Chapter 13 WACC

Question 1

COST OF CAPITALA

Answer 1

The return the firm’s investors could expect to earn if they invested in securities with comparable degrees of risk

Question 2

CAPITAL STRUCTURE

Answer 2

The mix of long-term debt and equity financing

Question 3

COMPANY COST OF CAPITAL

Answer 3

The weighted average of returns demanded by debt and equity investors (WACC)

Question 4

PREFERRED STOCK

Answer 4

Stock that takes priority over common stock in regard to dividends

Question 5

ISSUE WITH WACC - Debt has two costs:

Answer 5

1) Return on debt, or rate of interest bondholders demand (explicit cost)
2) Increased cost of equity demanded due to the increase in risk (implicit cost)

Question 6

ISSUE WITH WACc

Answer 6

1) Debt has two costs
2) Betas may change with capital structure
3) Corporate taxes complicate the analysis and may change our decision