BU340 Midterm Review Day 3

The change in net operating working capital (NOWC) associated with new projects is always positive, because new projects mean that more operating working capital will be required.

• True

• False

Which of the following is NOT a relevant cash flow and thus should NOT be reflected in the analysis of a capital budgeting project?

• Shipping and installation costs for machinery acquired.

• Cannibalization effects.

• Opportunity costs.

• Sunk costs that have been expensed for tax purposes.

Superior analytical techniques, such as NPV, used in combination with risk-adjusted cost of capital estimates, can overcome the problem of poor cash flow estimation and lead to generally correct accept/reject decisions for capital budgeting projects.

• True

• False

The primary advantage to immediately expensing depreciation rather than using straight-line depreciation is that with immediate expensing the total amount of depreciation that can be taken, assuming the asset is used for its full tax life, is greater.

• True

• False

In cash flow estimation, the existence of externalities should be taken into account if those externalities have any effects on the firm's long-run cash flows.

• True

• False

Because of improvements in forecasting techniques, estimating the cash flows associated with a project has become the easiest step in the capital budgeting process.

• True

• False

In a "Dutch auction" for new stock, individual investors place bids for shares directly. Each potential bidder indicates the price he or she is willing to pay and how many shares he or she will purchase at that price. The highest price that permits the company to sell all the shares it wants to sell is determined, and this is the "market clearing price." All bidders who specified this price or higher are allowed to purchase their shares at the market clearing price.

• True

• False

When working with the CAPM, which of the following factors can be determined with the most precision?

• The market risk premium (RP_M).

• The beta coefficient, b_i, of a relatively safe stock.

• The expected rate of return on the market, r_M.

• The beta coefficient of "the market," which is the same as the beta of an average stock.

If a typical U.S. company 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

• become riskier over time, but its intrinsic value will be maximized.

• become less risky over time, and this will maximize its intrinsic value.

• accept too many low-risk projects and too few high-risk projects.

• become more risky and also have an increasing WACC. Its intrinsic value will not be maximized.

For a company whose target capital structure calls for 50% debt and 50% common equity, which of the following statements is CORRECT?

• The WACC is calculated on a before-tax basis.

• The WACC exceeds the cost of equity.

• The cost of equity is always equal to or greater than the cost of debt.

• The cost of retained earnings typically exceeds the cost of new common stock.