Corporate Finance
1. Break-even analysis requires knowing the relationship between
A. sales and total costs.
B. sales and earnings.
C. sales and assets.
D. total revenues and fixed costs.
2. Break-even analysis is concerned with the relationship between
A. dividends and retained earnings.
B. total costs and revenues.
C. debt and equity.
D. financial leverage and risk.
3. Which of the following is a correct statement about operating leverage?
A. Operating leverage is associated with less risk and more certainty.
B. Operating leverage results from use of fixed instead of variable cost.
C. Operating leverage results from using debt financing.
D. Operating leverage is affected by the demand for the product.
4. A product sells for $2 per unit. If fixed costs are $200 and variable costs are $1 per unit, what is the break-even level of output?
A. 150 units
B. 100 units
C. 50 units
D. 200 units
5. Which of the following situations would provide corporate management with the strongest rationale to carry forward current-year losses?
A. Early in his first term this year, the President of the United States initiated legislation and signed into law a significant increase in income tax rates.
B. Management projects taxable income to remain unchanged over the next five years.
C. Management projects pre-tax losses over the next two years, and possibly even four years into the future.
D. Congress just passed a very popular bill that reduces marginal federal income tax rates.
6. Which of the following is an advantage of a corporation?
A. Elimination of double taxation
B. Ease of formation
C. Permanence
D. Dilution of ownership
7. Which of the following is a correct statement about corporate losses?
A. They are carried forward to future years.
B. They are carried forward three years and then carried back.
C. They are carried back three years and then carried forward.
D. They offset other sources of income in prior years.
8. The greater the degree of operating leverage, the larger is the variability of
A. operating income.
B. revenues.
C. interest.
D. debt financing.
9. If Sam's Diner has an EBIT of $350,000, what are the diner's net earnings after paying $50,000 in taxes and $34,000 in interest?
A. $434,000
B. $266,000
C. $334,000
D. $311,000
10. If a firm substitutes fixed for variable costs, which of the following will occur?
A. The degree of operating leverage will be increased.
B. The profits will always be higher.
C. The use of financial leverage will be increased.
D. The break-even level of output will be reduced.
11. Which of the following tends to vary spontaneously with changes in the level of sales?
A. Plant
B. Accounts payable
C. Long-term debt
D. Paid-in capital
12. Which of the following is usually a variable expense?
A. Salaries
B. Rent
C. Insurance premiums
D. Wages
13. Which of these situations offers the best rationale for organizing a business as a limited partnership?
A. Management needs to raise money through a stock offering, but does not want to relinquish control of the business to stockholders.
B. You want your small new business, which is operating out of your garage, to pay you and your partner (your spouse) dividends for which income tax will only be paid by you or your business, not both.
C. Management rejects the idea of personally assuming liability for the business.
D. You're an entrepreneur and you want two others' expertise, former business partners, to help execute your business plan.
14. Currently, a firm's accounts payable is 5 percent of sales. If the level of sales is anticipated to increase from $10,000 to $20,000, what is the level of accounts payable forecasted by the percent of sales method?
A. $500
B. $750
C. $1,000
D. $250
15. A firm's sales increased by 50 percent and inventory was $100,000. According to the percent of sales method of forecasting, what will the new inventory be?
A. $175,000
B. $150,000
C. $100,000
D. $120,000
16. If ABC, Inc. has $650,000 in sales and $230,000 in expenses, what are the firm's earnings before interest and taxes (EBIT)?
A. $420,000
B. $850,000
C. $650,000
D. $325,000
17. Which of the following events would be most likely to increase the quantity breakeven point, assuming other factors remain constant?
A. XYZ Corp agrees to increase its sales-commissions paid to employees by 12 percent.
B. The city council has finally been persuaded: Your taxi business will pay lower water and sewer rates.
C. Reduced marketplace competition enables LMN Corporation to raise its selling price for finance textbooks.
D. The pressure has subsided: The property owner, who rents space to your small manufacturing plant, has agreed to blacktop the employee and customer parking lot.
18. A firm does not obtain financial leverage by
A. issuing common stock.
B. borrowing from the bank.
C. issuing preferred stock.
D. issuing bonds.
19. If a firm produces 50,000 widgets and sells each unit for $20.50, what is the total revenue generated by this production?
A. $100,250
B. $10,250
C. $1,025,000
D. $10,250,000
20. A union contract suggests that labor costs may be
A. a noncash expense.
B. variable.
C. undetermined.
D. fixed.
21. The flotation costs of issuing new securities
A. don't affect the cost of capital.
B. encourage external financing.
C. decrease the cost of capital.
D. encourage the retention of earnings.
22. The internal rate of return and net present value methods of capital budgeting assume that the cash flows are reinvested at the
A. cost of capital for NPV and the internal rate of return for IRR.
B. cost of capital.
C. cost of capital for IRR and the internal rate of return for NPV.
D. internal rate of return.
23. Which of the following statements about the cost of debt is correct?
A. The cost of debt is greater than the cost of preferred stock.
B. The cost of debt is equal to the firm's interest rate.
C. The cost of debt is less than the cost of equity.
D. The cost of debt is greater than the cost of equity.
24. If the net present values of two mutually exclusive investments are positive, a firm should select
A. the investment with the higher present value.
B. neither investment.
C. both investments.
D. the investment with the higher net present value.
25. Which of the following statements about retained earnings is correct?
A. Retained earnings have the same cost as new shares of stock.
B. Retained earnings are cheaper than the cost of new shares.
C. Retained earnings are the firm's cheapest source of funds.
D. Retained earnings have no cost.
26. A firm should make an investment if the present value of the cash inflows on the investment is
A. less than zero.
B. greater than zero.
C. greater than the cost of the investment.
D. less than the cost of the investment.
27. NPV may be preferred to IRR because
A. NPV makes more conservative assumptions concerning reinvesting.
B. NPV excludes salvage value.
C. IRR excludes salvage value.
D. IRR makes more conservative assumptions concerning reinvesting.
28.
Coupon rate = 7 percent
Average tax rate = 32%
Price of common stock = $80
Price of preferred stock = $50
Bond yield risk premium = 7%
Return of the market = 12%
Marginal tax rate = 35%
Common stock dividend (Do) = $6
Preferred stock dividend (Do) = $4
Growth rate of common stock dividend = 6%
Risk-free rate of return = 6%
Beta = 1.2
According to the information given, what is the cost of equity using the bond yield plus risk premium method?
A. 14 percent
B. 13.2 percent
C. 12 percent
D. 13.95 percent
29. The net present value of an investment will be higher if
A. a firm uses straight-line depreciation.
B. the cost of the investment is lower.
C. the cost of capital is higher.
D. there's no salvage value.
30. The internal rate of return will be higher if the cost of
A. the investment is lower.
B. the investment is higher.
C. capital is lower.
D. capital is higher.
31. If the internal rates of return of two mutually exclusive investments exceed the firm's cost of capital, the firm should make
A. neither investment.
B. both investments.
C. the investment with the lower IRR.
D. the investment with the higher IRR.
32. A firm has two investment opportunities. Each investment costs $2,000, and the firm's cost of capital is 8 percent. The cash flows of each investment are as follows:
Cash Flow of Investment A
Year 1: $1800
Year 2: $600
Year 3: $500
Year 4: $400
Cash Flow of Investment B
Year 1: $900
Year 2: $900
Year 3: $900
Year 4: $900
According to the information, the NPV for Investment B is
A. $1,600.
B. $3,600.
C. $2,980.
D. $980.
33.
Coupon rate = 7 percent
Average tax rate = 32%
Price of common stock = $80
Price of preferred stock = $50
Bond yield risk premium = 7%
Return of the market = 12%
Marginal tax rate = 35%
Common stock dividend (Do) = $6
Preferred stock dividend (Do) = $4
Growth rate of common stock dividend = 6%
Risk-free rate of return = 6%
Beta = 1.2
According to the information given, what is the cost of debt?
A. 4.55 percent
B. 7.0 percent
C. 6.25 percent
D. 2.45 percent
34.
Coupon rate = 7 percent
Average tax rate = 32%
Price of common stock = $80
Price of preferred stock = $50
Bond yield risk premium = 7%
Return of the market = 12%
Marginal tax rate = 35%
Common stock dividend (Do) = $6
Preferred stock dividend (Do) = $4
Growth rate of common stock dividend = 6%
Risk-free rate of return = 6%
Beta = 1.2
According to the information given, what is the cost of equity using the expected growth method?
A. 12 percent
B. 14.4 percent
C. 13.95 percent
D. 13.2 percent
35. A firm has two investment opportunities. Each investment costs $2,000, and the firm's cost of capital is 8 percent. The cash flows of each investment are as follows:
Cash Flow of Investment A
Year 1: $1800
Year 2: $600
Year 3: $500
Year 4: $400
Cash Flow of Investment B
Year 1: $900
Year 2: $900
Year 3: $900
Year 4: $900
According to the information, the NPV for Investment A is
A. $3,300.
B. $2,871.
C. $1,300.
D. $871.
36. Which of the following statements about the marginal cost of capital is correct?
A. The marginal cost of capital declines as flotation costs alter equity financing.
B. The marginal cost of capital is a firm's cost of debt and equity finance.
C. The marginal cost of capital refers to the cost of additional funds.
D. The marginal cost of capital is constant once the optimal capital structure is determined.
37. The lower the debt ratio, the
A. higher are the firm's total assets.
B. lower are the firm's total assets.
C. lower is the use of financial leverage.
D. higher is the use of financial leverage.
38.
Coupon rate = 7 percent
Average tax rate = 32%
Price of common stock = $80
Price of preferred stock = $50
Bond yield risk premium = 7%
Return of the market = 12%
Marginal tax rate = 35%
Common stock dividend (Do) = $6
Preferred stock dividend (Do) = $4
Growth rate of common stock dividend = 6%
Risk-free rate of return = 6%
Beta = 1.2
According to the information given, what is the cost of equity using the capital asset pricing model?
A. 13.95 percent
B. 14.4 percent
C. 12 percent
D. 13.2 percent
39.
Coupon rate = 7 percent
Average tax rate = 32%
Price of common stock = $80
Price of preferred stock = $50
Bond yield risk premium = 7%
Return of the market = 12%
Marginal tax rate = 35%
Common stock dividend (Do) = $6
Preferred stock dividend (Do) = $4
Growth rate of common stock dividend = 6%
Risk-free rate of return = 6%
Beta = 1.2
According to the information given, what is the cost of preferred stock?
A. 12 percent
B. 9 percent
C. 10 percent
D. 8 percent
40. An increase of cost of capital will
A. increase an investment's IRR.
B. decrease an investment's NPV.
C. decrease an investment's IRR.
D. Increase an investment's NPV.