CF 1.11 Test

Q. With regard to capital allocation, an appropriate estimate of the incremental cash flows from an investment is least likely to include:

• A. externalities.
• B. interest costs.
• C. opportunity costs.

Q. The Bearing Corp. invests only in positive-NPV projects. Which of the following statements is true?

• A. Bearing’s return on invested capital (ROIC) is greater than its cost of capital (COC).
• B. Bearing’s COC is greater than its ROIC.
• C. We can’t reach any conclusions about the relationship between the company’s ROIC and COC.

A company has decided to switch to using accelerated depreciation from straight-line depreciation. Holding other factors constant, the degree of total leverage (DTL) will most likely:

• A. increase.
• B. not change.
• C. decrease.

Which of the following scenarios can best be described as offering superior protection of shareholder interests?

• A. When common law is practiced
• B. When CEO duality is common
• C. When stakeholder theory prevails

Q. Which of these statements is most accurate with respect to the use of debt by a start-up fashion retailer with negative cash flow and uncertain revenue prospects?

• A. Debt financing will be unavailable or very costly.
• B. The company will prefer to use equity rather than debt given its uncertain cash flow outlook.
• C. Both A and B.

Q. The net present value (NPV) of an investment is equal to the sum of the expected cash flows discounted at the:

• A. internal rate of return.
• B. risk-free rate.
• C. opportunity cost of capital.

A company’s $100 par value preferred stock with a dividend rate of 9.5% per year is currently priced at $103.26 per share. The company’s earnings are expected to grow at an annual rate of 5% for the foreseeable future. The cost of the company’s preferred stock is closest to:

• A. 9.5%.
• B. 9.2%.
• C. 9.7%.

Under the stakeholder theory, corporate governance is most consistent with a system of:

• A. internal controls and procedures by which individual companies are managed.
• B. defined roles for management and the majority shareowner(s).
• C. checks and balances to minimize the conflicting interests among shareowners.

Q. Brandon Wiene is a financial analyst covering the beverage industry. He is evaluating the impact of DEF Beverage’s new product line of flavored waters. DEF currently has a debt-to-equity ratio of 0.6. The new product line would be financed with $50 million of debt and $100 million of equity. In estimating the valuation impact of this new product line on DEF’s value, Wiene has estimated the equity beta and asset beta of comparable companies. In calculating the equity beta for the product line, Wiene is intending to use DEF's existing capital structure when converting the asset beta into a project beta. Which of the following statements is correct?

• A. Using DEF’s debt-to-equity ratio of 0.6 is appropriate in calculating the new product line’s equity beta.
• B. Using DEF’s debt-to-equity ratio of 0.6 is not appropriate; rather, the debt-to-equity ratio of the new product, 0.5, is appropriate to use in calculating the new product line’s equity beta.
• C. Wiene should use the new debt-to-equity ratio of DEF that would result from the additional $50 million debt and $100 million equity in calculating the new product line’s equity beta.

Q. Which of the following is least likely to be true with respect to optimal capital structure?

• A. The optimal capital structure minimizes WACC.
• B. The optimal capital structure is generally close to the target capital structure.
• C. Debt can be a significant portion of the optimal capital structure because of the tax-deductibility of interest.