The essence of finance is the process of raising capital (money), exclusively through the
sale of bonds.
Both operating leverage and financial leverage involve the substitution of fixed costs
for variable costs.
In the case of a replacement proposal, there are no tax effects reflected in the initial
cash flows.
A good business plan shows enough supporting detail to indicate that it is the product of
careful thinking.
Because each capital component has its own distinct cost that is related to the return
required by investors, each security has a cost that is sensitive to risk.
C-corporations issue real assets, such as debt, in order to raise money.
The future cash flows of a stand-alone project are as follows:
If the cost of capital is 16%, this project will contribute to shareholder wealth.
A sinking fund provides cash to pay off a stock’s principal at maturity.
The projected cash flows for mutually exclusive projects are:
If the replacement chain method is used to eliminate the disparity between the projects’
lives, project B’s third year cash flow is -$100,000.
-150 + 50 = -100
Under a floating rate system, exchange rates are set by international treaty and
administered by the International Monetary Fund.
Which of the following risks do debt ratings specifically measure?
A.Interest Rate Risk
B.Maturity Risk
C.Default Risk
D.Both b & c
E.All of the above
Suppose you put $100 into a savings account today, the account pays 8% compounded
semiannually, and you withdraw $50 one year after your initial deposit. What would
your ending balance be 20 years after the initial $100 deposit was made, assuming that
you make no additional deposits?
A.$250.31
B.$257.45
C.$258.16
D.$430.10
E.$480.10
Lengthening the credit period is likely to result in all of the following except:
A.higher credit sales.
B.more cash sales.
C.larger investment in receivables.
D.longer average collection period.
The following information pertains to the capital program of a firm:
Target capital structure: 30% debt, 20% preferred stock, 50% equity.
Unadjusted component costs of capital
kd= 10%
k = 12%
ke= 14%
Flotation Costs, Taxes, and Retained Earnings
Flotation costs are 8% on common and preferred stock and zero on debt
The total effective tax rate (federal and state) is 40%
Retained earnings of $1,250,000 are expected next year.
Investment Opportunities
a. Adjust the component costs of capital for taxes and flotation costs, and calculate the
WACC before and after the first break.
b. Calculate the location of the break point.
c. Sketch the MCC and the IOS on the same graph. What is the cost of capital for the
year? Why?
d. Which projects should the firm undertake? Why?
Capital Foods purchased an oven 5 years ago for $45,000. The oven is being
depreciated over its estimated 10-year life using the straight line method to a salvage
value of $5,000. Capital is planning to replace the oven with a more automated one that
will cost $150,000 installed. If the old oven can be sold for $30,000, what is the tax
liability? Assume a marginal tax rate of 40 percent.
A.$900
B.$2,000
C.$127,000
D.None of the above
The actual or expected return on a portfolio is equal to:
A.the average of the returns on the stocks in the portfolio weighted by the dollar
amounts invested in each stock
B.the simple average of the returns on the stocks in the portfolio plus the risk-free rate
of return.
C.the sum of the products of the anticipated returns.
D.the simple average of returns on the stocks in the portfolio less the risk-free rate of
return.
Which of the following is a characteristic(s) of initial public offerings (IPOs)?
A.Very stable
B.General public can get involved right away
C.Institutions are the largest investors in IPOs
D.Secondary market transaction
A firm has after-tax operating income of $12 million and a cost of capital of 17%. What
amount of funding (consider it to be inclusive of debt and equity) will generate an EVA
of zero?
A.$2.04 million
B.$70.59 million
C.$9.96 million
D.$123.28 million
What is the IRR of a project requiring a $1000 investment which yields cash inflows of
$700, $700, and $2000, in years 1, 2 and 3 respectively. The cost of capital is 12%.
(Round to nearest %)
A.32%
B.46%
C.54%
D.75%
Which of the following is true of the registration process in an IPO?
A.A prospectus is a part of the S-1 registration document.
B.Form S-1 is a registration statement filed with the Federal Reserve.
C.A prospectus is intended for distribution to the company’s existing investors.
D.The registration process is overseen by the Federal Reserve.
What is the sustainable growth rate of a firm with the following selected financial
results?
A.12%
B.8%
C.10%
D.6%
The certainty equivalent factor can take any value:
A.between -1 and 1
B.between 0 and 1
C.between 0 and 100
D.between -100 and 0
Possible sources of information about a credit applicant include:
A.financial statements submitted by the applicant.
B.reports of credit agencies.
C.U.S. Department of Commerce.
D.a and b.
An exchange rate states:
A.the price of one currency in terms of another.
B.what one is willing to pay for money.
C.how rapidly goods and services are exchanged between countries.
D.the difficulty of doing business abroad.
Average values are most appropriate in ratio analysis when:
A.the ratio reflects an activity that goes on throughout the year.
B.the company is relatively stable.
C.the company is growing rapidly.
D.Both a & b
E.Both a & c
Briefly outline the rationale behind the efficient market hypothesis and explain its
implications for technical and fundamental analysis.
Why don’t firms avoid exchange rate risk by purchasing a supply of foreign currency
and simply holding it until it’s needed?
Tancesco Inc. is considering acquiring Aldine Corp. which it has estimated will
generate the following after tax cash flows over the next three years ($000). After that
management expects a growth rate of 3% indefinitely.
In addition, Tancesco thinks a merger will produce $40,000 per year in after tax
synergies. Aldine has 65,000 shares of common stock outstanding. The company’s beta
is 1.6, the market is currently returning an average of 12% on stock investments and
short term treasury bills are yielding 3%.
What should Tancesco be willing to pay per share for Aldine if management is willing
to value the acquisition over an indefinitely long time horizon?
One year ago a $1,000 face value, 6% coupon bond was selling for $1,100. Since then,
the market yield has decreased by two percentage points. The bond pays interest
semiannually and now has four years to maturity. What is the bond’s price today?
Explain the idea of spontaneous financing and explain why, in spite of it, we still have
to fund working capital from outside sources.