© McGraw-Hill Australia Ross, Essentials of Corporate Finance, Fifth Edition Chapter 12 Testbank

Chapter 12 Testbank

1. The Whitehorse Book Company has 140 million shares outstanding. The market price of one
share is currently $2. The company's debentures are publicly traded and their market price is
equal to 93% of its face value. The debentures have a total book value of $50 000 000 and the
current yield to maturity of corporate debenture is 12% per annum. The risk-free rate is 8.50%
and the market risk premium is 5.20%. Market analysts estimated that the Whitehorse Book
Company has a beta of 0.90. The corporate tax rate is 30%. What is the company's weighted
average cost of capital (WACC) under the classical tax system?
A. 14.24%
B. 11.10%
C. 12.50%
D. 13.18%

2. The Whitehorse Book Company has 140 million shares outstanding. The market price of one
share is currently $2. The company's debentures are publicly traded and their market price is
equal to 93% of its face value. The debentures have a total book value of $50 000 000 and the
current yield to maturity of corporate debenture is 12% per annum. The risk-free rate is 8.50%
and the market risk premium is 5.20%. Market analysts estimated that the Whitehorse Book
Company has a beta of 0.90. The corporate tax rate is 30%. What is the company's weighted
average cost of capital (WACC) considering the imputation tax system?
A. 13.18%
B. 7.70%
C. 12.15%
D. 9.11%

3. Calculate the after-tax return to a shareholder assuming a dividend imputation system is used
in Australia (if the dividend is fully franked). The shareholder is currently subject to a marginal
tax rate of 40% and receives a dividend of $700 per annum. The corporate tax rate is equal to
30%.
A. $420
B. $700
C. $350
D. $600

4. The PMP Insurance Company preference shares are trading on the ASX at $9 each and a
dividend of $0.63 has just been paid. The face value of the issue is $10. What is the cost of
preference shares for PMP?
A. 14.29%
B. 6.30%
C. 1.11%
© McGraw-Hill Australia Ross, Essentials of Corporate Finance, Fifth Edition Chapter 12 Testbank

D. 7.00%

5. Rainbow Mining Pty Ltd is concerned that opening a new credit line will affect its share price.
Now the company has a risk return on its shares of 17.50%, determined by using a beta factor of
1.50. The risk free rate is 7%. What is the risk premium for Rainbow Mining?
A. 7.00%
B. 5.50%
C. 10.00%
D. 10.50%

6. Rainbow Mining Pty Ltd is concerned that opening a new credit line will affect its share price.
Now the company has a risk return on its shares of 17.50%, determined by using a beta factor of
1.50. The risk free rate is 7%. What is the market risk premium based on the information given
for Rainbow Mining?
A. 17.50%
B. 5.50%
C. 11.86%
D. 7.00%

7. The proportional cost of equity plus the proportional after tax cost of debt is called the:
A. pure play weight.
B. capital structure weight.
C. portfolio weight.
D. weighted average cost of capital.

8. Using the weighted average cost of capital (WACC) of another firm, one which is focused on
the type of project you are considering, rather than using your own firm's WACC is called the:
A. competitor's game.
B. project divisor.
C. insider's look.
D. pure play approach.

9. When the management of a firm evaluates the risk of a proposed project and adjusts the firm's
WACC based on that evaluation to ascertain the required return for the project, they are using the
_____ approach.
A. subjective
B. normative
C. insider
D. pure play

10. In an efficient market, a security with a beta of 0.98 will have a rate of return which lies:
© McGraw-Hill Australia Ross, Essentials of Corporate Finance, Fifth Edition Chapter 12 Testbank

A. on the SML just to the right of the market return.

B. on the SML just to the left of the market return.
C. just below the SML and to the right of the market return.
D. just below the security market line (SML) and to the left of the market return.

11. Which one of the following represents the best estimate for a firm's pre-tax cost of debt?
A. The current coupon on the firm's existing debt
B. The current yield on the firm's existing debt
C. Twice the rate of return currently offered on risk-free securities
D. The current yield-to-maturity on the firm's existing debt

12. An increase in the market value of a preferred preference share will _____ the cost of the
preferred preference share.
A. increase
B. either increase or decrease
C. decrease
D. not affect

13. Which one of the following is a correct statement regarding a firm's weighted average cost of
capital (WACC)?
A. A 5% increase in a firm's debt–equity ratio will tend to increase the firm's WACC.
B. The WACC will decrease when the tax rate decreases for all firms that utilise debt financing.
C. The WACC can be used as the required return for all new projects with similar risk to that of
the existing firm.
D. A reduction in the risk level of a firm will tend to increase the firm's WACC.

14. A firm has a cost of equity of 10%, a cost of preferred preference shares of 9% and an after-
tax cost of debt of 5%. Given this, which one of the following will decrease the firm's cost of
capital?
A. Decreasing the debt–equity ratio
B. Increasing the systematic risk of the firm
C. Decreasing the firm–specific risk associated with the firm
D. Issuing new debt to offset an increase in the dividend payout ratio

15. The cost of capital for a project should:

A. never exceed the cost of capital for the overall firm.
B. meet or exceed the internal rate of return of the project.
C. be adjusted based on the size of the project.
D. be adjusted based on the risk of the project.

16. When using the pure play approach, a firm is seeking a rate of return which:
© McGraw-Hill Australia Ross, Essentials of Corporate Finance, Fifth Edition Chapter 12 Testbank

A. is applicable to the risk level of the investment under consideration.

B. is lower than its own cost of capital.
C. matches the expected internal rate of return of the investment being considered.
D. will cause a project to have a positive net present value.

17. Nelson Enterprises just paid an annual dividend of $1.56 per share. This dividend is expected
to increase by 3% annually. Currently, the firm has a beta of 1.13 and a share price of $28 a
share. The risk-free rate is 3% and the market rate of return is 10.5%. What is your best estimate
of Nelson's cost of equity?
A. 8.74%
B. 10.11%
C. 11.48%
D. 9.72%

18. Horseless Carriages issued 20-year, 7% semi-annual bonds 11 years ago. The bonds currently
sell at 101.3% of face value. What is the firm's after tax cost of debt if the tax rate is 34%?
A. 4.87%
B. 6.83%
C. 6.71%
D. 4.49%

19. The 7% preferred share preference share of Winslow & Winslow is selling for $54 a share.
What is the firm's cost of preferred preference shares (face value $100)?
A. 3.78%
B. 17.56%
C. 7.71%
D. 12.96%

20. Which of the following are weaknesses of the dividend growth model?
I. Market risk premium fluctuations
II. Lack of dividends for some firms
III. Reliance on historical beta
IV. Sensitivity of model to dividend growth rate
A. I and II only
B. I and III only
C. II and IV only
D. I, II, III and IV

21. In an efficient market, the cost of equity for a risky firm does which one of the following,
according to the security market line?
A. Produces a return that will be less than the market rate but higher than the risk-free rate
B. Equals the market rate of return for all shares
© McGraw-Hill Australia Ross, Essentials of Corporate Finance, Fifth Edition Chapter 12 Testbank

C. Has a maximum cost equal to the market rate of return

D. Increases in direct relation to the share's systematic risk

22. Which of the following will increase the cost of equity for a firm with a beta of 1.1?
I. Decrease in the security's beta
II. Decrease in the market risk premium
III. Decrease in the risk-free rate
IV. Increase in the risk-free rate
A. II only
B. III only
C. I and II only
D. I and III only

23. Which one of the following will increase the cost of equity, all things being equal?
A. Increase in the dividend growth rate
B. Decrease in beta
C. Decrease in future dividends
D. Increase in share price

24. All things being equal, which of the following will increase the after-tax cost of debt for a
firm?
I. Increase in the yield to maturity of the firm's outstanding debt
II. Decrease in the yield to maturity of the firm's outstanding debt
III. Increase in the firm's tax rate
IV. Decrease in the firm's tax rate
A. I only
B. I and III only
C. I and IV only
D. II and III only

25. Which one of the following statements is correct?

A. An increase in the market value of preference shares will increase a firm's weighted average
cost of capital.
B. The cost of preference shares is unaffected by the issuer's tax rate.
C. Preference shares are generally the cheapest source of capital for a firm.
D. The cost of preference shares remains constant from year to year.

26. Alpha Industries is considering a project with an initial cost of $7.4 million. The project will
produce cash inflows of $1.54 million a year for seven years. The firm uses the subjective
approach to assign discount rates to projects. For this project, the subjective adjustment is +1.5%.
The firm has a pre–tax cost of debt of 8.6% and a cost of equity of 13.7%. The debt-equity ratio
is 0.0.65 and the tax rate is 35%. What is the net present value of the project?
© McGraw-Hill Australia Ross, Essentials of Corporate Finance, Fifth Edition Chapter 12 Testbank

A. –$372 951
B. –$187 016
C. $48 209
D. $269 480

27. The computation of which one of the following requires assigning every proposed investment
to a particular risk class?
A. Pure play cost of capital
B. Cost of equity
C. WACC
D. Subjective cost of capital

28. Which of the following is NOT an operating cost?

A. Interest payments
B. Advertising costs
C. Legal fees
D. Depreciation of non-current assets

29. Which of the following statements is correct with regard to debt financing?
A. The firm’s cost of equity is reduced.
B. The shareholders’ wealth is increased.
C. The firm’s tax bill is increased.
D. The firm’s risk level is reduced.

30. Consider the following information for the Golf Corporation: the market price per share is
$12; the book value per share is $10; the number of shares outstanding is 100 million; the market
price per bond is $800; the face value per bond is $1000; the number of bonds outstanding is 1
million. Calculate the proportion of debt and equity for the corporation that you would use for
estimating the weighted average cost of capital.
A. 40% debt and 60% equity
B. 50% debt and 50% equity
C. 45.5% debt and 54.5% equity
D. 70% debt and 30% equity

31. Katie owns 100 shares of ABC. Which one of the following terms is used to refer to the
return that Katie and the other shareholders require on their investment in ABC?
A. Weighted average cost of capital
B. Pure play cost
C. Cost of equity
D. Subjective cost
E. Cost of debt
© McGraw-Hill Australia Ross, Essentials of Corporate Finance, Fifth Edition Chapter 12 Testbank

32. Lester lent money to The Corner Store by purchasing bonds issued by the store. The rate of
return that he and the other lenders require is referred to as the:
A. pure play cost.
B. cost of debt.
C. weighted average cost of capital.
D. subjective cost.
E. cost of equity.

33. The weighted average cost of capital is defined as the weighted average of a firm's:
A. return on all of its investments.
B. cost of equity, cost of preferred and its after-tax cost of debt.
C. pre-tax cost of debt and its preferred and common equity securities.
D. bond coupon rates.
E. common and preferred share.

34. Farmer's Supply is considering opening a clothing store, which would be a new line of
business for the firm. Management has decided to use the cost of capital of a similar clothing
store as the discount rate to evaluate this proposed expansion. Which one of the following terms
describes this evaluation approach?
A. Equity approach
B. After-tax approach
C. Subjective approach
D. Market play
E. Pure play approach

35. Kate is the CFO of a major firm and has the job of assigning discount rates to each project
under consideration. Kate's method of doing this is to assign an incrementally higher rate as the
risk level of the project increases and a lower rate as the risk level declines. Kate is applying the
___ approach.
A. pure play
B. divisional rating
C. subjective
D. straight WACC
E. equity rating

36. Ted is trying to decide what cost of capital he should assign to a project. Which one of the
following should be his primary consideration in this decision?
A. Amount of debt used to finance the project
B. Use, or lack, of preferred share as a financing option
C. Mix of funds used to finance the project
D. Risk level of the project
E. Length of the project's life
© McGraw-Hill Australia Ross, Essentials of Corporate Finance, Fifth Edition Chapter 12 Testbank

37. Black Stone Furnaces wants to build a new facility. The cost of capital for this investment is
primarily dependent on which one of the following?
A. The firm's overall source of funds
B. Source of the funds used to build the facility
C. Current tax rate
D. The nature of the investment
E. Firm's historical average rate of return

38. Which one of the following statements is correct relating to the dividend growth model
approach to computing the cost of equity?
A. The rate of growth must exceed the required rate of return.
B. The rate of return must be adjusted for taxes.
C. The annual dividend used in the computation must be for Year 1 if you are Time 0’s share
price to compute the return.
D. The cost of equity is equal to the return on the share plus the risk-free rate.
E. The cost of equity is equal to the return on the share multiplied by the share's beta.

39. A firm has a return on equity of 12.4% according to the dividend growth model and a return
of 18.7% according to the capital asset pricing model. The market rate of return is 13.5%. What
rate should the firm use as the cost of equity when computing the firm's weighted average cost of
capital (WACC)?
A. 12.4% because it is lower than 18.7%
B. 18.7% because it is higher than 12.4%
C. The arithmetic average of 12.4% and 18.7%
D. The arithmetic average of 12.4%, 13.5% and 18.7%
E. 13.5%

40. When evaluating a project, the dividend growth model:

A. can only be used by firms that pay increasing dividends.
B. must be used by all dividend-paying firms.
C. is only applicable when the growth rate of the project exceeds the dividend growth rate.
D. is relatively simple to use.
E. must use the growth rate of the project as the rate of growth in the formula.

41. The results of the dividend growth model:

A. vary directly with the market rate of return.
B. can only be applied to projects that have a growth rate equal to that of the current firm.
C. are highly dependent upon the beta used in the model.
D. are sensitive to the rate of dividend growth.
E. are most reliable when the growth rate exceeds 10%.

42. In an efficient market, the cost of equity for a high-risk firm:

© McGraw-Hill Australia Ross, Essentials of Corporate Finance, Fifth Edition Chapter 12 Testbank

A. will be less than the market rate but higher than the risk-free rate.
B. must equal the market rate of return.
C. changes by 1% for every 1% change in the risk-free rate.
D. decreases as the beta of the firm's share increases.
E. increases in direct relation to the share's systematic risk.

43. Assume a firm has a beta of 1.2. All else held constant, the cost of equity for this firm will
increase if the:
A. market risk premium decreases.
B. risk-free rate decreases.
C. market rate of return decreases.
D. beta decreases.
E. either the risk-free rate or the market rate of return decreases.

44. An increase in a levered firm’s tax rate will:

A. decrease the cost of preferred share.
B. increase both the cost of preferred share and debt.
C. decrease the firm’s cost of capital.
D. decrease the cost of equity capital.
E. increase the firm’s WACC.

45. Which one of the following is used as the pre-tax cost of debt?
A. Average coupon rate on the firm's outstanding bonds
B. Coupon rate on the firm's latest bond issue
C. Weighted average yield to maturity on the firm's outstanding debt
D. Average current yield on the firm's outstanding debt
E. Annual interest divided by the market price per bond for the latest bond issue

46. Which one of the following will decrease the after-tax cost of debt for a firm?
A. Decrease in the firm's beta
B. Increase in tax rates
C. Increase in the risk-free rate of return
D. Decrease in the market price of the debt
E. Increase in a bond's yield to maturity

47. All else constant, an increase in a firm's cost of debt:

A. could be caused by an increase in the firm's tax rate.
B. will result in an increase in the firm's cost of capital.
C. will lower the firm's weighted average cost of capital.
D. will lower the firm's cost of equity.
E. will increase the firm's capital structure weight of debt.
© McGraw-Hill Australia Ross, Essentials of Corporate Finance, Fifth Edition Chapter 12 Testbank

48. The cost of preferred share:

A. increases when a firm's tax rate decreases.
B. is constant over time.
C. is unaffected by changes in the market price of the share.
D. is equal to the share's dividend yield.
E. increases as the price of the share increases.

49. Which one of the following will affect the capital structure weights used to compute a firm's
weighted average cost of capital?
A. Decrease in the book value of a firm's equity
B. Decrease in a firm's tax rate
C. Increase in the market value of the firm's common share
D. Increase in the market risk premium
E. Increase in the firm's beta

50. Which one of the following represents the minimum rate of return a firm must earn on its
assets if it is to maintain the current value of its securities?
A. Cost of equity
B. Pre-tax cost of debt
C. After-tax cost of debt
D. Weighted average cost of capital
E. Weighted average cost of preferred and common share

51. A firm has a cost of equity of 13%, a cost of preferred of 11%, an after tax cost of debt of
5.2% and a tax rate of 35%. Given this, which one of the following will increase the firm's
weighted average cost of capital?
A. Increasing the firm's tax rate
B. Issuing new bonds at par
C. Redeeming shares of common share
D. Increasing the firm's beta
E. Increasing the debt-equity ratio

52. All else constant, the weighted average cost of capital for a risky, levered firm will decrease
if:
A. the firm's bonds start selling at a premium rather than at a discount.
B. the market risk premium increases.
C. the firm replaces some of its debt with preferred shares.
D. corporate taxes are eliminated.
E. the dividend yield on the common share increases.

53. Old Town Industries has three divisions. Division X has been in existence the longest and has
the most stable sales. Division Y has been in existence for five years and is slightly less risky
© McGraw-Hill Australia Ross, Essentials of Corporate Finance, Fifth Edition Chapter 12 Testbank

than the overall firm. Division Z is the research and development side of the business. Given
this, the firm should probably:
A. require the highest rate of return from Division X since it has been in existence the longest.
B. assign the highest cost of capital to Division Z because it is most likely the riskiest of the three
divisions.
C. use the firm's WACC as the cost of capital for Division Z as it provides analysis for the entire
firm.
D. use the firm's WACC as the cost of capital for Divisions A and B because they are part of the
revenue-producing operations of the firm.
E. allocate capital funds evenly among the divisions to maintain the current capital structure of
the firm.

54. Kurt, who is a divisional manager, continually brags that his division's required return for its
projects is 1% lower than the return required for any other division of the firm. Which one of the
following most likely contributes the most to the lower rate requirement for Kurt's division?
A. Kurt tends to overestimate the projected cash inflows on his projects.
B. Kurt tends to underestimate the variable costs of his projects.
C. Kurt has the most efficiently managed division.
D. Kurt's division is less risky than the other divisions.
E. Kurt's projects are generally financed with debt while the other divisions' projects are financed
with equity.

55. Which one of the following is the primary determinant of an investment's cost of capital?
A. Life of the investment
B. Amount of the initial cash outlay
C. The investment’s level of risk
D. The source of funds used for the investment
E. The investment's net present value

56. Spartans has 6.5% bonds outstanding that mature in 18 years. The bonds pay interest semi-
annually and have a face value of $1000. Currently, the bonds are selling for $985 each. What is
the firm's pre-tax cost of debt?
A. 6.77%
B. 6.64%
C. 6.94%
D. 7.11%
E. 6.20%

57. Three years ago, the Fairchildress Co. issued 20-year, 7.75% semi-annual coupon bonds at
par. Today, the bonds are quoted at 102.6%. What is this firm's pre-tax cost of debt?
A. 57.32%
B. 7.13%
C. 7.48%
© McGraw-Hill Australia Ross, Essentials of Corporate Finance, Fifth Edition Chapter 12 Testbank

D. 7.88%
E. 7.34%

58. Pride of Lions has bonds outstanding that carry an annual coupon of 5.75%. The bonds
mature in 9 years and are currently priced at 98% of face value. What is the firm's pre-tax cost of
debt?
A. 6.04%
B. 9.850%
C. 8.60%
D. 11.28%
E. 12.02%

59. Madison Square Stores has a $20 million bond issue outstanding that currently has a market
value of $19.4 million. The bonds mature in 6.5 years and pay semi-annual interest payments of
$35 each. What is the firm's pre-tax cost of debt?
A. 8.21%
B. 7.59%
C. 7.08%
D. 7.74%
E. 7.80%

60. The preferred share of Dolphin Pools pays an annual dividend of $5.25 a share and sells for
$48 a share. The tax rate is 35%. What is the firm's cost of preferred share?
A. 9.67%
B. 10.94%
C. 15.07%
D. 15.59%
E. 16.47%
© McGraw-Hill Australia Ross, Essentials of Corporate Finance, Fifth Edition Chapter 12 Testbank

Chapter 12 Testbank Key

1. The Whitehorse Book Company has 140 million shares outstanding. The market price of one
share is currently $2. The company's debentures are publicly traded and their market price is
equal to 93% of its face value. The debentures have a total book value of $50 000 000 and the
current yield to maturity of corporate debenture is 12% per annum. The risk-free rate is 8.50%
and the market risk premium is 5.20%. Market analysts estimated that the Whitehorse Book
Company has a beta of 0.90. The corporate tax rate is 30%. What is the company's weighted
average cost of capital (WACC) under the classical tax system?
A. 14.24%
B. 11.10%
C. 12.50%
D. 13.18%
Ans: C
AACSB: Analytic
Blooms: Analysis
Difficulty: Medium
Learning Objective: 12.03 Determine a firm's overall cost of capital
Topic: The weighted average cost of capital

2. The Whitehorse Book Company has 140 million shares outstanding. The market price of one
share is currently $2. The company's debentures are publicly traded and their market price is
equal to 93% of its face value. The debentures have a total book value of $50 000 000 and the
current yield to maturity of corporate debenture is 12% per annum. The risk-free rate is 8.50%
and the market risk premium is 5.20%. Market analysts estimated that the Whitehorse Book
Company has a beta of 0.90. The corporate tax rate is 30%. What is the company's weighted
average cost of capital (WACC) considering the imputation tax system?
A. 13.18%
B. 7.70%
C. 12.15%
D. 9.11%
Ans: D
AACSB: Analytic
Blooms: Analysis
Difficulty: Medium
Learning Objective: 12.03 Determine a firm's overall cost of capital
Topic: The weighted average cost of capital

3. Calculate the after-tax return to a shareholder assuming a dividend imputation system is used
in Australia (if the dividend is fully franked). The shareholder is currently subject to a marginal
tax rate of 40% and receives a dividend of $700 per annum. The corporate tax rate is equal to
30%.
A. $420
© McGraw-Hill Australia Ross, Essentials of Corporate Finance, Fifth Edition Chapter 12 Testbank

B. $700
C. $350
D. $600
Ans: D
AACSB: Analytic
Blooms: Analysis
Difficulty: Easy
Learning Objective: 12.03 Determine a firm's overall cost of capital
Topic: The weighted average cost of capital

4. The PMP Insurance Company preference shares are trading on the ASX at $9 each and a
dividend of $0.63 has just been paid. The face value of the issue is $10. What is the cost of
preference shares for PMP?
A. 14.29%
B. 6.30%
C. 1.11%
D. 7.00%
Ans: D
AACSB: Analytic
Blooms: Analysis
Difficulty: Easy
Learning Objective: 12.02 Determine a firm's cost of debt
Topic: The costs of debt and preference shares

5. Rainbow Mining Pty Ltd is concerned that opening a new credit line will affect its share price.
Now the company has a risk return on its shares of 17.50%, determined by using a beta factor of
1.50. The risk free rate is 7%. What is the risk premium for Rainbow Mining?
A. 7.00%
B. 5.50%
C. 10.00%
D. 10.50%
Ans: D
AACSB: Analytic
Blooms: Analysis
Difficulty: Easy
Learning Objective: 12.01 Determine a firm's cost of equity capital
Topic: The cost of equity

6. Rainbow Mining Pty Ltd is concerned that opening a new credit line will affect its share price.
Now the company has a risk return on its shares of 17.50%, determined by using a beta factor of
1.50. The risk free rate is 7%. What is the market risk premium based on the information given
for Rainbow Mining?
A. 17.50%
B. 5.50%
C. 11.86%
D. 7.00%
Ans: D
© McGraw-Hill Australia Ross, Essentials of Corporate Finance, Fifth Edition Chapter 12 Testbank

AACSB: Analytic
Blooms: Analysis
Difficulty: Easy
Learning Objective: 12.01 Determine a firm's cost of equity capital
Topic: The cost of equity

7. The proportional cost of equity plus the proportional after tax cost of debt is called the:
A. pure play weight.
B. capital structure weight.
C. portfolio weight.
D. weighted average cost of capital.
Ans: D
AACSB: Analytic
Blooms: Analysis
Difficulty: Easy
Learning Objective: 12.03 Determine a firm's overall cost of capital
Topic: The weighted average cost of capital

8. Using the weighted average cost of capital (WACC) of another firm, one which is focused on
the type of project you are considering, rather than using your own firm's WACC is called the:
A. competitor's game.
B. project divisor.
C. insider's look.
D. pure play approach.
Ans: D
AACSB: Analytic
Blooms: Analysis
Difficulty: Easy
Learning Objective: 12.04 Identify some of the pitfalls associated with a firm's overall cost of capital and what to do about them
Topic: Divisional and project costs of capital

9. When the management of a firm evaluates the risk of a proposed project and adjusts the firm's
WACC based on that evaluation to ascertain the required return for the project, they are using the
_____ approach.
A. subjective
B. normative
C. insider
D. pure play
Ans: A
AACSB: Analytic
Blooms: Analysis
Difficulty: Easy
Learning Objective: 12.04 Identify some of the pitfalls associated with a firm's overall cost of capital and what to do about them
Topic: Divisional and project costs of capital

10. In an efficient market, a security with a beta of 0.98 will have a rate of return which lies:
A. on the SML just to the right of the market return.
© McGraw-Hill Australia Ross, Essentials of Corporate Finance, Fifth Edition Chapter 12 Testbank

B. on the SML just to the left of the market return.

C. just below the SML and to the right of the market return.
D. just below the security market line (SML) and to the left of the market return.
Ans: B
AACSB: Analytic
Blooms: Analysis
Difficulty: Easy
Learning Objective: 12.01 Determine a firm's cost of equity capital
Topic: The cost of equity

11. Which one of the following represents the best estimate for a firm's pre-tax cost of debt?
A. The current coupon on the firm's existing debt
B. The current yield on the firm's existing debt
C. Twice the rate of return currently offered on risk-free securities
D. The current yield-to-maturity on the firm's existing debt
Ans: D
AACSB: Analytic
Blooms: Analysis
Difficulty: Easy
Learning Objective: 12.03 Determine a firm's overall cost of capital
Topic: The weighted average cost of capital

12. An increase in the market value of a preferred preference share will _____ the cost of the
preferred preference share.
A. increase
B. either increase or decrease
C. decrease
D. not affect
Ans: C
AACSB: Analytic
Blooms: Analysis
Difficulty: Easy
Learning Objective: 12.02 Determine a firm's cost of debt
Topic: The costs of debt and preference shares

13. Which one of the following is a correct statement regarding a firm's weighted average cost of
capital (WACC)?
A. A 5% increase in a firm's debt–equity ratio will tend to increase the firm's WACC.
B. The WACC will decrease when the tax rate decreases for all firms that utilise debt financing.
C. The WACC can be used as the required return for all new projects with similar risk to that of
the existing firm.
D. A reduction in the risk level of a firm will tend to increase the firm's WACC.
Ans: C
AACSB: Analytic
Blooms: Analysis
Difficulty: Easy
Learning Objective: 12.03 Determine a firm's overall cost of capital
Topic: The weighted average cost of capital
© McGraw-Hill Australia Ross, Essentials of Corporate Finance, Fifth Edition Chapter 12 Testbank

14. A firm has a cost of equity of 10%, a cost of preferred preference shares of 9% and an after-
tax cost of debt of 5%. Given this, which one of the following will decrease the firm's cost of
capital?
A. Decreasing the debt–equity ratio
B. Increasing the systematic risk of the firm
C. Decreasing the firm–specific risk associated with the firm
D. Issuing new debt to offset an increase in the dividend payout ratio
Ans: D
AACSB: Analytic
Blooms: Analysis
Difficulty: Easy
Learning Objective: 12.03 Determine a firm's overall cost of capital
Topic: The weighted average cost of capital

15. The cost of capital for a project should:

A. never exceed the cost of capital for the overall firm.
B. meet or exceed the internal rate of return of the project.
C. be adjusted based on the size of the project.
D. be adjusted based on the risk of the project.
Ans: D
AACSB: Analytic
Blooms: Analysis
Difficulty: Medium
Learning Objective: 12.03 Determine a firm's overall cost of capital
Topic: The weighted average cost of capital

16. When using the pure play approach, a firm is seeking a rate of return which:
A. is applicable to the risk level of the investment under consideration.
B. is lower than its own cost of capital.
C. matches the expected internal rate of return of the investment being considered.
D. will cause a project to have a positive net present value.
Ans: A
AACSB: Analytic
Blooms: Analysis
Difficulty: Easy
Learning Objective: 12.04 Identify some of the pitfalls associated with a firm's overall cost of capital and what to do about them
Topic: Divisional and project costs of capital

17. Nelson Enterprises just paid an annual dividend of $1.56 per share. This dividend is expected
to increase by 3% annually. Currently, the firm has a beta of 1.13 and a share price of $28 a
share. The risk-free rate is 3% and the market rate of return is 10.5%. What is your best estimate
of Nelson's cost of equity?
A. 8.74%
B. 10.11%
C. 11.48%
© McGraw-Hill Australia Ross, Essentials of Corporate Finance, Fifth Edition Chapter 12 Testbank

D. 9.72%
Ans: B
AACSB: Analytic
Blooms: Analysis
Difficulty: Medium
Learning Objective: 12.01 Determine a firm's cost of equity capital
Topic: The cost of equity

18. Horseless Carriages issued 20-year, 7% semi-annual bonds 11 years ago. The bonds currently
sell at 101.3% of face value. What is the firm's after tax cost of debt if the tax rate is 34%?
A. 4.87%
B. 6.83%
C. 6.71%
D. 4.49%
Ans: D
AACSB: Analytic
Blooms: Analysis
Difficulty: Medium
Learning Objective: 12.02 Determine a firm's cost of debt
Topic: The costs of debt and preference shares

19. The 7% preferred share preference share of Winslow & Winslow is selling for $54 a share.
What is the firm's cost of preferred preference shares (face value $100)?
A. 3.78%
B. 17.56%
C. 7.71%
D. 12.96%
Ans: D
AACSB: Analytic
Blooms: Analysis
Difficulty: Easy
Learning Objective: 12.01 Determine a firm's cost of equity capital
Topic: The cost of equity

20. Which of the following are weaknesses of the dividend growth model?
I. Market risk premium fluctuations
II. Lack of dividends for some firms
III. Reliance on historical beta
IV. Sensitivity of model to dividend growth rate
A. I and II only
B. I and III only
C. II and IV only
D. I, II, III and IV
Ans: D
© McGraw-Hill Australia Ross, Essentials of Corporate Finance, Fifth Edition Chapter 12 Testbank

AACSB: Analytic
Blooms: Analysis
Difficulty: Easy
Learning Objective: 12.01 Determine a firm's cost of equity capital
Topic: The cost of equity

21. In an efficient market, the cost of equity for a risky firm does which one of the following,
according to the security market line?
A. Produces a return that will be less than the market rate but higher than the risk-free rate
B. Equals the market rate of return for all shares
C. Has a maximum cost equal to the market rate of return
D. Increases in direct relation to the share's systematic risk
Ans: D
AACSB: Analytic
Blooms: Analysis
Difficulty: Easy
Learning Objective: 12.01 Determine a firm's cost of equity capital
Topic: The cost of equity

22. Which of the following will increase the cost of equity for a firm with a beta of 1.1?
I. Decrease in the security's beta
II. Decrease in the market risk premium
III. Decrease in the risk-free rate
IV. Increase in the risk-free rate
A. II only
B. III only
C. I and II only
D. I and III only
Ans: B
AACSB: Analytic
Blooms: Analysis
Difficulty: Medium
Learning Objective: 12.01 Determine a firm's cost of equity capital
Topic: The cost of equity

23. Which one of the following will increase the cost of equity, all things being equal?
A. Increase in the dividend growth rate
B. Decrease in beta
C. Decrease in future dividends
D. Increase in share price
Ans: A
AACSB: Analytic
Blooms: Analysis
Difficulty: Medium
Learning Objective: 12.01 Determine a firm's cost of equity capital
Topic: The cost of equity
© McGraw-Hill Australia Ross, Essentials of Corporate Finance, Fifth Edition Chapter 12 Testbank

24. All things being equal, which of the following will increase the after-tax cost of debt for a
firm?
I. Increase in the yield to maturity of the firm's outstanding debt
II. Decrease in the yield to maturity of the firm's outstanding debt
III. Increase in the firm's tax rate
IV. Decrease in the firm's tax rate
A. I only
B. I and III only
C. I and IV only
D. II and III only
Ans: C
AACSB: Analytic
Blooms: Analysis
Difficulty: Easy
Learning Objective: 12.02 Determine a firm's cost of debt
Topic: The costs of debt and preference shares

25. Which one of the following statements is correct?

A. An increase in the market value of preference shares will increase a firm's weighted average
cost of capital.
B. The cost of preference shares is unaffected by the issuer's tax rate.
C. Preference shares are generally the cheapest source of capital for a firm.
D. The cost of preference shares remains constant from year to year.
Ans: B
AACSB: Analytic
Blooms: Analysis
Difficulty: Easy
Learning Objective: 12.02 Determine a firm's cost of debt
Topic: The costs of debt and preference shares

26. Alpha Industries is considering a project with an initial cost of $7.4 million. The project will
produce cash inflows of $1.54 million a year for seven years. The firm uses the subjective
approach to assign discount rates to projects. For this project, the subjective adjustment is +1.5%.
The firm has a pre–tax cost of debt of 8.6% and a cost of equity of 13.7%. The debt-equity ratio
is 0.0.65 and the tax rate is 35%. What is the net present value of the project?
A. –$372 951
B. –$187 016
C. $48 209
D. $269 480
Ans: A
AACSB: Analytic
Blooms: Analysis
Difficulty: Medium
Learning Objective: 12.04 Identify some of the pitfalls associated with a firm's overall cost of capital and what to do about them
Topic: Divisional and project costs of capital
© McGraw-Hill Australia Ross, Essentials of Corporate Finance, Fifth Edition Chapter 12 Testbank

27. The computation of which one of the following requires assigning every proposed investment
to a particular risk class?
A. Pure play cost of capital
B. Cost of equity
C. WACC
D. Subjective cost of capital
Ans: D
AACSB: Analytic
Blooms: Analysis
Difficulty: Easy
Learning Objective: 12.04 Identify some of the pitfalls associated with a firm's overall cost of capital and what to do about them
Topic: Divisional and project costs of capital

28. Which of the following is NOT an operating cost?

A. Interest payments
B. Advertising costs
C. Legal fees
D. Depreciation of non-current assets
Ans: A
AACSB: Analytic
Blooms: Analysis
Difficulty: Easy
Learning Objective: 12.04 Identify some of the pitfalls associated with a firm's overall cost of capital and what to do about them
Topic: Company valuation with the WACC

29. Which of the following statements is correct with regard to debt financing?
A. The firm’s cost of equity is reduced.
B. The shareholders’ wealth is increased.
C. The firm’s tax bill is increased.
D. The firm’s risk level is reduced.
Ans: D
AACSB: Analytic
Blooms: Analysis
Difficulty: Medium
Learning Objective: 12.04 Identify some of the pitfalls associated with a firm's overall cost of capital and what to do about them
Topic: Company valuation with the WACC

30. Consider the following information for the Golf Corporation: the market price per share is
$12; the book value per share is $10; the number of shares outstanding is 100 million; the market
price per bond is $800; the face value per bond is $1000; the number of bonds outstanding is 1
million. Calculate the proportion of debt and equity for the corporation that you would use for
estimating the weighted average cost of capital.
A. 40% debt and 60% equity
B. 50% debt and 50% equity
C. 45.5% debt and 54.5% equity
D. 70% debt and 30% equity
Ans: D
© McGraw-Hill Australia Ross, Essentials of Corporate Finance, Fifth Edition Chapter 12 Testbank

AACSB: Analytic
Blooms: Analysis
Difficulty: Medium
Learning Objective: 12.04 Identify some of the pitfalls associated with a firm's overall cost of capital and what to do about them
Topic: Company valuation with the WACC

31. Katie owns 100 shares of ABC. Which one of the following terms is used to refer to the
return that Katie and the other shareholders require on their investment in ABC?
A. Weighted average cost of capital
B. Pure play cost
C. Cost of equity
D. Subjective cost
E. Cost of debt
Ans: C
AACSB: Analytic
Blooms: Analysis
Difficulty: Easy
Learning Objective: 12.01 Determine a firm's cost of equity capital
Topic: The cost of equity

32. Lester lent money to The Corner Store by purchasing bonds issued by the store. The rate of
return that he and the other lenders require is referred to as the:
A. pure play cost.
B. cost of debt.
C. weighted average cost of capital.
D. subjective cost.
E. cost of equity.
Ans: B
AACSB: Analytic
Blooms: Analysis
Difficulty: Easy
Learning Objective: 12.02 Determine a firm's cost of debt
Topic: The costs of debt and preference shares

33. The weighted average cost of capital is defined as the weighted average of a firm's:
A. return on all of its investments.
B. cost of equity, cost of preferred and its after-tax cost of debt.
C. pre-tax cost of debt and its preferred and common equity securities.
D. bond coupon rates.
E. common and preferred share.
Ans: B
AACSB: Analytic
Blooms: Analysis
Difficulty: Easy
Learning Objective: 12.03 Determine a firm's overall cost of capital
Topic: The weighted average cost of capital
© McGraw-Hill Australia Ross, Essentials of Corporate Finance, Fifth Edition Chapter 12 Testbank

34. Farmer's Supply is considering opening a clothing store, which would be a new line of
business for the firm. Management has decided to use the cost of capital of a similar clothing
store as the discount rate to evaluate this proposed expansion. Which one of the following terms
describes this evaluation approach?
A. Equity approach
B. After-tax approach
C. Subjective approach
D. Market play
E. Pure play approach
Ans: E
AACSB: Analytic
Blooms: Analysis
Difficulty: Easy
Learning Objective: 12.04 Identify some of the pitfalls associated with a firm's overall cost of capital and what to do about them
Topic: Divisional and project costs of capital

35. Kate is the CFO of a major firm and has the job of assigning discount rates to each project
under consideration. Kate's method of doing this is to assign an incrementally higher rate as the
risk level of the project increases and a lower rate as the risk level declines. Kate is applying the
___ approach.
A. pure play
B. divisional rating
C. subjective
D. straight WACC
E. equity rating
Ans: C
AACSB: Analytic
Blooms: Analysis
Difficulty: Easy
Learning Objective: 12.04 Identify some of the pitfalls associated with a firm's overall cost of capital and what to do about them
Topic: Divisional and project costs of capital

36. Ted is trying to decide what cost of capital he should assign to a project. Which one of the
following should be his primary consideration in this decision?
A. Amount of debt used to finance the project
B. Use, or lack, of preferred share as a financing option
C. Mix of funds used to finance the project
D. Risk level of the project
E. Length of the project's life
Ans: D
AACSB: Analytic
Blooms: Analysis
Difficulty: Easy
Learning Objective: 12.04 Identify some of the pitfalls associated with a firm's overall cost of capital and what to do about them
Topic: Divisional and project costs of capital
© McGraw-Hill Australia Ross, Essentials of Corporate Finance, Fifth Edition Chapter 12 Testbank

37. Black Stone Furnaces wants to build a new facility. The cost of capital for this investment is
primarily dependent on which one of the following?
A. The firm's overall source of funds
B. Source of the funds used to build the facility
C. Current tax rate
D. The nature of the investment
E. Firm's historical average rate of return
Ans: D
AACSB: Analytic
Blooms: Analysis
Difficulty: Easy
Learning Objective: 12.04 Identify some of the pitfalls associated with a firm's overall cost of capital and what to do about them
Topic: Divisional and project costs of capital

38. Which one of the following statements is correct relating to the dividend growth model
approach to computing the cost of equity?
A. The rate of growth must exceed the required rate of return.
B. The rate of return must be adjusted for taxes.
C. The annual dividend used in the computation must be for Year 1 if you are Time 0’s share
price to compute the return.
D. The cost of equity is equal to the return on the share plus the risk-free rate.
E. The cost of equity is equal to the return on the share multiplied by the share's beta.
Ans: C
AACSB: Analytic
Blooms: Analysis
Difficulty: Easy
Learning Objective: 12.01 Determine a firm's cost of equity capital
Topic: The cost of equity

39. A firm has a return on equity of 12.4% according to the dividend growth model and a return
of 18.7% according to the capital asset pricing model. The market rate of return is 13.5%. What
rate should the firm use as the cost of equity when computing the firm's weighted average cost of
capital (WACC)?
A. 12.4% because it is lower than 18.7%
B. 18.7% because it is higher than 12.4%
C. The arithmetic average of 12.4% and 18.7%
D. The arithmetic average of 12.4%, 13.5% and 18.7%
E. 13.5%
Ans: C
AACSB: Analytic
Blooms: Analysis
Difficulty: Easy
Learning Objective: 12.03 Determine a firm's overall cost of capital
Topic: The weighted average cost of capital

40. When evaluating a project, the dividend growth model:

A. can only be used by firms that pay increasing dividends.
© McGraw-Hill Australia Ross, Essentials of Corporate Finance, Fifth Edition Chapter 12 Testbank

B. must be used by all dividend-paying firms.

C. is only applicable when the growth rate of the project exceeds the dividend growth rate.
D. is relatively simple to use.
E. must use the growth rate of the project as the rate of growth in the formula.
Ans: D
AACSB: Analytic
Blooms: Analysis
Difficulty: Easy
Learning Objective: 12.01 Determine a firm's cost of equity capital
Topic: The cost of equity

41. The results of the dividend growth model:

A. vary directly with the market rate of return.
B. can only be applied to projects that have a growth rate equal to that of the current firm.
C. are highly dependent upon the beta used in the model.
D. are sensitive to the rate of dividend growth.
E. are most reliable when the growth rate exceeds 10%.
Ans: D
AACSB: Analytic
Blooms: Analysis
Difficulty: Easy
Learning Objective: 12.01 Determine a firm's cost of equity capital
Topic: The cost of equity

42. In an efficient market, the cost of equity for a high-risk firm:

A. will be less than the market rate but higher than the risk-free rate.
B. must equal the market rate of return.
C. changes by 1% for every 1% change in the risk-free rate.
D. decreases as the beta of the firm's share increases.
E. increases in direct relation to the share's systematic risk.
Ans: E
AACSB: Analytic
Blooms: Analysis
Difficulty: Easy
Learning Objective: 12.01 Determine a firm's cost of equity capital
Topic: The cost of equity

43. Assume a firm has a beta of 1.2. All else held constant, the cost of equity for this firm will
increase if the:
A. market risk premium decreases.
B. risk-free rate decreases.
C. market rate of return decreases.
D. beta decreases.
E. either the risk-free rate or the market rate of return decreases.
Ans: B
© McGraw-Hill Australia Ross, Essentials of Corporate Finance, Fifth Edition Chapter 12 Testbank

AACSB: Analytic
Blooms: Analysis
Difficulty: Easy
Learning Objective: 12.01 Determine a firm's cost of equity capital
Topic: The cost of equity

44. An increase in a levered firm’s tax rate will:

A. decrease the cost of preferred share.
B. increase both the cost of preferred share and debt.
C. decrease the firm’s cost of capital.
D. decrease the cost of equity capital.
E. increase the firm’s WACC.
Ans: C
AACSB: Analytic
Blooms: Analysis
Difficulty: Easy
Learning Objective: 12.02 Determine a firm's cost of debt
Topic: The costs of debt and preference shares

45. Which one of the following is used as the pre-tax cost of debt?
A. Average coupon rate on the firm's outstanding bonds
B. Coupon rate on the firm's latest bond issue
C. Weighted average yield to maturity on the firm's outstanding debt
D. Average current yield on the firm's outstanding debt
E. Annual interest divided by the market price per bond for the latest bond issue
Ans: C
AACSB: Analytic
Blooms: Analysis
Difficulty: Easy
Learning Objective: 12.02 Determine a firm's cost of debt
Topic: The costs of debt and preference shares

46. Which one of the following will decrease the after-tax cost of debt for a firm?
A. Decrease in the firm's beta
B. Increase in tax rates
C. Increase in the risk-free rate of return
D. Decrease in the market price of the debt
E. Increase in a bond's yield to maturity
Ans: B
AACSB: Analytic
Blooms: Analysis
Difficulty: Easy
Learning Objective: 12.03 Determine a firm's overall cost of capital
Topic: The weighted average cost of capital

47. All else constant, an increase in a firm's cost of debt:

A. could be caused by an increase in the firm's tax rate.
© McGraw-Hill Australia Ross, Essentials of Corporate Finance, Fifth Edition Chapter 12 Testbank

B. will result in an increase in the firm's cost of capital.

C. will lower the firm's weighted average cost of capital.
D. will lower the firm's cost of equity.
E. will increase the firm's capital structure weight of debt.
Ans: B
AACSB: Analytic
Blooms: Analysis
Difficulty: Easy
Learning Objective: 12.02 Determine a firm's cost of debt
Topic: The costs of debt and preference shares

48. The cost of preferred share:

A. increases when a firm's tax rate decreases.
B. is constant over time.
C. is unaffected by changes in the market price of the share.
D. is equal to the share's dividend yield.
E. increases as the price of the share increases.
Ans: D
AACSB: Analytic
Blooms: Analysis
Difficulty: Easy
Learning Objective: 12.02 Determine a firm's cost of debt
Topic: The costs of debt and preference shares

49. Which one of the following will affect the capital structure weights used to compute a firm's
weighted average cost of capital?
A. Decrease in the book value of a firm's equity
B. Decrease in a firm's tax rate
C. Increase in the market value of the firm's common share
D. Increase in the market risk premium
E. Increase in the firm's beta
Ans: C
AACSB: Analytic
Blooms: Analysis
Difficulty: Easy
Learning Objective: 12.03 Determine a firm's overall cost of capital
Topic: The weighted average cost of capital

50. Which one of the following represents the minimum rate of return a firm must earn on its
assets if it is to maintain the current value of its securities?
A. Cost of equity
B. Pre-tax cost of debt
C. After-tax cost of debt
D. Weighted average cost of capital
E. Weighted average cost of preferred and common share
Ans: D
© McGraw-Hill Australia Ross, Essentials of Corporate Finance, Fifth Edition Chapter 12 Testbank

AACSB: Analytic
Blooms: Analysis
Difficulty: Easy
Learning Objective: 12.03 Determine a firm's overall cost of capital
Topic: The weighted average cost of capital

51. A firm has a cost of equity of 13%, a cost of preferred of 11%, an after tax cost of debt of
5.2% and a tax rate of 35%. Given this, which one of the following will increase the firm's
weighted average cost of capital?
A. Increasing the firm's tax rate
B. Issuing new bonds at par
C. Redeeming shares of common share
D. Increasing the firm's beta
E. Increasing the debt-equity ratio
Ans: D
AACSB: Analytic
Blooms: Analysis
Difficulty: Medium
Learning Objective: 12.03 Determine a firm's overall cost of capital
Topic: The weighted average cost of capital

52. All else constant, the weighted average cost of capital for a risky, levered firm will decrease
if:
A. the firm's bonds start selling at a premium rather than at a discount.
B. the market risk premium increases.
C. the firm replaces some of its debt with preferred shares.
D. corporate taxes are eliminated.
E. the dividend yield on the common share increases.
Ans: A
AACSB: Analytic
Blooms: Analysis
Difficulty: Medium
Learning Objective: 12.03 Determine a firm's overall cost of capital
Topic: The weighted average cost of capital

53. Old Town Industries has three divisions. Division X has been in existence the longest and has
the most stable sales. Division Y has been in existence for five years and is slightly less risky
than the overall firm. Division Z is the research and development side of the business. Given
this, the firm should probably:
A. require the highest rate of return from Division X since it has been in existence the longest.
B. assign the highest cost of capital to Division Z because it is most likely the riskiest of the three
divisions.
C. use the firm's WACC as the cost of capital for Division Z as it provides analysis for the entire
firm.
D. use the firm's WACC as the cost of capital for Divisions A and B because they are part of the
revenue-producing operations of the firm.
© McGraw-Hill Australia Ross, Essentials of Corporate Finance, Fifth Edition Chapter 12 Testbank

E. allocate capital funds evenly among the divisions to maintain the current capital structure of
the firm.
Ans: B
AACSB: Analytic
Blooms: Analysis
Difficulty: Easy
Learning Objective: 12.04 Identify some of the pitfalls associated with a firm's overall cost of capital and what to do about them
Topic: Divisional and project costs of capital

54. Kurt, who is a divisional manager, continually brags that his division's required return for its
projects is 1% lower than the return required for any other division of the firm. Which one of the
following most likely contributes the most to the lower rate requirement for Kurt's division?
A. Kurt tends to overestimate the projected cash inflows on his projects.
B. Kurt tends to underestimate the variable costs of his projects.
C. Kurt has the most efficiently managed division.
D. Kurt's division is less risky than the other divisions.
E. Kurt's projects are generally financed with debt while the other divisions' projects are financed
with equity.
Ans: D
AACSB: Analytic
Blooms: Analysis
Difficulty: Easy
Learning Objective: 12.04 Identify some of the pitfalls associated with a firm's overall cost of capital and what to do about them
Topic: Divisional and project costs of capital

55. Which one of the following is the primary determinant of an investment's cost of capital?
A. Life of the investment
B. Amount of the initial cash outlay
C. The investment’s level of risk
D. The source of funds used for the investment
E. The investment's net present value
Ans: C
AACSB: Analytic
Blooms: Analysis
Difficulty: Easy
Learning Objective: 12.04 Identify some of the pitfalls associated with a firm's overall cost of capital and what to do about them
Topic: Divisional and project costs of capital

56. Spartans has 6.5% bonds outstanding that mature in 18 years. The bonds pay interest semi-
annually and have a face value of $1000. Currently, the bonds are selling for $985 each. What is
the firm's pre-tax cost of debt?
A. 6.77%
B. 6.64%
C. 6.94%
D. 7.11%
E. 6.20%
Ans: B
© McGraw-Hill Australia Ross, Essentials of Corporate Finance, Fifth Edition Chapter 12 Testbank

AACSB: Analytic
Blooms: Analysis
Difficulty: Easy
Learning Objective: 12.02 Determine a firm's cost of debt
Topic: The costs of debt and preference shares

57. Three years ago, the Fairchildress Co. issued 20-year, 7.75% semi-annual coupon bonds at
par. Today, the bonds are quoted at 102.6%. What is this firm's pre-tax cost of debt?
A. 57.32%
B. 7.13%
C. 7.48%
D. 7.88%
E. 7.34%
Ans: C
AACSB: Analytic
Blooms: Analysis
Difficulty: Easy
Learning Objective: 12.02 Determine a firm's cost of debt
Topic: The costs of debt and preference shares

58. Pride of Lions has bonds outstanding that carry an annual coupon of 5.75%. The bonds
mature in 9 years and are currently priced at 98% of face value. What is the firm's pre-tax cost of
debt?
A. 6.04%
B. 9.850%
C. 8.60%
D. 11.28%
E. 12.02%
Ans: A
AACSB: Analytic
Blooms: Analysis
Difficulty: Easy
Learning Objective: 12.02 Determine a firm's cost of debt
Topic: The costs of debt and preference shares

59. Madison Square Stores has a $20 million bond issue outstanding that currently has a market
value of $19.4 million. The bonds mature in 6.5 years and pay semi-annual interest payments of
$35 each. What is the firm's pre-tax cost of debt?
A. 8.21%
B. 7.59%
C. 7.08%
D. 7.74%
E. 7.80%
Ans: B
© McGraw-Hill Australia Ross, Essentials of Corporate Finance, Fifth Edition Chapter 12 Testbank

AACSB: Analytic
Blooms: Analysis
Difficulty: Easy
Learning Objective: 12.02 Determine a firm's cost of debt
Topic: The costs of debt and preference shares

60. The preferred share of Dolphin Pools pays an annual dividend of $5.25 a share and sells for
$48 a share. The tax rate is 35%. What is the firm's cost of preferred share?
A. 9.67%
B. 10.94%
C. 15.07%
D. 15.59%
E. 16.47%
Ans: B
AACSB: Analytic
Blooms: Analysis
Difficulty: Easy
Learning Objective: 12.02 Determine a firm's cost of debt
Topic: The costs of debt and preference shares
© McGraw-Hill Australia Ross, Essentials of Corporate Finance, Fifth Edition Chapter 12 Testbank
© McGraw-Hill Australia Ross, Essentials of Corporate Finance, Fifth Edition Chapter 12 Testbank

Category
# of Questions
AACSB: Analytic
60
Blooms: Analysis
60
Difficulty: Easy
48
Difficulty: Medium
12
Learning Objective: 12.01 Determine a firm's cost of equity capital
15
Learning Objective: 12.02 Determine a firm's cost of debt
15
Learning Objective: 12.03 Determine a firm's overall cost of capital
15
Learning Objective: 12.04 Identify some of the pitfalls associated with a firm's overall cost of
capital and what to do about them
15
Topic: Company valuation with the WACC
3
Topic: Divisional and project costs of capital
12
Topic: The cost of equity
15
Topic: The costs of debt and preference shares
15
Topic: The weighted average cost of capital
15