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With respect to issues related to the cost of capital: Select one: a. an increase in the debt...

Question:

With respect to issues related to the cost of capital:

Select one:

a. an increase in the debt ratio will result in greater risk for debt-holders but not equity-holders.

b. the cost of capital is the return a firm must earn before tax to satisfy security holders.

c. the WACC is the correct discount rate for average-risk projects.

d. the expected return on equity is relevant to capital budgeting decisions.

Cost of Capital:

Cost of capital is a term used in finance. It refers to the cost of obatining cash to fund operations. That cash can be borrowed from a bank or raised from investors in exchange for an ownership stake. In other words, the two forms of capital are debt and equity and both have a cost. However, the cost of debt (interest) is tax deductible so the cost of debt is said to be less than the cost of equity.

Answer and Explanation:

a. an increase in the debt ratio will result in greater risk for debt-holders but not equity-holders.

False, leverage increases risk for all investors.

b. the cost of capital is the return a firm must earn before tax to satisfy security holders.

False, the cost of capital is the minimum required rate of return.

c. the WACC is the correct discount rate for average-risk projects.

False, the WACC is the correct discount rate for all projects, regardless of risk.

d. the expected return on equity is relevant to capital budgeting decisions.

True, the expected return on equity is a relevant metric for capital budgeting decisions. It can be used as an upper limit on the cost of capital.


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Capital Structure & the Cost of Capital

from Finance 101: Principles of Finance

Chapter 15 / Lesson 1
10K

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