Multiple choice questions
1.1 Nico Trading Corp is considering issuing long-term debt.
The debt would have a 30 year maturity and a 10 percent coupon rate. In order
to sell the issue, the bonds must be underpriced at a discount of 5 percent of
face value. In addition, the firm would have to pay flotation costs of 5
percent of face value. The firm’s tax rate is 35 percent. Given this
information, the after tax cost of debt for Nico Trading would be:
a) 7.26%
b) 11.17%
c) 10.0%
d) none of the above
1.3 As a source of financing, once retained earnings have been
exhausted, the weighted average cost of capital will:
a) increase.
b) remain the same.
c) decrease.
d) change in an undetermined direction.
1.4 A firm has common stock with a market price of $100 per
share and an expected dividend of $5.61 per share at the end of the coming
year. A new issue of stock is expected to be sold for $98, with a $2 per share
representing the underpricing necessary in the competitive capital market.
Flotation costs are expected to total $1 per share. The dividends paid on the
outstanding stock over the past five years are as follows:
Year Dividend
1
2
3
4
5 $4.00
$4.28
$4.58
$4.90
$5.24
The cost of this new issue of common stock is:
a) 5.8 percent
b) 7.7 percent
c) 10.8 percent
d) 12.8 percent
1.6 The wealth-maximizing investment decision for a firm
occurs when
a) the cost
of capital equals the return on the project
b) the
weighted marginal cost of capital is less than the investment opportunity
schedule
c) the
weighted cost of capital exceeds the marginal cost of capital
d) the
weighted marginal cost of capital equals the investment opportunity schedule
1.8 A firm has determined its cost of each source of capital
and optimal capital structure which is composed of the following sources and
target market value proportions:
Source of Capital Target
Market
Proportions
After-Tax Cost
Long-term debt
Preferred stock
Common stock equity 40%
10%
50% 6%
11%
15%
The weighted average cost of capital is:
a) 6 percent
b) 10.7 percent
c) 11 percent
d) 15 percent
1.14 The inexpensive nature of long-term debt in a firm’s
capital structure is due to the fact that
a) the
equity holders are the true owners of the firm
b) equity
capital has a fixed return
c) interest
payments are tax-deductible
d) equity
holders have a higher position in the priority of claims
1.18 Tangshan Mining has common stock at par of $200,000,
paid in capital in excess of par of $400,000, and retained earnings of
$280,000. In states where the firm’s legal capital is defined as the total of
par value and paid-in capital of common stock, the firm could pay out_______in
cash dividends without impairing its capital.
a) $280,000
b) $400,000
c) $480,000
d) $600,000
1.19 At the quarterly meeting of Tanshan Mining Corporation
held on September 10, the directors declared a $1.00 per share dividend for the
firm’s 100,000 shares of common stock outstanding. The net effect of declaring
and paying this dividend would be to:
a) decrease
total assets by $100,000 and increase stockholder’s equity by $100,000
b) decrease
total assets by $100,000 and decrease stockholder’s equity by $100,000
c) increase
total assets by $100,000 and increase stockholder’s equity by $100,000
d) increase
total assets by $100,000 and decrease stockholder’s equity by $100,000
1.20 Modigliani and Miller suggest that the value of the
firm is not affected by the firm’s dividend policy, due to:
a) the
relevance of dividends
b) the
clientele effect
c) the
informational content
d) the
optimal capital structure
1.21 What would be the cost of retained earnings equity for
Tangshan Mining if the expected return on U.S. Treasury Bills is 5.00 percent,
the market risk premium is 10.00 percent, and the firm’s beta is 1.3?
a) 11.5%
b) 18.0%
c) 10.0%
d) none of the above
1.22 A firm has issued preferred stock at its $125 per share
par value. The stock will pay a $15 annual dividend. The cost of issuing and
selling the stock was $4 per share. The cost of the preferred stock is:
a) 7.2
percent
b) 12
percent
c) 12.4
percent
d) 15
percent
Table 11.1
A firm has determined its optimal structure which is
composed of the following sources and target market value proportions.
Source of Capital Target
Market
Proportions
Long-term debt
Preferred stock
Common stock equity 20%
10%
70%
Debt: The firm can sell a 12-year, $1,000 par value, 7
percent bond for $960. A flotation cost of 2 percent of the face value would be
required in addition to the premium of $40.
Preferred Stock: The firm has determined it can issue
preferred stock at $75 per share par value. The stock will pay a $10 annual
dividend. The cost of issuing and selling the stock is $3 per share.
Common Stock: A firm’s common stock is currently selling for
$18 per share. The dividend expected to be paid at the end of the coming year
is $1.74. Its dividend payments have been growing at a constant rate for the
last four years. Four years ago, the dividend was $1.50. It is expected that to
sell, a new common stock issue must be underpriced $1 per share in flotation
costs. Additionally, the firm’s marginal tax rate is 40 percent.
1.23 The firm’s after-tax cost of debt is: (see Table 11.1.)
a) 3.25
percent
b) 4.6
percent
c) 8 percent
d) 8.13
percent
Table 11.2
A firm has determined its optimal structure which is
composed of the following sources and target market value proportions.
Source of Capital Target
Market
Proportions
Long-term debt
Common stock equity 60%
40%
Debt: The firm can sell a 15-year, $1,000 par value, 8
percent bond for $1,050. A flotation cost of 2 percent of the face value would
be required in addition to the premium of $50.
Common Stock: A firm’s common stock is currently selling for
$75 per share. The dividend expected to be paid at the end of the coming year
is $5. Its dividend payments have been growing at a constant rate for the last
five years. Five years ago, the dividend was $3.10. It is expected that to
sell, a new common stock issue must be underpriced $2 per share and the firm
must pay $1 per share in flotation costs. Additionally, the firm has a marginal
tax rate of 40 percent.
1.27 Assuming the firm plans to pay out all its earnings as
dividends, the weighted average cost of capital is: (see Table 11.2. above)
a) 9.6
percent
b) 10.9
percent
c) 11.6
percent
d) 12.1
percent
1.30 The cost utilized in making capital budgeting decisions
given an investment opportunity schedule is:
a) the
weighted average cost of all needed financing for funding
b) the
simple average of the cost of the last incremental amount of financing
c) the
weighted average cost of the last incremental amount of financing
d) the
weighted average cost of all bonds issued that are related to the capital
budget.
