What is the primary purpose of calculating the cost of capital for a business?

Determine minimum return for investments.

• Guides investment decisions effectively.

• Ensures financial viability of projects.

• Balances risk and return expectations.

True or False: The cost of capital includes only the cost of equity.

False. The cost of capital includes both the cost of equity and the cost of debt.

Fill in the blank: The weighted average cost of capital (WACC) is calculated by weighting the costs of ___ and ___ according to their proportion in the overall capital structure.

Debt and equity

Explain the significance of the cost of capital in setting a project's hurdle rate.

Cost of capital determines hurdle rate.

• Minimum return benchmark.

• Covers financing costs effectively.

• Guides strategic investment decisions.

What is the formula for calculating the cost of equity using the Capital Asset Pricing Model (CAPM)?

Cost of equity formula explained.

• Rf represents risk-free rate.

• β indicates stock's volatility.

• Rm is expected market return.

True or False: A company with a high cost of capital is expected to generate higher long-term returns.

False. A company with a high cost of capital is generally expected to generate lower long-term returns, which may negatively impact its valuation.

Fill in the blank: The cost of debt is calculated on an ___ basis, taking into account the company's marginal tax rate.

After-tax

Describe how the cost of capital varies by industry and provide an example.

Cost of capital varies by industry.

• Capital needs differ across sectors.

• Homebuilding has high costs (9.28%).

• Grocery retail has lower costs (5.31%).

What role does the cost of capital play in a company's financing strategy?

Cost of capital affects financing strategy.

• Determines debt-equity mix.

• Impacts financing costs directly.

• Influences overall risk profile.

True or False: Debt financing is typically less tax-efficient than equity financing.

False. Debt financing is generally more tax-efficient because interest payments are tax-deductible, unlike dividends paid on equity.

Fill in the blank: The overall cost of capital is the weighted average of the ___ and ___ of a firm.

Cost of debt and cost of equity

What is the impact of a company's cost of capital on its valuation?

Cost of capital affects valuation.

• Higher costs suggest lower returns.

• Investors value equity less.

• Direct impact on investment decisions.

True or False: A project that generates returns equal to the cost of capital is considered a wise investment.

False. A project generating returns equal to or less than the cost of capital may not be a wise use of resources, as it does not create value.

Fill in the blank: Companies often use a mix of ___ and ___ to fund their growth.

Debt and equity

How does a company's capital structure affect its overall cost of capital?

Capital structure influences financing costs.

• Determines debt and equity mix.

• Affects weighted average cost.

• Impacts overall financial strategy.

Fill in the blank: Excessive debt can lead to increased risk of ___ for a company.

Default

The cost of capital is primarily used to evaluate the ___ of a proposed project.

Financial viability