Cost of Capital Quiz

COST OF CAPITAL
(Group 6)
Theories
1. ______________ is the effective interest rate that a company pays on its current liabilities to
the creditor and debt holders.
a. Cost of debt
b. Cost of preferred stock
c. Cost of equity
d. None of the above
Cost of debt is the effective interest rate that a company pays on its current liabilities to the
creditor and debt holders.
2. Statement 1. The dividend Beta Model is also known as Gordon Beta Model. Statement 2.
There are two major methods for determining the cost of equity, namely; the CAPM Approach
and the Dividend Beta Model.
a. Only statement 1 is true.
b. Only statement 2 is true.
c. Both statements are true.
d. Both statements are false.
D, because it is not "Dividend Beta Model", but Dividend Growth Model.
3. The cost of preferred stock is equal to:

a. the preferred stock dividend divided by its par value.
b. [(1 - tax rate) times the preferred stock dividend] divided by price.
c. preferred stock dividend divided by net price plus growth rate.
d. preferred stock dividend divided by its market price.
D. (Kps = Dividend/Net Price)
4. What are the two methods in determining the cost of equity?

a. Capital Asset Pricing Method (CAPM)
b. Divided Growth Method/Dividend Discount Method
c. A and B
d. CAMP and Dividend Premium Method
The two methods in determining the cost of equity are Capital Asset Pricing Method (CAPM)
and Divided Growth Method/Dividend Discount Method.
5. The cost of retained earnings is not affected by flotation costs.

a. False
b. True
c. Maybe
d. None of the above
The cost of retained earnings are not affected by flotation costs because retained earnings are
not issued.
6. Which of the following statements is true about the flotation costs that are incurred when a
company issue new securities?
a. The higher the flotation costs, the higher the retained earnings.
b. When it incurs flotation costs, the firm normally receives a higher amount of net
proceeds form securities issued.
c. The required return depends on the risk, not how the money was raised.
d. All of them are true.
The amount of money spent on a float depends on a number of criteria, including the type of
securities being floated, their quantity, and the transaction's risks.
7. Statement 1: The first approach of flotation includes the cost as part of the project's upfront
costs. Statement 2: While in the second approach, incorporating the costs lowers the final price
of the issued shares, lowering the amount of capital a company may obtain.
a. Statement 1 is true
b. Statement 2 is true
c. Both statements are true
d. Both statements are false
According to the first approach, the cost of capital of a corporation must be taken into account
while calculating its cost of capital. Essentially, it states that a company's cost of capital rises as
a result of the cost of flotation.
8. What is the required component cost to get the after-tax component cost of debt?
a. Cost of preferred stock
b. Cost of common stock
c. Cost of equity
d. Before-tax cost of debt
To get the after-tax cost of debt, you need to compute its yield to maturity or the before-tax
cost of debt.
9. It is the cost of raising additional capital, with the weights representing the proportion of
each source of financing that is used.
a. Cost of long-term debt
b. Cost of common stock
c. Weighted average cost of capital
d. Cost of preferred stock
Weighted average cost of capital is the cost of raising additional capital, with the weights
representing the proportion of each source of financing that is used. It is calculated by
averaging the rate of all of the company’s sources of capital weighted by the proportion of each
component.
10. What is the complete formula of the weighted average cost of capital?
a. WACC = cost of debt + cost of preferred stocks + cost of common stocks
b. WACC = cost of debt + cost of preferred stocks
c. WACC = cost of equity + cost of preferred stocks + cost of common stocks
d. WACC = cost of preferred stocks + cost of common stocks
Formula, WACC = cost of debt + cost of preferred stocks + cost of common stocks
Problems
11. Geniuses Yarn Company took a loan of $200,000 from a Three Idiots Bank at the rate of
interest of 8% to issue a company bond of $200,000. Based on the loan amount and rate of
interest, interest expense will be $16,000 and the tax rate is 30%. What is the cost of debt?
a. $11,200
b. $4,800
c. $9,600
d. $25,200
Solution:
Cost of Debt = $16,000 (1−30%)
= $16000 (0.7)
= $11,200
12. Suppose a company wants to raise capital of $100,000 to expand its business for that
company issue 8,000 stocks with a value of $10 each where the rate of return on equity is 5%
which have generated fund of $80,000 and it borrowed loan from bank of $20,000 at a rate of
interest of 10%. The tax rate applicable is 30%. The weighted average cost of capital is?
a. 7.0%
b. 8.08%
c. 8.01%
d. 5.0%
Solution:
WACC = (80,000 / 100,000) * 10 + (20,000 / 100,000) * 5% * (1 – 30%)
= 8.01%
13. A debenture issued of 1,000,000 at an interest rate of 9% and the face value of debenture is
1000. The flotation cost if 2% and the tax rate is 40%. Find the pre-tax cost of debt. (Round off
to the nearest tenths)
a. 9.09%
b. 9.20%
c. 9.19%
d. 9.18%
Solution:
Interest = 9% of 1000 = 90
Flotation cost = 2% of 1000 = 20
Net Proceed = FV - FC = 1000 - 20 = 980
Kd = (i/NP) x 100
= (90/980) x 100
= 9.18%
14. A company has a debenture capital of 500,000. The coupon rate is 8%, the flotation cost is
3% and the tax rate is 30%. Find the cost of debt at an 8% discount.
a. 4.6%
b. 16.42%
c. 6.09%
d. 70%
Solution:
Interest = 8% of 500k = 40k
Net Proceed = 500k - 8% Discount
= 500k - 40k
= 460k
Kd = I x (1 - t)
= 40k x (1-30%)
= (28k/460k) x 100
= 6.09%
15. What is a company's cost of equity if:

Common stock = 700$
Dividend per share (D1) = 3$
Current price (Po) = 25$
Flotation cost in percentage (F) = 15%
Growth rate (g) = 12%
a. 26%
b. 25%
c. 24%
d. 28%
Solution:
Re = [D1 / Po ( 1 – f )] + g
= [ 3 / 25 ( 1 - 0.15 )] + 0.12
= [ 3 / 21.25 ] + 0.12
= 0.14 + 0.12
= 26%
16. Calculate the cost of new equity.

Common Stock 550 $
Dividend per share 5$
Current price 30$
Flotation Cost 13%
Growth rate 12%
a. 21%
b. 33%
c. 31%
d. 32%
Solution:
Re = [D1 / Po ( 1 - f )] + g
= [ 5 / 30 ( 1 - 0.13 )] + 0.12
= [ 5/ 26.10 ] + 0.12
= 0.19 + 0.12
= 31%
17. What is a company's cost of equity before a transaction of issuing new common stock?
Dividend per share 8$
Current share price 20$
Growth rate 11%
a. 52%
b. 51%
c. 53%
d. 50%
Solution:
Re = ( D1 / Po )+ g
= ( 8 / 20 ) + 0.11
= 0.4 + 0.11
= 51%
Items 18-20.
Type of Capital Book Value Market Value Specific Cost

Equity Capital 100,000 180,000 15%
Preference Capital 50,000 120,000 12%
Debentures 60,000 100,000 6%
Retained Earnings 40,000 - 15%
18. What is the weighted cost of equity capital in book value?

a. 6.00%
b. 5.96%
c. 6.60%
d. 6.06%
Solution:
Total book value: 100,000 + 50,000 + 60,000 + 40,000 = 250,000
Equity Capital = 100,000/250,000
= 0.4 × 15%
= 6.00%
19. What is the weighted cost of preference capital in market value?

a. 3.50%
b. 2.99%
c. 3.69%
d. 3.60%
Solution:
Total market value: 180,000 + 120,000 + 100,000 = 400,000
Preference Capital = 120,000/400,000
= 0.3 × 12%
= 3.60%
20. Calculate the weighted average cost of capital using market value as weights.
a. 12.85%
b. 11.85%
c. 11.90%
d. 13.85%
Solution:
Total market value: 180,000 + 120,000 + 100,000 = 400,000
Equity Capital = 180,000/400,000
= 0.45 × 15%
= 6.75%
Preference Capital = 120,000/400,000
= 0.3 × 12%
= 3.60%
Debentures = 100,000/400,000
= 0.25 × 6%
= 1.50%
WACC = Equity Capital + Preference Capital + Debentures
= 6.75% + 3.60% + 1.50%
= 11.85%

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COST OF CAPITAL

3. The cost of preferred stock is equal to:

4. What are the two methods in determining the cost of equity?

5. The cost of retained earnings is not affected by flotation costs.

15. What is a company's cost of equity if:

16. Calculate the cost of new equity.

Type of Capital Book Value Market Value Specific Cost

18. What is the weighted cost of equity capital in book value?

19. What is the weighted cost of preference capital in market value?

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