Question 1. For a typical firm with a given capital structure, which of the following is correct? (Note: All rates are after taxes.)
a. kd > ke > ks > WACC.
b. ks > ke > kd > WACC.
c. WACC > ke > ks > kd.
d. ke > ks > WACC > kd.
Question 2. Which of the following approaches to estimating the cost of common equity is the least difficult to estimate?
a. Expected growth rate, g.
b. Dividend yield, D1/Po.
c. Required return, ks.
d. Expected rate of return, k(hat)s.
Question 3. Wyden Brothers has no retained earnings. The company uses the CAPM to calculate the cost of equity capital. The company’s capital structure consists of common stock, preferred stock, and debt. Which of the following events will reduce the company’s WACC?
a. A reduction in the market risk premium.
b. An increase in the flotation costs associated with issuing new common stock.
c. An increase in the company’s beta.
d. An increase in expected inflation.
Question 4. If the result of applying the NPV technique for evaluating a capital project is a negative figure, it implies that:
a. the required rate of return has not been achieved
b. the investment will not add value or contribute to shareholder wealth
c. the present value of the expected cash outflows is greater than the present value of the expected cash flows.
d. All of the above
Question 5. A firm may not be able to undertake all possible capital projects that have positive NPVs. Some reasons may not be financial, but for a firm to determine which capital techniques are most financially viable:
a. the payback method has always proved reliable in ranking the best of the best capital projects
b. request that the treasury department secure more funding
c. techniques known as capital rationing must be used
d. all of the above
Question 6. When evaluating capital budgeting projects, most managers of big companies gravitate toward
a. NPV
b. Payback method
c. IRR
d. None of the above
Question 7. A project has an up-front cost of $100,000. The project’s WACC is 12 percent and its net present value is $10,000. Which of the following statements is most correct?
a. The project should be rejected since its return is less than the WACC.
b. The project’s internal rate of return is greater than 12 percent.
c. The project’s modified internal rate of return is less than 12 percent.
d. All of the statements above are correct.
Question 8. Which of the following statements is most correct?
a. If a project with normal cash flows has an IRR which exceeds the cost of capital, then the project must have a positive NPV.
b. If the IRR of Project A exceeds the IRR of Project B, then Project A must also have a higher NPV.
c. The modified internal rate of return (MIRR) can never exceed the IRR.
d. Statements a and c are correct.
Question 9. A company estimates that its weighted average cost of capital (WACC) is 10 percent. Which of the following independent projects should the company accept?
a. Project A requires an up-front expenditure of $1,000,000 and generates a net present value of $3,200.
b. Project B has a modified internal rate of return of 9.5 percent.
c. Project C requires an up-front expenditure of $1,000,000 and generates a positive internal rate of return of 9.7 percent.
d. Project D has an internal rate of return of 9.5 percent.
Question 10. The internal rate of return (IRR) is the rate of interest that makes the present value of the cash inflows:
a. greater than the present value of cash outflows
b. less than the present value of the cash outflows
c. equal to the present value of cash outflows
d. none of the above.
Question 11. A company is considering a new project. The company’s CFO plans to calculate the project’s NPV by discounting the relevant cash flows (which include the initial up-front costs, the operating cash flows, and the terminal cash flows) at the company’s cost of capital (WACC). Which of the following factors should the CFO include when estimating the relevant cash flows?
a. Any sunk costs associated with the project.
b. Any interest expenses associated with the project.
c. Any opportunity costs associated with the project.
d. Statements b and c are correct.
Question 12. Which of the following is discussed in the text as a method for analyzing risk in capital budgeting?
a. Sensitivity analysis.
b. Monte Carlo simulation.
c. Scenario analysis.
d. All of the above
Question 13. A firm is considering the purchase of an asset whose risk is greater than the current risk of the firm, based on any method for assessing risk. In evaluating this asset, the decision maker should
a. Increase the NPV of the asset to reflect the greater risk.
b. Reject the asset, since its acceptance would increase the risk of the firm.
c. Ignore the risk differential if the asset to be accepted would comprise only a small fraction of the total assets of the firm.
d. Increase the cost of capital used to evaluate the project to reflect the higher risk of the proj¬ect.
Question 14. Business risk is concerned with the operations of the firm. Which of the following is not associated with (or not a part of) business risk?
a. Demand variability.
b. Sales price variability.
c. The extent to which operating costs are fixed.
d. Changes in required returns due to financing decisions.
Question 15. Which of the following statements is most correct?
a. The capital structure that maximizes stock price is also the capital structure that minimizes the weighted average cost of capital (WACC).
b. The capital structure that maximizes stock price is also the capital structure that maximizes earnings per share.
c. The capital structure that maximizes stock price is also the capital structure that maximizes the firm’s times interest earned (TIE) ratio.
d. Statements a and b are correct.
Question 16. Which of the following statements is most correct?
a. Increasing financial leverage is one way to increase a firm’s basic earning power (BEP).
b. Firms with lower fixed costs tend to have greater operating leverage.
c. The debt ratio that maximizes EPS generally exceeds the debt ratio which maximizes share price.
d. Statements a and b are correct.
Question 17. Which of the following statements is most correct?
a. An increase in the personal tax rate would not affect firms’ capital structure decisions.
b. In general, a firm with low operating leverage has a small proportion of its total costs in the form of fixed costs.
c. A firm with high business risk is more likely to increase its use of financial leverage than a firm with low business risk, assuming all else equal.
d. Statements a and b are correct.
Question 18. When a firm offers its shareholders the opportunity to reinvest their dividends into additional shares of stock as an alternative to cash dividends, the tax implications:
a. are of no consequence because the shareholder does not receive any cash
b. require that the shareholder pay a tax at the time the additional shares are sold
c. require that the shareholder pay a tax in the year he or she receives the additional share to the extent of their dividend equivalency
d. require that the shareholder pay a tax on the appreciated value of the additional shares when they are eventually sold.
Question 19. The underlying reason for investors’ aversion to receiving income from dividends is the less favorable tax treatment of dividend income. Capital gain income offers the following tax advantage(s) over dividend income:
a. the deferral of any capital gains tax until the sale of the appreciated stock
b. upon the death of the investor, transfer of the stock to heirs at the stock’s then current market value, thus avoiding a capital gains
c. a slight reduction, under current law, in the tax rates applied to capital gains
d. all of the above