Question

1. Which of the following entities bears the risk (and therefore the cost) of bankruptcy?

Select one:

a. The CEO

b. The bondholders

c. The preferred shareholders

d. The Board of Directors

e. The common shareholders

2. The retained earnings break point is used to determine at what level of capital spending the firm's WACC will increase. What figure is used in the denominator of that calculation?

Select one:

a. The weight of common equity

b. The weight of preferred equity

c. The weight of debt

d. The weighted average cost of capital

e. Addition to Retained Earnings

3. Which of the following component costs is typically the highest cost to the firm?

Select one:

a. k_p

b. k_d(1-T)

c. k_e

d. k_n

4. Which of the following component costs is typically the lowest cost to the firm?

Select one:

a. k_p

b. k_e

c. k_n

d. k_d(1-T)

Answer 1

1)

Generally common shareholders have to bear the risk of cost of bankruptcy as they are the residual holders of a firms assets and in the event of liquidation get paid only after the debt holders are paid off.

Answer is e. The common shareholders

2)

As Retained earnings breakpoint is the amount of new capital that can be raised without changing the capital structure, its formula can be given by

REBP = Retained earnings / We where We is the proportion of equity in the capital structure.

Answer is a) Weight of common equity

3)

Typically Cost of equity adds the highest cost to the firm due to the risk return trade off for common share holders.

Answer is c) ke

4)

Debt holders have the lowest cost to the firm as they have the lowest risk among all the capital holders.

Answer is d) kd*(1-T)