Do you have answers to BAM 313 Introduction to Financial Management, Foundations of Finance Eighth Edition
Exam 1
1. The DEF Company is planning a $64 million expansion. The expansion is to be financed by selling $25.6 million in new debt and $38.4 million in new common stock. The before-tax required rate of return on debt is 9 percent and the required rate of return on equity is 14 percent. If the company is in the 35 percent tax bracket, what is the firm's cost of capital?
a. 8.92%
b. 10.74%
c. 11.50%
d. 9.89%
Valley Flights, Inc. has a capital structure made up of 40% debt and 60% equity and a tax rate of 30%. A new issue of $1,000 par bonds maturing in 20 years can be issued with a coupon of 9% at a price of $1,098.18 with no flotation costs. The firm has no internal equity available for investment at this time, but can issue new common stock at a price of $45. The next expected dividend on the stock is $2.70. The dividend for the firm is expected to grow at constant annual rate of 5% per year indefinitely. Flotation costs on new equity will be $7.00 per share. The company has the following independent investment projects available:
| Project |
Initial Outlay |
IRR |
| 1 |
$100,000 |
10% |
| 2 |
$10,000 |
8.50% |
| 3 |
$50,000 |
12.50% |
2. Which of the above projects should the company take on?
a. Project 3 only
b. Projects 1, 2 and 3
c. Projects 1 and 3
d. Projects 1 and 2
3. PrimaCare has a capital structure that consists of $7 million of debt, $2 million of preferred stock, and $11 million of common equity, based upon current market values. The firm's yield to maturity on its bonds is 7.4%, and investors require an 8% return on the firm's preferred stock and a 14% return on PrimaCare's common stock. If the tax rate is 35%, what is PrimaCare's WACC?
a. 7.21%
b. 10.18%
c. 12.25%
d. 8.12%
4. JPR Company is financed 75 percent by equity and 25 percent by debt. If the firm expects to earn $30 million in net income next year and retain 40% of it, how large can the capital budget be before common stock must be sold?
a. $15.5 million
b. $7.5 million
c. $16.0 million
d. $12.0 million
5. All else equal, an increase in beta results in:
a. an increase in the cost of retained earnings
b. an increase in the cost of common equity, whether or not the funds come from retained earnings or newly issued common stock
c. an increase in the cost of newly issued common stock
d. an increase in the after-tax cost of debt
6. Haroldson Inc. common stock is selling for $22 per share. The last dividend was $1.20, and dividends are expected to grow at a 6% annual rate. Flotation costs on new stock sales are 5% of the selling price. What is the cost of Haroldson's retained earnings?
a. 12.09%
b. 11.78%
c. 11.45%
d. 5.73%
7. A company has preferred stock that can be sold for $21 per share. The preferred stock pays an annual dividend of 3.5% based on a par value of $100. Flotation costs associated with the sale of preferred stock equal $1.25 per share. The company's marginal tax rate is 35%. Therefore, the cost of preferred stock is:
a. 14.26%
b. 12.94%
c. 18.87%
d. 17.72%
8. Which of the following should NOT be considered when calculating a firm's WACC?
a. after-tax YTM on a firm's bonds
b. cost of newly issued preferred stock
c. after-tax cost of accounts payable
d. cost of newly issued common stock
9. Your firm is considering an investment that will cost $920,000 today. The investment will produce cash flows of $450,000 in year 1, $270,000 in years 2 through 4, and $200,000 in year 5. The discount rate that your firm uses for projects of this type is 11.25%. What is the investment's profitability index?
a. 1.26
b. 1.69
c. 1.21
d. 1.43
10. Your firm is considering investing in one of two mutually exclusive projects. Project A requires an initial outlay of $3,500 with expected future cash flows of $2,000 per year for the next three years. Project B requires an initial outlay of $2,500 with expected future cash flows of $1,500 per year for the next two years. The appropriate discount rate for your firm is 12% and it is not subject to capital rationing. Assuming both projects can be replaced with a similar investment at the end of their respective lives, compute the NPV of the two chain cycle for Project A and three chain cycle for Project B.
a. $2,865 and $94
b. $3,528 and $136
c. $5,000 and $1,500
d. $2,232 and $85
11 The capital budgeting manager for XYZ Corporation, a very profitable high technology company, completed her analysis of Project A assuming 5-year depreciation. Her accountant reviews the analysis and changes the depreciation method to 3-year depreciation. This change will:
a. increase the present value of the NCFs
b. have no effect on the NCFs because depreciation is a non-cash expense
c. only change the NCFs if the useful life of the depreciable asset is greater than 5 years
d. decrease the present value of the NCFs
12. Lithium, Inc. is considering two mutually exclusive projects, A and B. Project A costs $95,000 and is expected to generate $65,000 in year one and $75,000 in year two. Project B costs $120,000 and is expected to generate $64,000 in year one, $67,000 in year two, $56,000 in year three, and $45,000 in year four. Lithium, Inc.'s required rate of return for these projects is 10%. The modified internal rate of return for Project B is:
a. 18.52%
b. 22.80%
c. 19.75%
d. 17.84%
13. A capital budgeting project has a net present value of $30,000 and a modified internal rate of return of 15%. The project's required rate of return is 13%. The internal rate of return is:
a. greater than $30,000
b. greater than 15%
c. between 13% and 15%
d. less than 13%
14. A new project is expected to generate $800,000 in revenues, $250,000 in cash operating expenses, and depreciation expense of $150,000 in each year of its 10-year life. The corporation's tax rate is 35%. The project will require an increase in net working capital of $85,000 in year one and a decrease in net working capital of $75,000 in year ten. What is the free cash flow from the project in year one?
a. $410,000
b. $375,000
c. $380,000
d. $298,000
15. A local restaurant owner is considering expanding into another rural area. The expansion project will be financed through a line of credit with City Bank. The administrative costs of obtaining the line of credit are $500, and the interest payments are expected to be $1,000 per month. The new restaurant will occupy an existing building that can be rented for $2,500 per month. The incremental cash flows for the new restaurant include:
a. $2,500 per month rent
b. $500 administrative costs, $1,000 per month interest payments, $2,500 per month rent
c. $1,000 per month interest payments, $2,500 per month rent
d. $500 administrative costs, $2,500 per month rent
16. Which of the following should be included in the initial outlay?
a. increased investment in inventory and accounts receivable
b. preexisting firm overhead reallocated to the new project
c. first year depreciation expense on any new equipment purchased
d. taxable gain on the sale of old equipment being replaced
17. QRW Corp. needs to replace an old lathe with a new, more efficient model. The old lathe was purchased for $50,000 nine years ago and has a current book value of $5,000. (The old machine is being depreciated on a straight-line basis over a ten-year useful life.) The new machine costs $100,000. It will cost the company $10,000 to get the new lathe to the factory and get it installed. The old machine will be sold as scrap metal for $2,000. The new machine is also being depreciated on a straight-line basis over ten years. Sales are expected to increase by $8,000 per year while operating expenses are expected to decrease by $12,000 per year. QRW's marginal tax rate is 40%. Additional working capital of $3,000 is required to maintain the new machine and higher sales level. The new lathe is expected to be sold for $5,000 at the end of the project's ten-year life. What is the incremental free cash flow during year 1 of the project?
a. $11/100
b. $15,200
c. $12,800
d. $14,400
18. The cost of retained earnings is less than the cost of new common stock because:
a. dividends are not tax deductible
b. flotation costs are incurred when new stock is issued
c. accounting rules allow a deduction when using retained earnings
d. marginal tax brackets increase
19. Beauty Inc. plans to maintain its optimal capital structure of 40 percent debt, 10 percent preferred stock, and 50 percent common equity indefinitely. The required return on each component source of capital is as follows: debt--8 percent; preferred stock--12 percent; common equity--16 percent. Assuming a 40 percent marginal tax rate, what after-tax rate of return must the firm earn on its investments if the value of the firm is to remain unchanged?
a. 12.00 percent
b. 11.12 percent
c. 12.40 percent
d. 10.64 percent
20. Your firm is considering an investment that will cost $920,000 today. The investment will produce cash flows of $450,000 in year 1, $270,000 in years 2 through 4, and $200,000 in year 5. The discount rate that your firm uses for projects of this type is 11.25%. What is the investment's internal rate of return?
a. 15.98%
b. 27.28%
c. 20.53%
d. 21.26%
21. The advantages of NPV are all of the following EXCEPT:
a. it provides the amount by which positive NPV projects will increase the value of the firm
b. it allows the comparison of benefits and costs in a logical manner through the use of time value of money principles
c. it recognizes the timing of the benefits resulting from the project
d. it can be used as a rough screening device to eliminate those projects whose returns do not materialize until later years
22. Which of the following are included in the terminal cash flow?
a. recapture of any working capital increase included in the initial outlay
b. the expected salvage value of the asset
c. any tax payments or receipts associated with the salvage value of the asset
d. all of the above
23. Which of the following differentiates the cost of retained earnings from the cost of newly issued common stock?
a. the larger dividends paid to the new common stockholders
b. the flotation costs incurred when issuing new securities
c. the cost of the pre-emptive rights held by existing shareholders
d. the greater marginal tax rate faced by the now-larger firm
24. Lithium, Inc. is considering two mutually exclusive projects, A and B. Project A costs $95,000 and is expected to generate $65,000 in year one and $75,000 in year two. Project B costs $120,000 and is expected to generate $64,000 in year one, $67,000 in year two, $56,000 in year three, and $45,000 in year four. Lithium, Inc.'s required rate of return for these projects is 10%. The profitability index for Project B is:
a. 1.55
b. 1.39
c. 1.33
d. 1.48
25. When terminating a project for capital budgeting purposes, the working capital outlay required at the initiation of the project will:
a. increase the cash flow because it is recaptured
b. decrease the cash flow because it is an outlay
c. not affect the cash flow
d. decrease the cash flow because it is a historical cost
Exam 2
Multiple Choice Questions (Enter your answers on the enclosed answer sheet)
1. A high degree of variability in a firm's earnings before interest and taxes refers to:
a. business risk
b. financial leverage
c. operating leverage
d. financial risk
2. If a firm has no operating leverage and no financial leverage, then a 10% increase in sales will have what effect on EPS?
a. EPS will increase by 10%
b. EPS will remain the same
c. EPS will increase by less than 10%
d. EPS will decrease by 10%
3. According to the moderate view of capital costs and financial leverage, as the use of debt financing increases:
a. the cost of capital continuously increases
b. there is an optimal level of debt financing
c. the cost of capital remains constant
d. the cost of capital continuously decreases
4. The primary weakness of EBIT-EPS analysis is that:
a. it double counts the cost of debt financing
b. it applies only to firms with large amounts of debt in their capital structure
c. it may only be used by firms that are profitable this year
d. it ignores the implicit cost of debt financing
5. Potential applications of the break-even model include:
a. optimizing the cash-marketable securities position of a firm
b. replacement for time-adjusted capital budgeting techniques
c. pricing policy
d. All of the above.
6. The Modigliani and Miller hypothesis does NOT work in the "real world" because:
a. interest expense is tax deductible, providing an advantage to debt financing
b. higher levels of debt increase the likelihood of bankruptcy, and bankruptcy has real costs for any corporation
c. both a and b
d. dividend payments are fixed and tax deductible for the corporation
7. A corporation with very high growth prospects and many positive NPV projects to fund may want to increase its dividend based on the:
a. very low agency costs of the corporation
b. information effect
c. tax bias against capital gains
d. residual dividend theory
8. Which of the following strategies may be used to alter a firm's capital structure toward a higher percentage of debt compared to equity?
a. stock split
b. stock repurchase
c. stock dividend
d. maintain a low dividend payout ratio
9. AFB, Inc.'s dividend policy is to maintain a constant payout ratio. This year AFB, Inc. paid out a total of $2 million in dividends. Next year, AFB, Inc.'s sales and earnings per share are expected to increase. Dividend payments are expected to:
a. increase above $2 million only if the company issues additional shares of common stock
b. decrease below $2 million
c. increase above $2 million
d. remain at $2 million
10. Which of the following is true?
a. In industries with volatile earnings, the residual dividend policy results in the most consistent dividend stream.
b. If the clientele effect is correct, firms should follow a constant dividend payout ratio policy.
c. In general, the higher the number of positive NPV investment opportunities for a firm, the lower the dividend payout ratio.
d. According to the informational content of dividends, an increase in dividends is always a positive signal.
11. Which of the following is always a non-cash expense?
a. salaries
b. depreciation
c. income taxes
d. None of the above.
12. Which of the following is a limitation of the "percent of sales method" of preparing pro forma financial statements?
a. Inventory levels are seldom affected by changes in sales volume.
b. A firm's investment in accounts receivable is seldom related to sales volume.
c. Not all assets and liabilities increase or decrease as a constant percent of sales.
d. The dividend payout ratio may change from one year to the next.
13. Spontaneous sources of funds refer to all of the below EXCEPT:
a. accounts payable
b. accruals
c. common stock
d. a bank loan
14. Selection of a source of short-term financing should include all of the following EXCEPT:
a. the effect of the use of credit from a particular source on the cost and availability of other sources of credit
b. the floatation costs for debentures
c. the effective cost of credit
d. the availability of financing in the amount and for the time needed
15. The terminal warehouse agreement differs from the field warehouse agreement in that:
a. the cost of the terminal warehouse agreement is lower due to the lower degree of risk
b. the warehouse procedure differs for both agreements
c. the terminal agreement transports the collateral to a public warehouse
d. the borrower of the field warehouse agreement can sell the collateral without the consent of the lender
16. Your company buys supplies on credit terms of 2/10 net 45. Suppose the company makes a purchase of $20,000 today. Which of the following payment options makes the most sense as a general rule?
a. pay the bill as soon as possible to keep the supplier happy
b. pay the bill on day 10 to get the discount
c. either pay the bill on day 10 to get the discount, or wait until day 45
d. pay the bill on day 45 due to the time value of money
17. Which of the following statements about financial leverage is true?
a. Financial leverage is the responsiveness of the firm's EBIT to fluctuations in sales.
b. Financial leverage is the responsiveness of the firm's EPS to fluctuations in EBIT.
c. Financial leverage involves the incurrence of fixed operating costs in the firm's income stream.
d. Financial leverage reduces a firm's risk.
18. Which of the following statements about combined (operating & financial) leverage is true?
a. Usage of both operating and financial leverage reduces a firm's risk.
b. If a firm employs both operating and financial leverage, any percent change in sales will produce a larger percent change in earnings per share.
c. High operating leverage and high financial leverage offset one another, meaning that if sales increase by 10%, then EPS will also increase by 10%.
d. A firm that is in a capital-intensive industry should use a higher level of financial leverage than a firm that employs low levels of operating leverage.
19. The "bird-in-the-hand dividend theory" supports which view of the effect of dividend policy on company value?
a. constant dividends increase stock values
b. high dividends increase stock values
c. a firm's dividend policy is irrelevant
d. low dividends increase stock values
20. All of the following will increase the discretionary financing needed EXCEPT:
a. decrease the dividend payout ratio
b. decrease the spontaneous financing
c. decrease the sales growth rate
d. decrease the net profit margin
21. If a firm relies on short-term debt or current liabilities in financing its asset investments, and all other things remain the same, what can be said about the firm's liquidity?
a. The liquidity of the firm will be unchanged.
b. The firm will be relatively more liquid.
c. The firm will be relatively less liquid.
d. The firm will be more liquid only if interest rates are below the company's weighted average cost of capital.
22. Dakota Oil, Inc. reported that its sales and EBIT increased by 10%, but its EPS increased by 30%. The much larger change in earnings per share could be the result of:
a. high operating leverage
b. high financial leverage
c. high fixed costs of production
d. a high percentage of credit sale collections from prior years
23. Which of the following statements would be consistent with the bird-in-the-hand dividend theory?
a. Dividends are less certain than capital gains.
b. Investors are indifferent whether stock returns come from dividend income or capital gains income.
c. Wealthy investors prefer corporations to defer dividend payments because capital gains produce greater after-tax income.
d. Dividends are more certain than capital gains income.
24. The term "lumpy asset" means:
a. assets that have economies of scale but not economies of scope
b. assets that must be purchased in discrete quantities
c. the same thing as assets that exhibit scale economies
d. assets that can be purchased in incremental units
25. All of the following are potential advantages of commercial paper EXCEPT:
a. ability to borrow very large amounts
b. flexible repayment terms
c. no compensating balance requirements
d. lower interest rates than comparable sources of short-term financing