#1
Which of the following is NOT a component of the cost of capital?
Cost of goods sold
ExplanationCost of goods sold is a part of operational expenses, not cost of capital.
#2
What is the formula for Weighted Average Cost of Capital (WACC)?
WACC = (Weight of Debt × Cost of Debt) + (Weight of Equity × Cost of Equity)
ExplanationWACC considers the cost of both debt and equity, weighted by their proportions in the capital structure.
#3
Which capital structure theory suggests that firms prefer a mix of debt and equity to minimize the weighted average cost of capital and maximize value for shareholders?
Trade-off theory
ExplanationTrade-off theory aims to find the balance between tax benefits of debt and costs of financial distress.
#4
Which of the following statements is true regarding the cost of debt?
The cost of debt is inversely related to the company's credit rating.
ExplanationHigher credit rating typically results in lower cost of debt due to reduced risk.
#5
What is the relationship between the cost of debt and the company's credit rating?
As the credit rating improves, the cost of debt decreases.
ExplanationHigher credit rating lowers perceived risk, hence decreasing the cost of debt.
#6
What is the primary drawback of using only equity financing for a company?
It dilutes ownership and control.
ExplanationEquity financing involves issuing shares, which can dilute existing ownership and control.
#7
Under the Modigliani-Miller theorem with taxes, what happens to the cost of equity as the level of debt increases?
It increases due to higher financial risk.
ExplanationAs debt increases, financial risk increases, leading to higher expected returns demanded by equity holders.
#8
What is the key assumption of the Modigliani-Miller theorem regarding capital structure?
There are no taxes.
ExplanationModigliani-Miller theorem assumes no taxes, bankruptcy costs, or agency costs.