A firm is considering a new project whose risk is greater than the risk of the firms average project, based on all methods for assessing risk. In evaluating this project, it would be reasonable for management to do which of the following? ____ Increase the estimated IRR of the project to reflect its greater risk Reject the project, since its acceptance would increase the firms risk Ignore the risk differential if the project would amount to only a small fraction of the firms total assets Increase the cost of capital used to evaluate the project to reflect the projects higher-than-average risk Currently, DEF Ltd. Has a beta of 1 and its sales and profits are positively correlated with the overall economy. The company estimates that a proposed new project would have a higher standard deviation and coefficient of variation than one of the companys average projects. Also, the new projects sales would be counter-cyclical in the sense that they would be high when the overall economy is down and low when the overall economy is strong. On the basis of this information, which of the following is true? ____ The proposed new project would have more stand-alone risk than the firms typical project The proposed new project would increase the firms corporate risk The proposed new project would not affect the firms risk at all The proposed new project would have less stand-alone risk than the firms typical project If a firm is losing money, then the after-tax cost of debt is ____ Equal to kd(1-T) Found by trial and error Equal to the pre-tax cost of debt Equal to the yield-to-maturity Both (C) and (D) Determine the weighted average cost of capital for the ABC Co. that will finance its optimal capital budget with $120 million of long-term debt (kd = 12.5%) and $180 million in retained earnings (ks = 16%). ABCs current capital structure is considered optimal. The companys tax rate is 40%. ____ 14.3% 12.6% 14.6% None of the above Hint: What is the cost of a preferred share with a $100 par value that pays a $9.60 dividend per year? The security has a flotation cost of $3.37 and will be retired at its par value in 20 years. ____ 9.6% 9.9% 10.0% Undetermined Hint: DEF Ltd. has a beta of 1.15. If 3-month Treasury bills currently yield 7.9% and the market risk premium is estimated to be 8.3%, what is DEFs cost of equity capital? ____ 17.45% 8.36% 9.55% Undetermined Hint: ABC Co. has a current dividend of $1.80. Dividends are expected to grow at a rate of 7% a year into the foreseeable future. What is ABCs cost of external equity if its shares can be sold to net $46 a share? ____ 10.9% 11.2% 7.2% None of the above Hint: If a firm sells asset to generate cash flows, the cost of these funds is ____ The firms cost of equity The firms cost of cash flows The firms weight cost of capital Zero Infinite Retained earnings are a cheaper source of funds than the sale of new equity because ____ Retention defers the payment of taxable dividends to shareholders There are no flotation costs New shares are usually priced below current market price All of the above None of the above The CAPM assumes that the only risk of concern to the investor is ____, which is measured by ___. ____ Nonsystematic risk; beta Systematic risk; the return to the market portfolio Systematic risk; beta Nonsystematic risk; the return to the market portfolio If a firm adopts a large proportion of above-average-risk investment projects that are not offset by below-average-risk investment projects ____ Its cost of capital will rise The average risk premium for the firm will decline The risk-free rate will increase as more risk is added None of the above