1) Shannon Co. is considering a project that has the following cash flow and WACC
data. What is the project’s discounted payback?
WACC:10.00%
Year01234
Cash flows-$950$525$485$445$405
a.1.61 years
b.1.79 years
c.1.99 years
d.2.22 years
e.2.44 years
2) Which of the following statements is CORRECT?
a.Net cash flow (NCF) is defined as follows:
NCF = Net income – Depreciation and Amortization.
b.Changes in working capital have no effect on free cash flow.
c.Free cash flow (FCF) is defined as follows:
FCF = EBIT(1 – T)
+ Depreciation and Amortization
– Capital expenditures required to sustain operations
– Required changes in net operating working capital.
d.Free cash flow (FCF) is defined as follows:
FCF = EBIT(1 – T)+ Depreciation and Amortization + Capital expenditures.
e.Net cash flow is the same as free cash flow (FCF).
3) For a typical firm, which of the following sequences is CORRECT? All rates are
after taxes, and assume that the firm operates at its target capital structure.
a.re > rs > WACC > rd
b.WACC > re > rs > rd
c.rd > re > rs > WACC
d.WACC > rd > rs > re
e.rs > re > rd > WACC
4) Which of the following statements is CORRECT?
a. While the distinctions are blurring, investment banks generally specialize in lending
money, whereas commercial banks generally help companies raise capital from other
parties
b. A security whose value is derived from the price of some other “underlying” asset is
called a liquid security
c. Money market mutual funds usually invest most of their money in a well-diversified
portfolio of liquid common stocks
d. Money markets are markets for common stocks and long-term debt
e. The NYSE operates as an auction market, whereas the Nasdaq is a dealer market
5) Which of the following statements is CORRECT?
a.A cost should be assigned to reinvested earnings due to the opportunity cost principle,
which refers to the fact that the firm’s stockholders would themselves expect to earn a
return on earnings that were distributed rather than retained and reinvested
b.No cost should be assigned to reinvested earnings because the firm does not have to
pay anything to raise them. They are generated as cash flows by operating assets that
were raised in the past; hence, they are “free.”
c.Suppose a firm has been losing money and thus is not paying taxes, and this situation
is expected to persist into the foreseeable future. In this case, the firm’s before-tax and
after-tax costs of debt for purposes of calculating the WACC will both be equal to the
interest rate on the firm’s currently outstanding debt, provided that debt was issued
during the past 5 years
d.If a firm has enough reinvested earnings to fund its capital budget for the coming
year, then there is no need to estimate either a cost of equity or a WACC
e.The component cost of preferred stock is expressed as rp(1 – T). This follows because
preferred stock dividends are treated as fixed charges, and as such they can be deducted
by the issuer for tax purposes
6) EP Enterprises has the following income statement. How much net operating profit
after taxes (NOPAT) does the firm have?
Sales$1,800.00
Costs1,400.00
Depreciation 250.00
EBIT$ 150.00
Interest expense 70.00
EBT$ 80.00
Taxes (40%) 32.00
Net income$ 48.00
a.$81.23
b.$85.50
c.$90.00
d.$94.50
e.$99.23
7) If a bank loan officer were considering a company’s request for a loan, which of the
following statements would you consider to be CORRECT?
a. Other things held constant, the lower the current ratio, the lower the interest rate the
bank would charge the firm
b. The lower the company’s EBITDA coverage ratio, other things held constant, the
lower the interest rate the bank would charge the firm
c. Other things held constant, the higher the debt ratio, the lower the interest rate the
bank would charge the firm
d. Other things held constant, the lower the debt ratio, the lower the interest rate the
bank would charge the firm
e. The lower the company’s TIE ratio, other things held constant, the lower the interest
rate the bank would charge the firm
8) Assume that you are an intern with the Brayton Company, and you have collected the
following data: The yield on the company’s outstanding bonds is 7.75%; its tax rate is
40%; the next expected dividend is $0.65 a share; the dividend is expected to grow at a
constant rate of 6.00% a year; the price of the stock is $15.00 per share; the flotation
cost for selling new shares is F = 10%; and the target capital structure is 45% debt and
55% common equity. What is the firm’s WACC, assuming it must issue new stock to
finance its capital budget?
a.6.89%
b.7.26%
c.7.64%
d.8.04%
e.8.44%
9) Refer to Exhibit 15.3. Now assume that BB is considering changing from its original
capital structure to a new capital structure with 45% debt and 55% equity. This results
in a weighted average cost of capital equal to 10.4% and a new value of operations of
$576,923. Assume BB raises $259,615 in new debt and purchases T-bills to hold until it
makes the stock repurchase. BB then sells the T-bills and uses the proceeds to
repurchase stock. How many shares remain after the repurchase, and what is the stock
price per share immediately after the repurchase?
a.11,001; $28.85
b.12,711; $35.62
c.13,901; $42.57
d.15,220; $54.31
e.17,105; $89.67
10) Lindley Corp.’s stock price at the end of last year was $33.50, and its book value
per share was $25.00. What was its market/book ratio?
a. 1.34
b. 1.41
c. 1.48
d. 1.55
e. 1.63
11) The capital intensity ratio is generally defined as follows:
a.The percentage of liabilities that increase spontaneously as a percentage of sales
b.The ratio of sales to current assets
c.The ratio of current assets to sales
d.The amount of assets required per dollar of sales, or A0*/S0
e.Sales divided by total assets, i.e., the total assets turnover ratio
12) Which of the following statements is CORRECT?
a.One defect of the IRR method versus the NPV is that the IRR does not take account of
the time value of money
b.One defect of the IRR method versus the NPV is that the IRR does not take account
of the cost of capital
c.One defect of the IRR method versus the NPV is that the IRR values a dollar received
today the same as a dollar that will not be received until sometime in the future
d.One defect of the IRR method versus the NPV is that the IRR does not take proper
account of differences in the sizes of projects
e.One defect of the IRR method versus the NPV is that the IRR does not take account of
cash flows over a project’s full life
13) Aubey Aircraft recently announced that its net income increased sharply from the
previous year, yet its net cash flow from operations declined. Which of the following
could explain this performance?
a.The company’s operating income declined
b.The company’s expenditures on fixed assets declined
c.The company’s cost of goods sold increased
d.The company’s depreciation and amortization expenses declined
e.The company’s interest expense increased
14) The projected capital budget of Kandell Corporation is $1,000,000, its target capital
structure is 60% debt and 40% equity, and its forecasted net income is $550,000. If the
company follows a residual dividend policy, what total dividends, if any, will it pay
out?
a. $122,176
b. $128,606
c. $135,375
d. $142,500
e. $150,000
15) Robbins Inc. is considering a project that has the following cash flow and WACC
data. What is the project’s NPV? Note that if a project’s expected NPV is negative, it
should be rejected.
WACC:10.25%
Year012345
Cash flows-$1,000$300$300$300$300$300
a.$105.89
b.$111.47
c.$117.33
d.$123.51
e.$130.01
16) Buchholz Corporation follows a moderate current asset investment policy, but it is
now considering a change, perhaps to a restricted or maybe to a relaxed policy. The
firm’s annual sales are $400,000; its fixed assets are $100,000; its target capital
structure calls for 50% debt and 50% equity; its EBIT is $35,000; the interest rate on its
debt is 10%; and its tax rate is 40%. With a restricted policy, current assets will be 15%
of sales, while under a relaxed policy they will be 25% of sales. What is the difference
in the projected ROEs between the restricted and relaxed policies?
a.4.25%
b.4.73%
c.5.25%
d.5.78%
e.6.35%
17) Other things held constant, which of the following actions would increase the
amount of cash on a company’s balance sheet?
a.The company purchases a new piece of equipment
b.The company repurchases common stock
c.The company pays a dividend
d.The company issues new common stock
e.The company gives customers more time to pay their bills
18) Which of the following statements is CORRECT?
a. It is usually easier to transfer ownership in a corporation than it is to transfer
ownership in a sole proprietorship
b. Corporate shareholders are exposed to unlimited liability
c. Corporations generally face fewer regulations than sole proprietorships
d. Corporate shareholders are exposed to unlimited liability, and this factor may be
compounded by the tax disadvantages of incorporation
e. Shareholders in a regular corporation (not an S corporation) pay higher taxes than
owners of an otherwise identical proprietorship
19) Barnes’ Brothers has the following data for the year ending 12/31/12: Net income =
$600; Net operating profit after taxes (NOPAT) = $700; Total assets = $2,500;
Short-term investments = $200; Stockholders’ equity = $1,800; Total debt = $700; and
Total operating capital = $2,100. Barnes’ weighted average cost of capital is 10%. What
is its economic value added (EVA)?
a.$399.11
b.$420.11
c.$442.23
d.$465.50
e.$490.00
20) As the winner of a contest, you are now CFO for the day for Maguire Inc. and your
day’s job involves raising capital for expansion. Maguire’s common stock currently sells
for $45.00 per share, the company expects to earn $2.75 per share during the current
year, its expected payout ratio is 70%, and its expected constant growth rate is 6.00%.
New stock can be sold to the public at the current price, but a flotation cost of 8%
would be incurred. By how much would the cost of new stock exceed the cost of
common from reinvested earnings?
a.0.09%
b.0.19%
c.0.37%
d.0.56%
e.0.84%
21) Westbrook’s Painting Co. plans to issue a $1,000 par value, 20-year noncallable
bond with a 7.00% annual coupon, paid semiannually. The company’s marginal tax rate
is 40.00%, but Congress is considering a change in the corporate tax rate to 30.00%. By
how much would the component cost of debt used to calculate the WACC change if the
new tax rate was adopted?
a.0.57%
b.0.63%
c.0.70%
d.0.77%
e.0.85%
22) Ann has a portfolio of 20 average stocks, and Tom has a portfolio of 2 average
stocks. Assuming the market is in equilibrium, which of the following statements is
CORRECT?
a.The required return on Ann’s portfolio will be lower than that on Tom’s portfolio
because Ann’s portfolio will have less total risk
b.Tom’s portfolio will have more diversifiable risk, the same market risk, and thus more
total risk than Ann’s portfolio, but the required (and expected) returns will be the same
on both portfolios
c.If the two portfolios have the same beta, their required returns will be the same, but
Ann’s portfolio will have less market risk than Tom’s
d.The expected return on Jane’s portfolio must be lower than the expected return on
Dick’s portfolio because Jane is more diversified
e.Ann’s portfolio will have less diversifiable risk and also less market risk than Tom’s
portfolio
23) Rogoff Co.’s 15-year bonds have an annual coupon rate of 9.5%. Each bond has
face value of $1,000 and makes semiannual interest payments. If you require an 11.0%
nominal yield to maturity on this investment, what is the maximum price you should be
willing to pay for the bond?
a.$891.00
b.$913.27
c.$936.10
d.$959.51
e.$983.49
24) Worthington Inc. is considering a project that has the following cash flow data.
What is the project’s payback?
Year0123
Cash flows-$500$150$200$300
a.2.03 years
b.2.25 years
c.2.50 years
d.2.75 years
e.3.03 years
25) Which of the following should be considered when a company estimates the cash
flows used to analyze a proposed project?
a.Since the firm’s director of capital budgeting spent some of her time last year to
evaluate the new project, a portion of her salary for that year should be charged to the
project’s initial cost
b.The company has spent and expensed $1 million on R&D associated with the new
project
c.The company spent and expensed $10 million on a marketing study before its current
analysis regarding whether to accept or reject the project
d.The firm would borrow all the money used to finance the new project, and the interest
on this debt would be $1.5 million per year
e.The new project is expected to reduce sales of one of the company’s existing products
by 5%
26) Which of the following statement completions is CORRECT? If the yield curve is
upward sloping, then the marketable securities held in a firm’s portfolio, assumed to be
held for emergencies, should
a.consist mainly of short-term securities because they pay higher rates
b.consist mainly of U.S. Treasury securities to minimize interest rate risk
c.consist mainly of short-term securities to minimize interest rate risk
d.be balanced between long- and short-term securities to minimize the adverse effects
of either an upward or a downward trend in interest rates
e.consist mainly of long-term securities because they pay higher rates
27) Larsen Films’ is analyzing its cost structure. Its fixed operating costs are $470,000,
its variable costs of $2.80 per unit produced, and its products sell for $4.00 per unit.
What is the company’s breakeven point, i.e., at what unit sales volume would income
equal costs?
a.391,667
b.411,250
c.431,813
d.453,403
e.476,073
28) A 10-year corporate bond has an annual coupon of 9%. The bond is currently selling
at par ($1,000). Which of the following statements is NOT CORRECT?
a.The bond’s yield to maturity is 9%
b.The bond’s current yield is 9%
c.If the bond’s yield to maturity remains constant, the bond will continue to sell at par
d.The bond’s current yield exceeds its capital gains yield
e.The bond’s expected capital gains yield is positive
29) The term “additional funds needed (AFN)” is generally defined as follows:
a.Funds that a firm must raise externally from non-spontaneous sources, i.e., by
borrowing or by selling new stock to support operations
b.The amount of assets required per dollar of sales
c.The amount of internally generated cash in a given year minus the amount of cash
needed to acquire the new assets needed to support growth
d.A forecasting approach in which the forecasted percentage of sales for each balance
sheet account is held constant
e.Funds that are obtained automatically from routine business transactions
30) In accounting, emphasis is placed on determining net income in accordance with
generally accepted accounting principles. In finance, the primary emphasis is also on
net income because that is what investors use to value the firm. However, a secondary
financial consideration is cash flow, because cash is needed to operate the business.
31) Superior analytical techniques, such as NPV, used in combination with risk-adjusted
cost of capital estimates, can overcome the problem of poor cash flow estimation and
lead to generally correct accept/reject decisions.
32) The reason why reinvested earnings have a cost equal to rs is because investors
think they can (i.e., expect to) earn rs on investments with the same risk as the firm’s
common stock, and if the firm does not think that it can earn rs on the earnings that it
retains, it should distribute those earnings to its investors. Thus, the cost of reinvested
earnings is based on the opportunity cost principle.
33) The cost of debt is equal to one minus the marginal tax rate multiplied by the
average coupon rate on all outstanding debt.
34) Assume that two investors each hold a portfolio, and that portfolio is their only
asset. Investor A’s portfolio has a beta of minus 2.0, while Investor B’s portfolio has a
beta of plus 2.0. Assuming that the unsystematic risks of the stocks in the two portfolios
are the same, then the two investors face the same amount of risk. However, the holders
of either portfolio could lower their risks, and by exactly the same amount, by adding
some “normal” stocks with beta = 1.0.
35) If an investment project would make use of land which the firm currently owns, the
project should be charged with the opportunity cost of the land.
36) An increase in the firm’s WACC will decrease projects’ NPVs, which could change
the accept/reject decision for any potential project. However, such a change would have
no impact on projects’ IRRs. Therefore, the accept/reject decision under the IRR
method is independent of the cost of capital.
37) We would almost always find that the beta of a diversified portfolio is less stable
over time than the beta of a single security.
38) High current and quick ratios always indicate that a firm is managing its liquidity
position well.