4) Assume General Motors has a weighted average cost of capital of 10%. GM is
considering investing in a new plant that will save the company $30 million over each of
the irst two years, and then $25 million each year thereafter. If the investment is $150
million, what is the net present value (NPV) of the project?
A) $65.2 million
B) -$76.1 million
C) -$86.9 million
D) $108.7 million
AACSB Objective: Analytic Skills
Author: KB
Question Status: Previous Edition
5) When we use the WACC to assess a project, we assume that the ________ ratio does not
change.
A) reward to systematic risk
B) risk to reward
C) debt to equity
D) volatility to systematic risk
AACSB Objective: Analytic Skills
Author: KB
Question Status: Previous Edition
6) When we compute the cost of equity capital for a project we assume that the ________ of
the project is equivalent to the average market risk of the irm’s investments.
A) diversiiable risk
B) market risk
C) unsystematic risk
D) volatility
AACSB Objective: Analytic Skills
Author: KB
Question Status: Previous Edition
31
7) Assume SAP Inc. received a $1 million grant under its Small Business Innovation
program. SAP invested the grant money and developed a system to remove metal
contaminants from storm water in shipyards. The irm estimates that each shipyard spends
$500,000 a year on storm water clean-up eforts. If SAP is able to sign up and retain four
shipyards from the irst year onwards, what is the present value (PV) of the project (net of
investment) if the cost of capital for SAP is 20% per year? Assume a cost of operations and
other costs for SAP equal 60% of revenue.
A) $3.00 million
B) $3.30 million
C) 3.60 million
D) $3.90 million
AACSB Objective: Analytic Skills
Author: KB
Question Status: Previous Edition
8) Assume SAP Inc. received a $2 million grant under its Small Business Innovation
program. SAP invested the grant money and developed a system to remove metal
contaminants from storm water in shipyards. The irm estimates that each shipyard spends
$600,000 a year on storm water clean-up eforts. If SAP is able to sign up and retain four
shipyards from the irst year onwards, what is the present value (PV) of the project (net of
investment) if the cost of capital for SAP is 14% per year? Assume a cost of operations and
other costs for SAP equal 60% of revenue.
A) $3.89 million
B) $4.13 million
C) $4.86 million
D) $5.10 million
AACSB Objective: Analytic Skills
Author: KB
Question Status: Previous Edition
32
9) SAP Inc. received a $1.5 million grant under its Small Business Innovation program. SAP
invested the grant money and developed a system to remove metal contaminants from
storm water in shipyards. The irm estimates that each shipyard spends $500,000 a year on
storm water clean-up eforts. If SAP is able to sign up and retain four shipyards in the irst
year onwards, what is the present value (PV) of the project (net of investment) if the cost of
capital for SAP is 14% per year? Assume a cost of operations and other costs for SAP equal
50% of revenue.
A) $4.51 million
B) $4.80 million
C) $5.93 million
D) $5.64 million
AACSB Objective: Analytic Skills
Author: KB
Question Status: Previous Edition
10) A irm is considering investing in a new project with an upfront cost of $400 million.
The project will generate an incremental free cash low of $50 million in the irst year and
this cash low is expected to grow at an annual rate of 3% forever. If the irm’s WACC is
12%, what is the value of this project?
A) $155.6 million
B) $555.6 million
C) $583.3 million
D) $183.3 million
AACSB Objective: Analytic Skills
Author: WC
Question Status: Previous Edition
11) Which of the following is NOT a step in the WACC valuation method?
A) Compute the weighted average cost of capital.
B) Discount the incremental free cash lows of the investment using the weighted average
cost of capital.
C) Determine the incremental free cash lows of the investment.
D) Determine the mean weighted average cost of capital for the irm’s industry.
AACSB Objective: Analytic Skills
Author: WC
Question Status: Previous Edition
33
12) What is the assumption about risk when using WACC to evaluate a project?
AACSB Objective: Analytic Skills
Author: SS
Question Status: Previous Edition
13) What is the assumption about leverage when using WACC to evaluate a project?
AACSB Objective: Analytic Skills
Author: SS
Question Status: Previous Edition
13.5 Project-Based Costs of Capital
1) Firms that have many divisions with diferent lines of business do not use a
companywide WACC to evaluate projects.
AACSB Objective: Analytic Skills
Author: KB
Question Status: Previous Edition
2) Divisional costs of capital are more appropriate when evaluating a project for a line of
business when the types of business in a irm are ________.
A) mature businesses
B) similar
C) new businesses
D) diferent
AACSB Objective: Analytic Skills
Author: KB
Question Status: Previous Edition
34
3) Anheuser Busch, a manufacturer of beverages, is planning to purchase Six Flags theme
parks. Anheuser Busch should use the ________ to evaluate the business of Six Flags.
A) WACC of Anheuser Busch
B) WACC of Six Flags
C) average market return
D) divisional cost of capital
AACSB Objective: Analytic Skills
Author: KB
Question Status: Previous Edition
4) Diferent divisions with difering lines of business use diferent costs of capital because
their cost of ________ could be diferent.
A) debt
B) equity
C) capital
D) assets
AACSB Objective: Analytic Skills
Author: KB
Question Status: Previous Edition
5) Diferent divisions with difering lines of business use diferent costs of capital because
their cost of equity is diferent and also because the ________ could be diferent.
A) optimal volatility
B) optimal current ratio
C) optimal asset mix
D) optimal debt-equity ratio
AACSB Objective: Analytic Skills
Author: KB
Question Status: Previous Edition
35
6) Verano Inc. has two business divisions—a software product line and a waste water clean-
up product line. The software business has a cost of equity capital of 10% and the waste
water clean-up business has a cost of equity capital of 7%. Verano has 50% of its revenue
from software and the rest from the waste water business. Verano is considering a
purchase of another company in the waste water business using equity inancing. What is
the appropriate cost of capital to evaluate the business?
A) 10.0%
B) 7.0%
C) 8.5%
D) 9.0%
AACSB Objective: Relective Thinking Skills
Author: KB
Question Status: Previous Edition
7) Verano Inc. has two business divisions—a software product line and a waste water clean-
up product line. The software business has a cost of equity capital of 11% and the waste
water clean-up business has a cost of equity capital of 4%. Verano has 50% of its revenue
from software and the rest from the waste water business. Verano is considering a
purchase of another company in the waste water business using equity inancing. What is
the appropriate cost of capital to evaluate the business?
A) 11.0%
B) 7.5%
C) 4.0%
D) 6.0%
AACSB Objective: Analytic Skills
Author: KB
Question Status: Revised
36
8) Verano Inc. has two business divisions—a software product line and a waste water clean-
up product line. The software business has a cost of equity capital of 10% and the waste
water clean-up business has a cost of equity capital of 8%. Verano has 50% of its revenue
from software and the rest from the waste water business. Verano is considering a
purchase of another company in the waste water business using equity inancing. What is
the appropriate cost of capital to evaluate the business?
A) 10.0%
B) 8.0%
C) 9.0%
D) 11.0%
AACSB Objective: Analytic Skills
Author: KB
Question Status: Revised
13.6 When Raising External Capital Is Costly
1) The costs of external inancing must be deducted from the net present value (NPV) of a
project to evaluate if it is worth undertaking.
AACSB Objective: Analytic Skills
Author: KB
Question Status: Previous Edition
2) Internal inancing is more costly than external inancing because of issuance costs.
AACSB Objective: Analytic Skills
Author: KB
Question Status: Previous Edition
37
3) Assume Ford Motors expects a new hybrid-engine project to produce incremental cash
lows of $90 million each year and expects these to grow at 3% each year. The upfront
project costs are $900 million and Ford’s weighted average cost of capital is 9%. If the
issuance costs for external inances are $20 million, what is the net present value (NPV) of
the project?
A) $986 million
B) $696 million
C) $609 million
D) $580 million
AACSB Objective: Analytic Skills
Author: KB
Question Status: Revised
4) Assume Ford Motors expects a new hybrid-engine project to produce incremental cash
lows of $50 million each year, and expects these to grow at 4% each year. The upfront
project costs are $420 million and Ford’s weighted average cost of capital is 9%. If the
issuance costs for external inances are $20 million, what is the net present value (NPV) of
the project?
A) $504 million
B) $560 million
C) $588 million
D) $616 million
AACSB Objective: Analytic Skills
Author: KB
Question Status: Previous Edition
38
5) Assume Ford Motors expects a new hybrid-engine project to produce incremental cash
lows of $45 million each year, and expects these to grow at 3% each year. The upfront
project costs are $380 million and Ford’s weighted average cost of capital is 9%. If the
issuance costs for external inances are $10 million, what is the net present value (NPV) of
the project?
A) $324 million
B) $378 million
C) $360 million
D) $396 million
AACSB Objective: Analytic Skills
Author: KB
Question Status: Previous Edition
6) A irm is considering acquiring a competitor. The irm plans on ofering $160 million for
the competitor. The irm will need to issue new debt and equity to inance the acquisition.
You estimate the issuance costs to be $10 million. The acquisition will generate an
incremental free cash low of $20 million in the irst year and this cash low is expected to
grow at an annual rate of 3% forever. If the irm’s WACC is 13%, what is the value of this
project?
A) $30 million
B) $38 million
C) $45 million
D) $53 million
AACSB Objective: Analytic Skills
Author: WC
Question Status: Previous Edition
39
7) Which of the following statements is FALSE?
A) Issuance costs increase the WACC.
B) External equity is less expensive than retained earnings.
C) A project that can be inanced with internal funds will be less costly than the same
project if it were inanced with external funds.
D) Issuance costs should be treated as cash outlows in NPV analysis.
AACSB Objective: Analytic Skills
Author: WC
Question Status: Revised
40