BEC 2

Question 1

The optimal capitalization for an organization usually can be determined by what

Answer 1

The lowest total weighted average cost of capital which serves to maximize shareholders’ equity

Question 2

What rates is most commonly compared to the internal rate of return to evaluate whether to market an investment?

Answer 2

Weighted average cost of capital is often sued as the hurdle rate within capital budgeting techniques.

Question 3

What model is one of the methods used to calculate the required rate of return on retained earnings?

What is the formula?

Answer 3

Capital asset pricing model

Cost of RE = risk free rate - (beta * (market return - risk free rate))

Risk premium = beta * (market return - risk free rate)

Market risk premium = market return - risk free rate

Question 4

What can be the factor that might causes a firm to increase the debt in its financial structure

Answer 4

An increase in the corporate income tax rate as interest is tax deductible while dividends are not

Question 5

Can a capital investment whose rate of return exceeds the rate of return associated with the firm’s beta factor increase the value of the firm?

Answer 5

Yes

Question 6

What is the stated interest rate on a bond

Answer 6

The actual amount of interest paid by a bond issuer

Question 7

When will the bond be selling at a premium

Answer 7

When the stated coupon rate is more than make interest rate (rate of return). This means market value of bond will be more than the face value

Question 8

Formula of cost of retained earnings other than CAPM

What is this formula needed for?

Answer 8

Cost of RE = current dividend per share/current market value or price of the outstanding common stock + the constant (expected)rate of growth in dividends

Question 9

Formula to calculate Cost of RE using bond yield plus premium

Answer 9

= pretax cost of LTD + market risk premium

Question 10

Formula to calculate cost of RE using discounted cash flow

Answer 10

= today’s dividend / today’s stock price + growth rate of dividends

Growth rate of dividends (also called retention rate) = return on equity * (1- payout rate)

Return on equity = net income / equity

Question 11

If the company common stock returns has been less volatile than overall market, what impact will be on the cost of RE method? Which method? In which direction

Answer 11

CAPM, lower

Because less volatile means beta goes down therefore risk premium goes down