Question

True or False question

1. The after-tax cost of debt generally increases when a firm's bond rating decreases.
2. The weighted average cost of capital for a firm is the discount rate which the firm should apply to all of the projects it undertakes.
3. Assigning discount rates to individual projects based on the risk level of each project may cause the firm's overall weighted average cost of capital to either increase or decrease over time.
4. Other things being equal, the weighted average cost of capital (WACC) should decrease as the firm's debt-equity ratio increases.
5. The WACC will remain constant unless a firm retires some of its debt.
6. If a firm uses its WACC as the discount rate for all of the projects it undertakes then the firm will tend to favor high risk projects over low risk projects.
7. Kirksville Inc. is a multi-divisional firm that uses its WACC as the discount rate for all proposed projects. Each division is in a separate line of business and each presents risks unique to those lines. Given this, a division within the firm will tend to receive less project funding if its line of business is riskier than that of the other divisions.
8. Incorporating flotation costs into the analysis of a project will increase the net present value of the project.
9. The discount rate assigned to an individual project should be based on the risks associated with the use of the funds required by the project.

Answer 1

1)

When bond rating decrease, required return on bond will increase.

After-tax cost of debt = Required return on bond×(1-Tax rate)

From the above formula we can say that given statement is True.

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