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WorksheetsFinance exam 3
Total questions: 97
Worksheet time: 53mins
Each project should be judged against
the specific means of financing used to support its implementation.
the existing interest rate at that point in time.
the cost of new common stock equity.
None of these options are true.
The overall weighted average cost of capital is used instead of costs for individual sources of funds because
the use of the cost for individual sources of capital would make investment decisions inconsistent.
a project with the highest return would always be accepted under the specific cost criteria.
investments funded by low-cost debt would have an advantage over other investments.
the use of the cost for specific sources of capital would make investment decisions inconsistent, and investments funded by low-cost debt would have an advantage over other investments.
Debreu Beverages has an optimal capital structure that is 70% common equity, 20% debt, and 10% preferred stock. Debreu's pretax cost of equity is 9%. Its pretax cost of preferred equity is 7%, and its pretax cost of debt is also 5%. If the corporate tax rate is 21%, what is the weighted average cost of capital?
Between 7% and 8%
Between 8% and 9%
Between 9% and 10%
Between 10% and 12%
Debreu Beverages has an optimal capital structure that is 70% common equity, 10% preferred stock, and 20% debt. Debreu's pretax cost of equity is 9%. Its pretax cost of preferred equity is 7%, and its pretax cost of debt is also 5%. If the corporate tax rate is 21%, what is the weighted average cost of capital?
8.74%
8%
5.2%
7.79%
For a firm paying 5% for new debt, the higher the firm's tax rate
the higher the after-tax cost of debt.
the lower the after-tax cost of debt.
the after-tax cost is unchanged.
Not enough information to judge.
The cost of a firm's debt is determined by taking the
present value of the interest payments and principal times one minus the tax rate.
coupon rate on bonds times one minus the tax rate.
yield on bonds issued minus the corporation’s marginal tax rate.
None of these options are true.
The coupon rate on a debt issue is 6%. If the yield to maturity on the debt is 9%, what is the after-tax cost of debt in the weighted average cost of capital if the firm's tax rate is 21%?
3.96%
4.08%
7.11%
7.92%
The coupon rate on an issue of debt is 8%. The yield to maturity on this issue is 10%. The corporate tax rate is 21%. What would be the approximate after-tax cost of debt for a new issue of bonds?
5.28%
2.48%
7.9%
3.14%
A firm's cost of financing, in an overall sense, is equal to its
weighted average cost of capital.
required yield that investors seek for various kinds of securities.
required rate of return that investors seek for various kinds of securities.
all of these options are true.
A firm's optimal capital structure is 60% equity. If the firm has $12 million in retained earnings available to invest, above what capital structure will the firm need to issue additional stock? (Assume no growth in retained earnings.)
$72 million
$30 million
$20 million
There is insufficient information to determine an answer.
A firm's optimal capital structure is 50% equity. If the firm has $15 million in retained earnings available to invest, above what capital structure will the firm need to issue additional stock? (Assume no growth in retained earnings.)
$75 million
$30 million
$20 million
Tobin's Barbeque has a bank loan at 8% interest and an after-tax cost of debt of 6%. What will the after-tax cost of debt be if a new loan is taken out yielding 11%?
7.52%
8.25%
13.33%
None of these options are true.
The pre-tax cost of debt for a new issue of debt is determined by
the investor's required rate of return on issued stock.
the coupon rate of existing debt.
the yield to maturity of outstanding or comparable bonds.
All of these options are true.
Lewis, Schultz, and Nobel Development Corporation has an after-tax cost of debt of 4.5%. With a tax rate of 21%, what is the yield on the debt?
4.5%
9.0%
1.89%
5.70%
A firm is paying an annual dividend of 2.65foritspreferredstockthatissellingfor 57.00. There is a selling cost of $3.30. What is the after-tax cost of preferred stock if the firm's tax rate is 21%?
3.30%
4.93%
5.79%
The cost of equity capital in the form of new common stock will be higher than the cost of retained earnings because of
the existence of taxes.
the existence of flotation costs.
investors' unwillingness to purchase additional shares of common stock.
the existence of financial leverage.
If the flotation cost goes up, the cost of retained earnings will
go up.
go down.
stay the same.
slowly increase.
Flotation cost is the
cost of holding stock on hand.
cost of issuing new debt.
cost of issuing new stock.
sales price of common stock.
Why is the cost of debt normally lower than the cost of preferred stock?
Preferred stock dividends are tax deductions.
Interest on debt is tax deductible.
Preferred stock dividends must be paid before common stock dividends.
Common stock dividends are not tax-deductible.
If flotation costs go down, the cost of new preferred stock will
go up.
go down.
stay the same.
slowly increase.
Ten years ago, Stigler Company issued 100parvaluepreferredstockyielding6 102 per share. What is the approximate current yield or cost of the preferred stock? (Disregard flotation costs.)
7.76%
8%
5.9%
There is not enough information to answer the question.
A firm's debt-to-equity ratio varies at times because
a firm will want to sell common stock when prices are high and bonds when interest rates are low.
a firm will want to take advantage of timing its fund-raising in order to minimize costs over the long run.
the market allows some leeway in the debt-to-equity ratio before penalizing the firm with a higher cost of capital.
All of these are accurate statements.
Using the constant dividend growth model for common stock, if the market price of stock (P₀) goes up, assuming all other variables are constant
the assumed cost goes up.
the assumed cost goes down.
the assumed cost remains unchanged.
New common stock is more expensive than required rate of return (Ke) because new common stock has to
compensate for risk.
compensate for more dividends.
compensate for expansionary problems.
cover distribution costs.
In computing the cost of common equity, if the dividend (D1) goes downward and market price (P0) goes up, required rate of return (Ke) will
go up.
go down.
stay the same.
slowly increase.
In determining the cost of retained earnings
the dividend valuation model is inappropriate.
flotation costs are included.
growth is not considered.
the capital asset pricing model can be used.
Which of the following statements is not an advantage of the dividend valuation model?
It is a very conservative model of valuation.
It rates the stability of a mature business.
It ignores the effects of a stock buyback.
It is easy to understand.
The _________ is the cost to a corporation of funds that it has generated, meaning it approximates the return that investors expect to earn on their equity investment.
cost of retained earnings
cost of capital
cost of debt
None of these.
Using the constant growth model, a firm's expected dividend yield (D1) is 4% of the stock price, and its growth rate is 5%. If the tax rate is 21%, what is the firm's cost of equity?
10%
6.65%
9.0%
5.85%
A firm's stock is selling for $65. The dividend yield is 6%. A 7% growth rate is expected for the common stock. The firm's tax rate is 21%. What is the firm's cost of retained earnings?
8.16%
13.00%
12.35%
7.8%.
A firm's stock is selling for 62.Thenextannualdividendisexpectedtobe 3.00. The growth rate is 9%. The flotation cost is $5.00. What is the cost of retained earnings?
13.84%
12.46%
12.7%
None of these options are correct
For many firms, the cheapest and most important source of equity capital is in the form of:
debt.
common stock.
preferred stock.
retained earnings.
Retained earnings has a cost associated with it because:
new funds must be raised.
there is an opportunity cost associated with stockholder funds.
Ke > g.
flotation costs increase the cost of funding.
The optimal capital structure for firms in cyclical industries should contain _________ than firms in stable industries.
less debt
more equity
higher dividends
more retained earnings
Which of the following is NOT true about debt financing and the weighted average cost of capital?
Debt is usually the cheapest source of financing.
As the level of debt increases beyond the optimum capital structure, the cost of capital increases.
No debt in the firm's capital structure will minimize the firm's weighted average cost of capital.
None of these options are false.
A firm in a stable industry should use
a large amount of debt to lower the cost of capital.
no debt at all.
preferred stock in place of debt.
a limited amount of debt to lower the cost of capital.
Although debt financing is usually the cheapest component of capital, it cannot be used in excess because
interest rates may change.
the firm's stock price will increase and raise the cost of equity financing.
the financial risk of the firm may increase and thus drive up the cost of all sources of financing.
underwriting costs may change.
A firm in a cyclical industry should use
a large amount of debt to lower the cost of capital.
no debt at all.
preferred stock in place of debt.
a limited amount of debt to lower the cost of capital.
1) Most firms are able to use _________% debt in their capital structure without exceeding norms acceptable to creditors and investors.
30-50
40-60
50-70
60-80
Marginal cost of capital
recognizes that cost of capital does not stay constant as more funds are raised.
usually provides the same capital budgeting choices as the use of weighted average cost of capital.
can be defined as the cost of capital when no retained earnings are available for expansion.
None of these options apply.
The weighted average cost of capital is used as a discount rate because
it is an indication of how much the firm is earning overall.
as long as the cost of capital is earned, the common stock value of the firm will be maintained.
it is comparable to the prevailing market interest rates.
returns below the cost of capital will cover all fixed costs associated with capital and provide an excess return to stockholders.
Use of the marginal cost of capital
acknowledges that when retained earnings are used up as a source of equity, the cost of capital rises as new common stock is sold to support more growth.
recognizes that the return from the last dollar of funds generated should be greater than or equal to the cost of the last dollar of funds raised.
acknowledges that when retained earnings are used up as a source of equity, the cost of capital rises as new common stock is sold to support more growth and recognizes that the return from the last dollar of funds generated should be greater than or equal to the cost of the last dollar of funds raised.
None of these options are correct.
The general rule for using the weighted average cost of capital (WACC) in capital budgeting decisions is to accept all projects with
A. rates of return greater than or equal to the WACC.
B. rates of return less than the WACC.
Oak Enterprises has a beta of 1.2, the market return is 8%, and the T-bill rate is 4%. Its tax rate is 21%. What is its expected required return of common equity?
between 11% and 12%
between 8% and 9%
between 7% and 8%
between 5% and 6%
All of the following are important considerations for minimizing the cost of capital EXCEPT
future inflation rates.
industry debt ratios.
future economic conditions.
current coupon rates of outstanding debt.
In a general sense, cash flow can be said to equal operating income
less taxes plus depreciation.
less taxes.
before depreciation and taxes plus depreciation.
after taxes minus depreciation.
The reason cash flow is used in capital budgeting is because
cash rather than income is used to purchase new machines.
cash outlays need to be evaluated in terms of the present value of the resultant cash inflows.
to ignore the tax shield provided from depreciation would ignore the cash flow provided by the machine, which should be reinvested to replace older machines.
all the above
The first step in the capital budgeting process is
collection of data.
idea development.
assign probabilities.
determine cash flows.
Which of the following is not a step in the capital budgeting decision-making process?
Search for and discovery of investment opportunities
Collection of data
Evaluation and decision making
All of the above are steps used in this process.
Capital budgeting is primarily concerned with
capital formation in the economy.
planning future financing needs.
evaluating investment alternatives.
minimizing the cost of capital.
An appropriate capital budgeting process requires that the following steps be taken in which order?
d, a, c, b
d, a, b, c
Assume a corporation has earnings before depreciation and taxes of 82,000,depreciationof 45,000, and that it has a 25% combined tax bracket. What are the after-tax cash flows for the company?
$72,750
$82,000
$42,000
$127,000
Which of the following is not a time-adjusted method for ranking investment proposals?
The net present value method
The payback method
The internal rate of return method
All of these options are time-adjusted methods.
Which of the following statements about the payback method is true?
The payback method considers cash flows after the payback has been reached.
The payback method does not consider the time value of money.
The payback method uses discounted cash-flow techniques.
The payback method generally leads to the same decision as other investment selection methods.
Which of the following is a disadvantage of the payback method?
Payback ignores the return that is earned during the period of time the project is in place.
Payback emphasizes receiving money back as fast as possible for reinvestment.
Payback is basic to use and understand.
The payback method has several disadvantages, among them: Which of the above is correct?
Payback fails to choose the optimum or most economical solution to a capital budgeting problem.
Payback ignores cash inflows after the payback period.
Payback fails to choose the optimum or most economical solution to a capital budgeting problem, and it ignores cash inflows after the payback period.
None of these options are disadvantages.
Assume a $6,500 investment and the following cash flows for two alternatives. Year Investment X Investment Y 1 1,000 1,300 2 1,800 2,000 3 1,700 1,100 4 2,000 1,500 5 - $600 Under the payback method, which of the following could be concluded?
Investment X should be selected.
Investment Y should be selected.
Investment X and Y provide the same payback period.
The investments are not comparable since they have different time frames.
Machine A ( 10,000cost)Inflows:year1 6,000, year 2 3,000,year3 3,000, year 4 $0 Machine B ( 22,500cost)Inflows:year1 12,000, year 2 7,500,year3 1,500, year 4 $1,500 Machine C ( 35,500cost)Inflows:year1 0, year 2 30,000,year3 5,000, year 4 $20,000 Under the payback method and assuming these machines are mutually exclusive, which machine(s) would Dammon Corporation choose?
Machine A
Machine B
Machine C
Machine A and B
Suppose that interest rates (and, therefore, the firm's weighted average cost of capital) increase. This WOULD NOT CHANGE the capital budgeting choices a firm would make if it uses
payback method analysis.
net present value analysis.
internal rate of return analysis.
profitability indices.
You buy a new piece of equipment for 7,360,andyoureceiveacashinflowof 1,000 per year for 10 years. What is the internal rate of return?
4%
6%
8%
10%
You require an internal rate of return of 8% to accept a project. If the project will yield $10,000 per year for 10 years, what is the maximum amount that you would be willing to invest in the project?
$51,400
$67,100
$100,000
$144,870
How would the salvage value be treated in a net present value calculation?
disregard the salvage
as a positive cash flow in the final year that the asset is used
as a negative cash flow in the final year that the asset is used
as a negative cash flow in the first year that the asset is used
The longer the life of an investment the
more significant the discount rate.
less significant the discount rate.
more it can initially cost.
less it can initially cost.
Stone Incorporated is evaluating a project with an initial cost of 9,500.Cashinflowsareexpectedtobe 1,500, 1,500,and 10,000 in the three years over which the project will produce cash flows. If the discount rate is 6%, what is the net present value of the project?
$11,150
$26,930
$8,430
$1,650
Assuming that a firm has no capital rationing constraint and that a firm's investment alternatives are not mutually exclusive, the firm should accept all investment proposals.
for which it can obtain financing.
that have a positive net present value.
that have positive cash flows.
that provide returns greater than the after-tax cost of debt.
If projects are mutually exclusive
they can only be accepted under capital rationing.
the selection of one alternative precludes the selection of other alternatives.
the payback method should be used.
only the net present value method can be used.
The internal rate of return and net present value methods
always give the same investment decision answer.
never give the same investment decision answer.
usually give the same investment decision answer.
always give conclusions different from the payback method.
A characteristic of capital budgeting is that
a large amount of money is always involved.
the net present value must be negative to be accepted.
the internal rate of return must be greater than the cost of capital.
the time horizon is at least five years.
A project requires an investment of 2,500andhasanetpresentvalueof 430. If the internal rate of return is 10%, what is the profitability index for the project?
0.25
2.33
0.70
1.17
A project requires an investment of 3,500andhasanetpresentvalueof 450. If the internal rate of return is 10%, what is the profitability index for the project?
0.25
1.13
0.70
1.17
With non-mutually exclusive projects,
the payback method will select the best project.
only one project can be accepted.
the IRR, NPV, and payback methods are all treated equally in the decision-making process.
the net present value and the internal rate of return methods will accept or reject the same projects.
The net present value method (NPV) is a more conservative technique for selecting investment projects than the internal rate of return method because the NPV method
assumes that cash flows are reinvested at the project's internal rate of return.
concentrates on the liquidity aspects of investment projects.
assumes that cash flows are reinvested at the firm's weighted average cost of capital.
None of these options are true.
The _________ assumes returns are reinvested at the cost of capital.
payback method
internal rate of return method
net present value method
capital rationing procedure
In using the internal rate of return method, it is assumed that cash flows can be reinvested at the
cost of equity.
cost of capital.
internal rate of return.
prevailing interest rate.
If an investment project has a positive net present value, then the internal rate of return is
less than the cost of capital.
greater than the cost of capital.
equal to the cost of capital.
indeterminate, because it depends on the length of the project.
As the cost of capital increases
fewer projects are accepted.
more projects are accepted.
project selection remains unchanged.
none of these options.
The net present value (NPV) method is considered to be a better method of evaluation than the internal rate of return (IRR) method because the NPV method
A) uses time value of money while IRR does not.
A) is a more liberal method of analysis.
A) assumes that cash flows can be reinvested at the firm's more conservative cost of capital.
The modified internal rate of return (MIRR) assumes that
inflows are invested at the traditional interest rate of return.
inflows are reinvested at the cost of capital.
outflows must be funded with debt
outflows must be funded with equity.
Capital rationing
is a way of preserving the assets of the firm over the long term.
is a less than optimal way to arrive at capital budgeting decisions.
assures stockholder wealth maximization.
assures maximum potential profitability.
If a firm is experiencing no capital rationing, it should accept all investment proposals
as long as it has available funds.
that return an amount equal to or greater than the cost of capital.
that return an amount greater than the cost of equity.
that are available, regardless of return.
A firm may adopt capital rationing because
it is hesitant to use external sources of financing.
it wishes to maximize profits.
it wishes to maximize growth.
all of the options are true.
Capital rationing assumes that
a limited amount of capital is available.
a limited amount of investments are available.
maximum profitability will be obtained.
a limited amount of investments are available and maximum profitability will be obtained.
The net present value profile
doesn't work if projects have a negative net present value.
is a substitute for the internal rate of return method.
graphically portrays the relationship between the discount rate and the net present value.
measures the initial cost to the present value of all future earnings.
Which of the following is not a step in creating the net present value profile?
A) Determine the net present value at a zero discount rate.
B) Determine the net present value at a normal discount rate.
C) Determine the project's internal rate of return.
D) Determine the payback for the project.
Which statement(s) are true about depreciation?
Depreciation is a non-cash expense that provides tax shield benefits.
The greater the depreciation expenses in earlier years, the higher the present value of the project.
For tax purposes, the MACRS depreciation schedules supersede the old methods of sum-of-the-years' digits, double declining balance, and so on.
All of these are true.
Which statement(s) are true about the tax law changes in 2017?
Congress wanted businesses to invest more in long-lived assets.
Companies are temporarily allowed to take 100% bonus depreciation in the first year that an asset is placed in service.
This bonus will be phased out beginning in 2023 and expire by 2027.
All of these are true.
Which of the following statement(s) are not true of the Tax Cut and Jobs Act of 2017?
Dramatically cut corporate tax rates from 35 percent to 21 percent.
Most U.S. states imposed corporate income taxes ranging from 3 to 12 percent.
Large corporations with foreign tax obligations may pay higher or lower effective rates.
All of these are true.
An asset fitting into the 7-year MACRS category was purchased two years ago for $72,000. The book value of this asset is now
$44,064.
$31,200.
$48,317.
$51,429.
For MACRS depreciation, automobiles and light trucks fit into the
3-year MACRS category.
5-year MACRS category.
7-year MACRS category.
10-year MACRS category.
A firm purchases an asset falling into the 3-year MACRS category for $48,000. The second year's depreciation expense for this asset would be
$34,710.
$21,360.
$16,000.
The answer cannot be determined without knowing second-year earnings before depreciation and taxes.
Elective expensing has the following characteristic:
It is primarily beneficial to large businesses.
It is exclusively used for financial reporting.
It allows a more rapid write-off than MACRS depreciation.
It is primarily beneficial to large businesses and it allows a more rapid write-off than MACRS depreciation.
At higher tax rates, depreciation is
more beneficial.
less beneficial.
unaffected.
None of these options are correct.
If the capital budgeting decision includes a replacement analysis, then
a gain from the sale of the old asset will represent a tax savings inflow.
only incremental cash flows should be considered.
the sale price and tax savings will increase the cash inflows throughout the asset's life.
net present value can no longer be measured in replacement analysis.
An equipment replacement decision, under incremental analysis, requires
calculating the present value of all cash flows associated with the new equipment minus the salvage value of the old asset.
calculating the present value of all changes in cash flows from the old equipment to the new equipment.
subtracting the purchase price of the old equipment from the purchase price of the new equipment.
Two of the options are correct.
In a replacement decision, if an old asset sells below its book value
a gain has incurred.
a loss has incurred.
there is no gain or loss since it is replaced.
the net present value is negative.
All of the following is information required to create a net present value profile except for which one?
NPV at a 0 discount rate
NPV at the risk-free rate
NPV at the cost of capital
IRR of investment
Capital rationing
is a way of preserving the assets of the firm over the long term.
is a less than optimal way to arrive at capital budgeting decisions.
assures stockholder wealth maximization.
assures maximum potential profitability.
