Cost of Capital

5584 Words Nov 19th, 2015 23 Pages
MANAGEMENT ADVISORY SERVICES
COST OF CAPITAL

THEORY
1. All of the following statements are correct except: a. The matching of asset and liability maturities is considered desirable because this strategy minimizes interest rate risk. b. Default risk refers to the inability of the firm to pay off its maturing obligations. c. The matching of assets and liability maturities lowers default risk. d. An increase in the payables deferral period will lead to a reduction in the need to non-spontaneous funding.

2. Which of the following would increase risk? a. Increase the level of working capital. b. Change the composition of working capital to include more liquid assets. c. Increase the amount of short-term
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12. The explicit cost of debt financing is the interest expense. The implicit cost(s) of debt financing is (are) the a. Increase in the cost of debt as the debt-to-equity ratio increases. b. Increases in the cost of debt and equity as the debt-to-equity ratio increases. c. Increase in the cost of equity as the debt-to-equity ratio decreases. d. Decrease in the weighted-average cost of capital as the debt-to-equity ratio increases.

13. In computing the cost of capital, the cost of debt capital is determined by a. Annual interest payment divided by the proceeds from debt issuance. b. Interest rate times (1 – the firm’s tax rate) c. Annual interest payment divided by the book value of the debt. d. The capital asset pricing model.

14. The interest rate on the bonds is greater for the second alternative consisting of pure debt than it is for the first alternative consisting of both debt and equity because A. The diversity of the combination alternative creates greater risk for the investor. B. The pure debt alternative would flood the market and be more difficult to sell. C. The pure debt alternative carries the risk of increasing the probability of default. D. The combination alternative carries the risk of increasing dividend payments.

15. If a $1,000 bond sells for $1,125, which of the following statements are correct? I. The market rate of

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