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27 terms

The firm should calculate its cost of capital as a(n) ___________ ________ of the after-tax costs of the various types of funds it uses.

weighted average

There are ___________ methods that can be used to determine the cost of common equity.

three

Assigning a cost to reinvested earnings is based on the _____________ ___________ principle.

opportunity cost

Companies must earn more than rs on new shares because they incur _____________ _______ to issue new stock.

flotation costs

Using the Capital Asset Pricing Model (CAPM), the required rate of return on common stock is found as a function of the _______-________-_______, the firm's _______ ______________, and the required rate of return on an average __________.

risk-free rate (rrf); beta coefficient (b); stock (rm)

The cost of common equity may also be found by adding a(n) _______ __________ to the interest rate on the firm's own long-term debt.

risk premium

The required rate of return on common equity may also be estimated as the expected ____________ _________ on the common stock plus the expected future __________ ________ of the dividends.

dividend yield; growth rate

The proportions of _______, _____________ ________, and __________ ________ in the target capital structure should be used to calculate the ______________ __________ cost of capital.

debt; preferred stock; common equity; weighted average

The component cost of preferred stock is calculated as the ___________ ___________ divided by the _____ ____________ _______ of preferred stock.

preferred dividends; net issuing price

One method for estimating g involves multiplying the ___________ _______ by the company's expected future rate of return on equity (ROE).

retention rate

The two most important factors that affect the cost of capital and which are beyond the firm's direct control are the level of ____________ rates and _________.

interest; taxes

A firm can affect its cost of capital through its ____________ ______________ policy, its ___________ policy, and its ____________ (capital budgeting) policy.

capital structure; dividend; investment

The cost of capital is sometimes referred to as the __________ rate because projects must jump over it to be accepted.

hurdle

The hurdle rate for each project should reflect the ____________ of the project itself, not necessarily those associated with the firm's _________ project as reflected in the firm's composite WACC.

risk; average

Three separate and distinct types of risk can be identified: ________-_________ risk, ____________ risk, and __________ risk.

stand-alone; corporate (within-firm); market (beta)

Of the three risk measures, ___________ risk is theoretically the most relevant measure because of its direct effect on stock prices.

market

If the expected rate of return on a given capital project lies __________ the SML, the expected rate of return on the project is more than enough to compensate for its risk, and the project should be accepted.

above

_________-_________ risk is the risk an asset would have if it were the firm's only asset.

Stand-alone

Two approaches have been developed for estimating project betas: the ________ ________ and the ______________ __________ methods.

pure play; accounting beta

Projects are classified into subjective risk categories and then ________-____________ _________ _____ _____________ are developed for each category using the composite WACC as a starting point.

risk-adjusted costs of capital

_________ _____________ analysis is a similar process to the corporate valuation model, except that it focuses on proposed new projects rather than on the firm's existing assets.

Capital budgeting

Most firms employ several types of capital, called __________ _______________, with common and preferred stock, along with debt, being the three most frequently used types.

capital components

rd is the ____________ cost of new debt to be raised during the planning period.

marginal

The combined effects of ____________ _______ and _________ ____________ inhibit companies from issuing additional common stock.

flotation costs; price pressure

The correct weights to use in the WACC calculation are those based on the firm's ___________ capital structure, since this is the best estimate of how the firm will, on average, raise money in the future.

target

For many firms, ____________ is the largest source of funds as shown in their statement of cash flows and is available to support the capital budget.

depreciation

The opportunity cost of depreciation is the ____________ __________ _______ _____ __________.

weighted average cost of capital