Michaelangelo, Inc., an art firm has debt of $40,000 (market value). The cost of debt for the firm before-tax is 18.33%. The tax rate for the firm is 40%. If the firm also has equity of $60,000 (market value) whose cost is 17%, what would be the firm's cost of capital assuming that the firm uses only these two sources of financing?
12.93%
14.6%
16.39%
17%
Question 2.2. Expansion Video is considering expanding its video rental library to 8,000 tapes. The purchase price of the additional videos will be $80,000 and the shipping cost is another $4,000. To house the tapes, the owner will have to spend another $10,000 for display shelves, increase net working capital by $1,000, and interest expenses will add another $3,000 to the operating cost. What is the net investment to Expansion Video for this project?
$95,000
$99,000
$84,000
$107,000
Question 3.3. If I had a net investment of $40,000 with cash inflows amounting to $20,000 per year for three years (years 1-3) what would be the discounted payback on the project if the cost of capital is 10%? If I had a cutoff of two years in discounted payback, would I accept this project? (Points : 3)
1.35 years; accept
1.95 years; reject
2.35 years; reject
exactly 3 years; reject
Question 4.4. Time Turman, Inc., is considering a drill press costing $30,000 and is expected to have a 10 year life. The drill press will be depreciated on a straight-line basis over 10 years to a zero estimated salvage value. This machine is expected to reduce the firm's cash operating costs by $4,500 per year. If the firm is in the 40 percent marginal tax bracket, determine the annual net cash flows generated by the drill press.
$4,500
$900
$5,700
$3,900
Question 5.5. Parker Chemicals purchased a hexene extractor 10 years ago for $120,000. It is being depreciated on a straight-line basis over 15 years to an estimated salvage value of zero. It can be sold today for $10,000. Parker is considering purchasing a new more efficient extractor that would cost $270,000 installed and would be depreciated as a 10-year MACRS asset. The company's marginal tax rate is 40%. Determine the NINV if the old extractor is sold and the new one is purchased.
$252,000
$228,000
$260,000
$248,000
Question 6.6. Consider a capital expenditure project with an expected 10-year economic life and forecasted revenues equal to $40,000 per year; cash expenses are estimated to be $29,000 per year. The cost of the project equipment is $23,000, and the equipment's estimated salvage value at the end of the project is $9000.The equipment's $23,000 cost will be depreciated using MACRS depreciation (7-year asset). The project requires a $7,000 working capital investment in year 0 and another $5,000 in year 5. The company's marginal tax rate is 40%. Calculate the expected net cash flow in year 10 of the project. (Points : 3)
$32,000
$27,000
$24,000
$18,000
Question 7.7. If I have an initial outlay of $560 on a project and it has cash inflows of $290 per year for three years, would I invest in the project if I had a cost of capital of 13.6%. Assume I use the Internal rate of return method.
Yes, I would. Calculated IRR exceeds 13.6%.
No, I would not. Calculated IRR is lower than cost of capital.
The project would not add to the company and therefore I would not invest in it. IRR is not the method but based strictly on payback I would be forced to refuse this project.
Question 8.8. What is the discounted payback period for a project with an initial outlay of $40,000 and cash inflows of $20,000 per year for 3 years. Assume that the cost of capital is 10%. (Points : 3)
3 years
2.94 years
1.78 years
2.35 years
no discounted payback for this project
Question 9.9. Enjam Loving, Inc., is considering two mutually exclusive projects. Project A and Project B both have an initial outlay of $500. The cash flows from project A (in dollars) are: 100 in year 1, 200 in year 2, 300 in year 3 and 400 in year 4. Project B pays 400 dollars in year 1, 300 dollars in year 2, 200 dollars in year 3 and 100 dollars in year 4. Loving uses both NPV and Simple payback period criterion for decision making. Assuming a cost of capital of 6%, which project would the company choose? (Points : 3)
A
B
B since A's NPV is higher
A since B's PBP is lower
Neither A nor B
Question 10.10. The stock price of Webliography Inc., a web search engine company is currently $31.51 and the current quarterly dividend is $0.25. Consensus estimates for Webliography indicate a growth rate in earnings of 10% into the foreseeable future. If Webliography plans to sell 1 million shares to raise new capital for expansion, what is the cost of new equity if the issuance costs are 8%? (Hint: You need to calculate annual dividend from the quarterly dividend and use that as D0) (Points : 3)
13.49%
10.87%
13.21%
13.17%
Question 11.11. Project OBOL has an inital outlay of $2000. If the cash flows from the project are 200 in year 1, 600 in year 2, 800 in year 3, and 1,400 in year 4, what would be the MIRR for the project given that the cost of capital for the project is 10%? (Points : 3)
A little under 11%
exactly 9.86%
11.7% approximately
13.10%
Question 12.12. Which of the following is not part of a group that includes the other three: (Points : 3)
Trade Credit
Accrued Expenses
Commercial paper
Deferred Income
Question 13.13. A ten year bond has a $1,000 face value and was issued 5 years ago. The bond which matures in 5 years has a 7% annual coupon rate (paid semi-annually in two payments of $35 each). The bond currently sells for $1042.65. What is the after tax cost of debt for this bond if the tax rate for the company is 40%? (Points : 3)
About 1.8%
About 1.2%
6%
7%
3.6%
Question 14.14. An investment project requires a net investment of $100,000. The project is expected to generate annual net cash inflows of $28,000 for the next 5 years. The firm's cost of capital is 12 percent. Determine the internal rate of return for the project (to the nearest tenth of one percent). (Points : 3)
12.0%
12.6%
3.6%
12.38%
Question 15.15. Mid-South Utilities will sell $10 million of $100 par value preferred stock that will pay an annual dividend of $9.75. Mid-South will receive $93.98 per share after flotation costs. What is the cost of the preferred issue? (Points : 3)
10.37%
10.50%
10.23%
9.75%
Question 16.16. The risk-adjusted discount rate approach is preferable to the weighted cost of capital approach when (Points : 3)
all projects have the same risk characteristics
the risk-free rate is known with certainty
the projects under consideration have different risk characteristics
the firm is unlevered
Question 17.17. Sally Harmon's broker told her that the expected return from her portfolio was 14.2%. If 40% of her securities have an expected return of 10.3 percent and 20% have an expected return of 12.8 percent, what is the expected return of the remaining portion of her portfolio? (Points : 3)
28.9%
18.8%
12.5%
cannot be determined
Question 18.18. What is the weighted average cost of capital for Big Fun Corporation?
Source of Capital
Capital Components
Cost
Long Term Debt
$60,000
5.6% after-tax
Preferred Stock
$15,000
10.6%
Common Stock
$75,000
13.0%
(Points : 3)
6.9%
8.5%
10.2%
9.8%
Question 19.19. Multiple internal rates of return can occur when there is (are): (Points : 3)
large abandonment costs at the end of a project's life
a major shutdown and rebuilding of a facility sometime during its life
more than one sign change in the pattern of cash flows over a project's life.
all of the above are correct
Question 20.20. A firm's _______________ is equal to its operating cycle minus its ____. (Points : 3)
cash conversion cycle, inventory conversion period
cash conversion cycle, receivables conversion period
cash conversion cycle, payables deferral period
none of the above
Question 21.21. If a project has an initial outlay of $300, and cash inflows of $80 per year for four years and a cash inflow of $110 in year 5, its Profitability Index will be below 1 given a cost of capital of 15%. (Points : 3)
True
False
Question 22.22. What is the internal rate of return for a project that has a net investment of $60,000 and the following net cash flows: Year 1 = $15,000; Year 2 = $20,000; Year 3 = $25,000; Year 4 = $32,000? (Points : 3)
17.08%
16.7%
15.7%
16.3%
Question 23.23. An investment project requires a net investment of $100,000. The project is expected to generate annual net cash inflows of $28,000 for the next 5 years. The firm's cost of capital is 12 percent. Determine the payback period for the project. (Points : 3)
0.28 years
1.4 years
3.57 years
17.86 years
Question 24.24. A firm's operating cycle is equal to its ____. (Points : 3)
inventory conversion period plus receivables conversion period
cash conversion cycle minus payables deferral period
a and b
none of the above
Question 25.25. If a project has an inital outlay of $560 and cash inflows of $240 per year for three years, what would be its MIRR? Assume a cost of capital of 12%. Would you accept this project? (Points : 3)
12%; No
11.79%; No
13.09%, yes
15.3%, no
Question 26.26. Project Harness has an outlay of $300,000 and cash inflows of -$50,000 in year 1, $100,000 in year 2, $100,000 in year 3, $400,000 in year 4 and $300,000 in year 5. If the cost of capital for Harness is 15%, what is the NPV for the project. (Points : 3)
over $300,000 but under $456,789
over $200,000 but under $300,000
approximately $1,567,903
over $100,000 but below $200,000
Question 27.27. Corey plans to invest 75 percent of her funds in the common stock of B. Gamma Industries and 25 percent in K. Epsilon Company. The standard deviation of returns for Gamma is 8 percent and for Epsilon is 12 percent. The correlation between the returns for Gamma and Epsilon is +0.8.
Determine the standard deviation of returns for Corey's portfolio. (Points : 4)
7.38%
6.779%
13.059%
8.59%
Question 28.28. Which of the following is not a major step in the capital budgeting process? (Points : 3)
generating investment project proposals
estimating cash flows
analyzing the effect of a project on the firm's financial ratios
performing a project post-audit and review
Question 29.29.
The certainty equivalent factors used to adjust the cash flows for risk can range from
(Points : 3)
-1 to +1
0 to infinity
+.01 to +.99
0 to +1.0
Question 30.30. A firm can raise up to $700 million for investment from a mixture of debt, preferred stock and retained equity. Above $700 million, the firm must issue new common stock. Assuming that debt costs and preferred stock costs remain unchanged, the marginal cost of capital for amounts up to $700 million will be ____ the marginal cost of capital for amounts over $700 million. (Points : 3)
less than
equal to
greater than
cannot be determined from the information given
Question 31.31.
The length of the operating cycle is equal to the length of the
I. Inventory conversion period.
II. Receivables conversion period.
(Points : 3)
Only statement I is correct.
Only statement II is correct.
Both statements I and II are correct.
Neither statement I nor II is correct.
Question 32.32. Billy Bob is considering building a water slide park that will require a net investment of $200,000 and yield the following net cash flows:
Year
Net Cash Flows
Cert. Equiv. Factor
1
$120,000
.90
2
90,000
.80
3
60,000
.65
4
30,000
.50
5
10,000
.30
If the risk-free rate is 8 percent and the market risk premium is 6 percent, what is the certainty equivalent NPV for this project? (Points : 3)
$12,805
$ 5,746
$ 3,703
$11,025
Question 33.33. Calco is a multi-divisional firm with a weighted cost of capital of 14 percent and a risk-adjusted discount rate for its can division of 17 percent. A planned expansion in the can division requires a net investment of $170,000 and results in expected cash inflows of $42,000 a year for seven years. Should Calco invest in this expansion? (Points : 3)
Yes, NPV = $10,096
Yes, NPV = $ 9,896
No, NPV = -$5,276
No, NPV = -$9,896