Which of the following would not be an appropriate guideline for determining the
interest rate to use in discounting project cash flows in capital budgeting?
A.For replacement projects, given that their risk is consistent with that of the present
business, use the cost of capital.
B.For expansion projects of moderate size, given that their risk is slightly greater than
that of the present business, use the cost of capital, plus a small risk premium of one to
three percent.
C.For new ventures, given that their risk can be far greater than current operations, use
the cost of capital plus a risk premium of at most five percent since using anything
higher usually guarantees rejection.
D.All of the above are appropriate guidelines.
The future cash flows of a stand-alone capital project follow:
With the project’s approximate IRR?
A.10%
B.12%
C.8%
D.($26)
The Johnson Company bought a truck costing $60,000 two years ago. The truck’s
estimated life was six years at the time of purchase. It was accounted for by using
straight line depreciation with zero salvage value. If the truck was sold yesterday for
$65,000, what is the capital gain that must be reported on the sale of the truck?
A.$20,000
B.$25,000
C.$30,000
D.$35,000
E.$40,000
The basis for stock value is the:
A.future value of the stock.
B.present value of future cash inflows
C.annuity of constant future returns
D.forecasted dividends.
When fixed operating costs are incurred by the firm, a relative change in ____ is
magnified into a larger relative change in earnings before interest and taxes.
A.overhead expenses
B.interest charges
C.labor costs
D.sales revenue
Three years ago a machine was purchased for $5,000. Assuming a ten-year life and
straight line depreciation with a no salvage value, which of the following will appear on
the income statement and balance sheet respectively after four years?
A.Depreciation expense of $2,000, accumulated depreciation of $2,000.
B.Depreciation expense of $500, accumulated depreciation of $2,000.
C.Accumulated depreciation of $2,000, depreciation expense of $500.
D.Accumulated depreciation of $500, depreciation expense of $2,000.
E.Depreciation expense of $1,500, accumulated depreciation of $500.
Common equity does not come from:
A.the sale of new common stock.
B.the sale of new preferred stock.
C.retention of earnings.
D.Any of the above
Metcalf, Inc. is planning to buy a new machine to begin making one of its component
parts internally rather than contracting it out to a supplier. Since this is a major
investment, they plan to fund it by issuing additional common stock. Assuming that this
change has no initial impact on EBIT, the change should:
A.increase operating leverage and decrease financial leverage.
B.decrease operating leverage and increase financial leverage.
C.increase both operating and financial leverage.
D.decrease both operating and financial leverage.
E.The impact on financial and operating leverage cannot be determined.
Capital structures based on book and market values are generally different because:
A.market values of securities change all the time.
B.market values reflect the cost of capital already spent.
C.market values of securities are reflected on company books.
D.market values reflect the prices at which the securities are sold.
_____ exists when performance together is better than the sum of separate
performances.
A.Energy
B.Synergy
C.Cooperation
D.A merger
Assuming a 5% annual discount rate, what is the value of receiving $100.00 annual
payments perpetually starting today?
A.$1,666.67
B.$2,000.00
C.$2,666.67
D.$2,100.00
Frazier Manufacturing paid a dividend last year of $2, which is expected to grow at a
constant rate of 5%. Frazier has a beta of 1.3. If the market is returning 11% and the
risk-free rate is 4%, calculate the value of Frazier’s stock.
A.$25.93
B.$31.33
C.$38.53
D.$41.63
Which of the following is not a real option?
A.Abandonment option
B.Expansion option
C.Investment timing option
D.Flexibility option
E.All of the above are real options.
Alpha Inc. has a $1,000 par value bond that was issued ten years ago for a thirty year
term. Interest rates were very high at that time and the bond’s coupon rate is 22%. The
relevant bond market interest rate is now 10%. All of Alpha’s bonds have a call feature.
It allows the company to pay off the bond any time after the first fifteen years, but
requires that bondholders be compensated with an extra year’s interest at the coupon
rate if such a payoff is exercised. What is the bond’s market price assuming investors
expect it will be called as soon as possible?
A.$1463.29
B.$1598.35
C.$2029.50
D.$1600.74
A drill press costs $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.
A.$4,500
B.$900
C.$5,700
D.$3,900
A vice president of a manufacturing company said: “We own five acres of land next to
our own plant. It won’t cost us a thing to use that land for our new expansion wing.”
That vice president does not fully understand the concept of:
A.sunk costs.
B.side-effect costs.
C.fixed costs.
D.opportunity costs.
E.depreciation.