The cost of equity is the return a company requires to decide if an investment meets capital return requirements.

The marginal cost of capital (MCC) is the composite cost of the last dollar of new capital raised.

The long-term financial requirement means the finance needed to acquire land and building for business concern, purchase of plant and machinery and other fixed expenditures. Long-term loans (payback period over 5 years, up to about 30 years such as for mortgage credits.

Bankruptcy risk negatively affects the value of a firm. Firstly, the before-tax cost of debt increases which makes debt financing more costly. Secondly, the stockholders who hold residual claims in sharing the earnings and assets of the company demand a higher yield. Since creditors have a priority in their claims, higher debt ratios and the rising probability of bankruptcy heighten the risk borne by the stockholders. As a result, the cost of the funds raised by the company, no matter debt or equity upsurge, raises the weighted average cost of capital (WACC). The value of the firm declines as the bankruptcy risk rises since the free cash flows (FCF) drop with the loss of confidence in the firm. Another problem that is caused by the rising bankruptcy risk is the underinvestment in positive NPV projects. The correct answer is A.

The cost of each capital component is weighed at the proportions in the capital structure to quantify the firm’s WACC.

, where wD is the weight of debt financing in the capital structure, kD is the cost component of debt funds, T is the tax rate, accordingly wPS is the weight of preferred stocks, kPS is its cost component, wCE is the weight of common equity and kCE is the cost of equity capital. Therefore;

WACC=0.20*0.07*(1-0.40)+0.10*0.13+0.40*0.15=0.0814

As it can be seen from the above calculation the WACC for A & B is 8.14%. The correct answer is E.

Residual claims on assets: If the company is wound up, the ordinary or equity shareholders have the right to get the claims on assets. These rights are only available to the equity shareholders. The correct answer is D.

Economic profit refers to the risk-adjusted present value of revenue minus all costs, including the opportunity cost of capital.

Positive economic profits (or positive net present value projects) can stem from two sources: i) market imperfections, ii) creating competitive advantage. The correct answer is D.

(1.5 +( 1*0.06))/(29-4) =1.56 / 25=0.0624 +0.06 =0.1224

Commonly applied capital investment project analysis techniques are payback period, discounted payback period, net present value, internal rate of return, modified internal rate of return, and profitability index. Decision trees are, however, tools to associate probabilities to each possible outcome for an event and map out the possible outcomes and the value of the investment opportunity associated with these different outcomes. The correct answer is C.

In bond issues, if the interest rate is floating and not fixed, then it is called as an indexed bond. The index can be any economic indicator but mostly it is a price index, such as the inflation rate, the oil price or the gold price index. The correct answer is E.

There are no taxes is one of the assumptions of Modigliani and Miller Capital Structure Theory

A traditional approach is an intermediate model, compromising between the net income approach and the net operating income approach.

Financial leverage is an indicator of financial risk and occurs in case of borrowing

Common stock, also named as equity shares, represents equity or an ownership position in a corporation. The conceptual structure of the corporation assumes that shareholders elect directors who, in turn, hire management to carry out their directives. Shareholders, therefore, control the corporation through the right to elect the directors.

Normally, a business follows a target capital structure, where the percentages of different financing sources are set in an effort to minimize the average cost of capital. The weighted average cost of capital (WACC) is the average cost of the different types of capital employed by the firm. The correct answer is C.

As a broad definition, we can say that the debt and equity mix is called the capital structure of a firm. Because the capital structure determines the value of the firm, a target capital structure is tried to be maintained for shareholders’ wealth maximization, nevertheless, the actual portions of debt and equity financing alter over time. Assessing the target capital structure requires an appraisal of the financing sources, the evaluation of their risk, the examination of the maturity-cost relation of debt and the estimation of the cost of equity for different capital budget amounts. The correct answer is D.

As the main goal of investors is wealth maximization, companies seek to attain an optimal capital structure which maximizes the firm value. However, there cannot be a prescribed optimal capital structure for any business because there are many different factors influencing the capital structure decisions. Even for a single company, the optimal capital mix might require variations in the level of financial leverage over time in relation to changing market forces as a , economic environment, industry specific factors and firm-specific factors.

1. The cost of equity is the return a company requires to decide if an investment meets capital return requirements.
2. A firm uses cost of equity to assess the relative attractiveness of investments
3. A business can raise equity capital either through a common stock issue or a preferred stock issue.

All of the statements above are true for cost of equity.