sp08exam3(2) - Fin 221 Spring 2008 Exam 3 covers Chapters...

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Fin 221 Spring 2008 Exam 3 covers Chapters 10-12 & 16. Multiple Choice Identify the choice that best completes the statement or answers the question. 1. Which of the following statements is CORRECT? A. The WACC as used in capital budgeting is an estimate of a company's before-tax cost of capital. B. There is an "opportunity cost" associated with using retained earnings they are not "free." C. The WACC as used in capital budgeting is an estimate of the cost of all the capital a company has raised to acquire its assets. D. The percentage flotation costs associated with issuing new common equity are typically smaller than the flotation costs for new debt. E. The WACC as used in capital budgeting will be the after-tax cost of debt if the firm plans to use only debt to finance its capital budget during the coming year. 2. Which of the following statements is CORRECT? A. In the WACC calculation, we must adjust the cost of preferred stock (the market yield) because 70% of the dividends received by corporate investors are excluded from their taxable income. B. We should use historical measures of the component costs from prior financings when estimating a company's WACC for capital budgeting purposes. C. The cost of new equity (r e ) could possibly be lower than the cost of retained earnings (r s ) if the market risk premium, risk-free rate, and the company's beta all decline by a sufficiently large amount. D. The component cost of preferred stock is expressed as r p (1 T), because preferred stock dividends are treated as fixed charges, similar to the treatment of debt interest. E. The cost of retained earnings is the rate of return stockholders require on a firm's common stock. 3. If a typical U.S. company uses the same cost of capital to evaluate all projects, the firm will most likely become A. Riskier over time, and its intrinsic value will not be maximized. B. Riskier over time, but its intrinsic value will be maximized. C. Less risky over time, and its intrinsic value will not be maximized. D. Less risky over time, and its intrinsic value will be maximized. E. There is no reason to expect its risk position or value to change over time as a result of its use of a single discount rate.
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4. Assume that a firm's total dollar capital budget is fixed and will not be changed. Which of the following will decrease the retained earnings break point, i.e., decrease the dollar amount of total capital at which the WACC will increase due to having to issue new common stock? A. The firm decides to pay out a lower percentage of its income as dividends. B. The firm increases the amount of debt in its target capital structure. C. The average risk of projects in the capital budget decreases. D.
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This note was uploaded on 02/17/2009 for the course FIN FIN 221 taught by Professor Jochec during the Summer '08 term at University of Illinois at Urbana–Champaign.

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sp08exam3(2) - Fin 221 Spring 2008 Exam 3 covers Chapters...

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