CPA Business Environment and Concepts (BEC) : Weighted Average Cost of Capital Formula
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Example Questions
Example Question #1 : Financial Management Formulas
Which one of a firm's sources of new capital usually has the lowest after-tax cost?
Common stock
Bonds
Retained earnings
Preferred stock
Bonds
Debt is a cheaper source of financing than equity. In addition, there is a tax deduction for interest paid on debt.
Example Question #1 : Weighted Average Cost Of Capital Formula
Which of the following rates is most commonly compared to the internal rate of return to evaluate whether to make an investment?
Short term rate on US Treasury bonds
Long term rate on US Treasury bonds
Prime rate of interest
Weighted average cost of capital
Short term rate on US Treasury bonds
WACC is used as the hurdle rate within capital budgeting techniques. Investments that provide a return that exceeds the WACC should continuously add to the value of the firm.
Example Question #2 : Weighted Average Cost Of Capital Formula
Which one of the following factors might cause a firm to increase the debt in its financial structure?
An increase in the PE ratio
An increase in the corporate income tax rate
Increased economic uncertainty
A decrease in the times interest earned ratio
An increase in the corporate income tax rate
Interest on debt financing is tax-deductible whereas dividends from equity are not. An increase in tax rates might cause a firm to increase debt financing.
Example Question #4 : Financial Management Formulas
The marketable securities with the least amount of default risk are:
Repurchase agreements
Federal government agency securities
US Treasury securities
Bankers acceptances
US Treasury securities
Default risk is the risk that the security will not be paid. US Treasury securities are issued by the Treasury Department which has no risk of non payment.
Example Question #5 : Financial Management Formulas
Which of the following measurement models is being used if a calculation includes risk-free rate, beta coefficient, rate of return, and required rate of return?
Constant growth
Overall cost of capital
Weighted marginal cost of capital
Capital asset pricing
Capital asset pricing
These factors are included in the calculation of CAPM.
Example Question #6 : Financial Management Formulas
Which of the following would never be included in the WACC formula?
Risk
Required rate of return
Tax rate
Summed market values of a firm's capital structure
Risk
Risk is not assessed in calculating the WACC. WACC is used to determine the cost of financing for a firm.
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