Chapter 11 Discussion Questions


11-1. Why do we use the overall cost of capital for investment decisions even when only one source of capital will be used (e.g., debt)?
11-2. How does the cost of a source of capital relate to the valuation concepts presented previously in Chapter 10?
11-3. In computing the cost of capital, do we use the historical costs of existing debt and equity or the current costs as determined in the market? Why?
11-4. Why is the cost of debt less than the cost of preferred stock if both securities are priced to yield 10 percent in the market?
11-5. What are the two sources of equity (ownership) capital for the firm?
11-6. Explain why retained earnings have an opportunity cost associated?
11-7. Why is the cost of retained earnings the equivalent of the firm’s own required rate of return on common stock (Ke)?
11-8. Why is the cost of issuing new common stock (Kn) higher than the cost of retained earnings (Ke)?
11-9. How are the weights determined to arrive at the optimal weighted average cost of capital?
11-10. Explain the traditional, U-shaped approach to the cost of capital.
11-11. It has often been said that if the company can’t earn a rate of return greater than the cost of capital it should not make investments. Explain.
11-12. What effect would inflation have on a company’s cost of capital? (Hint: Think about how inflation influences interest rates, stock prices, corporate profits, and growth.)
11-13. What is the concept of marginal cost of capital?
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