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Chapter 15:   Required Returns and the Cost of Capital

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1. The MINIMUM required rate of return for accepting any investment proposal should be the one that keeps the common stock price (at the least) unchanged.

2. A firm's overall cost of capital is simply the sum of the firm's cost of equity, cost of debt, and cost of preferred stock.

3. A bond's yield to maturity (YTM) is the same thing as the before-tax cost of debt, kd.

4. The cost of preferred stock formula is not adjusted for the tax effect because the payment of preferred dividends occurs after taxes are paid.

5. The tax advantage that comes from debt financing is of special benefit to a firm that is losing money.

6. The complexity of the CAPM is offset by the fact that it gives an exact measure of the cost of equity capital.

7. A good proxy for E(Rm), the expected return for the market, is the expected return on a broad-based stock market index such as Standard and Poor's 500.

8. In calculating financing weights, the book values of the various financing components should be used, as they are consistent with the goal of maximizing shareholders' wealth.

9. The critical assumption in any cost of capital weighting system is that the firm will raise funds in the future in the weighting proportions specified.

10. A sometimes questionable assumption underlying the capital-asset pricing model approach to project evaluation is that only the systematic risk of the firm is important.

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