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CHAPTER 8THE COST OF CAPITAL

TRUE/FALSE
1. Capital refers to items on the right-hand side of a firm's balance sheet.

2. The component costs of capital are market-determined variables in as much as they are based on investors' required returns.

3. The cost of debt is equal to one minus the marginal tax rate multiplied by the coupon rate on outstanding debt.

4. The cost of issuing preferred stock by a corporation must be adjusted to an after-tax figure because of the 70 percent dividend exclusion provision for corporations holding other corporations' preferred stock.

5. The firm's cost of external equity capital is the same as the required rate of return on the firm's outstanding common stock.

6. The cost of equity raised by retaining earnings can be less than, equal to, or greater than the cost of equity raised by selling new issues of common stock, depending on tax rates, flotation costs, the attitude of investors, and other factors.

7. The cost of equity capital from the sale of new common stock (ke) is generally equal to the cost of equity capital from retention of earnings (ks), divided by one minus the flotation cost as a percentage of sales price (1 - F).

8. Funds acquired by the firm through retaining earnings have no cost because there are no dividend or interest payments associated with them, but capital raised by selling new stock or bonds does have a cost.

9. The weighted average cost of capital increases if the total funds required call for an amount of equity in excess of what can be obtained as retained earnings.

10. The marginal cost of capital (MCC) is the cost of the last dollar of new capital that the firm raises, and the marginal cost declines as more and more of a specific type of capital is raised during a given period.

11. Even if a firm obtains all of its common equity from retained earnings, its MCC schedule might still increase if very large amounts of new capital are needed.

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12. There is a jump, or break, in a firm's MCC schedule each time the firm runs out of a particular source of capital at a particular cost. For example, a firm may use up its 10 percent debt and can then issue more debt only if it offers a higher rate to investors.

13. The correct discount rate for a firm to use in capital budgeting, assuming that new investments are of the same degree of risk as the firm's existing assets, is its marginal cost of capital.

14. The firm's cost of capital represents the maximum rate of return that a firm can earn from its capital budgeting projects to ensure that the value of the firm increases.

15. The cost of capital is the firm's average cost funds given what the market demands be paid to attract the funds.

16. The cost of capital used in capital budgeting must be determined using the specific financing used to fund that particular project.

17. A firm's capital structure has no impact on the firm's weighted average cost of capital.

18. Each component cost of particular types of capital is identical for each source of funds found in a firm's capital structure.

19. The after tax cost of debt is used to calculate the weighted average cost of capital since we are concerned with the after-tax cash flows of the firm.

20. Tax adjustments to the cost of preferred stock must be made when determining the cost of capital since dividend expenses on preferred stocks are tax deductible.

21. If a firm cannot invest retained earnings and earn at least the cost of equity, it should pay these funds to shareholders and let them invest directly in other assets that do provide this return.

22. Long-term capital gains are taxed at a lower rate than dividends for most stockholders leading companies to pay out dividends rather than use retained earnings to fund capital projects.

23. Flotation costs associated with issuing new equity cause the cost of external equity to be lower than the cost of retained earnings.

24. If expectations for long-term inflation rose, but the slope of the SML remained constant, this would have a greater impact on the required rate of return on equity, ks, than on the interest rate on long-term debt, kd, for most firms.

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In other words, the percentage point increase in the cost of equity would be greater than the increase in the interest rate on long-term debt.

25. A firm going from a lower to a higher tax bracket could increase its use of debt, yet actually wind up with a lower after-tax cost of debt.

26. Since 70 percent of preferred dividends received by a corporation is excluded from taxable income, the component cost of equity for a company which pays half of its earnings out as common dividends and half as preferred dividends should, theoretically, be Cost of equity = ks(0.30)(0.50) + ks(1 - T)(0.70)(0.50).

27. The steeper the demand curve for a firm's stock, the closer the values of ks and ke are to one another, other things held constant.

28. In general, it is not possible for ke, the cost of new equity, to be lower than ks, the cost of retained earnings. However, an exception to this rule occurs when the stock price increases just prior to the firm issuing new equity such that it more than offsets the flotation costs and thus, ke becomes less than ks.

29. The cost of debt, kd, is always less than ks, so kd(1 - T) will certainly be less than ks. Therefore, since a firm cannot be 100% debt financed, the weighted average cost of capital will always be greater than kd(1 - T).

30. Firms should use their weighted average cost of capital (WACC) when they are funding their capital projects with a variety of sources. However, when the firm plans on using only debt or only equity to fund a particular project, it should use the after-tax cost of the specific source of capital to evaluate that project.

MULTIPLE CHOICE
1. Which of the following is not considered a capital component for the purpose of calculating the weighted average cost of capital as it applies to capital budgeting? a. Long-term debt. b. Common stock. c. Short-term debt. d. Preferred stock. e. All of the above are considered capital components for WACC and capital budgeting purposes.

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2. Which of the following statements is most correct? a. If a company's tax rate increases but the yield to maturity of its noncallable bonds remains the same, the company's marginal cost of debt capital used to calculate its weighted average cost of capital will fall. b. All else equal, an increase in a company's stock price will increase the marginal cost of retained earnings. c. All else equal, an increase in a company's stock price will increase the marginal cost of issuing new common equity. d. Answers a and b are both correct. e. Answers b and c are both correct. The debt cost used to calculate a firm's WACC is kd (1-T). If kd remains constant but T increases, then the term (1-T) decreases and the value of the entire equation, kd (1-T), decreases. Statement b is false; if a company's stock price increases, and all else remains constant, then the dividend yield decreases and ks decreases. This can be seen from the equation stock is . Statement c is also false for the same reason. The cost of issuing a new common . If P0 increases but there's no change in the flotation cost, ke will decrease.

3. Which of the following factors in the discounted cash flow (DCF) approach to estimating the cost of common equity is the least difficult to estimate? a. Expected growth rate, g b. Dividend yield, c. Required return, ks d. Expected rate of return, e. All of the above are equally difficult to estimate.

4. If a firm can shift its capital structure so as to change its weighted average cost of capital (WACC), which of the following results would be preferred? a. The firm should try to decrease the WACC because such an action will increase the value of the firm. b. The firm should try to increase the WACC because such an action will increase the value of the firm. c. The firm should try to decrease the WACC because such an action will decrease the value of the firm. d. The firm should try to increase the WACC because such an action will decrease the value of the firm. e. The firm should not try to change the WACC because changing the WACC will not change the value of the firm.

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5. The firm's weighted average cost of capital (WACC) is a. set by the board of directors of the firm because it is the benchmark they use to evaluate upper management. b. regulated by the Internal Revenue Service (IRS) because tax-deductible debt is included in the computation. c. determined by the financial markets because investors provide the funds used by firms and these funds have costs, which are the returns demanded by investors. d. the same as the firm's internal rate of return (IRR). e. the total net present value (NPV) of all the capital budgeting projects in which the firm invests in any year.

6. The before-tax cost of debt, kd, is the same as the a. average yield to maturity (YTM) associated with the firm's bonds. b. dividend yield associated with the firm's common stock. c. average coupon rate of the firm's bonds. d. ke if the firm has no preferred stock. e. the firm's marginal tax rate.

7. Alice Stewart, who is the CFO of Meyers Foods, is teaching an upper-level course in corporate finance at the University of Phoenix. One of the assignments Alice gave her class was to compute the component costs of capital for Meyers Foods. Meyers Foods uses debt and common stock (no preferred stock) to finance its investments. Students in the class did not reach the same conclusions about the relationships among the components coststhat is, the after-tax cost of debt, kdT, the cost of retained earnings (i.e., internal equity), ks, and the cost of new, or external, equity, ke. Which of the following relationships should be correct for Meyers Foods? a. kdT < ks < ke b. ks < kdT < ke c. ke < kdT < ks d. ke < ks < kdT e. None of the above is a correct relationship.

8. Under normal circumstances, the weighted average cost of capital is used as the firm's required rate of return because a. as long as the firm's investments earn returns greater than the cost of capital, the value of the firm will not decrease. b. returns below the cost of capital will cover all the fixed costs associated with capital and provide excess returns to the firm's stockholders. c. it is comparable to the average of all the interest rates on debt that currently prevail in the financial markets. d. it is an indication of the return the firm is earning from all of its assets in combination.

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9. Estimating the cost of common equity using the discounted cash flow approach may be difficult to evaluate because a. the dividend yield is extremely difficult to estimate. b. the proper growth rate is difficult to establish. c. the current price of the common equity is always changing making it difficult to determine. d. all of the above are difficult to estimate.

10. Although it is a subjective measure, analysts often estimate the cost of common equity by adding a risk premium of 3 to 5 percentage points to the a. the cost of preferred stock for the firm. b. the risk free rate. c. interest rate on the firm's long term debt. d. the market return. e. the growth rate of the firm.

11. The target capital structure of a firm is the capital structure that a. minimizes the operating risk of the firm's assets. b. maximizes the tax shield created by debt. c. minimizes the default risk of long-term debt. d. maximizes the price of the firm's stock. e. none of the above.

12. The marginal cost of capital __________ as more capital is raised during a given period. a. does not change b. decreases c. increases d. changes in an unpredictable way e. approaches zero

13. A graph of a firm's acceptable capital projects ranked in the order of the projects' internal rate of return is called the firm's ______________. a. marginal cost of capital schedule b. investment opportunity schedule c. modified internal rate of return schedule d. internal project classification schedule e. optimal capital budget schedule

14. Which of the following may be true concerning debt and equity? a. The cost of debt for Firm A is greater than the cost of equity for Firm A. b. The cost of debt for Firm A is greater than the cost of equity for Firm B. c. The cost of internally generated equity for Firm A is greater than the cost of externally generated equity funds for Firm A. d. The cost of internally generated equity for Firm A is less than the cost of debt for Firm A. e. None of the above could be true.

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15. Which of the following statements is correct? a. Capital components are the types of capital used by firms to raise money. All capital comes from one of three components: long-term debt, preferred stock, and equity. b. Preferred stock does not involve any adjustment for flotation cost since the dividend and price are fixed. c. The cost of debt used in calculating the WACC is an average of the after-tax cost of new debt and of outstanding debt. d. The opportunity cost principle implies that if the firm cannot invest retained earnings and earn at least ks, it should pay these funds to its stockholders and let them invest directly in other assets that do provide this return. e. The cost of new common equity includes an adjustment for flotation costs which is expressed as a fixed percentage of the current stock price. The flotation percentage is determined jointly by the current price of the firm's stock and its growth rate.

16. Which of the following statements is most correct? a. An increase in the corporate tax rate would lower the weighted average cost of capital for an average firm, other things held constant. b. Depreciation-generated funds have a cost equal to the firm's lowest WACC, and hence they have no impact on the MCC schedule. c. As a firm's debt ratio approaches 100 percent, the after-tax cost of debt, kdT, at its lowest level. d. Statements a, b, and c are all true. e. Statements a, b, and c are all false.

17. Typically, according to the text, the MCC schedule is either horizontal or rising, which implies that the cost of capital to a firm increases as it raises larger and larger amounts of capital. The rising section of MCC schedule a. Is caused by economies of scale in financing. b. Would be eliminated (that is, the MCC schedule would be horizontal) if the firm retained all of its earnings. c. Results from a change in the debt ratio as the firm expands. d. Occurs because the firm must, if it is to expand, be willing to take on riskier and riskier projects, and this causes an increase in the cost of capital. e. Results from flotation costs associated with the sale of new common and preferred stock, along with higher debt costs, as the firm's rate of expansion increases.

18. Which of the following statements is correct? a. Under normal conditions, the CAPM approach to estimating a firm's cost of retained earnings gives a better estimate than the DCF approach. b. The CAPM approach is typically used to estimate a firm's flotation cost adjustment factor, and this factor is added to the DCF cost estimate. c. The risk premium used in the bond-yield-plus-risk-premium method is the same as the one used in the CAPM method. d. In practice (as opposed to theory), the DCF method and the CAPM method usually produce exactly the same estimate for k. e. The above statements are all false.

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19. In applying the CAPM to estimate the cost of equity capital, which of the following elements is not subject to dispute or controversy? a. Expected rate of return on the market, kM. b. The stock's beta coefficient, i. c. Risk-free rate, kRF. d. Market risk premium (MRP). e. All of the above are subject to dispute.

20. Which of the following statements is correct? a. The cost of capital used to evaluate a project should be the cost of the specific type of financing used to fund that project. b. The cost of debt used to calculate the weighted average cost of capital is based on an average of the cost of debt already issued by the firm and the cost of new debt. c. One problem with the CAPM approach to estimating the cost of equity capital is that if a firm's stockholders are, in fact, not well diversified, beta might be a poor measure of the firm's true investment risk. d. The bond-yield-plus-risk-premium approach is the most sophisticated and objective method of estimating a firm's cost of equity capital. e. The cost of equity capital is generally easier to measure than the cost of debt, which varies daily with interest rates, or the cost of preferred stock which is issued infrequently.

21. Which of the following statements is correct? a. Beta measures market risk, but if a firm's stockholders are not well diversified, beta may not accurately measure the firm's total risk. b. If the calculated beta underestimates the firm's true investment risk, then the CAPM method will overestimate ks. c. The discounted cash flow method of estimating the cost of equity can't be used unless the growth component, g, is constant during the analysis period. d. An advantage shared by both the DCF and CAPM methods of estimating the cost of equity capital, is that they yield precise estimates and require little or no judgement. e. None of the above is a correct statement.

22. Which of the following statements is false? a. From a theoretical standpoint, the capital weights used to calculate the WACC should be based on the market values of the different securities. However, if a firm's book value weights are closest to its market value weights, book value weights can be used as proxies. b. Generally, only long-term debt is included in the calculation of the WACC, because the WACC is used for capital budgeting purposes, which includes long-term assets, and those assets are financed with long-term capital. c. The first break point a firm encounters in capital budgeting is for retained earnings, unless a firm has zero or negative net income. d. The weighted average cost of capital will change whenever a break point occurs. e. Answers a and b are both false.

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23. Which of the following statements is most correct? a. One purpose of calculating the WACC is to have a singular cost of capital measure that can be applied to evaluate all of the firm's projects, including those of greater than and lesser than average risks. b. A firm facing a steep demand curve (that is, high flotation costs) for new equity would likely also face, at some point, a steeply upward sloping WACC curve. c. A breakpoint is based on the dollar value used of a specific type of capital, and occurs at the point where the cost of that capital type increases. Thus, if a firm has $100,000 in earnings, and stockholders want $50,000 of those earnings paid as dividends, then retained earnings will have two breakpoints. d. Answers a and b are both correct. e. All of the above are false.

24. Which of the following statements is correct? a. Suppose a firm is losing money and thus, is not paying taxes, and that this situation is expected to persist for a few years whether or not the firm uses debt financing. Then the firm's after-tax cost of debt will equal its before-tax cost of debt. b. The component cost of preferred stock is expressed as kps(1 - T), because preferred stock dividends are treated as fixed charges, similar to the treatment of debt interest. c. The reason that a cost of capital is assigned to retained earnings is because these funds are already earning a return in the business, the reason does not involve the opportunity cost principle. d. The bond-yield-plus-risk-premium approach to estimating a firm's cost of common equity involves adding a subjectively determined risk-premium to the market risk-free bond rate. e. None of the above is a correct statement.

25. Consider the discussions concerning the cost of common equity. What is the relationship between the cost of retained earnings (internal equity), ks, and the cost of new common equity (external equity), ke? a. ks > ke, because new stockholders are willing to accept a lower return and "pay their dues" before they start receiving the higher returns that existing, loyal stockholders receive. b. 0 = ks < ke, because there is no "real" cost to the income that the firm decides to retain to reinvest in assets rather than payout to common stockholders as dividends. c. 0 < ks < ke, because there is a real cost to retaining income (earnings) for reinvestment, but the firm has to pay flotation costs when issuing new common stock. d. ks = ke, because they both represent essentially the same source of funds, so they must have the same cost. e. None of the above is a correct answer.

26. Which of the following is least likely to lead to a break point in the marginal cost of capital schedule? a. an increase in the required return demanded by investors for a new bond issue. b. increased flotation costs associated with seasoned equity offerings. c. decreased liquidity in money markets leading to lower selling prices for commercial paper. d. using retained earnings to fund new projects for the firm. e. issuing preferred stock to institutional investors.

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27. Which of the following steps is not necessary for calculating the marginal cost of capital schedule? a. Determine each point at which a break in the marginal cost of capital schedule occurs. b. Make a list of all the break points. c. Determine the cost of capital for each component in the intervals between the breaks. d. Estimate the change in the cost of capital within each interval. e. Calculate the weighted averages of these component costs to obtain the WACCs in each interval.

28. Which of the following statements is correct? a. Because we often need to make comparisons among firms that are in different income tax brackets, it is best to calculate the WACC on a before-tax basis. b. If a firm has been suffering accounting losses and is expected to continue suffering such losses (and therefore its tax rate is zero), it is possible that its after-tax component cost of preferred stock as used to calculate the WACC will be less than its after-tax component cost of debt. c. Due to the way the MCC is constructed, the first break point in the MCC schedule must be associated with using up all available retained earnings and having to issue common stock. d. Normally, the cost of external equity raised by issuing new common stock is above the cost of retained earnings. Moreover, the higher the growth rate relative to the dividend yield, the more the cost of external equity will exceed the cost of retained earnings. e. None of the above is a correct statement.

29. Bouchard Company's stock sells for $20 per share, its last dividend (D0) was $1.00, its growth rate is a constant 6 percent, and the company would incur a flotation cost of 20 percent if it sold new common stock. Retained earnings for the coming year are expected to be $1,000,000, and the common equity ratio is 60 percent. If Bouchard has a capital budget of $2,000,000, what component cost of common equity will be built into the WACC for the last dollar of capital the company raises? a. 11.30% b. 11.45% c. 11.80% d. 12.15% e. 12.63%

30. Allison Engines Corporation has established a target capital structure of 40 percent debt and 60 percent common equity. The firm expects to earn $600 in after-tax income during the coming year, and it will retain 40 percent of those earnings. The current market price of the firm's stock is P0 = $28; its last dividend was D0 = $2.20, and its expected dividend growth rate is 6 percent. Allison can issue new common stock at a 15 percent flotation cost. What will Allison's marginal cost of equity capital (not the WACC) be if it must fund a capital budget requiring $600 in total new capital? a. 15.8% b. 13.9% c. 7.9% d. 14.3% e. 9.7%

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31. Your company's stock sells for $50 per share, its last dividend (D0) was $2.00, its growth rate is a constant 5 percent, and the company would incur a flotation cost of 15 percent if it sold new common stock. Net income for the coming year is expected to be $500,000 and the firm's payout ratio is 60 percent. The firm's common equity ratio is 30 percent and it has no preferred stock outstanding. The firm can borrow up to $300,000 at an interest rate of 7 percent; any additional debt will have an interest rate of 9 percent. Your company's tax rate is 40 percent. If the firm has a capital budget of $1,000,000, what is the WACC for the last dollar of capital the company raises? a. 3.78% b. 6.76% c. 9.94% d. 11.81% e. 13.25%

32. SW Ink's preferred stock, which pays a $5 dividend each year, currently sells for $62.50. The company's marginal tax rate is 40 percent. What is the cost of preferred stock, kps, that should be included in the computation of the SW Ink's weighted average cost of capital (WACC)? a. 8.0% b. 4.8% c. 3.2% d. The dividend growth rate is needed to compute kps; so not enough information is given to answer this question. e. None of the above is correct.

Gulf Electric Company

Gulf Electric Company (GEC) uses only debt and equity in its capital structure. It can borrow unlimited amounts at an interest rate of 10 percent so long as it finances at its target capital structure, which calls for 55 percent debt and 45 percent common equity. Its last dividend was $2.20; its expected constant growth rate is 6 percent; its stock sells on the NYSE at a price of $35; and new stock would net the company $30 per share after flotation costs. GEC's tax rate is 40 percent, and it expects to have $100 million of retained earnings this year. GEC has two projects available: Project A has a cost of $200 million and a rate of return of 13 percent, while Project B has a cost of $125 million and a rate of return of 10 percent. All of the company's potential projects are equally risky. 33. Refer to Gulf Electric Company. What is GEC's cost of equity from newly issued stock? a. 13.77% b. 12.66% c. 13.33% d. 12.29% e. 10.00%

34. Refer to Gulf Electric Company. Assume now that GEC needs to raise $300 million in new capital. What is GEC's marginal cost of capital for evaluating the $300 million in capital projects and any others that might arise during the year? a. 6.00% b. 13.77% c. 12.66% d. 9.50% e. 9.00%

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Byron Corporation
Byron Corporation's present capital structure, which is also its target capital structure, is 40 percent debt and 60 percent common equity. Next year's net income is projected to be $21,000, and Byron's payout ratio is 30 percent. The company's earnings and dividends are growing at a constant rate of 5 percent; the last dividend (D0) was $2.00; and the current equilibrium stock price is $21.88. Byron can raise all the debt financing it needs at 14.0 percent. If Byron issues new common stock, a 20 percent flotation cost will be incurred. The firm's marginal tax rate is 40 percent. 35. Refer to Byron Corporation. What is the maximum amount of new capital that can be raised at the lowest component cost of equity? (In other words, what is the retained earnings break point?) a. $12,600 b. $14,700 c. $17,400 d. $21,000 e. $24,500

36. Refer to Byron Corporation. What is the component cost of the equity raised by selling new common stock? a. 17.0% b. 16.4% c. 15.0% d. 14.6% e. 12.0% . 37. Refer to Byron Corporation. Assume (contrary to the situation in the question just above) that at one point along the marginal cost of capital schedule the component cost of equity is 18.0 percent. What is the weighted average cost of capital at that point? a. 10.8% b. 13.6% c. 14.2% d. 16.4% e. 18.0%

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Rollins Corporation
Rollins Corporation is constructing its MCC schedule. Its target capital structure is 20 percent debt, 20 percent preferred stock, and 60 percent common equity. Its bonds have a 12 percent coupon, paid semiannually, a current maturity of 20 years, and sell for $1,000. The firm could sell, at par, $100 preferred stock which pays a 12 percent annual dividend, but flotation costs of 5 percent would be incurred. Rollins' beta is 1.2, the risk-free rate is 10 percent, and the market risk premium is 5 percent. Rollins is a constant growth firm which just paid a dividend of $2.00, sells for $27.00 per share, and has a growth rate of 8 percent. The firm's policy is to use a risk premium of 4 percentage points when using the bond-yield-plus-risk-premium method to find ks. The firm's net income is expected to be $1 million, and its dividend payout ratio is 40 percent. Flotation costs on new common stock total 10 percent, and the firm's marginal tax rate is 40 percent. 38. Refer to Rollins Corporation. What is Rollins' component cost of debt? a. 10.0% b. 9.1% c. 8.6% d. 8.0% e. 7.2%

39. Refer to Rollins Corporation. What is Rollins' cost of preferred stock? a. 10.0% b. 11.0% c. 12.0% d. 12.6% e. 13.2%

40. Refer to Rollins Corporation. What is Rollins' cost of retained earnings using the CAPM approach? a. 13.6% b. 14.1% c. 16.0% d. 16.6% e. 16.9%

41. Refer to Rollins Corporation. What is the firm's cost of retained earnings using the DCF approach? a. 13.6% b. 14.1% c. 16.0% d. 16.6% e. 16.9%

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42. Refer to Rollins Corporation. What is Rollins' cost of retained earnings using the bond-yield-plus-risk-premium approach? a. 13.6% b. 14.1% c. 16.0% d. 16.6% e. 16.9%

43. Refer to Rollins Corporation. What is Rollins' lowest WACC? a. 13.6% b. 14.1% c. 16.0% d. 16.6% e. 16.9%

44. Refer to Rollins Corporation. What is Rollins' retained earnings break point? a. $600,000 b. $800,000 c. $1,000,000 d. $1,200,000 e. $1,400,000

45. Refer to Rollins Corporation. What is Rollins' WACC once it starts using new common stock financing? a. 13.6% b. 14.1% c. 16.0% d. 16.6% e. 16.9%

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Jackson Company
The Jackson Company has just paid a dividend of $3.00 per share on its common stock, and it expects this dividend to grow by 10 percent per year, indefinitely. The firm has a beta of 1.50; the risk-free rate is 10 percent; and the expected return on the market is 14 percent. The firm's investment bankers believe that new issues of common stock would have a flotation cost equal to 5 percent of the current market price. 46. Refer to Jackson Company. What will be Jackson's cost of new common stock if it issues new stock in the marketplace today? a. 15.25% b. 16.32% c. 17.00% d. 12.47% e. 9.85%

J. Ross and Sons Inc.

J. Ross and Sons Inc. has a target capital structure that calls for 40 percent debt, 10 percent preferred stock, and 50 percent common equity. The firm's current after-tax cost of debt is 6 percent, and it can sell as much debt as it wishes at this rate. The firm's preferred stock currently sells for $90 a share and pays a dividend of $10 per share; however, the firm will net only $80 per share from the sale of new preferred stock. Ross expects to retain $15,000 in earnings over the next year. Ross' common stock currently sells for $40 per share, but the firm will net only $34 per share from the sale of new common stock. The firm recently paid a dividend of $2 per share on its common stock, and investors expect the dividend to grow indefinitely at a constant rate of 10 percent per year. 47. Refer to J. Ross and Sons Inc. What is the firm's cost of retained earnings? a. 10.0% b. 12.5% c. 15.5% d. 16.5% e. 18.0%

48. Refer to J. Ross and Sons Inc. What is the firm's cost of newly issued common stock? a. 10.0% b. 12.5% c. 15.5% d. 16.5% e. 18.0%

49. Refer to J. Ross and Sons Inc. What is the firm's cost of newly issued preferred stock? a. 10.0% b. 12.5% c. 15.5% d. 16.5% e. 18.0%

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50. Refer to J. Ross and Sons Inc. Where will a break in the WACC curve occur? a. $30,000 b. $20,000 c. $10,000 d. $42,000 e. There will be no breaks in the WACC curve.

51. Refer to J. Ross and Sons Inc. What will be the WACC above this break point? a. 12.5% b. 8.3% c. 10.6% d. 11.9% e. 14.1%

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TRUE/FALSE 1. T 2. T 3. F 4. F 5. F 6. F 7. F 8. F 9. T 10. F 11. T 12. T 13. T 14. F 15. T 16. F 17. F 18. F 19. T 20. F 21. T 22. F 23. F 24. F 25. T 26. F 27. F 28. F 29. T

30. F MULTIPLE CHOICE 1. C 2. A 3. B 4. A 5. C 6. A 7. A 8. A 9. B 10. C 11. D 12. C 13. B 14. B 15. D 16. A 17. E 18. E 19. E 20. C 21. A 22. C 23. B 24. A 25. C 26. D 27. D 28. B 29. E

30. A 31. B 32. A 33. A 34. D 35. E 36. A 37. C 38. E 39. D 40. C 41. C 42. C 43. A 44. C 45. B 46. B 47. C 48. D 49. B 50. A 51. D