) = $4

Growth rate of common stock dividend = 6%

Risk-free rate of return = 6%

Beta = 1.2

According to the information given, what is the cost of equity using the bond yield plus risk premium

method?

**A. **13.2 percent

**B. **12 percent

**C. **13.95 percent

**D. **14 percent

** **

**10. **Which of the following statements about the marginal cost of capital is *correct?*

**A. **The marginal cost of capital is a firm’s cost of debt and equity finance.

**B. **The marginal cost of capital refers to the cost of additional funds.

**C. **The marginal cost of capital declines as flotation costs alter equity financing.

**D. **The marginal cost of capital is constant once the optimal capital structure is determined.

** **

**11. **The lower the debt ratio, the

**A. **lower is the use of financial leverage.

**B. **higher is the use of financial leverage.

**C. **higher are the firm’s total assets.

**D. **lower are the firm’s total assets.

** **

**12. **If the net present values of two mutually exclusive investments are positive, a firm should select

**A. **both investments.

**B. **the investment with the higher net present value.

**C. **the investment with the higher present value.

**D. **neither investment.

** **

**13. **A firm should make an investment if the present value of the cash inflows on the investment is

**A. **greater than zero.

**B. **less than zero.

**C. **greater than the cost of the investment.

**D. **less than the cost of the investment.

** **

**14. **If the internal rates of return of two mutually exclusive investments exceed the firm’s cost of capital,

the firm should make

**A. **both investments.

**B. **the investment with the higher IRR.

**C. **the investment with the lower IRR.

**D. **neither investment.

** **

**15.**

Coupon rate = 7 percent

Average tax rate = 32%

Price of common stock = $80

Price of preferred stock = $50

Bond yield risk premium = 7%

Return of the market = 12%

Marginal tax rate = 35%

Common stock dividend (Do) = $6

Preferred stock dividend (Do) = $4

Growth rate of common stock dividend = 6%

Risk-free rate of return = 6%

Beta = 1.2

According to the information given, what is the cost of equity using the expected growth method?

**A. **13.95 percent

**B. **14.4 percent

**C. **12 percent

**D. **13.2 percent

** **

**16. **An increase of cost of capital will

**A. **increase an investment’s IRR.

**B. **Increase an investment’s NPV.

**C. **decrease an investment’s NPV.

**D. **decrease an investment’s IRR.

** **

**17. **The net present value of an investment will be higher if

**A. **the cost of capital is higher.

**B. **there’s no salvage value.

**C. **the cost of the investment is lower.

**D. **a firm uses straight-line depreciation.

** **

**18.**

Coupon rate = 7 percent

Average tax rate = 32%

Price of common stock = $80

Price of preferred stock = $50

Bond yield risk premium = 7%

Return of the market = 12%

Marginal tax rate = 35%

Common stock dividend (Do) = $6

Preferred stock dividend (Do) = $4

Growth rate of common stock dividend = 6%

Risk-free rate of return = 6%

Beta = 1.2

According to the information given, what is the cost of debt?

**A. **2.45 percent

**B. **7.0 percent

**C. **4.55 percent

**D. **6.25 percent

** **

**19. **A firm has two investment opportunities. Each investment costs $2,000, and the firm’s cost of capital is

8 percent. The cash flows of each investment are as follows:

**Cash Flow of Investment A**

Year 1: $1800

Year 2: $600

Year 3: $500

Year 4: $400

**Cash Flow of Investment B**

Year 1: $900

Year 2: $900

Year 3: $900

Year 4: $900

Based on the information, if the investments are independent, the firm should select

**A. **all investments with an IRR that’s less than 8 percent.

**B. **all investments with an IRR that’s greater than 8 percent.

**C. **only one investment if the IRR is greater than 8 percent.

**D. **the higher IRR investment.

** **

**20. **Which of the following statements *best *explains why a rising ratio of debt-to-total assets increases the

cost of debt?

**A. **As total assets decline in relation to a stable debt level, equity declines.

**B. **If debt remains constant while the ratio increases, rising assets must be finance with more expensive equity financing.

**C. **As the ratio increases, creditors require higher interest rates to compensate them for higher default risk.

**D. **As debt increases, the contribution of more expensive equity financing decreases.

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