Chapter 10 (Exam 2)

Front 1

A 15-year, 12% (APR) semiannual coupon bond sells for $1,153.72 and has face value of $1,000. What is the (marginal/pretax) cost of debt (rd) (APR)?

Back 1

I=5%

5% x 2= 10%

(Because it is semi annual)

Front 2

Why is there ANY “cost” for retained earnings?

Back 2

-Earnings can be reinvested or paid out as dividends.
-Investors could buy other securities with dividends and earn a return that way.
-If earnings are retained instead, there is an opportunity cost (the return that stockholders could earn on alternative investments of equal risk).

Front 3

If earnings are retained instead, there is an _______________.

Back 3

opportunity cost

Front 4

What is the the return that stockholders could earn on alternative investments of equal risk?

Back 4

opportunity cost

Front 5

Why is the cost of retained earnings cheaper than the cost of issuing new common stock?

Back 5

-When a company issues new common stock they also have to pay flotation costs to the underwriter.
-As an aside, issuing new common stock may send a negative signal to the capital markets, which may depress the stock price.

Front 6

issuing new common stock may send a ___________ to the capital markets, which may ________ the stock price.

Back 6

negative signal; depress

Front 7

Why if you are issuing new common stock, it may send a negative signal to the capital markets, which may depress the stock price?

Back 7

Markets suspect that if someone’s offering them something, maybe that “something” is overvalued (a “lemon” in used car terms)

Front 8

A company’s assets are financed by either ______ or ______.

Back 8

debt; equity

Front 9

_______ is the average of the costs of these sources of financing, each of which is weighted by how much of the overall financing it represents.

Back 9

WACC

Front 10

By taking a _________, we see how much the company has to pay for every dollar it finances.

Back 10

weighted average

Front 11

The demands by bondholders are more _______ (yields can be solved for based on bond prices)

Back 11

explicit

Front 12

Thus, the _____ is the “correct” value by which to discount future cash flows

Back 12

WACC

Front 13

If the firm makes the WACC, it can't/can afford to pay all of its investors what they’ve been promised (or “expect”/ “require”)

Back 13

can

Front 14

What does the WACC really mean/measure?

Back 14

the “correct” value by which to discount future cash flows