Chapter 12 Flashcards
(9 cards)
Jenn is the CFO of a major firm and has the job of assigning discount rates to each project under consideration. Jenn’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. Jenn is applying the _____________ approach
subjective
When calculating a firm’s weighted average cost of capital, the capital structure weights…
are based on the market values of the outstanding securities
A firm has a return on equity of 12.4 percent according to the dividend growth model and a
return of 18.7 percent according to the capital asset pricing model. The market rate of return is 13.5 percent. What rate should the firm use as the cost of equity when computing the firm’s weighted average cost of capital (WACC)?
The arithmetic average of 12.4 percent and 18.7 percent
The cost of preferred stock…
is equal to the stock’s dividend yield
Which statement is true?
The cost of preferred stock is unaffected by the issuer’s tax rate
When determining a firm’s weighted average cost of capital, the item with the least amount
of impact is the…
standard deviation of the company’s common stock
Which statement is correct, all else held constant?
A decrease in a firm’s WACC will increase the attractiveness of the firm’s investment options. (*think of the relationship between discount interest rate and present value, they are inversely related)
Jenn is trying to decide what discount interest rate she should assign to an investment project. Which one of the following should be her primary consideration in this decision?
Risk level of the investment project
TechCo is a large, stable technology company with a WACC of 8%. It’s evaluating two very different projects. The firm adopts a subjective approach and uses an adjustment factor of ± 3 percent based on the risky level of the project. Which one is correct of appropriate discount rate applicable to each of the projects?
Project A – Mobile App Update. This project involves updating an existing mobile app. It targets TechCo’s existing customer base. There’s minimal uncertainty, and the cash flows are quite predictable. This project has lower risk level than the current business operation.
Project B – Space Tech Venture. This project involves entering a completely new market of
aerospace hardware. TechCo is unfamiliar with the new venture which is capital-intensive
and highly subject to regulatory uncertainty.
Project A: 5%, Project B: 11%
