CH 9

Question 1

Front

Answer 1

Back

Question 2

Definition: Cost of Capital

Answer 2

The required rate of return that a firm must offer to attract funds from creditors and shareholders.

Question 3

Formula: Weighted Average Cost of Capital (WACC)

Answer 3

WACC = (E/V)×r_ce + (P/V)×r_ps + (D/V)×r_d×(1−T); where V = E + P + D

Question 4

Key Step: After-Tax Cost of Debt

Answer 4

r_d(1 − T); Interest is tax-deductible, reducing the effective cost of debt.

Question 5

Term: E, P, D, and V

Answer 5

E = Market value of equity; P = Market value of preferred stock; D = Market value of debt; V = E + P + D

Question 6

Formula: Cost of Preferred Stock (no flotation)

Answer 6

r_ps = D_ps / P_ps

Question 7

Formula: Cost of Preferred with Flotation

Answer 7

r_ps = D_ps / [P_ps × (1 − F)]; (F = fraction for flotation cost)

Question 8

Formula: Cost of Equity (CAPM)

Answer 8

r_ce = r_RF + β × (r_M − r_RF)

Question 9

Formula: Cost of Equity (Dividend Growth Model)

Answer 9

r_ce = (D₁ / P₀) + g

Question 10

Term: Retained Earnings vs. New Stock

Answer 10

Retained Earnings = internally generated funds; New Stock = external issuance, typically higher cost due to flotation

Question 11

Key Step: Finding r_d (Cost of Debt) from a Bond

Answer 11

Use YTM on existing bonds or yields of similar-rated bonds.

Question 12

Term: Flotation Costs

Answer 12

Fees paid to underwriters/bankers when issuing new securities; they reduce the net proceeds to the firm.

Question 13

Essential Fact: Marginal Cost of Capital

Answer 13

Always focus on the cost of new or incremental funds, not historical costs.

Question 14

Essential Step: Calculating WACC in Capital Budgeting

Answer 14

1. Estimate each component cost.; 2. Determine weights (E/V, P/V, D/V).; 3. Combine in WACC formula.

Question 15

Hard Fact: Tax Deductibility

Answer 15

Only debt interest is tax-deductible; preferred and common dividends are not.

Question 16

Checklist: Divisional Cost of Capital Steps

Answer 16

1. Identify division’s risk profile.; 2. Estimate β, cost of debt, capital structure for that division.; 3. Use that data to find the division’s WACC.