7. As the level of debt rises, the cost of equity _____________ and the WACC ___

Question

7. As the level of debt rises, the cost of equity _____________ and the WACC _______________.

a)      Increases at an increasing rate; falls and then rises

b)      Decreases; falls and then rises

c)      Increases at an increasing rate; rises and then falls

d)      Decreases; rises and then falls

8. Which of the following is TRUE?

a)    It is standard practice to evaluate investment decisions using the cost of the specific financing method involved.

b)    The calculation of the cost of capital depends upon the historical cost of funds.

c)      In determining the cost of preferred stock, the earnings on outstanding preferred stock may be used as a proxy.

d)      The cost of debt is equal to the current bond yield on bonds of similar risk class, adjusted for the corporate tax rate.

9. Which of the following is TRUE?

a)    Operating leverage is beneficial when product volume is increasing.

b)    If economic conditions were expected to be favorable, an investor would likely prefer a firm with a low degree of leverage.

c)    The use of debt is not typically needed for firms in industries that offer some degree of stability, are in a positive stage of growth, and are operating in favorable economic conditions.

d)    The degree of combined leverage is the sum of the degree of operating leverage and the degree of financial leverage.

10. Under which of the following conditions could the overuse of financial leverage be detrimental to the firm?

a)    In a stable industry.

b)    When there is cyclical demand for the firm's products.

c)    During an upswing in the business cycle.

d)    When there is low interest cost compared to return on assets.

Explanation / Answer

Ans 7 option A , as debt increases cost of equity increases but wacc initially decrease and rise later

Ans 8 option A if fcff method is used , we prefer using wacc and if fcfe method is used cost of equity is used

Ans 9 option D

Ans 10 option B

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