1. The weighted average cost of capital is defined as the weighted average of a
ID: 2660697 • Letter: 1
Question
1. The weighted average cost of capital is defined as the weighted average of a firm's:
return on its investments. cost of equity and its aftertax cost of debt. pretax cost of debt and equity securities. bond coupon rates. dividend and capital gains yields.2 Black Stone Furnaces wants to build a new facility. The cost of capital for this investment is primarily dependent on which one of the following? Firm's overall source of funds Source of the funds used to build the facility Current tax rate The nature of the investment Firm's historical average rate of return
3.hich of the following features are advantages of the dividend growth model?
I. Easy to understand
II. Model simplicity
III. Constant dividend growth rate
IV. Model's applicability to all common stocks II only I and III only II and IV only I and II only I, II, and III only
Explanation / Answer
Hi,
Please find the correct and detailed answer as follows:
Part A:
Notes:
Formula Used for Calculating WACC = Weight of Equity*Cost of Equity + Weight of Debt*After Tax Cost of Debt
Part B:
The nature of the investment is the correct answer.
Notes:
It is so because all the other options mentioned in the question would have importance once the investment has been made. Cost of capital is primariliy dependant on the nature of the project in which the investment is proposed to be made.
Part C:
I and II only is the correct answer.
Notes:
Constant dividend rate is not an advantage of Gordon Model, rather it would be treated as a limitation because in practical world, dividends are rarely constant. Gordon Model cannot be used in case of all the stocks. It assumes constant dividend growth rate which would normally be relevant for established or mature companies.
Thanks.
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