Cost of capital and time value of money - One Line Questions

1. What is the future value of an ordinary annuity of $1,000 per year for 10 years at an interest rate of 7%? (FVIF for 10 years at 7% is approximately 13.816) — $13,816
2. If you need $10,000 in 5 years and can earn 6% per year compounded annually, how much do you need to invest today? (PV factor for 5 years at 6% is approximately 0.747) — $7,470
3. If a company's capital structure consists of 60% debt and 40% equity, and the after-tax cost of debt is 5% and the cost of equity is 12%, what is the WACC? — 9.2%
4. What is the effective annual rate (EAR) if the nominal rate is 8% compounded quarterly? — 8.16%
5. Which of the following statements about the time value of money is FALSE? — A longer time period leads to a higher present value.
6. A perpetuity is: — A series of equal payments made at equal intervals forever
7. An annuity is best described as: — A series of equal payments made at equal intervals
8. Why is the cost of retained earnings considered an opportunity cost? — Because these earnings could have been distributed to shareholders as dividends.
9. The Gordon Growth Model assumes that dividends will grow at a constant rate indefinitely. What is a major limitation of this assumption? — Companies cannot sustain growth indefinitely.
10. What is the process of determining the present value of a future sum of money called? — Discounting
11. Which of the following is NOT a component of the cost of capital? — Cost of Advertising
12. Which financial decision is most directly impacted by the time value of money? — Choosing between two investment projects with different cash flow timings.
13. Which of the following scenarios best illustrates the concept of compounding? — Depositing $1000 in a savings account, earning $50 interest, and then earning interest on the original $1000 plus the $50 in the second year.
14. What is the process of determining the future value of a present sum of money called? — Compounding
15. The present value of an annuity due is always: — Higher than the present value of an ordinary annuity
16. The formula for Future Value (FV) with simple interest is FV = PV * (1 + r). What does 'PV' represent? — Present Value
17. Which concept is crucial for investment appraisal techniques like Net Present Value (NPV)? — Time Value of Money
18. Discounting is used to determine: — The current worth of future cash flows
19. If a company repurchases its own shares, how does this typically affect its cost of equity? — Decreases the cost of equity
20. The cost of debt is typically calculated after considering its tax deductibility because: — Interest payments are tax-deductible, reducing the effective cost
21. The time value of money concept is essential for making sound financial decisions because: — It recognizes that a rupee today is worth more than a rupee tomorrow due to its earning potential
22. When the cost of debt is calculated, what adjustment is typically made for preferred stock? — It is not adjusted for taxes
23. Which of the following is a disadvantage of using the CAPM to calculate the cost of equity? — It is difficult to estimate the beta coefficient accurately.
24. When calculating the cost of debt, the yield to maturity (YTM) is often used because: — It reflects the current market rate of return required by debt holders.
25. The cost of retained earnings is generally considered to be: — Lower than the cost of new equity
26. When calculating WACC, the weights of different capital components should be based on: — Market values
27. The 'time value of money' principle states that: — Money today is worth more than the same amount of money in the future
28. If the WACC of a company increases, what is the likely impact on the company's investment decisions? — Fewer projects will become acceptable.
29. The formula for Present Value (PV) is PV = FV / (1 + r)^n. What does 'n' represent? — Number of years
30. When calculating the cost of capital for a company with multiple classes of shares, which cost needs to be considered? — Common equity and preferred equity
31. The present value of a perpetuity is calculated as: — Payment / r
32. An annuity due differs from an ordinary annuity in that: — Payments are made at the beginning of each period for an annuity due.
33. The cost of capital is used as a benchmark for: — Evaluating investment opportunities
34. What is the Weighted Average Cost of Capital (WACC)? — The blended cost of all capital sources, weighted by their proportion in the capital structure
35. The cost of capital for a project should ideally be: — Specific to the risk profile of the project
36. The dividend growth model for cost of equity is: Ke = (D1 / P0) + g. What does 'D1' represent? — The expected dividend in the next period
37. What does 'g' represent in the dividend growth model (Gordon Growth Model)? — The constant growth rate of dividends
38. In the context of the time value of money, 'present value' represents: — The current worth of a future sum of money, discounted at an appropriate rate.
39. The concept of 'terminal value' in the context of the time value of money is: — The value of an investment at a specific future point in time.
40. What does the beta coefficient (β) measure in the CAPM? — The systematic risk of a security relative to the market
41. The cost of preferred stock is calculated using the formula: Cost of Preferred Stock = Dp / Pp, where 'Dp' is: — The dividend paid on preferred stock
42. If a company has a WACC of 10%, what does this imply for a potential project? — The project must earn at least 10% to be considered viable
43. The CAPM formula for cost of equity is: Cost of Equity = Rf + β(Rm - Rf). What does 'Rf' represent? — The risk-free rate of return
44. A company's capital structure refers to: — The mix of debt and equity used to finance its operations
45. What is the primary purpose of discounting future cash flows when calculating NPV? — To reduce their value to reflect the risk and opportunity cost of not having the money today.
46. What is the primary objective of calculating the cost of capital? — To determine the minimum acceptable rate of return on investment
47. Which of the following is a common method for estimating the cost of retained earnings? — Using the dividend growth model (Gordon Growth Model)
48. If a company's debt-to-equity ratio increases significantly, what is the likely effect on its WACC, assuming other factors remain constant? — WACC will increase due to higher financial risk.
49. Which method is commonly used to estimate the cost of equity? — Capital Asset Pricing Model (CAPM)
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