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CHAPTER 9—THE COST OF CAPITAL
TRUE/FALSE
1. "Capital" is sometimes defined as funds supplied to a firm by investors.
ANS: T PTS: 1 DIF: Difficulty: Easy

OBJ: LO: 9-1 NAT: BUSPROG: Reflective Thinking
STA: DISC: Capital budgeting and cost of capital LOC: TBA
TOP: Capital KEY: Bloom’s: Knowledge
2. The cost of capital used in capital budgeting should reflect the average cost of the various sources of
long-term funds a firm uses to acquire assets.

TOP: Cost of capital KEY: Bloom’s: Knowledge
3. The component costs of capital are market-determined variables in the sense that they are based on
investors' required returns.

TOP: Component capital costs KEY: Bloom’s: Knowledge
4. Suppose you are the president of a small, publicly-traded corporation. Since you believe that your
firm's stock price is temporarily depressed, all additional capital funds required during the current year
will be raised using debt. In this case, the appropriate marginal cost of capital for use in capital
budgeting during the current year is the after-tax cost of debt.
ANS: F PTS: 1 DIF: Difficulty: Easy

TOP: Specific capital cost KEY: Bloom’s: Knowledge
5. The before-tax cost of debt, which is lower than the after-tax cost, is used as the component cost of
debt for purposes of developing the firm's WACC.

TOP: Cost of debt KEY: Bloom’s: Knowledge
6. The cost of debt is equal to one minus the marginal tax rate multiplied by the average coupon rate on
all outstanding debt.

© 2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
7. The cost of debt is equal to one minus the marginal tax rate multiplied by the interest rate on new debt.

8. The cost of preferred stock to a firm must be adjusted to an after-tax figure because 70% of dividends
received by a corporation may be excluded from the receiving corporation's taxable income.

TOP: Cost of preferred stock KEY: Bloom’s: Knowledge
9. The cost of perpetual preferred stock is found as the preferred's annual dividend divided by the market
price of the preferred stock. No adjustment is needed for taxes because preferred dividends, unlike
interest on debt, is not deductible by the issuing firm.

TOP: Cost of preferred stock KEY: Bloom’s: Knowledge
10. The cost of common equity obtained by retaining earnings is the rate of return the marginal
stockholder requires on the firm's common stock.

TOP: Cost of common stock KEY: Bloom’s: Knowledge
11. For capital budgeting and cost of capital purposes, the firm should always consider reinvested earnings
as the first source of capital⎯i.e., use these funds first⎯because reinvested earnings have no cost to
the firm.

12. Funds acquired by the firm through retaining earnings have no cost because there are no dividend or
interest payments associated with them, and no flotation costs are required to raise them, but capital
raised by selling new stock or bonds does have a cost.

13. The cost of equity raised by retaining earnings can be less than, equal to, or greater than the cost of
external equity raised by selling new issues of common stock, depending on tax rates, flotation costs,
the attitude of investors, and other factors.

14. The firm's cost of external equity raised by issuing new stock is the same as the required rate of return
on the firm's outstanding common stock.

TOP: Cost of new common stock KEY: Bloom’s: Knowledge
15. The higher the firm's flotation cost for new common equity, the more likely the firm is to use preferred
stock, which has no flotation cost, and reinvested earnings, whose cost is the average return on the
assets that are acquired.

TOP: Flotation and capital KEY: Bloom’s: Knowledge
16. For capital budgeting and cost of capital purposes, the firm should assume that each dollar of capital is
obtained in accordance with its target capital structure, which for many firms means partly as debt,
partly as preferred stock, and partly common equity.

TOP: WACC KEY: Bloom’s: Knowledge
17. In general, firms should use their weighted average cost of capital (WACC) to evaluate capital
budgeting projects because most projects are funded with general corporate funds, which come from a
variety of sources. However, if the firm plans to use only debt or only equity to fund a particular
project, it should use the after-tax cost of that specific type of capital to evaluate that project.
ANS: F
In general, this statement is false, because the firm should be viewed as an ongoing entity, and using
debt (or equity) to fund a given project will change the capital structure, and this factor should be
recognized by basing the cost of capital for all projects on a target capital structure. Under some
special circumstances, where a project is set up as a separate entity, then "project financing" may be
used, and only the project's specific situation is considered. This is a specific situation, however, and
not the "in general" case.
PTS: 1 DIF: Difficulty: Moderate OBJ: LO: 9-8

NAT: BUSPROG: Reflective Thinking STA: DISC: Capital budgeting and cost of capital
LOC: TBA TOP: Specific capital cost KEY: Bloom’s: Comprehension
18. If a firm's marginal tax rate is increased, this would, other things held constant, lower the cost of debt
used to calculate its WACC.
ANS: T PTS: 1 DIF: Difficulty: Moderate
TOP: After-tax cost of debt KEY: Bloom’s: Comprehension
19. The reason why reinvested earnings have a cost equal to rs is because investors think they can (i.e.,
expect to) earn rs on investments with the same risk as the firm's common stock, and if the firm does
not think that it can earn rs on the earnings that it retains, it should distribute those earnings to its
investors. Thus, the cost of reinvested earnings is based on the opportunity cost principle.

TOP: Reinvested earnings KEY: Bloom’s: Comprehension
20. When estimating the cost of equity by use of the CAPM, three potential problems are (1) whether to
use long-term or short-term rates for rRF, (2) whether or not the historical beta is the beta that investors
use when evaluating the stock, and (3) how to measure the market risk premium, RPM. These problems
leave us unsure of the true value of rs.
ANS: T
Unfortunately, this is true.

LOC: TBA TOP: Cost of equity: CAPM KEY: Bloom’s: Comprehension
21. When estimating the cost of equity by use of the DCF method, the single biggest potential problem is
to determine the growth rate that investors use when they estimate a stock's expected future rate of
return. This problem leaves us unsure of the true value of rs.
ANS: T

LOC: TBA TOP: Cost of equity: DCF KEY: Bloom’s: Comprehension
22. When estimating the cost of equity by use of the bond-yield-plus-risk-premium method, we can
generally get a good idea of the interest rate on new long-term debt, but we cannot be sure that the risk
premium we add is appropriate. This problem leaves us unsure of the true value of rs.
ANS: T

LOC: TBA TOP: Cost of equity: BY + RP KEY: Bloom’s: Comprehension
23. The cost of external equity capital raised by issuing new common stock (re) is defined as follows, in
words: "The cost of external equity equals the cost of equity capital from retaining earnings (r s),
divided by one minus the percentage flotation cost required to sell the new stock, (1 − F)."
ANS: F
This statement is true only if the expected growth rate is zero. Here are some illustrative numbers that
show that the statement is true if g = 0 but false otherwise.
Positive g Zero g
Price $10.00 $10.00
Dividend $0.50 $0.50
Growth 6.00% 0.00%
Flotation 5.00% 5.00%
rs = D1/P0 + g 11.00% 5.00%
re = D1/P0(1 − F) + g 11.263% 5.263% Equal only if g = zero.
rs/(1 − F) 11.579% 5.263%

LOC: TBA TOP: Cost of new common equity KEY: Bloom’s: Comprehension
24. If the expected dividend growth rate is zero, then the cost of external equity capital raised by issuing
new common stock (re) is equal to the cost of equity capital from retaining earnings (rs) divided by one
minus the percentage flotation cost required to sell the new stock, (1 − F). If the expected growth rate
is not zero, then the cost of external equity must be found using a different formula.
ANS: T
This statement is true. Here are some illustrative numbers to demonstrate this point.
Positive g Zero g
Price $10.00 $10.00
Dividend $0.50 $0.50
Growth 6.00% 0.00%
Flotation 5.00% 5.00%
rs = D1/P0 + g 11.00% 5.00%
re = D1/P0(1 − F) + g 11.263% 5.263% Equal only if g = zero.
rs/(1 − F) 11.579% 5.263%

LOC: TBA TOP: Cost of new common equity KEY: Bloom’s: Comprehension
25. Suppose the debt ratio (D/TA) is 50%, the interest rate on new debt is 8%, the current cost of equity is
16%, and the tax rate is 40%. An increase in the debt ratio to 60% would decrease the weighted
average cost of capital (WACC).
ANS: F PTS: 1 DIF: Difficulty: Moderate

TOP: Factors affecting WACC KEY: Bloom’s: Comprehension
26. Firms raise capital at the total corporate level by retaining earnings and by obtaining funds in the
capital markets. They then provide funds to their different divisions for investment in capital projects.
The divisions may vary in risk, and the projects within the divisions may also vary in risk. Therefore, it
is conceptually correct to use different risk-adjusted costs of capital for different capital budgeting
projects.
TOP: Adjusting cap. costs for risk KEY: Bloom’s: Comprehension
27. If a firm is privately owned, and its stock is not traded in public markets, then we cannot measure its
beta for use in the CAPM model, we cannot observe its stock price for use in the DCF model, and we
don't know what the risk premium is for use in the bond-yield-plus-risk-premium method. All this
makes it especially difficult to estimate the cost of equity for a private company.
ANS: T
True, but data on comparable publicly owned firms can often be obtained and used as proxies for
private firms.

LOC: TBA TOP: Cost of equity: private cos. KEY: Bloom’s: Comprehension
28. The cost of debt, rd, is normally less than rs, so rd(1 − T) will normally be much less than rs. Therefore,
as long as the firm is not completely debt financed, the weighted average cost of capital (WACC) will
normally be greater than rd(1 − T).

TOP: WACC KEY: Bloom’s: Comprehension
29. The lower the firm's tax rate, the lower will be its after-tax cost of debt and also its WACC, other
things held constant.

TOP: Taxes, cost of debt, and WACC KEY: Bloom’s: Comprehension
30. The text identifies three methods for estimating the cost of common stock from reinvested earnings
(not newly issued stock): the CAPM method, the DCF method, and the bond-yield-plus-risk-premium
method. However, only the DCF method is widely used in practice.

TOP: Cost of equity estimates KEY: Bloom’s: Comprehension
method. However, only the CAPM method always provides an accurate and reliable estimate.
ANS: F
None of the methods always provides accurate and reliable estimates. With the CAPM, we don't know
the beta that investors are using, we are not totally sure of what rRF to use, and we don't know if the
CAPM is truly correct.
LOC: TBA TOP: Cost of equity estimates KEY: Bloom’s: Comprehension
method. Since we cannot be sure that the estimate obtained with any of these methods is correct, it is
often appropriate to use all three methods, then consider all three estimates, and end up using a
judgmental estimate when calculating the WACC.
ANS: T

LOC: TBA TOP: Cost of equity estimates KEY: Bloom’s: Comprehension
33. Since 70% of the preferred dividends received by a corporation are excluded from taxable income, the
component cost of equity for a company that pays half of its earnings out as common dividends and
half as preferred dividends should, theoretically, be
Cost of equity = rs(0.30)(0.50) + rps(1 − T)(0.70)(0.50).
ANS: F
The preferred dividend exclusion is a benefit to the holder of the preferred, not the issuer; hence, this
statement is not true. It actually is just nonsense anyway!

LOC: TBA TOP: Cost of equity KEY: Bloom’s: Comprehension
34. If expectations for long-term inflation rose, but the slope of the SML remained constant, this would
have a greater impact on the required rate of return on equity, rs, than on the interest rate on long-term
debt, rd, for most firms. Therefore, the percentage point increase in the cost of equity would be greater
than the increase in the interest rate on long-term debt.
ANS: F
Increased inflation results in a parallel upward shift in the SML, which means equal percentage
increases in the required return on debt and equity.

LOC: TBA TOP: Inflation and cap. costs KEY: Bloom’s: Comprehension
35. If investors' aversion to risk rose, causing the slope of the SML to increase, this would have a greater
impact on the required rate of return on equity, rs, than on the interest rate on long-term debt, rd, for
most firms. Other things held constant, this would lead to an increase in the use of debt and a decrease
in the use of equity. However, other things would not stay constant if firms used a lot more debt, as
that would increase the riskiness of both debt and equity and thus limit the shift toward debt.

TOP: Inflation and cap. costs KEY: Bloom’s: Comprehension
MULTIPLE CHOICE
36. Which of the following is NOT a capital component when calculating the weighted average cost of
capital (WACC) for use in capital budgeting?
a. Accounts payable.
b. Common stock “raised” by reinvesting earnings.
c. Common stock raised by new issues.
d. Preferred stock.
e. Long-term debt.
ANS: A PTS: 1 DIF: Difficulty: Easy
OBJ: LO: 9-1 NAT: BUSPROG: Analytic
TOP: Capital components KEY: Bloom’s: Comprehension
MSC: TYPE: Multiple Choice: Conceptual
37. With its current financial policies, Flagstaff Inc. will have to issue new common stock to fund its
capital budget. Since new stock has a higher cost than reinvested earnings, Flagstaff would like to
avoid issuing new stock. Which of the following actions would REDUCE its need to issue new
common stock?
a. Increase the percentage of debt in the target capital structure.
b. Increase the proposed capital budget.
c. Reduce the amount of short-term bank debt in order to increase the current ratio.
d. Reduce the percentage of debt in the target capital structure.
e. Increase the dividend payout ratio for the upcoming year.
ANS: A
Statement a is correct, because if more debt is used, then less equity will be needed to fund the capital
budget, so the need for a stock issue would be reduced.
PTS: 1 DIF: Difficulty: Easy OBJ: LO: 9-11

NAT: BUSPROG: Analytic STA: DISC: Capital budgeting and cost of capital
LOC: TBA TOP: Factors affecting WACC KEY: Bloom’s: Comprehension
38. Burnham Brothers Inc. has no retained earnings since it has always paid out all of its earnings as
dividends. This same situation is expected to persist in the future. The company uses the CAPM to
calculate its cost of equity, and its target capital structure consists of common stock, preferred stock,
and debt. Which of the following events would REDUCE its WACC?
a. The flotation costs associated with issuing new common stock increase.
b. The company's beta increases.
c. Expected inflation increases.
d. The flotation costs associated with issuing preferred stock increase.
e. The market risk premium declines.
ANS: E PTS: 1 DIF: Difficulty: Easy
TOP: Factors affecting WACC KEY: Bloom’s: Comprehension
39. For a typical firm, which of the following sequences is CORRECT? All rates are after taxes, and
assume that the firm operates at its target capital structure.
a. re > rs > WACC > rd.
b. WACC > re > rs > rd.
c. rd > re > rs > WACC.
d. WACC > rd > rs > re.
e. rs > re > rd > WACC.
ANS: A PTS: 1 DIF: Difficulty: Easy
TOP: Capital components KEY: Bloom’s: Comprehension
40. When working with the CAPM, which of the following factors can be determined with the most
precision?
a. The beta coefficient, bi, of a relatively safe stock.
b. The most appropriate risk-free rate, rRF.
c. The expected rate of return on the market, rM.
d. The beta coefficient of "the market," which is the same as the beta of an average stock.
e. The market risk premium (RPM).
ANS: D
By definition, both the market and an average stock have betas of 1.0. Since we know this to be the
case, we can obviously determine beta for the market or an average stock with precision.

LOC: TBA TOP: Cost of equity: CAPM KEY: Bloom’s: Analysis
41. Bloom and Co. has no debt or preferred stock⎯it uses only equity capital, and has two equally-sized
divisions. Division X's cost of capital is 10.0%, Division Y's cost is 14.0%, and the corporate
(composite) WACC is 12.0%. All of Division X's projects are equally risky, as are all of Division Y's
projects. However, the projects of Division X are less risky than those of Division Y. Which of the
following projects should the firm accept?
a. A Division Y project with a 12% return.
b. A Division X project with an 11% return.
c. A Division X project with a 9% return.
d. A Division Y project with an 11% return.
e. A Division Y project with a 13% return.
ANS: B
The correct answer is statement b. Division X should accept only projects with returns greater than
10%, while Division Y should accept only projects with returns greater than 14%. Only statement b
meets this criterion.

LOC: TBA TOP: Divisional risk KEY: Bloom’s: Analysis
42. Taylor Inc. estimates that its average-risk projects have a WACC of 10%, its below-average risk
projects have a WACC of 8%, and its above-average risk projects have a WACC of 12%. Which of the
following projects (A, B, and C) should the company accept?
a. Project C, which is of above-average risk and has a return of 11%.
b. Project A, which is of average risk and has a return of 9%.
c. None of the projects should be accepted.
d. All of the projects should be accepted.
e. Project B, which is of below-average risk and has a return of 8.5%.
ANS: E
Project B has a return greater than its risk-adjusted cost of capital, so it should be accepted.

LOC: TBA TOP: Risk and projects KEY: Bloom’s: Analysis
43. Weatherall Enterprises has no debt or preferred stock⎯it is an all-equity firm⎯and has a beta of 2.0.
The chief financial officer is evaluating a project with an expected return of 14%, before any risk
adjustment. The risk-free rate is 5%, and the market risk premium is 4%. The project being evaluated
is riskier than an average project, in terms of both its beta risk and its total risk. Which of the following
statements is CORRECT?
a. The project should definitely be rejected because its expected return (before risk
adjustment) is less than its required return.
b. Riskier-than-average projects should have their expected returns increased to reflect their
higher risk. Clearly, this would make the project acceptable regardless of the amount of
the adjustment.
c. The accept/reject decision depends on the firm's risk-adjustment policy. If Weatherall's
policy is to increase the required return on a riskier-than-average project to 3% over rS,
then it should reject the project.
d. Capital budgeting projects should be evaluated solely on the basis of their total risk. Thus,
insufficient information has been provided to make the accept/reject decision.
e. The project should definitely be accepted because its expected return (before any risk
adjustments) is greater than its required return.
ANS: C
Statement c is correct. Here is the proof:
rs = 5% + 4%(2.0) = 5% + 8% = 13%.
Required return for risky projects = 13% + 3% = 16%.
Project return = 14% < adjusted rs = 16%. Thus, the project should be rejected.

LOC: TBA TOP: Risk and projects KEY: Bloom’s: Analysis
44. The Anderson Company has equal amounts of low-risk, average-risk, and high-risk projects. The
firm's overall WACC is 12%. The CFO believes that this is the correct WACC for the company's
average-risk projects, but that a lower rate should be used for lower-risk projects and a higher rate for
higher-risk projects. The CEO disagrees, on the grounds that even though projects have different risks,
the WACC used to evaluate each project should be the same because the company obtains capital for
all projects from the same sources. If the CEO's position is accepted, what is likely to happen over
time?
a. The company will take on too many low-risk projects and reject too many high-risk
projects.
b. Things will generally even out over time, and, therefore, the firm's risk should remain
constant over time.
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c. The company's overall WACC should decrease over time because its stock price should be
increasing.
d. The CEO's recommendation would maximize the firm's intrinsic value.
e. The company will take on too many high-risk projects and reject too many low-risk
projects.
ANS: E
Low-risk projects will tend to have low expected returns and vice versa for high-risk projects due to
competition in the economy. By not adjusting the cost of capital for project risk, the firm will tend to
reject low-risk projects even though they earn higher returns than their risk-adjusted costs of capital,
and vice versa for high-risk projects. In addition, as the firm takes on more high-risk projects, its
correct WACC will increase over time. Therefore, statement e is correct.

LOC: TBA TOP: Risk-adjusted capital cost KEY: Bloom’s: Analysis
45. Suppose Acme Industries correctly estimates its WACC at a given point in time and then uses that
same cost of capital to evaluate all projects for the next 10 years, then the firm will most likely
a. become less risky over time, and this will maximize its intrinsic value.
b. accept too many low-risk projects and too few high-risk projects.
c. become more risky and also have an increasing WACC. Its intrinsic value will not be
maximized.
d. continue as before, because there is no reason to expect its risk position or value to change
over time as a result of its use of a single cost of capital.
e. become riskier over time, but its intrinsic value will be maximized.
ANS: C
Low-risk projects will tend to have low expected returns and vice versa for high-risk projects due to
competition in the economy. By not adjusting the cost of capital for project risk, the firm will tend to
reject low-risk projects even though they earn higher returns than their risk-adjusted costs of capital,
and vice versa for high-risk projects. As the firm takes on more high-risk projects, its true WACC will
increase over time. Of course, the true WACC might change over time due to changes in market
conditions, but that could cause the true WACC to either rise or decline. Therefore, statement c is
correct.

46. Which of the following statements is CORRECT?

a. All else equal, an increase in a company's stock price will increase its marginal cost of
reinvested earnings (not newly issued stock), rs.
b. All else equal, an increase in a company's stock price will increase its marginal cost of
new common equity, re.
c. Since the money is readily available, the after-tax cost of reinvested earnings (not newly
issued stock) is usually much lower than the after-tax cost of debt.
d. If a company's tax rate increases but the YTM on its noncallable bonds remains the same,
the after-tax cost of its debt will fall.
e. When calculating the cost of preferred stock, a company needs to adjust for taxes, because
preferred stock dividends are deductible by the paying corporation.
ANS: D
Statement d is true, because the after-tax cost of debt is rd(1 − T). So, if rd remains constant but T
increases, rd(1 − T) will decline. The other statements are false.

LOC: TBA TOP: Capital components KEY: Bloom’s: Analysis

a. When calculating the cost of preferred stock, companies must adjust for taxes, because
dividends paid on preferred stock are deductible by the paying corporation.
b. Because of tax effects, an increase in the risk-free rate will have a greater effect on the
after-tax cost of debt than on the cost of common stock as measured by the CAPM.
c. If a company's beta increases, this will increase the cost of equity used to calculate the
WACC, but only if the company does not have enough reinvested earnings to take care of
its equity financing and hence must issue new stock.
d. Higher flotation costs reduce investors' expected returns, and that leads to a reduction in a
company's WACC.
e. When calculating the cost of debt, a company needs to adjust for taxes, because interest
payments are deductible by the paying corporation.
ANS: E
Statement e is true; interest payments on debt are tax deductible. The other statements are false.

LOC: TBA TOP: Capital components KEY: Bloom’s: Analysis

a. We should use historical measures of the component costs from prior financings that are
still outstanding when estimating a company's WACC for capital budgeting purposes.
b. The cost of new equity (re) could possibly be lower than the cost of reinvested earnings (rs)
if the market risk premium, risk-free rate, and the company's beta all decline by a
sufficiently large amount.
c. A firm's cost of reinvesting earnings is the rate of return stockholders require on a firm's
common stock.
d. The component cost of preferred stock is expressed as rp(1 − T), because preferred stock
dividends are treated as fixed charges, similar to the treatment of interest on debt.
e. In the WACC calculation, we must adjust the cost of preferred stock (the market yield) to
reflect the fact that 70% of the dividends received by corporate investors are excluded
from their taxable income.
ANS: C PTS: 1 DIF: Difficulty: Moderate
TOP: Capital components KEY: Bloom’s: Analysis

a. The percentage flotation cost associated with issuing new common equity is typically
smaller than the flotation cost for new debt.
b. The WACC as used in capital budgeting is an estimate of the cost of all the capital a
company has raised to acquire its assets.
c. There is an "opportunity cost" associated with using reinvested earnings, hence they are
not "free."
d. The WACC as used in capital budgeting would be simply the after-tax cost of debt if the
firm plans to use only debt to finance its capital budget during the coming year.
e. The WACC as used in capital budgeting is an estimate of a company's before-tax cost of
capital.
ANS: C PTS: 1 DIF: Difficulty: Moderate
TOP: WACC KEY: Bloom’s: Analysis

a. WACC calculations should be based on the before-tax costs of all the individual capital
components.
b. Flotation costs associated with issuing new common stock normally reduce the WACC.
c. If a company's tax rate increases, then, all else equal, its weighted average cost of capital
will decline.
d. An increase in the risk-free rate will normally lower the marginal costs of both debt and
equity financing.
e. A change in a company's target capital structure cannot affect its WACC.
ANS: C
Statement c is true, because the cost of debt for WACC purposes = rd(1 − T), so if T increases, then
rd(1 − T) declines.

LOC: TBA TOP: WACC KEY: Bloom’s: Analysis

a. The after-tax cost of debt usually exceeds the after-tax cost of equity.
b. For a given firm, the after-tax cost of debt is always more expensive than the after-tax cost
of non-convertible preferred stock.
c. Retained earnings that were generated in the past and are reported on the firm's balance
sheet are available to finance the firm's capital budget during the coming year.
d. The WACC that should be used in capital budgeting is the firm's marginal, after-tax cost
of capital.
e. The WACC is calculated using before-tax costs for all components.
ANS: D PTS: 1 DIF: Difficulty: Moderate
TOP: WACC and cap. components KEY: Bloom’s: Analysis
52. Which of the following statements is CORRECT? Assume a company's target capital structure is 50%
debt and 50% common equity.
a. The WACC is calculated on a before-tax basis.
b. The WACC exceeds the cost of equity.
c. The cost of equity is always equal to or greater than the cost of debt.
d. The cost of reinvested earnings typically exceeds the cost of new common stock.
e. The interest rate used to calculate the WACC is the average after-tax cost of all the
company's outstanding debt as shown on its balance sheet.
ANS: C
Statement c is true, because equity is more risky than debt and hence investors require a higher return
on equity. Also, interest on debt is deductible, and this further reduces the cost of debt. The other
statements are false.

LOC: TBA TOP: WACC and cap. components KEY: Bloom’s: Analysis

a. The tax-adjusted cost of debt is always greater than the interest rate on debt, provided the
company does in fact pay taxes.
b. If a company assigns the same cost of capital to all of its projects regardless of each
project's risk, then the company is likely to reject some safe projects that it actually should
accept and to accept some risky projects that it should reject.
c. Because no flotation costs are required to obtain capital as reinvested earnings, the cost of
reinvested earnings is generally lower than the after-tax cost of debt.
d. Higher flotation costs tend to reduce the cost of equity capital.
e. Since debt capital can cause a company to go bankrupt but equity capital cannot, debt is
riskier than equity, and thus the after-tax cost of debt is always greater than the cost of
equity.
ANS: B PTS: 1 DIF: Difficulty: Moderate
TOP: Cost of capital concepts KEY: Bloom’s: Analysis
54. The Tierney Group has two divisions of equal size: an office furniture manufacturing division and a
data processing division. Its CFO believes that stand-alone data processor companies typically have a
WACC of 9%, while stand-alone furniture manufacturers typically have a 13% WACC. She also
believes that the data processing and manufacturing divisions have the same risk as their typical peers.
Consequently, she estimates that the composite, or corporate, WACC is 11%. A consultant has
suggested using a 9% hurdle rate for the data processing division and a 13% hurdle rate for the
manufacturing division. However, the CFO disagrees, and she has assigned an 11% WACC to all
projects in both divisions. Which of the following statements is CORRECT?
a. The decision not to adjust for risk means, in effect, that it is favoring the data processing
division. Therefore, that division is likely to become a larger part of the consolidated
company over time.
b. The decision not to adjust for risk means that the company will accept too many projects
in the manufacturing division and too few in the data processing division. This will lead to
a reduction in the firm's intrinsic value over time.
c. The decision not to risk-adjust means that the company will accept too many projects in
the data processing business and too few projects in the manufacturing business. This will
lead to a reduction in its intrinsic value over time.
d. The decision not to risk-adjust means that the company will accept too many projects in
the manufacturing business and too few projects in the data processing business. This may
affect the firm's capital structure but it will not affect its intrinsic value.
e. While the decision to use just one WACC will result in its accepting more projects in the
manufacturing division and fewer projects in its data processing division than if it
followed the consultant's recommendation, this should not affect the firm's intrinsic value.
ANS: B
By not making the risk adjustment, the firm will accept too many projects in the manufacturing
division and too few in the data processing division. As a result, the company will become riskier
overall, raising its cost of capital. Investors will discount the firm's cash flows at a higher rate, and the
firm's value will fall. Therefore, statement b is true and the other statements are false.
PTS: 1 DIF: Difficulty: Challenging OBJ: LO: 9-11

55. Careco Company and Audaco Inc are identical in size and capital structure. However, the riskiness of
their assets and cash flows are somewhat different, resulting in Careco having a WACC of 10% and
Audaco a WACC of 12%. Careco is considering Project X, which has an IRR of 10.5% and is of the
same risk as a typical Careco project. Audaco is considering Project Y, which has an IRR of 11.5%
and is of the same risk as a typical Audaco project.
Now assume that the two companies merge and form a new company, Careco/Audaco Inc. Moreover,
the new company's market risk is an average of the pre-merger companies' market risks, and the
merger has no impact on either the cash flows or the risks of Projects X and Y. Which of the following
statements is CORRECT?
a. If evaluated using the correct post-merger WACC, Project X would have a negative NPV.
b. After the merger, Careco/Audaco would have a corporate WACC of 11%. Therefore, it
should reject Project X but accept Project Y.
c. Careco/Audaco's WACC, as a result of the merger, would be 10%.
d. After the merger, Careco/Audaco should select Project Y but reject Project X. If the firm
does this, its corporate WACC will fall to 10.5%.
e. If the firm evaluates these projects and all other projects at the new overall corporate
WACC, it will probably become riskier over time.
ANS: E PTS: 1 DIF: Difficulty: Challenging
TOP: Div. risk and projects KEY: Bloom’s: Analysis

a. A cost should be assigned to reinvested earnings due to the opportunity cost principle,
which refers to the fact that the firm's stockholders would themselves expect to earn a
return on earnings that were distributed rather than retained and reinvested.
b. No cost should be assigned to reinvested earnings because the firm does not have to pay
anything to raise them. They are generated as cash flows by operating assets that were
raised in the past; hence, they are "free."
c. Suppose a firm has been losing money and thus is not paying taxes, and this situation is
expected to persist into the foreseeable future. In this case, the firm's before-tax and
after-tax costs of debt for purposes of calculating the WACC will both be equal to the
interest rate on the firm's currently outstanding debt, provided that debt was issued during
the past 5 years.
d. If a firm has enough reinvested earnings to fund its capital budget for the coming year,
then there is no need to estimate either a cost of equity or a WACC.
e. The component cost of preferred stock is expressed as rp(1 − T). This follows because
preferred stock dividends are treated as fixed charges, and as such they can be deducted by
the issuer for tax purposes.
Exploring the Variety of Random
Documents with Different Content
paltry Sunday dinner in a worn bag: the eager eyes of the poorer
hawkers, which light up pathetically when a penny comes their way:
the men whose faces change at a drunken jibe into such faces as we
have seen behind the bars of a cage in a zoological garden, and the
crowd of men, women, and children rushing to enjoy the gratuitous
spectacle of a fight: the cheap, middle-aged prostitute, whose
features are a caricature of the features of woman.
You may see these things in all parts of London—north, south,
east, and west—every Saturday evening, and many other evenings,
all the year round. You may see them in all the other large towns
and cities of Britain, and the cities of France and Germany and the
United States and all other “great civilisations.” I have studied them
on Saturday nights in half the cities of Britain: in Amsterdam and
Brussels and Cologne, in Paris and Nice, in Venice and Rome and
Naples, in New York and Chicago: and in the light of our historical
research one sees their ancestors in all the great cities of all the
great civilisations that ever were. As it was in the beginning ... But
that refers to the glory of God.
Follow to their homes these more pathetic figures of a London
crowd. You need not do so literally, for more observant and
sympathetic visitors have been there before you, and they told
London long ago, as far as London was willing to hear, how the
majority of its citizens live. Mr. Booth’s book, Life and Labour in
London, had better be suppressed when its work is done, lest the
men and women of a more humane age learn too much about us;
also Mr. Rowntree’s book, which shows this same fetid poverty lying
at the feet of a superb minster, the symbol of ages of ecclesiastical
wealth and power; and many other books. Let me summarise the
relevant record of the natural history of London.
We may begin with the lowest depth, with life as it is lived in
some of the streets which still linger about Covent Garden, and in
east and west and south. We are beginning to see the grim humour
of tolerating the existence of these hotbeds of corruption under the
very shadow of our marble palaces of justice and our marble hotels
for millionaires, and we are destroying them; but the life remains still
in sufficient quantity to fill a large town. In tenements of this order
fifteen rooms out of twenty are indescribably filthy. Legions of bugs
lurk by day behind the faded rags of ancient wallpaper or in the
crevices of the unwashed floor, or even venture forth as securely as
if they were conscious of free citizenship in these places. The
“windows” are a rough mosaic of dirty glass and roughly plastered
paper. The ceiling is pale black, the floor filthy. A table, one or two
dilapidated chairs, a kind of bed—the “landlord” would, in most
cases, not raise two shillings on the lot—and an entire family of
ragged, vermin-eaten human beings fill this foul box, which is often
only eight or ten feet square.
These people are thieves, cheap prostitutes, hawkers, porters,
charwomen, flower-sellers, ragmen—the most pitiful of the irregulars
which we suffer, age after age, to live and breed and die beyond the
extreme fringe of our industrial army. Sometimes they have nearly
as much food to eat as a workhouse-idler: generally not. Drink—the
vile mixtures of the cheaper public-house—they have more
constantly; and their children are not in their teens before they are
familiar with all the vice and crime and brutality which seven out of
ten of these rooms breed as naturally as they breed lice or bugs. In
winter the doors and windows are sealed, and men, women, and
children huddle together or, at times, crouch over a few lighted
sticks. And year by year, century by century, babies are ushered into
this underworld in edifying abundance, to live its ghastly life until the
yellow frame and dull brain are worn out.
Shocking, you will say, but happily rare. Do you know that,
according to the best authorities, 50,000 men, women, and children
in London alone live in this atmosphere of squalor and brutality and
chronic hunger?
Let us pass to the next higher circle of the modern Inferno—the
category of casual or very badly paid labour and chronic poverty, the
makers of your cheap furniture and clothes and brushes, your
match-boxes and chocolate-boxes, the hawkers and costers and
regular porters and dockers. Now there are generally two rooms to
each family, but the vermin still thrive in more than half of them, and
the rooms are filthy, and the children breathe an air that is foul with
drink and cursing and the most open and gross sexuality: not now in
fifteen cases out of twenty, it is true, but in ten cases out of twenty.
Food is habitually insufficient, for labour is uncertain, and profit is
infinitesimal; and, as a man must drink, there are constant
disturbances to break the monotony and help one to forget the
customary hunger. You may have at times noticed the dejected
hawker returning, on a wet summer’s day, with his tomatoes unsold:
or the children eager to collect fragments of the lids of orange-boxes
in the winter. Countess Russell told me that she once visited,
unexpectedly, a group of homes of this class, within a few minutes’
walk of Gordon Square, in the depth of winter. Hardly any had the
material for a fire, and few had food in the house. So they live, year
in, year out; and all that we propose to do is to give them five
shillings a week each if they will sustain the burden honestly for six
decades, or house and feed them in jail if they do not succeed in
curbing their criminal impulses.
Once, in the Westminster Court, I saw a young and humane
judge hand certain tickets to the jury, when they had established the
guilt of two petty criminals of this class. “These, gentlemen,” he said,
“are permits to inspect the jail; go some day and see the place to
which you send criminals.” A very wise and benevolent innovation,
but we still await the judge who will send the jury to inspect the
homes in which these men conceive crime.
About 400,000 citizens of the greatest city in the world belong
to this class. If 400,000 do not constitute a sufficiently important
problem, let us see the homes of the next category. These are the
irregularly employed and badly paid, though not the worst paid,
workers: costers, labourers, dockers, etc. There are about a million
of them in London alone. They know quite well what hunger is: for
weeks together, sometimes, the wage does not suffice to buy that
minimum quantity of nitrogen and carbon which men of science
have declared to be necessary, and the money is ill expended. They
know what cold is, for many a hard spell of winter finds them in
want. They have two or three rooms to each family, but, as a rule,
not much of that “Christian reticence” on which our clergy
congratulate us.
To the great majority of these million and a half of London’s
poor, sexual pleasure is the one cheap luxury; and we encourage
them to breed industriously. My wife, with other ladies and
gentlemen, addresses them on the subject from the tail of a cart in
South London, and teaches the heavy-burdened mothers how to
avoid having so many children; and the leader of this little group
was sourly and menacingly (and quite falsely) told by a distinguished
Churchman, sitting in a Royal Commission, that they were breaking
the law of the land. A friend of mine has been hounded out of the
United States by the police for attempting to give similar information
to the poorer mothers of New York.
Even in this third and very large category of London homes
there is much filth; and the windows, across which is drawn an odd
cloth or a ragged and dirty curtain, abound in broken panes. They
have periods of comparative plenty, when the children get boots and
socks, and their elders soak in beer and may even venture to a
cinematograph show, if the crude pictures on its garish façade
promise a sufficiently silly or sufficiently bloody programme. All that
the police and the clergy care about is that not more than an inch or
two of underclothing are exhibited in these places. They have also
periods of want, when the clothes go to the pawnshop, and life runs
on the exasperating, brutalising lines of the lower class. The daily
round of life is itself stupefying. At five or six they are dragged out of
an insufficient sleep, and they dully take their tea (of a kind) and
bread and margarine on a dirty table. After ten or twelve hours of
anxious quest of minute profits they return home for a slightly better
meal—a kipper, perhaps, or a few bits of cheap meat—too tired in
mind and body to do more than smoke and drink. They have plenty
of fun, of a sort, and take their tragedies lightly; but the angels, if
there are any, must fold their wings over their faces at the aspect of
these fellow-immortals. Even a politician might be expected to blush
for this self-governing democracy. It is a squalid, degrading,
stupefying life, below the level of civilisation.
Nearly one-third of the citizens of London do not rise above this
level. The three classes that I have described, or the mass of people
who spread continuously over these classes, were found by Mr.
Booth to number 1,300,000 of the four and a half million inhabitants
of the city. The figure for the Greater London of to-day is, of course,
immensely higher. “The submerged tenth” is a most unfortunate
phrase. It leads many, who know little of these matters, to suppose
that only a tenth of the inhabitants of London are very poor. The
truth is that a tenth live in a condition of misery, filth, and
degradation of which the ordinary decent citizen can form no
conception. They are the shirkers, the abnormal, and the worst
casual workers. But the life of this further million—or nearly one-
fourth of the total inhabitants of the Metropolis—the irregular or
badly paid workers, is a grave and accusing problem to every man of
decent sentiment. Their condition is not consistent with civilisation.
Certainly large numbers of them live clean and cheerful lives, but
even in these cases it is scandalous that sober and willing toil should
receive wage enough only to secure cleanliness and the necessaries
of life; while a far larger number sink under the burden, and are
dirty, intemperate, gross, and improvident.
Conceive the extension of this class all over Britain: the further
vast contingents of this army of poverty in the slums of Glasgow and
Liverpool and Manchester, in all our great manufacturing and
shipping towns, even in the heart of pretty rural England, where the
wretched wage and low standard and large family stunt and degrade
our agricultural worker. It is a very serious error to imagine that this
is merely an unhappy issue of the crowding in our great cities. In
picturesque and highly respectable York Mr. Rowntree found that
thirty per cent. of the citizens lived in very real poverty: that ten per
cent. did not earn money enough to buy a normal and sufficient
quantity of plain food, to say nothing of luxuries.
This is the problem of poverty. If you want it in figures, a fourth
of the inhabitants of London, where rents are appalling, live on from
eighteen to twenty-one shillings weekly per family, and some
hundreds of thousands live on less than this. One might with some
profit and pertinence go on to inquire into the life of the half of the
population of London who are described as “comfortable workers.”
Whether the little luxuries they have are a fit reward for the hard
work they usually do, whether there can be any development of
distinctively human powers among them, whether we may cherish a
feeling of entire security in basing our political system on that
foundation, are questions worth putting; and some day they will put
them to us. But it is better for the moment to confine ourselves to
that pitiful fourth of the community which lives in degrading poverty
because it has only irregular or wretchedly paid employment. Is it an
exaggeration to suspect that this vast acreage of poverty will make
the future historian hesitate to class us as civilised?
Our social structure is of the nature of a pyramid. At its apex,
glittering in the sun, calling forth our pride and praise, are culture
and wealth and power, and all the fine things they bring into
existence. At its base are the supporting stones, crushed into the soil
by the towering mass: the millions of stunted or brutalised lives. I
know both extremes of this social order, and I have felt, hundreds of
times, that if it is permanently to retain this pyramidal form, the
refined lives and great achievements of the few resting on this broad
base of squalid and undeveloped lives, civilisation is an impossible
dream. I have felt that, if men and women realised the full meaning
and range of poverty, they would suspend the progress of art and
science, of commerce and industry, for a hundred years, if need
were, in order to concentrate the best intelligence of the race upon
the search for the remedy of this vast disorder. And, if it be true, as I
think, that these people, once dead, are dead for ever, and that the
tradition of a hundredfold reward in heaven for their privations on
earth is an illusion with which pastors and masters have reconciled
them to their burdens, I would, if I could, send that assurance like a
trumpet-blast through the slums of the world and make this vast
army of the stricken summon us, the intelligent minority, to a tardy
judgment.
I do not, as will appear later, advocate the equal distribution of
wealth. I do assuredly not plead that one who has wealth should
give it to the poor: to see it gather again, perhaps, in less worthy
hands. I add the contrast of wealth at this point only in order to
make quite sensible the darkness of the life of millions. One’s first
task is to establish, with what faint power the pen has, the appalling
magnitude of the evil. If any very large number of us did really grasp
the human significance of these facts and figures, the industrial
problem would not long be resigned, as it is, to bloodless economists
and obscure propagandist bodies.
And the second aim of those who would see the world bettered
is, as I said, to inquire into the effect of the remedies we actually
trust and apply. Here we enter the mistier region of controversy, and
I can but set out the grounds of my sincere convictions.
Of labour bureaux, in the first place, it will not be doubted that
they are an advantage to employed and employers. They are an
advance toward organisation. They bring the worker more promptly
to the work that awaits him. But they, obviously, do not add one iota
to the insufficient work, for which myriads are struggling: they do
not add one penny to the wage that is earned: and they are of little
or no service to the poorest workers, who chiefly concern us.
Old age pensions and insurance and free education are,
similarly, great advantages to the workers, in which we may justly
take some pride, but they do not promise to abolish or greatly
diminish poverty. The pension, or the insurance benefit, is
necessarily granted on the poverty scale, and is in some sense a
recognition of it as one of the permanent institutions of life; and the
elementary instruction which we give has raised the qualifications for
work, as well as the equipment, so that the proportion of
unemployed, or ill-employed, is little changed. Nor would it be
entirely wrong to say that, in relieving the poor man of the direct
charge of education and insurance, we have put the difference on
his rent.
Of our poor-law system, that lamentable compromise with a
stupid old tradition, it is difficult to speak with patience. The able-
bodied idlers of our workhouses and our countryside are a mockery
of the workers. The tramp, the professional idler in search of
idleness, maintained in his repulsive ways by an undiscriminating
system of poorhousing and by a large body of “charitable” women, is
one of the quaintest survivals of an older order. His father idled
through life before him, and he in turn drags along the road a mate
and children who will sustain the ignoble tradition. He ought to be
washed, clothed, and put on an industrial estate; and, if his disease
prove incurable, he ought to be anæthetised out of existence, or at
least prevented from reproducing his like.
Then there are the emigration societies. One fears that in large
part they transport to the colonies either the men whom the colonies
do not want, the men who will enlarge the slum-area of colonial
cities, or the men whom we ought not to spare. At the best,
emigration is a means of leaving the problem of poverty to our
grandchildren, who will find no more open spaces for the dumping of
our human surplus. In point of fact, however, apart from the
dispatch of a small proportion of specially prepared boys, emigration
is not affecting our problem of poverty. The half-million very poor of
London, with the corresponding hundreds of thousands in our other
cities, do not make emigrants at all; and very few of the next and far
larger class are, or could be, fit for agricultural deportation.
Lastly of these devices which the less thoughtful are apt to
regard as relieving poverty, we have the Salvation Army, which is
quite the most preposterous social sham of our age. But its religious-
social burlesque, its pretentious concealment of bad results and loud
proclamation of good results, its refusal to print a plain balance-
sheet from which a social student can measure the definite good
done and the cost of it, its undercutting of existing work, and so on,
have been sufficiently exposed to excuse us from dwelling on it. It
contains some earnest men and women, and has had undoubted
successes, but the system is too nebulous, garrulous, and wasteful
to merit serious attention.
Let us turn to graver matters. The mass of the workers, apart
from the more advanced bodies of Socialists and Syndicalists, believe
that the solution of the problem of poverty will be found in the
development of Trade Unions and of the political power of Labour. By
political power, with the aid of sympathetic members of the middle-
class, they have won the right of combination and a whole code of
labour-laws; by an increased political power, ultimately a political all-
power, they will secure all the legislation they deem expedient.
In spite of the distraction of many of the workers by Anarchists
and Syndicalists, who despise political action, and in spite of the
restrictions of the franchise which are maintained by the older
political parties, it seems plain that at some not very remote date
the workers will control the world. Ever since the door of the political
world was opened to Demos, eighty years ago, he was certain
eventually to reach the throne, no matter how long he might be
seduced to tarry by the way. Those who think otherwise must put
their trust in the permanent unintelligence of the workers. The
interests of the mass of workers are so far identical that they must
finally combine to promote them. We are plainly moving, all over the
world, in this direction. In Australasia, where the virgin soil permitted
an exceptionally rapid growth, we see the farthest point yet reached,
and within a decade or so Labour will have unshakable power all
over Australia, at least. “Conservatism” has already disappeared, or
changed its name to “Liberalism.” In Germany and France and
Belgium we see the same disposition of the rival parties to unite in
face of advancing Demos. In England there are signs that we shall at
no distant date see a similar redistribution of political forces, and it is
anticipated in the United States. In all countries the political energies
are slowly gathering about two poles: Liberal (including the old
Conservatives) and Labour. Even in such countries as Spain, Russia,
Turkey, Japan, and China the initial stages of the development may
be detected. When the workers at last unite and secure an absolute
majority-power, they will legislate on familiar lines. Wages will rise,
hours of labour will be shortened, and place will be found for larger
numbers of workers.
It is little use moralising on this change. It is coming on like the
tide. There will, no doubt, be temporary abuses of power, as there
have always been, but the workers will learn the vital needs of an
industrial order, and they will not starve the roots of their new
prosperity. Let us assume that a state of equilibrium has been
reached: that the workers have paramount political power, and
wages are considerably increased. Does this promise a solution of
the problem of poverty?
I am purposely leaving out of account the contemporary growth
of rings and trusts. Paradoxical as it may seem to say so, they are
not an essential element of the problem. The employers will (as is
happening) form unions in face of the men’s unions, and the strain
laid on individual employers and small companies will favour the
growth of trusts. In so far as these make for economy, they are
clearly useful; but no doubt they will be tempted to use their
monopoly to dictate arbitrary prices. When, however, the workers
have a majority-power, they can either slay the trusts or draw their
teeth. On the other hand, a beneficent or labour-saving trust will not
afford any advantage to the less skilful workers, who make up the
great army of the poor, and it will reduce prices only by an
unimportant fraction. The chief significance of trusts is that they
tend to annihilate the individualist employer, who was once
considered an indispensable institution, and they may thus dispose
obstinate admirers of the older industrial order to welcome a radical
change. They are more deadly to the middle-class than to the
working-class.
The really vital question is whether the raising of wages and
reduction of hours, accompanied by a large amount of secondary
legislation to the advantage of the worker, will solve the social
problem: which is not the problem of the existence of a few
thousand prostitutes, but the problem of the existence of, in every
country, several million people who live in privation and squalor, and
cannot develop human personalities. On this I offer two or three
observations.
Does the price of commodities rise in proportion to the rise of
wages? If it does, the securing of a nominally higher wage is clearly
a delusion. This seems, however, to be our experience. In England,
during sixty or seventy years of trade-combination, wages have
risen, and hours and conditions of labour have been improved, to a
remarkable extent, in spite of open competition in an overcrowded
market. But prices and rents also have risen, and it is not clear that
there has been a net advantage to the worker. It is very difficult to
answer the question precisely, because other factors (such as the
application of science) have increased the productiveness of labour
and have cheapened certain commodities (books, clothes, pictures,
tea, etc.). The workers have shared these advantages, and are in a
position of far greater comfort than they were formerly. But in
seriously testing the claim and promise of the Trade Unionist and the
Labour politician we have to endeavour to subtract the improvement
in the workers’ condition which is due to the application of science,
and of better methods, to production and distribution. When we
make allowance for this, it is certainly not clear that the rise of
wages shows a margin over the increased price of commodities:
that, in other words, the higher wage is a real advantage.
It is difficult to see how it could be otherwise. When wages are
raised, who pays the increment in the cost of production? The
employer or the consumer? It is a familiar experience, and an
inherent necessity of our industrial order, that the consumer does;
and the consumer is the worker—the middle-class or wealthy
consumer generally gets the difference in other ways. It would be
bold to say that our employers have paid even a fraction of the
increased wage out of their own pockets. More usually they put a
fifth of a penny on commodities when the worker has secured a
sixth. Competition alone restrains them, and this is largely
superseded by agreements. We have had innumerable instances of
this during the war. Class after class of workers claimed a higher
wage, and prices rose higher and higher “on account of the
increased cost of production.” If a Labour Government were to
prevent employers from increasing the cost of commodities and
raising rents in exact proportion to the demand for higher wages—
were, in other words, to direct the employers to pay the increase of
wage out of their own profits—we should soon see the end of this
industrial order. The State would be compelled to become the
employer.
This seems to be true of practically all the legislation which a
political power of Labour could secure. Compensation, pennons, and
insurance are typical instances. The new demand on the employer’s
profits is met in one of two ways: he withdraws voluntary
contributions to these or similar purposes, or he raises the price of
his goods. The larger consumer meets the burden by raising his
rents or fees. The unreflecting worker imagines that “the country”
pays for these things; he forms, in this respect, a larger proportion
of the country than he thinks.
The second and more important consideration is that this power
to dictate wages and pass measures in favour of the workers does
not hold out a prospect of absorbing that surplusage of labour which
is our real problem. I am assuming that even the poorer and
unskilled workers will have their unions and their share of the
political power. Their wage will rise, and the price of their food and
clothing and rooms will rise; but it is of greater consequence to
reflect that the less competent workers on the fringe of the industrial
army will receive little advantage. Some benefit they will certainly
have, since the curtailment of hours and the slowing of the pace of
production will make room for more workers in each industry;
though we must remember that the pay of these new workers will
either be taken from the older workers, whose hours are shortened,
or—which comes to the same thing—will be put on the commodities.
The total production will not be increased, and the employer will not
relinquish his profit. In any case, even this method of finding room
for more workers will affect relatively few.
Again I may quote the experience of Australia, where the
workers have very great power. In Melbourne, alone, in 1913, I
found 30,000 men unemployed; and there and in other cities the
tainted area of poverty and distress was increasing. All the elaborate
organisation and political power of the workers could not add to the
sum of available work and thus absorb the surplus of labour. I am
contending that until we do this we do not solve the poverty-
problem. The chief cause of this appalling social disease is the
inequality of natural endowment—either of muscle or nerve—in face
of an unorganised system of production. There is not work, with
regular and decent wage, for all. The weaker, the lazier, the more
drunken, and the slower of intellect, are crowded out of the ranks
and driven to casual employment. This is the tap-root of poverty,
and the benefits secured for those who are in regular employment
will not affect it.
Thirdly, this labour-legislation will not touch the second chief
root of poverty, the extreme inequality of the distribution of wealth.
Since wealth is, in this regard, a fixed quantity,—we are not
concerned here with the effect of fresh applications of science to
production,—an accumulation of commodities at one point leads to
thinness at another. I am not pleading for equality of income. Many
workers have an exaggerated idea of the gain they might have by an
equal distribution of wealth. The total annual income of the
population of the United Kingdom is now believed to be about
£2,400,000,000. If this were distributed equally amongst the heads
of our ten million families and our large army of unmarried workers,
the result would be barely £200 a year; and the equalisation of
taxation, the granting of substantial pensions, etc., would further
reduce it. There is, however, no serious need to discuss this idea. I
see no moral principle which forbids that we should reward a man
according to his productiveness or inventiveness or other value to
the community, although his fellows are not responsible for their
lesser capacity; and it is idle to speculate on some imaginary phase
of human development in which the more gifted and more useful will
refuse to be more richly rewarded than the less useful.
But it does not follow that the community has no right to control
the distribution of wealth. At one time such a proposal would have
been branded “robbery.” To-day even Conservatives do not threaten
to remove the death-duties and graduated income-tax by which we
confiscate some of the wealth of the more fortunate. The only
question is, to what extent we may or ought to prevent the
excessive accumulation of wealth, or to disperse it after
accumulation.
There occur at once two methods of enrichment which invite
careful attention. One is the power to transmit wealth to one’s
descendants in perpetuity, or until they choose to dissipate it. Most
of us will admit that in a social order at all resembling our own—and
I do not care to speculate about Utopian or imaginable orders—the
power to win advantages for one’s children as well as for oneself is a
sound incentive to work. But the wish to relieve one’s descendants
of the need to work, to make them for ever a burden on the
community, is a perverse ideal. It is one of those unsound primitive
traditions which we detect in the actual stream of our ideas and
sentiments, and instances are not unknown in our time of such
holders of hereditary wealth revolting against the tradition. When we
realise that this inherited wealth means, in plain terms, the right to
have a hundred or a thousand fellow-men working for us or our
descendants in perpetuity, for no merit or service on our part, and
when we consider the folly and waste which so commonly follow
large inherited fortunes, we must regard this tradition as evil and
indefensible. One wonders how long the working community is going
to sustain this burden, and how long refined men and women will
imagine that they have a right to live like Oriental potentates
because they had a shrewd or a gifted ancestor.
It is sometimes said in their favour that they employ labour with
their wealth. I have heard bishops give them this foolish consolation.
As if the wealth would cease to exist, and to employ labour, if it were
in the pockets of a thousand men, instead of the pockets of one
Duke of Norfolk or Duke of Westminster! The only difference would
be that this wealth, instead of paying a thousand servants and
tradespeople to work for the comfort of one family, would pay a
thousand men, who would lose nothing by the change of
employment, to produce comfort for a thousand families. Meantime,
the Duke is embarrassed by his wealth, or spends it on superfluous
things, and the thousand families live in vicious misery. Their babies
die for lack of good milk in the hot summer, and the rich youth or
maiden—I have known this done—carelessly takes a bath of milk.
Let us understand clearly this economic truth: great wealth is the
accumulation in one man’s hands of the right or power of a
thousand families to employ labour.
The second source of wealth which invites consideration is the
unearned increment on ground-values, or any other unearned and
accidental increase of value. It is now very commonly admitted that
this belongs to the community, and I need not enlarge on it.
We have, as I said, admitted the community’s right to interfere
with this scandalous clotting of wealth, and no doubt a Labour-
majority would increase death-duties until money could not be
transmitted beyond, at most, the third generation, and not in
quantities sufficient to make men and women a lifelong burden on
the working community. Possibly some day there will be a general
scrutiny of titles to wealth: not merely as far back as the enclosure
of the commons a hundred years ago, but back to the landing in this
country of William of Normandy. Possibly a day will come when men
and women will conceal the fact that their ancestors “came over
with the Conqueror,” since it generally implies that the descendants
of those lucky adventurers have not done an honest day’s work since
that time. Possibly the sons of some of our “captains of industry” of
a century ago will burn the family records, lest some prying historian
should learn by what horrible exploitation of child-labour the fortune
was made. Prescriptive right is a purely artificial right created by the
community, and it may be withdrawn by the community.
Such measures as these a Labour Government will, no doubt,
eventually take, and they will do much to relieve poverty and
increase the production of commodities of general use. But they will
add rather to the comfort of workers who are already above the
poverty-line, and they will not prevent an excessive accumulation of
wealth, though they may finally disperse it. This means the
continuance of deep poverty. As long as a gifted man may amass a
fortune in a comparatively short time, without adding to the wealth
of the community, there will be squalid poverty somewhere.
In sum, if the political ideal of Labour were fully realised, it
would not put an end to, and might not very materially lessen, our
widespread poverty. It would not enlarge the amount of available
productive employment, and so the weak in body or mind or
character would still form a pitiable army of slum-dwellers. It would,
having no more control of industry than the present Parliament has,
be unable to meet any grave disturbance of the industrial world,
such as the release of hundreds of thousands of workers by
disarmament. It would have no power to secure for the workers
their full share of the advantage of any new application of science,
and it would be unable to guide into new positions the men
displaced by this application. We should continue to suffer the
disadvantage of an imperfectly organised industrial system; each
new enlistment of the great forces of nature or of the cunning of
science in the service of man would enrich a few and impoverish
many. In order to meet all these grave difficulties—in order to do
more than secure certain advantages for the better equipped
workers—a Labour Power would be forced radically to alter its
principle and undertake the organisation of employment.
This organisation of industry seems to be the only device which
will gradually restrict, and finally abolish, poverty. The opposition to
it of middle-class workers and of so many artisans is unintelligible. It
is time that we ceased to confine the term “workers” to the poorer
and less cultivated caste among those who work: time that the
lawyer and actor and housewife claimed that honourable title no less
than the carpenter or navvy. In restricting the term to manual and
badly paid workers we have concealed from ourselves the real
community of interest of all who work. All of us, except those who
live on the labour of others, have an interest in the proper
organisation of the work of the world and the removal from our
shoulders of this intolerable burden of the irregular workers and the
idlers. The middle-class has an even greater interest than what is
narrowly called the working-class, because the tendency of Labour-
legislation is, and will increasingly be, to put the heavier charge, not
on large employers, who easily evade it, but on the middle-class
generally. Here again the war has luminously illustrated our position.
Both employers and employed (in the current industrial sense) have
made great profit by it: the middle-class generally has suffered
severely. A proper organisation of work would have prevented this.
It can easily be shown that this national organisation of
employment, with graded incomes according to service rendered, is
the only remedy of poverty. The chief root of poverty is, as I said,
the insufficiency of properly paid work, and this is entirely due to the
haphazard and unsystematic nature of our industrial order. The
private employer looks only to the actual demand of commodities, or
to the actual funds for buying commodities. He has no interest in the
moneyless unemployed; indeed, he finds it a convenience to have a
large number from which he may select his workers. As a result, a
large proportion of our people are unable to demand their normal
share of commodities because they are not employed, or because
they have no wage; and they are not employed because they do not
demand commodities. Plainly, the community alone can alter this
paradoxical state of things; and, since the community is now
compelled by its more humane sentiments to carry the poor on its
shoulders, it may at length be induced to see that it would be better
to set them on their own feet. In a properly organised industrial
system a worker will be paid by the commodities which he or she
actually produces, or their exchange-value. There can be no such
thing as a superfluous worker. It is only a lamentable issue of our
perverse pre-scientific system that millions must lack the food and
clothing and luxuries which they themselves could and would, under
a more orderly system, produce.
This implies, of course, the transfer to the community, at a just
payment, of the land, the mines, and the means of transit, and the
gradual extension of municipal enterprise to productive and
distributive industries. I am contending only for principles, and
would refer the closer inquirer to such detailed constructive works as
those of Mr. H. G. Wells. It would be futile to construct a rigid
scheme of collectivist organisation. Such industries as the press,
literature, art, etc., present difficulties which it would be foolish to
override. But these affect comparatively few workers, and it is
pedantry of an unintelligent kind to wrangle over them while we
have a clear case in regard to other industries which involve many
millions of workers. We would do well, however, to remember that
the middle-class industries themselves are overcrowded and chaotic,
and that most members of that class would gain by organisation,
wherever it is possible. Instead of shrinking from it and inventing
difficulties, we ought to be eager to discover its possibilities.
I ignore also certain more or less academic objections which
have been made against this proposal to organise employment. Mill’s
essay On Liberty is a monument of the futility of this kind of
reasoning. Mill was a civil servant, and, except in the case of the idle
and criminal, no restriction of individual liberty is proposed other
than that which Mill cheerfully endured. Middle-class men are apt to
take fright at the word “Socialism.” It ought to be by this time
generally known that half a dozen very different theories pass under
that name, and it is particularly unintelligent to confuse the extreme
and the moderate proposals. Nearly the whole of the employment in
any civilisation could be organised without laying on any who are
willing to work a greater restraint than is laid on officials of the
postal service. As to “confiscation,” it will be gathered from an earlier
page that I favour generous compensation to actual holders of land
or mines, but no perpetual pensions.
I do not anticipate from this change all the advantages which
some Socialist writers expect. Their schemes of high universal
prosperity seem to me to have an absurdly slender basis of actual
work. Mr. William Morris conjectured that if all of us were to work for
four hours a day there would be enough produced for all of us to live
in luxury; whereas Mr. Sidney Webb calculates that it would need six
hours’ work a day, on the part of all, to produce the necessaries of
life. It is true that a very large body of middlemen, commercial
travellers, footmen and other servants, and duplicate workers in rival
industries would be set free for sound productive or distributive or
professional work; but the easing of the hours of our actual workers,
the removal of the young from the market, and other collateral
improvements, must be taken into account. If we take one hour a
day from the actual workers in our heavier industries, we absorb at
once more than a million new men without increasing production. In
any case, it is lamentable to dangle before the eyes of men the ideal
of working only four hours a day. We want more of Browning’s
gospel of work with cheerfulness. No doubt the idea is that, if the
hours of labour are reduced, the leisure will be employed in reading
Bergson and mastering Brahms. This optimistic theory seems to be
at variance with our experience. Improvement of financial position
more usually means the substitution of Bass or Dewar for cheap ale,
and of stalls for the gallery at the variety theatre. A later chapter
will, however, discuss our interests in this connection.
The fact remains that collectivism is the only remedy of poverty.
The redistribution of wealth, or the prevention of excessive wealth,
would, in my view, add comparatively little to the wages of the
millions; and we must not put to the credit of an economic scheme
the profit of such changes as disarmament. It is not this, but the
note of efficiency, organisation, and economy which appeals to me in
the Socialist ideal. It would abolish a vast amount of duplicate and
unnecessary work, and it would conduct to their proper place in the
industrial order the large army of casual workers. London or New
York is a colossal monument of industrial inefficiency. Our chaotic
mass of duplicate and triplicate rival grocers, bakers, butchers, etc.,
our rival railways and other purveyors and producers, with their
separate staffs and their appalling waste in advertisement, are a
reproach to our intelligence. We want an orderly and economical
system both of production and distribution, and only the municipality
(or else a vast and tyrannical trust) can conduct it. Most of all we
want a power that will sweep the myriads of costers, hawkers,
newspaper-youths, flower-girls, casual porters, loafers, musicians,
etc., off our streets, and put them to productive work. We want a
great curtailment of certain luxury-industries and fictitious industries.
This would give us an immensely increased volume of productive
work, and a great saving in distribution. The middle-class has not
less to gain than the workers by such a scheme of organising our
resources, and it offers us the only confident prospect of abolishing
poverty and crime and gradually uplifting the mass of the people.
Naturally, we should for a long time have to deal with a great
deal of refractory material. Idleness and crime are diseases, and
they ought to be treated by the methods of modern medicine:
scientific, humane, sometimes surgical. Certainly we would exercise
“tyranny” in dealing with these. Probably in a properly ordered
society all citizens would be enrolled in an industrial register. The
hyper-sensitive would have the same guarantee of privacy as under
our income-tax system, and the police would have a most effective
means of locating the criminal. Any who were permanently
refractory, or showed an incurable disposition to revert to crime or to
the vagrant industries which disgrace our cities to-day, would have
no moral right to burden us with their existence. The community
would offer work and sufficient wage to all. The rest might disappear
into segregated “homes of idleness,” or, if we are as wise as we
ought to be, into lethal chambers.
This incurably refractory group would, however, probably prove
smaller than many believe. We are at present a little too much
inclined to consult scientific theorists about heredity (which is still
very obscure in science) and too little inclined to make social
experiments. I am assuming that a dozen other reforms would
proceed simultaneously with the reform of industry. Education would
no longer confine itself to giving an elementary literacy to children,
without any further care what use they make of their literacy; it
would, as I will suggest later, seriously concern itself with the adult
population. A bolder treatment of the housing question would
stimulate those who have evil traditions; we should not confine
ourselves to building clean rooms for them, which they might make
filthy if they wished. Prudential restriction of the birth-rate would be
impressed on the poorer class, with great benefit to themselves and
their children and the State. Eugenic proposals might be practically
formulated and encouraged. We should not expect industrial
betterment to have some mystic or magical effect of itself in uplifting
the mass of the people; but, until this betterment occurs, other
efforts to help them will be seriously hampered or entirely futile. The
very magnitude of the task would prove a magnificent tonic and
stimulation to the jaded mind of the community.
An increasing number of middle-class men and women now
recognise that this is, not merely the only solution of the problem of
poverty, but the most profitable scheme of national life for all who
are willing to work. So detached an observer as Mr. Carveth Read,
professor of Philosophy at London University, observes that
“probably the future lies either with Co-operation or with Socialism”
(Natural and Social Morals, p. 211). On the Continent, especially in
Italy, France, Holland, Belgium, Denmark, Germany, and Russia,
there is a high proportion of cultivated and professional men in the
Socialist movement. No one need fear its advance except the idler
and the man whose work does not add to the wealth of the
community or facilitate its distribution. It is the application of sound
and tried business-principles to national life; and, when those
principles have first been applied to the governmental machine, and
made it an effective and disinterested administration, we shall move
more quickly toward the Collectivist ideal.
Some may wonder that a student of science should come to this
conclusion. There is a vague idea abroad that an individualist
struggle for existence and survival of the fittest is the supreme and
unalterable law of life. This idea, though encouraged by men like Mr.
Kidd, is due to a merely superficial acquaintance with biology. In
past ages nature has certainly evolved higher types mainly by a
bloody struggle of individuals or a very calamitous pressure of
environment. In the past: there is the limit of the teaching of
biology. A new thing—human intelligence—has now entered the life
of the earth, and it has in countless ways superseded the laws (that
is to say, practices) of unconscious nature. The human mind is now
a part of nature, and therefore “natural selection” is a wholly
different matter from what it once was. Maurice Maeterlinck has
suggested this with his usual felicity. He imagines himself on a hill,
from which he sees two watercourses stretching toward the sea.
One meanders over the plains, wasting time and space, blindly
finding its way over the uneven ground: that is the old, unintelligent
method of nature. The other waterway stretches straight across the
landscape, a canal cut by man in the course of a few years, with no
waste of ground: it is the new, intelligent method of nature. By this
method we now create new species of plants in a thousandfold less
time than natural selection (in the usual sense) could do; and we do
it precisely by dispensing with the individualist struggle, by
intelligent arrangement and control.
Early science set up unintelligent nature as a grand model for
man. It is time we outgrew this phase of infancy. Intelligence must
increasingly count in the life of the earth. We first organise a nation,
and presently we shall organise international life. We organise
particular businesses, and presently we shall organise the whole
industrial life of the planet. There is no part of human life which calls
more urgently for the application of intelligence than this disordered,
wasteful, pitiless, poverty-saturated industrial world of ours. Let us
treat human beings at least as intelligently as we treat our flowers,
and as humanely as we treat our horses. We do not entrust those to
the tragedy of struggle and survival. We need not fear that there will
be any restriction of the development of personality. Under such a
Collectivist system as I have in mind, personality will be developed
until every man and woman is conscious of his or her share in the
control of the destinies of this planet, and the sheep-like respect for
ancient traditions and abuses, which impedes our progress to-day,
will be for ever abolished.
CHAPTER VI.
IDOLS OF THE HOME
Among the claims of reconstruction which the insurgent literature of

our time puts forward, none, perhaps, so startles and inflames the
Conservative as the demand for a reform of the family. Criticism of
this institution is, in fact, so severely punished or so slanderously
misrepresented that it is usually exercised in the more or less
impersonal form of the drama or novel. It happens, however, that
the drama or the novel is now quite the most effective means of
inoculating millions with critical ideas, and at least half the more
brilliant novelists and dramatists of Europe employ their art for this
purpose, or reflect some such sentiments in their work. Hence the
outcry about the “unclean novel”: which is usually far cleaner than
the Old Testament, but more critical. Positivism had assured us that
this institution would be transferred intact to a human foundation,
and Murillo’s “Holy Family” hung reverently over the hearths of the
new pagans. Now, half in fear and half in exultation, the clergy cry
that humanism has betrayed its moral poison and its social menace.
Our favourite phrase here is the saying that the family is the
foundation of the State. If one patiently considered the matter, one
would discover that the divine right of kings was once regarded with
equal confidence as the indispensable foundation of the State. It
may very well be that the divine duty of the family is no less open to
reconsideration. It might be noticed that the change from aristocracy
to democracy was at one time hailed with lurid prophecy even by
distinguished moralists and sociologists, yet this change has led to
greater efficiency and prosperity. We might perceive that the
Christian dogmas were once thought vital to our welfare, and it may
be that the Christian ethic is in some points as disputable as the
Christian dogmas. Few reflect on these matters, and the writer who
criticises the family is denounced with peculiar bitterness. Quite
certainly that tomb of dead civilisations yawns ominously before us if
we lend ear to this kind of rebel. The family is so plainly
indispensable an institution that it must be protected from criticism:
lest we be tempted to dispense with it.
I propose, however, to make a critical study of the family.
Indeed, I venture to say at once that our ideal of the family is so
encrusted with ancient superstitions that it pressingly invites the
critical attention of our age: that the family is the foundation of the
State only in an historical sense, not in the sense that a State cannot
be based on any other procreative arrangement: and that the cloak
of superstition and rhetoric that we have put about it has covered
for ages, and still covers, an appalling amount of vice, hypocrisy, and
misery. My point of view has been stated. The affairs of this planet
must be run by men for men. The supreme aim must be to lighten
the burden of suffering which we inherit from a less intelligent and
less humane past. Any creed, code, or institution which forbids
progress on these lines must be assailed.
The first and most damnable superstition in regard to the family
is the claim that marriage ought to be indissoluble. In its strict form
this belief is held only by Roman Catholics, and by a section of the
Church of England which was only partially reformed in the sixteenth
century and has a strange ambition to disavow even that limited
reform. But the most insidious mischief of this old ideal is that it has
embedded deep in our minds the feeling that, although indissoluble
marriage is an intolerable yoke, we must be very chary and
niggardly in granting relief. This feeling we ascribe to a wise concern
for our social welfare, whereas it is due to the subconscious tyranny
of the old superstition. Recently we have seen the strange spectacle
of a non-Christian moralist standing amongst our bishops to bar the
way of reform: seeking to prolong, in the name of humanity, a
superstition that darkens the homes of a large part of humanity. The
bishops may have smiled.
A distinguished sociological writer, Mr. L. Hobhouse, in
classifying forms of marriage, says, with unconscious humour:
“Marriage is indissoluble among the Andamanese, some Papuans of
New Guinea, at Watubela, at Lampong in Sumatra, among the
Igorrotes and Italones of the Philippines, the Veddahs of Ceylon, and
in the Romish Church.” One trusts that the Roman (and Anglican)
Catholics like the company they keep; the peoples enumerated by
Mr. Hobhouse are the very lowest and least intelligent savages
known to science. The Church of Rome has long boasted that its
ideal of indissoluble union is the final and culminating point of
human wisdom in regard to the family. It now appears that
indissoluble marriage was the most primitive human tradition, and
was discarded by the Roman and all other civilisations when they
passed from childhood to manhood.
Sociologists have been accustomed to say that monogamy was
gradually developed out of promiscuity. This was mere speculation,
and Professor Westermarck and other recent authorities rightly
dissent. The institution is older than humanity. We find monogamic
family life among the anthropoid apes and amongst the lowest
peoples, which represent early man; and many writers on prehistoric
man now contend that we find him passing from family to social life,
not in the reverse way. When the last Ice Age forced men to live in
caves, and the scattered families clung together and formed large
social groups, the family life was modified, and few of the higher
tribes maintained the primitive form. Réclus tells of a Khond who, on
hearing of the monogamous life of the wild Veddahs of Ceylon,
exclaimed in disgust: “They live like the apes.”
We may assume that little hardship arises from incompatibility
of temperament among the Igorrotes or the Veddahs, and there is
no need to describe the eccentric forms of marriage which arose
among higher savages. None of the great civilisations of the past
entertained the idea of indissoluble marriage. The clergy, of course,
know nothing of the real line of evolution, and (as Bishop Diggle has
done) they represent the Roman system as a comparative
refinement of early promiscuity, on which Christianity was to make
the final advance. The precious testimony of Juvenal is invoked
(against the warning of all modern historians): and we are expected
to shudder because St. Jerome tells us of a Roman lady who had
been married a score of times. It is not stated what harm was done
to the lady, or to anybody else, or whether she was a freak in her
generation. It is enough, as Mrs. Humphry Ward knows, to say that
divorce is frequent anywhere, and thousands of hands will rise to
heaven: what the precise social consequences are the thousand of
heads seem to regard as irrelevant.
I have read most of the literature of the Roman Imperial period,
and have found that the greater part of the statements made about
it by clerical moralists are rubbish. Every serious student knows that
it was precisely the more rigid and intolerable earlier form of Roman
marriage (the confarreatio) which led to laxity in the early Empire;
that the Roman Lawyers of the first and second centuries, who
relaxed marriage, were among the most conscientious that the legal
world has ever produced; and that in the time of St. Jerome—an
embittered and intensely puritanical priest, who says worse things
about his sacerdotal colleagues than he does about the pagans—we
have the solid testimony of such documents as the Letters of
Symmachus and the instructive Saturnalia of Macrobius to show that
the family life of the pagans was generally healthy, sober, and
harmonious. There is not a particle of proof that Roman society
suffered because of the facility of divorce, or generally abused this
facility.
But the misrepresentation of Roman morals is light in
comparison with the misrepresentation of later Christian morals.
Christianity took its ideal from the Jews. Amongst this partially
civilised people marriage had been made easy for the male by the
retention of polygamy, and it was not customary to consult the
feelings of the woman. In the course of time Greek influence
entered Judæa, and the Rabbis held learned debates on marriage
and divorce. Both the stricter and the laxer view found expression in
the New Testament and in early Christian literature, but a celibate
priesthood obtained supreme power in Europe and the stricter view
was enforced. The moral consequences were disastrous. While the
Roman Curia, which could always find a flaw in the marriage of a
wealthy man, was enriched, Europe was degraded, and sexual
immorality became general. It is enough to recall that a tradition of
looseness, in strict correspondence with the law of indissoluble
marriage, survives from the ages of faith to our own time in the
Latin countries. Some have spoken of “the hot southern blood” and
cast the blame on the climate. I would invite the informed moralist
to run his eye over the map of the earth, and ask himself whether
chastity increases, or the sex-organs lose vitality, in proportion as
nations are removed from the Equator. It is a ludicrous effort of
Catholics to conceal the evils of indissoluble marriage. Until the
Reformation sexual laxity was the same all over Europe.
In England the old priest-made law was retained after the
Reformation, and laxity of morals was general. Except for a very few
wealthy people, divorce was impossible until 1857, when a slender
measure of reform was wrested from the clergy. This, the present
law of England, a miserable compromise with religious prejudice and
a permanent source of vice and misery, puts English legislation on
an important aspect of “the foundation of the State” below that of
any other civilised community. Instead of ridding themselves entirely
of clerical influence, and directing civic life on civic grounds, our
legislators looked still to ancient Judæa, and substituted the less
stringent view of the Rabbis for the more stringent. The legendary
leader of a rude Arab tribe had granted divorce for adultery, and the
English nation of the nineteenth century followed his example. The
result was the most stupid and mischievous law of marriage outside
the sphere of the Holy Catholic Church.
English people are proud of their national concern for purity, yet
they tolerate, and their priests defend as something sacred, a state
of law which is medieval in its crudeness and barbarity. When two
people have obeyed our counsel to marry early, and they discover
that they have misjudged each other, we tell them that there is no
relief for them unless they commit adultery: which, when it is
committed, we brand as the darkest sin. To the husband we give the
further injunction that he must be cruel to his wife before we will
release him. We then, although we take especial pride in the
“cleanness” of our press and literature, print whole columns about
their conduct in suspicious situations,—sometimes entitling the
account, in large type, to attract attention, “A Horrible Case,”—and
we ask each other whether England is not in a state of decay and
contracting the continental spirit. If there are any who do not choose
to commit adultery, or do not choose to have their servants bribed to
describe their conduct for the entertainment of the public, we grant
them a legal permit to be happy and vicious, or miserable and
virtuous, for the remainder of their lives: the thing we call a judicial
separation.
This extraordinary situation is certainly a slight improvement on
indissoluble marriage, but the pride of our bishops and puritans in it
is peculiar. One may not expect them to take into account the
suffering which hundreds of thousands endure under the law, but
the adultery to which it leads would seem to be a proper subject for
their consideration. As a rule, they entreat us to maintain religion,
whether it be true or no, in the name of morality: here they ask us
to maintain immorality in the name of religion,—in the name of a
supposed Christian precept,—and we obey even more readily. When
a Royal Commission recommends that our law be brought into line
with the law of other civilised nations, they burn with indignation
and inspire a Minority Report: a remarkable mixture of
contradictions, worthless quotations, and irrelevant rhetoric. The
question of immorality they shirk; and to the unhappiness which
large numbers of our people endure under the present law they are
so insensitive that they hardly mention it.
Such consequences are to be expected as long as we borrow
our social legislation from an ancient polygamous nation with a great
disdain for women. It is said, however, as usual, that our social
interest coincides with the supposed command of Christ. We have
here one of the most singular confusions of the whole controversy.
Marriage is held to be the foundation of the State, because it is
believed to be the surest way to supply it with citizens. This duty of
procreation is, in fact, the only feature which disposes priests to give
their blessing to so distasteful a thing as sexual union. Yet when a
majority of the Commissioners recommend that people should be
free to remarry if the desertion, cruelty, insanity, or imprisonment of
one spouse defrauds the State of its supply of little citizens, the
bishops raise their crosiers. Even so ascetic and anti-feminist a
divine as St. Augustine could not deny that a man had a right to
take a concubine when his wife proved sterile. Our divines speak
much more fervently than St. Augustine did of our social interest, yet
they forbid us to consult it.
In sum, we have generally rejected the view that marriage
ought to be indissoluble, and we pride ourselves on curbing the
influence of priests; but our whole attitude toward divorce is shaped
by the old superstition and the clergy. In the name of that
superstition we condemn large numbers of our fellow-citizens to live
in deep and acute misery. Which of our social interests would be
prejudiced by granting relief to the man or woman whose life is
embittered by the desertion, incurable insanity, cruelty, or criminal
conduct of his or her partner? The suggestion is preposterous; and,
if we do not grant this relief, adultery is in their case a venial
offence, if not a right.
Some explain that they fear “the thin edge of the wedge.” As if
wedges had a way of pressing deeper by their own weight, once we
have admitted them! If England chooses to grant these reforms, and
no others, she need not be deterred by empty phrases. But I believe
that the alert and resolute race which is coming will go much further
than this. Before many generations, if not in ours, there will be
divorce for incompatibility of temperament in every civilised country.
Men and women will be divorced, after due delay, because they
wish, or when one of them can show grave cause to separate from
the other. Ill-informed people express a concern about the children
or the social consequences. They do not take the trouble to inquire
what happens in some of the American States, or in Denmark,
Norway, Sweden, and Switzerland, where there is long and ample
experience of divorce by mutual consent. The social consequences
are just what any unprejudiced person would expect: happier
homes, and more healthily engendered and reared children. But the
puritan does not want to inquire: he is not sincere. Would he agree
to divorce by mutual consent where there are no children or where
either or both parents make adequate provision for them? He would
not. I will, however, return later to the question of children.
Europe will be far happier when some such humane law as the
Danish is generally adopted, and, after a few years’ separation, the
discontented are free to remarry. But no one who is acquainted with
the tendency and influence of modern literature can fancy that this
will be the last state of the old ideal of the family. From the first
years when men were free to declare their opinions without fear of
the stake, writers of great power have claimed the right of what has
come to be called “free love.” Some would abolish marriage, but the
normal shape of the demand is that men and women shall be free to
love and beget children whether or no they ask the blessing of
Church or State. By the latter part of the eighteenth century, when
Goethe took a concubine on the pagan model, many of the first
literary men in Europe pressed this demand, and it is sustained by
some of the most brilliant writers in every country to-day. The
movement exhibits the slow and steady growth characteristic of
reforms which eventually triumph. It is no mere bubble on the
surface of our effervescent life; it is the new intelligence of the race
examining the old traditions.
Moralists, lay and clerical, have a preposterous way of
representing this as a surging of selfish passion against the barriers
which human experience or superhuman wisdom has erected. There
is, it is true, much in our rebellious literature itself which
misrepresents the movement. You get the impression that, as the
eighteenth century questioned the divine right of kings and the
nineteenth century that of priests, the twentieth century is
challenging the divine right of moralists. But this is due to the
common practice of giving a narrow meaning to the word
“immorality.” Goethe and Swinburne became zealous for “morality,”
but they never altered their opinions on “free love.” Sudermann and
Anatole France and Pérez Galdós and d’Annunzio, G. B. Shaw and T.
Hardy and E. Carpenter and H. G. Wells, are sincere moralists: they
inculcate honour, truthfulness, kindliness, and justice as firmly as our
bishops, and more effectively than most of our clergy. It is not
morality that stands at the bar. The real question is whether any
sound moral principle implies that marriage alone sanctions sex-
union: whether social good or social evil would result from an
alteration of our standards.
This is a quite natural and legitimate question, and any healthy-
minded person ought to be able to discuss it without hysteria or

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1. "Capital" is sometimes defined as funds supplied to a firm by investors.

ANS: T PTS: 1 DIF: Difficulty: Easy

ANS: T PTS: 1 DIF: Difficulty: Easy

ANS: T PTS: 1 DIF: Difficulty: Easy

ANS: F PTS: 1 DIF: Difficulty: Easy

ANS: F PTS: 1 DIF: Difficulty: Easy

ANS: F PTS: 1 DIF: Difficulty: Easy

ANS: T PTS: 1 DIF: Difficulty: Easy

ANS: F PTS: 1 DIF: Difficulty: Easy

ANS: T PTS: 1 DIF: Difficulty: Easy

ANS: T PTS: 1 DIF: Difficulty: Easy

ANS: F PTS: 1 DIF: Difficulty: Easy

ANS: F PTS: 1 DIF: Difficulty: Easy

ANS: F PTS: 1 DIF: Difficulty: Easy

ANS: F PTS: 1 DIF: Difficulty: Easy

ANS: F PTS: 1 DIF: Difficulty: Easy

ANS: T PTS: 1 DIF: Difficulty: Easy

PTS: 1 DIF: Difficulty: Moderate OBJ: LO: 9-8

ANS: T PTS: 1 DIF: Difficulty: Moderate

PTS: 1 DIF: Difficulty: Moderate OBJ: LO: 9-6

PTS: 1 DIF: Difficulty: Moderate OBJ: LO: 9-7

PTS: 1 DIF: Difficulty: Moderate OBJ: LO: 9-8

PTS: 1 DIF: Difficulty: Moderate OBJ: LO: 9-9

PTS: 1 DIF: Difficulty: Moderate OBJ: LO: 9-9

ANS: F PTS: 1 DIF: Difficulty: Moderate

PTS: 1 DIF: Difficulty: Moderate OBJ: LO: 9-10

ANS: T PTS: 1 DIF: Difficulty: Moderate

ANS: F PTS: 1 DIF: Difficulty: Moderate

ANS: F PTS: 1 DIF: Difficulty: Moderate

PTS: 1 DIF: Difficulty: Moderate OBJ: LO: 9-9

Cost of equity = rs(0.30)(0.50) + rps(1 − T)(0.70)(0.50).

PTS: 1 DIF: Difficulty: Moderate OBJ: LO: 9-4

PTS: 1 DIF: Difficulty: Moderate OBJ: LO: 9-6

ANS: T PTS: 1 DIF: Difficulty: Moderate

PTS: 1 DIF: Difficulty: Easy OBJ: LO: 9-11

PTS: 1 DIF: Difficulty: Moderate OBJ: LO: 9-6

PTS: 1 DIF: Difficulty: Moderate OBJ: LO: 9-11

PTS: 1 DIF: Difficulty: Moderate OBJ: LO: 9-11

PTS: 1 DIF: Difficulty: Moderate OBJ: LO: 9-11

PTS: 1 DIF: Difficulty: Moderate OBJ: LO: 9-11

PTS: 1 DIF: Difficulty: Moderate OBJ: LO: 9-11

46. Which of the following statements is CORRECT?

PTS: 1 DIF: Difficulty: Moderate OBJ: LO: 9-9

47. Which of the following statements is CORRECT?

PTS: 1 DIF: Difficulty: Moderate OBJ: LO: 9-8

48. Which of the following statements is CORRECT?

49. Which of the following statements is CORRECT?

50. Which of the following statements is CORRECT?