preferred stock should be ignored when computing a firm's weighted-average cost of capital

by Prof. Salvatore Ferry Published 3 years ago Updated 2 years ago

Preferred stock should be ignored when computing a firm's weighted-average cost of capital. Both the capital asset pricing model and the dividend discount model can be used to determine the cost of equity financing. The cost of equity will generally increase for risky firms when the risk-free rate of return increases.

Should preferred stock be ignored when computing the weighted-average cost of capital?

This problem has been solved! a. Suppose that your firm has a cost of equity of 14% and a pre-tax cost of debt of 8%. If the target debt/equity ratio is 0.40, and the tax rate is 30%, what is the firm's weighted average cost of capital (WACC)? b. Preferred stock should be ignored when computing a firm's weighted-average cost of capital.

What is the weighted average cost of capital?

The cost of preferred stock: A. should be adjusted for taxes when computing WACC. B. is ignored by all firms when computing WACC. C. is generally calculated using the overall firm's beta. D. is equal to the stock's dividend yield. E. is set equal to the pretax cost of debt since it is a fixed income security.

Why is a firm's WACC higher when its stock price is volatile?

true. A firm's weighted average cost of capital is a marginal measurement meaning it is concerned with measuring the cost of funds already raised and previously invested in the firm. false. Funds raised by the issuance of preferred stock are …

What is the relationship between cost of capital and cost of equity?

Theresa's Flower Garden has 750 bonds outstanding that are selling for $989 each, 2,500 shares of preferred stock with a market price of $47 a share, and 30,000 shares of common stock valued at $56 a share. What weight should be assigned to the common stock when computing the firm's weighted average cost of capital? A. 62.08 percent B. 66.16 ...

Why is the cost of debt less than the cost of preferred stock if both securities are priced to yield 10 percent in the market?

Why is the cost of debt less than the cost of preferred stock if both securities are priced to yield 10 percent in the market? the cost of debt is less because the interest on debt is a tax-deductible expense.

What is the firm's weighted average cost of capital quizlet?

A firm's weighted average cost of capital is the average cost of the various long-term sources of financing employed by the firm. Funds raised by the issuance of common stock are not considered part of a firm's capital.

What will be the effect of using book value of debt in WACC decisions if interest rates have decreased substantially since a firm's long-term bonds were issued?

What will be the effect of using the book value of debt in WACC decisions if interest rates have decreased substantially since a firm's long-term bonds were issued? The debt-to-value ratio will be understated.

How do you calculate optimal WACC?

The optimal capital structure is estimated by calculating the mix of debt and equity that minimizes the weighted average cost of capital (WACC) of a company while maximizing its market value. The lower the cost of capital, the greater the present value of the firm's future cash flows, discounted by the WACC.

What is the weighted average cost of capital for a firm?

The weighted average cost of capital (WACC) is a calculation of a firm's cost of capital in which each category of capital is proportionately weighted. All sources of capital, including common stock, preferred stock, bonds, and any other long-term debt, are included in a WACC calculation.

What is the other name for weighted average cost of capital?

The weighted average cost of capital (WACC) is the rate that a company is expected to pay on average to all its security holders to finance its assets. The WACC is commonly referred to as the firm's cost of capital.

Why do we use market based weights instead of book value based weights when computing the WACC?

While calculating the weighted-average of the returns expected by various providers of capital, market value weights for each financing element (equity, debt, etc.) must be used, because market values reflect the true economic claim of each type of financing outstanding whereas book values may not.

How do book value weights differ from market value weights in measurement of cost of capital?

Book value is the net value of a firm's assets found on its balance sheet, and it is roughly equal to the total amount all shareholders would get if they liquidated the company. Market value is the company's worth based on the total value of its outstanding shares in the market, which is its market capitalization.

What will be the effect of using book value of debt in WACC?

There will be no effect on WACC decisions. D. Cannot be determined without knowing interest rates. Thus, the debt-to-value ratio is .

What factors should you consider when choosing the optimal capital structure?

While designing an optimum capital structure the following factors are to be considered carefully:

Profitability: An optimum capital structure must provide sufficient profit. ...
Liquidity: ...
Control: ...
Industry Average: ...
Nature of Industry: ...
Maneuverability in Funds: ...
Timing of Raising Funds: ...
Firm's Characteristics:

How does capital structure affect WACC?

Assuming that the cost of debt is not equal to the cost of equity capital, the WACC is altered by a change in capital structure. The cost of equity is typically higher than the cost of debt, so increasing equity financing usually increases WACC.

Is a higher WACC better?

A high WACC typically signals higher risk associated with a firm's operations because the company is paying more for the capital that investors have put into the company. In general, as the risk of an investment increases, investors demand an additional return to neutralize the additional risk.

What is the capital structure of Black River Tours?

Black River Tours has a capital structure of 55 percent common stock, 5 percent preferred stock, and 40percent debt. The firm has a 30 percent dividend payout ratio, a beta of 1.21, and a tax rate of 34 percent.

What is the tax rate for Lamey Co?

Lamey Co. has an unlevered cost of capital of 10.9 percent, a tax rate of 35 percent , and expected earnings before interest and taxes of $21,800. The company has $25,000 in bonds outstanding that sell at par and have a coupon rate of 6 percent.

What is wilderness adventure?

Wilderness Adventures specializes in back-country tours and resort management. Travel Excitement specializes in making travel reservations and promoting vacation travel. Wilderness Adventures has an after tax cost of capital of 13 percent and Travel Excitement has an after tax cost of capital of 11 percent.

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