Chap 17 - Since you incorrectly answered 5 questions, it...

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Since you incorrectly answered 5 questions, it would be worthwhile to read the explanations for each mistake. That will help you improve your understanding of cost of capital concepts. Also, it is highly recommended that you go to "Practice Mode" where you can get personal, detailed feedback on each problem you complete. - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - Question #1 A company's weighted average cost of capital (WACC) is best described by which of the following statements? A. The weighted average cost of capital is the return earned and paid on a company's securities in the past. B. The weighted cost of capital is the minimum acceptable return on any current average risk project under consideration today. C. The cost of capital is the cost of raising specific sources of funds in financial markets today. D. The cost of capital is the required return on new company securities today independent of where the funds are invested. Correct answer: B Your answer: B Explanation for correct answer The cost of capital (WACC) focuses on the investment side of the balance sheet and seeks to estimate the minimum acceptable return on average risk investments (similar to the portfolio of assets already in the company) proposed today. While the analyst must focus on financial market (financing) data, the use of the WACC will be in evaluating asset investments, probably in a net present value analysis. Explanation for incorrect answers A. The cost of capital concept is concerned with the required return today by suppliers of capital, not in the past. Think of this, "If we had to raise funds today, what return would the capital markets require?"
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C. While the steps taken in calculating the cost of capital focuses on estimating the current required rates of return on specific sources of funds, the WACC is an important variable used in assessing the acceptability of new investment projects. D. The cost of capital, or required return on new funds raised in securities markets, is directly related to the estimated risk of the investment proposal under consideration. - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - Question #2 All but one of the following is an estimate of the component cost of equity when calculating the weighted average cost of capital? A. CAPM B. calculating the yield to maturity on similar companies' stock C. the market's equity premium over a long period of time D. using the constant growth dividend model Correct answer: B Your answer: B Explanation for correct answer The yield to maturity is an estimated return on a bond held to maturity. All of the other answers are used to estimate the required return on equity. Explanations for incorrect answers A. The Capital Asset Pricing Model is frequently used to estimate the required rate of return on common equity. C.
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This note was uploaded on 11/09/2010 for the course FINC 2012 taught by Professor Andrew during the Three '10 term at University of Sydney.

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Chap 17 - Since you incorrectly answered 5 questions, it...

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