Part A: True or False Questions e cost of preferred stock is computed the same a

Question

Part A: True or False Questions e cost of preferred stock is computed the same as the rate of return on an annuity 2. A firm's overall cost of equity is unaffected by changes in the market risk premium. 3. The capital asset pricing model approach to equity valuation assumes the reward-to- risk ratio is constant. 4. The deferred tax on capital gains favors a low dividend policy. 5. The fact that flotation costs can be significant is an argument for maintaining a low dividend policy and rarely issuing extra dividends.

Explanation / Answer

1. True..cost of preferred stock=Dividend/Price..THis is the same as return on perpetual annuity

2. False..cost of equity=risk free rate+beta*market risk premium..hence cost of equity is affected by market risk premium

3. True..CAPM uses constant risk to reward as market risk premium

4. True..Investors would want more capital gains and less dividends in case of deferred tax given the immediate tax liability

5. True..Low diivdends increase the amount of cash and thus decrease the need of additional capital and hence floatation costs can be avoided by low dividend payout

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