Cost of Capital and Capital Structure Quiz

Cost of goods sold is a part of operational expenses, not cost of capital.

WACC considers the cost of both debt and equity, weighted by their proportions in the capital structure.

Trade-off theory aims to find the balance between tax benefits of debt and costs of financial distress.

Higher credit rating typically results in lower cost of debt due to reduced risk.

Higher credit rating lowers perceived risk, hence decreasing the cost of debt.

Equity financing involves issuing shares, which can dilute existing ownership and control.

The tax rate primarily affects the cost of debt, not equity.

Pecking order theory proposes a hierarchy of financing preferences based on the cost and availability of funds.

Credit rating influences the perceived risk by lenders, thus impacting the cost of debt.

CAPM calculates cost of equity based on risk-free rate, market risk premium, and beta representing asset's risk.

Financial leverage amplifies returns and risks due to fixed-cost financing.

Trade-off theory posits that firms balance tax advantages of debt with potential costs of financial distress.

As cost of debt decreases, it reduces WACC since debt is a component of WACC.

Preferred stock often carries fixed dividend payments, resembling debt in terms of fixed costs.

Pecking order theory assumes companies prioritize internal funds, then prefer debt over equity for external financing.

Tax rate influences cost of debt, but not cost of equity which is primarily affected by market risk and investor expectations.

Optimal capital structure balances risk and return to maximize shareholder value.

Financial distress raises the perceived risk for lenders, leading to higher cost of debt.

As debt increases, financial risk increases, leading to higher expected returns demanded by equity holders.

Modigliani-Miller theorem assumes no taxes, bankruptcy costs, or agency costs.