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2. The weighted average cost of capital
The importance of knowing a firm's cost of capital
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Warm Duck Brewing Company has two divisions: one is very risky, and the other exhibits significantly less risk. The
company uses its investors' overall required rate of return to evaluate its investment projects. It is most likely that
the firm will become:
Less risky over time, and its value will increase
Less risky over time, and its value will decrease
Riskier over time, and its value will increase
Riskier over time, and its value will decrease
Which of the following statements is correct?
The market value of a firm's debt and equity will continuously change throughout the day, but the book value
of debt and equity tends to stay more stable over time. Consequently, the firm should use the book-value
weight to define its optimal capital structure.
When all other factors are held constant, a higher tax rate will lower a firm's weighted average cost of capital
only if the firm uses debt financing.
A firm's after-tax cost of preferred stock may be significantly less than its before-tax cost, because issuing
preferred stock dividends creates a tax shelter.
