Cipcommunity

Financial Management and Capital Budgeting

Financial Management and Capital Budgeting

Chapter 10 Question 1 Marks: 1 Which of the following is NOT a capital component when calculating the weighted average cost of capital (WACC)? Choose one answer. | a. Long-term debt. | | | b. Accounts payable. | | | c. Retained earnings. | | | d. Common stock. | | | e. Preferred stock. | | Correct Marks for this submission: 1/1. Question 2 Marks: 1 For a typical firm, which of the following sequences is CORRECT? All rates are after taxes, and assume the firm operates at its target capital structure. Choose one answer. | a. re > rs > WACC > rd. | | | b. rs > re > rd > WACC. | | c. WACC > re > rs > rd. | | | d. rd > re > rs > WACC. | | | e. WACC > rd > rs > re. | | Correct Marks for this submission: 1/1. Question 3 Marks: 1 Jackson Inc. uses only equity capital, and it has 2 equally-sized divisions. Division A’s cost of capital is 10. 0%, Division B’s cost is 14. 0%, and the composite WACC is 12. 0%. All of Division A’s projects have the same risk, as do all of Division B’s projects. However, the projects in Division A have less risk than those in Division B. Which of the following projects should Jackson accept? Choose one answer. a. A Division B project with a 13% return. | | | b. A Division B project with a 12% return. | | | c. A Division A project with an 11% return. | | | d. A Division A project with a 9% return. | | | e. A Division B project with an 11% return. | | The correct answer is statement c. Division A should accept only projects with a return greater than 10%, and Division B should accept only projects with a return greater than 14%. Only statement c meets this criterion. Correct Marks for this submission: 1/1. Question 4 Marks: 1 Which of the following statements is CORRECT? Choose one answer. a. In the WACC calculation, we must adjust the cost of preferred stock (the market yield) to reflect the fact that 70% of the dividends received by corporate investors are excluded from their taxable income. | | | b. We should use historical measures of the component costs from prior financings when estimating a company’s WACC for capital budgeting purposes. | | | c. The cost of new equity (re) could possibly be lower than the cost of retained earnings (rs) if the market risk premium, risk-free rate, and the company’s beta all decline by a sufficiently large amount. | | | d.

Its cost of retained earnings is the rate of return stockholders require on a firm’s common stock. | | | e. The component cost of preferred stock is expressed as rp(1 ? T), because preferred stock dividends are treated as fixed charges, similar to the treatment of interest on debt. | | Correct Marks for this submission: 1/1. Question 5 Marks: 1 Hettenhouse Company’s perpetual preferred stock sells for $102. 50 per share, and it pays a $9. 50 annual dividend. If the company were to sell a new preferred issue, it would incur a flotation cost of 4. 00% of the price paid by investors.

What is the company’s cost of preferred stock for use in calculating the WACC? Choose one answer. | a. 9. 27% | | | b. 9. 65% | | | c. 10. 04% | | | d. 10. 44% | | | e. 10. 86% | | Preferred stock price| $102. 50| Preferred dividend| $9. 50| Flotation cost| 4. 00%| rp = Dp/(Pp(1 ? F))| 9. 65%| | | Correct Marks for this submission: 1/1. Question 6 Marks: 1 Assume that you are a consultant to Magee Inc. , and you have been provided with the following data: rRF = 4. 00%; RPM = 5. 00%; and b = 1. 15. What is the cost of equity from retained earnings based on the CAPM approach? Choose one answer. | a. 9. 5% | | | b. 10. 04% | | | c. 10. 34% | | | d. 10. 65% | | | e. 10. 97% | | rRF| 4. 00%| RPM| 5. 00%| b| 1. 15| rs = rRF + (RPM ? b)| 9. 75%| | | Correct Marks for this submission: 1/1. Question 7 Marks: 1 Assume that you are a consultant to Broske Inc. , and you have been provided with the following data: D1 = $1. 30; P0 = $42. 50; and g = 7. 00% (constant). What is the cost of equity from retained earnings based on the DCF approach? Choose one answer. | a. 9. 08% | | | b. 9. 56% | | | c. 10. 06% | | | d. 10. 56% | | | e. 11. 09% | | D1| $1. 30| P0| $42. 50| g| 7. 00%| rs = D1/P0 + g| 10. 06%| | | Correct

Marks for this submission: 1/1. Question 8 Marks: 1 P. Lange Inc. hired your consulting firm to help them estimate the cost of equity. The yield on Lange’s bonds is 7. 25%, and your firm’s economists believe that the cost of equity can be estimated using a risk premium of 3. 50% over a firm’s own cost of debt. What is an estimate of Lange’s cost of equity from retained earnings? Choose one answer. | a. 10. 75% | | | b. 11. 18% | | | c. 11. 63% | | | d. 12. 09% | | | e. 12. 58% | | Bond yield| 7. 25%| Risk premium| 3. 50%| re = rd + Risk Premium| 10. 75%| | | Correct Marks for this submission: 1/1. Question 9 Marks: 1

To help finance a major expansion, Delano Development Company sold a noncallable bond several years ago that now has 15 years to maturity. This bond has a 10. 25% annual coupon, paid semiannually, it sells at a price of $1,025, and it has a par value of $1,000. If Delano’s tax rate is 40%, what component cost of debt should be used in the WACC calculation? Choose one answer. | a. 5. 11% | | | b. 5. 37% | | | c. 5. 66% | | | d. 5. 96% | | | e. 6. 25% | | Coupon rate| 10. 25%| Periods/year| 2| Maturity (yr)| 15| Bond price| $1,025. 00| Par value| $1,000| Tax rate| 40%| | | Calculator inputs: N = 2 ? 15| 30| PV = Bond’s price| ? $1,025. 00|

PMT = coupon rate * par/2| $51. 25| FV = Par = Maturity value| $1,000| I/YR| 4. 96%| times periods/yr = before-tax cost of debt| 9. 93%| = After-tax cost of debt (A? T rd) for use in WACC| 5. 96%| | | Correct Marks for this submission: 1/1. Question 10 Marks: 1 You were hired as a consultant to Kroncke Company, whose target capital structure is 40% debt, 10% preferred, and 50% common equity. The after-tax cost of debt is 6. 00%, the cost of preferred is 7. 50%, and the cost of retained earnings is 13. 25%. The firm will not be issuing any new stock. What is its WACC? Choose one answer. | a. 9. 48% | | | b. 9. 78% | | | c. 10. 07% | | | d. 0. 37% | | | e. 10. 68% | | | Weights| Costs| Debt| 40%|   6. 00%| Preferred| 10%|   7. 50%| Common| 50%| 13. 25%| WACC = wd ? rd(1 ? T) + wp ? rp + wc ? rs|  |   9. 78%| | | | Correct Marks for this submission: 1/1. Question 11 Marks: 1 Exhibit 10-1 (The following data apply to the problem(s) below. ) You are employed by CGT, a Fortune 500 firm that is a major producer of chemicals and plastics, including plastic grocery bags, styrofoam cups, and fertilizers. You are on the corporate staff as an assistant to the CFO. This is a position with high visibility and the opportunity for rapid advancement, providing you make the right decisions.

Your boss has asked you to estimate the weighted average cost of capital for the company. The balance sheet and some other information about CGT follows below. Assets|  | Current assets| $  38,000,000| Net plant, property, and equipment|   101,000,000| Total assets| $139,000,000| |  | Liabilities and equity|  | Accounts payable| $  10,000,000| Accruals|       9,000,000| Current liabilities| $  19,000,000| Long term debt (40,000 bonds, $1,000 par value)|     40,000,000| Total liabilities| 59,000,000| Common stock (10,000,000 shares)| 30,000,000| Retained earnings|     50,000,000| Total shareholders equity| 80,000,000|

Total liabilities and shareholders equity| $139,000,000| | | You check The Wall Street Journal and see that CGT stock is currently selling for $7. 50 per share and that CGT bonds are selling for $875. 00 per bond. The bonds have a S1,000 par value, a 7. 25% annual coupon rate, semiannual payments, are not callable, and a 20-year maturity. CGT’s beta is 1. 25, the yield on a 6-month Treasury bill is 3. 50%, and the yield on a 20-year Treasury bond is 5. 50%. The expected return on the stock market is 11. 50%, but the market has had an average annual return of 14. 50% during the past 5 years. CGT is in the 40% tax bracket.

Refer to Exhibit 10-1. What is the best estimate of the after-tax cost of debt for CGT? Choose one answer. | a. 4. 64% | | | b. 4. 88% | | | c. 5. 14% | | | d. 5. 40% | | | e. 5. 67% | | Coupon rate| 7. 25%|  | Periods/year| 2|  | Maturity (yr)| 20|  | Bond price| $875|  | Par value| $1,000|  | Tax rate| 40%|  | Calculator inputs:|  |  | N| 40|  | PV| ? $875. 00|  | PMT = (coupon rate ? Par)/2| $36. 25|  | FV = Par| $1,000|  | Yield = I/YR (solved for)| 4. 28%| times 2 = 8. 57% = rd = Before-tax cost of debt|  | After-tax cost of debt for use in WACC = rd(1 ? T) = 5. 14%| | | | Correct Marks for this submission: 1/1.

Question 12 Marks: 1 Exhibit 10-1 (The following data apply to the problem(s) below. ) You are employed by CGT, a Fortune 500 firm that is a major producer of chemicals and plastics, including plastic grocery bags, styrofoam cups, and fertilizers. You are on the corporate staff as an assistant to the CFO. This is a position with high visibility and the opportunity for rapid advancement, providing you make the right decisions. Your boss has asked you to estimate the weighted average cost of capital for the company. The balance sheet and some other information about CGT follows below. Assets|  | Current assets| $  38,000,000|

Net plant, property, and equipment|   101,000,000| Total assets| $139,000,000| |  | Liabilities and equity|  | Accounts payable| $  10,000,000| Accruals|       9,000,000| Current liabilities| $  19,000,000| Long term debt (40,000 bonds, $1,000 par value)|     40,000,000| Total liabilities| 59,000,000| Common stock (10,000,000 shares)| 30,000,000| Retained earnings|     50,000,000| Total shareholders equity| 80,000,000| Total liabilities and shareholders equity| $139,000,000| | | You check The Wall Street Journal and see that CGT stock is currently selling for $7. 50 per share and that CGT bonds are selling for $875. 0 per bond. The bonds have a S1,000 par value, a 7. 25% annual coupon rate, semiannual payments, are not callable, and a 20-year maturity. CGT’s beta is 1. 25, the yield on a 6-month Treasury bill is 3. 50%, and the yield on a 20-year Treasury bond is 5. 50%. The expected return on the stock market is 11. 50%, but the market has had an average annual return of 14. 50% during the past 5 years. CGT is in the 40% tax bracket. Refer to Exhibit 10-1. Using the CAPM approach, what is the best estimate of the cost of equity for CGT? Choose one answer. | a. 13. 00% | | | b. 13. 52% | | | c. 14. 06% | | | d. 14. 62% | | e. 15. 21% | | rRF| 5. 50%| Expected rM| 11. 50%| b| 1. 25| RPM = Expected return on Market ? rRF =| 6. 00%| rs = rRF + rRF(RPM * b)| 13. 00%| | | Correct Marks for this submission: 1/1. Question 13 Marks: 1 Exhibit 10-1 (The following data apply to the problem(s) below. ) You are employed by CGT, a Fortune 500 firm that is a major producer of chemicals and plastics, including plastic grocery bags, styrofoam cups, and fertilizers. You are on the corporate staff as an assistant to the CFO. This is a position with high visibility and the opportunity for rapid advancement, providing you make the right decisions.

Your boss has asked you to estimate the weighted average cost of capital for the company. The balance sheet and some other information about CGT follows below. Assets|  | Current assets| $  38,000,000| Net plant, property, and equipment|   101,000,000| Total assets| $139,000,000| |  | Liabilities and equity|  | Accounts payable| $  10,000,000| Accruals|       9,000,000| Current liabilities| $  19,000,000| Long term debt (40,000 bonds, $1,000 par value)|     40,000,000| Total liabilities| 59,000,000| Common stock (10,000,000 shares)| 30,000,000| Retained earnings|     50,000,000| Total shareholders equity| 80,000,000|

Total liabilities and shareholders equity| $139,000,000| | | You check The Wall Street Journal and see that CGT stock is currently selling for $7. 50 per share and that CGT bonds are selling for $875. 00 per bond. The bonds have a S1,000 par value, a 7. 25% annual coupon rate, semiannual payments, are not callable, and a 20-year maturity. CGT’s beta is 1. 25, the yield on a 6-month Treasury bill is 3. 50%, and the yield on a 20-year Treasury bond is 5. 50%. The expected return on the stock market is 11. 50%, but the market has had an average annual return of 14. 50% during the past 5 years.

CGT is in the 40% tax bracket. Refer to Exhibit 10-1. Which of the following is the best estimate for the weights to be used when calculating the WACC? Choose one answer. | a. wc = 68. 2%; wd = 31. 8% | | | b. wc = 69. 9%; wd = 30. 1% | | | c. wc = 71. 6%; wd = 28. 4% | | | d. wc = 73. 4%; wd = 26. 6% | | | e. wc = 75. 3%; wd = 24. 7% | | Bond price| $875. 00| Number of bonds| 40,000| Market value of debt| $35,000,000| P0| $7. 50| Shares outstanding| 10,000,000| Market value of equity| $75,000,000| wd| 31. 8%| wc| 68. 2%| | | Correct Marks for this submission: 1/1. Question 14 Marks: 1 Exhibit 10-1 The following data apply to the problem(s) below. ) You are employed by CGT, a Fortune 500 firm that is a major producer of chemicals and plastics, including plastic grocery bags, styrofoam cups, and fertilizers. You are on the corporate staff as an assistant to the CFO. This is a position with high visibility and the opportunity for rapid advancement, providing you make the right decisions. Your boss has asked you to estimate the weighted average cost of capital for the company. The balance sheet and some other information about CGT follows below. Assets|  | Current assets| $  38,000,000|

Net plant, property, and equipment|   101,000,000| Total assets| $139,000,000| |  | Liabilities and equity|  | Accounts payable| $  10,000,000| Accruals|       9,000,000| Current liabilities| $  19,000,000| Long term debt (40,000 bonds, $1,000 par value)|     40,000,000| Total liabilities| 59,000,000| Common stock (10,000,000 shares)| 30,000,000| Retained earnings|     50,000,000| Total shareholders equity| 80,000,000| Total liabilities and shareholders equity| $139,000,000| | | You check The Wall Street Journal and see that CGT stock is currently selling for $7. 50 per share and that CGT bonds are selling for $875. 0 per bond. The bonds have a S1,000 par value, a 7. 25% annual coupon rate, semiannual payments, are not callable, and a 20-year maturity. CGT’s beta is 1. 25, the yield on a 6-month Treasury bill is 3. 50%, and the yield on a 20-year Treasury bond is 5. 50%. The expected return on the stock market is 11. 50%, but the market has had an average annual return of 14. 50% during the past 5 years. CGT is in the 40% tax bracket. Refer to Exhibit 10-1. What is the best estimate of the WACC for CGT? Choose one answer. | a. 9. 88% | | | b. 10. 18% | | | c. 10. 50% | | | d. 10. 81% | | | e. 11. 14% | | wd| 31. 8%| d(1 ? T)| 5. 14%| wc| 68. 2%| rs| 13. 00%| WACC = wd(rd)(1 ? T) + wc(rs) =| 10. 50%| | | Correct Marks for this submission: 1/1. Self-Test Chapter 11 Review of attempt 2 ————————————————- Top of Form Bottom of Form Started on| Sunday, 16 October 2011, 11:46 PM| Completed on| Sunday, 16 October 2011, 11:47 PM| Time taken| 1 min 27 secs| Grade| 15 out of a maximum of 15 (100%)| Question 1 Marks: 1 Which of the following statements is CORRECT? Assume that the project being considered has normal cash flows, with one outflow followed by a series of inflows. Choose one answer. | a.

A project’s NPV is found by compounding the cash inflows at the IRR to find the terminal value (TV), then discounting the TV at the WACC. | | | b. The lower the WACC used to calculate it, the lower the calculated NPV will be. | | | c. If a project’s NPV is less than zero, then its IRR must be less than the WACC. | | | d. If a project’s NPV is greater than zero, then its IRR must be less than zero. | | | e. The NPV of a relatively low risk project should be found using a relatively high WACC. | | Correct Marks for this submission: 1/1. Question 2 Marks: 1 Which of the following statements is CORRECT? Choose one answer. | a.

One defect of the IRR method is that it does not take account of cash flows over a project’s full life. | | | b. One defect of the IRR method is that it does not take account of the time value of money. | | | c. One defect of the IRR method is that it does not take account of the cost of capital. | | | d. One defect of the IRR method is that it values a dollar received today the same as a dollar that will not be received until some time in the future. | | | e. One defect of the IRR method is that it assumes that the cash flows to be received from a project can be reinvested at the IRR itself, and that assumption is often not valid. | The IRR assumes reinvestment at the IRR, and that is generally not as valid as assuming reinvestment at the WACC, as with the NPV. Correct Marks for this submission: 1/1. Question 3 Marks: 1 Which of the following statements is CORRECT? Choose one answer. | a. The regular payback method recognizes all cash flows over a project’s life. | | | b. The discounted payback method recognizes all cash flows over a project’s life, and it also adjusts these cash flows to account for the time value of money. | | | c. The regular payback method was, years ago, widely used, but virtually no companies even calculate the payback today. | | d. The regular payback is useful as an indicator of a project’s liquidity because it gives managers an idea of how long it will take to recover the funds invested in a project. | | | e. The regular payback does not consider cash flows beyond the payback year, but the discounted payback overcomes this defect. | | Statement d is true. The payback does indicate how long it should take to recover the investment, hence it is a measure of liquidity. Correct Marks for this submission: 1/1. Question 4 Marks: 1 Which of the following statements is CORRECT?

Assume that the project being considered has normal cash flows, with one outflow followed by a series of inflows. Choose one answer. | a. If Project A has a higher IRR than Project B, then Project A must have the lower NPV. | | | b. If Project A has a higher IRR than Project B, then Project A must also have a higher NPV. | | | c. The IRR calculation implicitly assumes that all cash flows are reinvested at the WACC. | | | d. The IRR calculation implicitly assumes that cash flows are withdrawn from the business rather than being reinvested in the business. | | | e.

If a project has normal cash flows and its IRR exceeds its WACC, then the project’s NPV must be positive. | | Correct Marks for this submission: 1/1. Question 5 Marks: 1 Which of the following statements is CORRECT? Choose one answer. | a. If a project with normal cash flows has an IRR greater than the WACC, the project must have a positive NPV. | | | b. If Project A’s IRR exceeds Project B’s, then A must have the higher NPV. | | | c. A project’s MIRR can never exceed its IRR. | | | d. If a project with normal cash flows has an IRR less than the WACC, the project must have a positive NPV. | | | e.

If the NPV is negative, the IRR must also be negative. | | Correct Marks for this submission: 1/1. Question 6 Marks: 1 Which of the following statements is CORRECT? Choose one answer. | a. The IRR method appeals to some managers because it gives an estimate of the rate of return on projects rather than a dollar amount, which the NPV method provides. | | | b. The discounted payback method eliminates all of the problems associated with the payback method. | | | c. When evaluating independent projects, the NPV and IRR methods often yield conflicting results regarding a project’s acceptability. | | d. To find the MIRR, we discount the TV at the IRR. | | | e. A project’s NPV profile must intersect the X-axis at the project’s WACC. | | Correct Marks for this submission: 1/1. Question 7 Marks: 1 Johnson Enterprises 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 projected NPV is negative, it should be rejected. WACC:| 10. 00%|  |  |  |  | Year:| 0| 1| 2| 3| 4| Cash flows:| ? $1,000| $350| $350| $350| $350| | | | | | | Choose one answer. | a. $98. 78 | | | b. $103. 98 | | | c. $109. 45 | | | d. 114. 93 | | | e. $120. 67 | | WACC:| 10. 00%|  |  |  |  | Year:| 0| 1| 2| 3| 4| Cash flows:| ? $1,000| $350| $350| $350| $350| | | | | | | NPV = $109. 45 Correct Marks for this submission: 1/1. Question 8 Marks: 1 Rappaport Enterprises is considering a project that has the following cash flow and WACC data. What is the project’s NPV? Note that a project’s projected NPV can be negative, in which case it will be rejected. WACC:| 10. 00%|  |  |  |  | Year:| 0| 1| 2| 3| 4| Cash flows:| ? $1,000| $400| $405| $410| $415| | | | | | | Choose one answer. | a. $190. 16 | | | b. $211. 29 | | c. $234. 77 | | | d. $260. 85 | | | e. $289. 84 | | WACC:| 10. 00%|  |  |  |  | Year:| 0| 1| 2| 3| 4| Cash flows:| ? $1,000| $400| $405| $410| $415| | | | | | | NPV = $289. 84 Correct Marks for this submission: 1/1. Question 9 Marks: 1 Rentz Recreation Inc. is considering a project that has the following cash flow data. What is the project’s IRR? Note that a project’s projected IRR can be less than the WACC (and even negative), in which case it will be rejected. Year:| 0| 1| 2| 3| 4| Cash flows:| ? $650| $250| $230| $210| $190| | | | | | | Choose one answer. | a. 14. 04% | | | b. 5. 44% | | | c. 16. 99% | | | d. 18. 69% | | | e. 20. 56% | | Year:| 0| 1| 2| 3| 4| Cash flows:| ? $650| $250| $230| $210| $190| | | | | | | IRR = 14. 04% Correct Marks for this submission: 1/1. Question 10 Marks: 1 Stewart Associates is considering a project that has the following cash flow data. What is the project’s payback? Year:| 0| 1| 2| 3| 4| 5| Cash flows:| ? $1,000| $300| $310| $320| $330| $340| | | | | | | | Choose one answer. | a. 2. 11 years | | | b. 2. 34 years | | | c. 2. 60 years | | | d. 2. 89 years | | | e. 3. 21 years | | Year:| 0| 1| 2| 3| 4| 5| Cash flows:| ? 1,000| $300| $310| $320| $330| $340| Cumulative CF| ? $1,000| ? $700| ? $390| ? $70| $260| $600| Payback = 3. 21| –| –| –| –| 3. 21| –| | | | | | | | Correct Marks for this submission: 1/1. Question 11 Marks: 1 Bey Bikes is considering a project that has the following cash flow and WACC data. What is the project’s discounted payback? WACC:| 10. 00%|  |  |  |  | Year:| 0| 1| 2| 3| 4| Cash flows:| ? $1,000| $525| $485| $445| $405| | | | | | | Choose one answer. | a. 1. 72 years | | | b. 1. 92 years | | | c. 2. 13 years | | | d. 2. 36 years | | | e. 2. 60 years | | WACC:| 10. 00%|  |  |  |  |

Year:| 0| 1| 2| 3| 4| Cash flows:| ? $1,000| $525| $485| $445| $405| PV of CFs| ? $1,000| $477| $401| $334| $277| Cumulative CF| ? $1,000| ? $523| ? $122| $212| $489| Payback = 2. 36| –| –| –| 2. 36| –| | | | | | | Correct Marks for this submission: 1/1. Question 12 Marks: 1 Last month, Smith Systems Inc. decided to accept the project whose cash flows are shown below. However, before actually starting the project, the Federal Reserve took actions that lowered interest rates and therefore Smith’s WACC. By how much did the change in the WACC affect the project’s forecasted NPV?

Assume that the Fed action does not affect the cash flows, and note that a project’s projected NPV can be negative, in which case it should be rejected. New WACC:| 8. 00%|  | Old WACC:| 11. 00%| Year:| 0| 1| 2| 3| Cash flows:| ? $1,000| $500| $500| $500| | | | | | Choose one answer. | a. $57. 18 | | | b. $60. 19 | | | c. $63. 36 | | | d. $66. 69 | | | e. $70. 03 | | New WACC: | 8. 00%|  | Old WACC:| 11. 00%| Year:| 0| 1| 2| 3| Cash flows:| ? $1,000| $500| $500| $500| |  |  |  |  | New NPV =| $288. 55|  |  |  | Old NPV =| $221. 86|  |  |  | Change =|   $66. 69|  |  |  | | | | | | Correct

Marks for this submission: 1/1. Question 13 Marks: 1 Assuming that their NPVs based on the firm’s cost of capital are equal, the NPV of a project whose cash flows accrue relatively rapidly will be more sensitive to changes in the discount rate than the NPV of a project whose cash flows come in later in its life. Choose one answer. | a. True | | | b. False | | Correct Marks for this submission: 1/1. Question 14 Marks: 1 The internal rate of return is that discount rate that equates the present value of the cash outflows (or costs) with the present value of the cash inflows. Choose one answer. | a.

True | | | b. False | | Correct Marks for this submission: 1/1. Question 15 Marks: 1 A firm with a 10 percent cost of capital is considering a project for this year’s capital budget. The project’s expected after-tax cash flows are as follows: Year:| 0| 1| 2| 3| 4| Cash flow:| ? $5,000| $2,100| $2,300| $2,500| $2,400| | | | | | | Calculate the project’s profitability index (PI). Choose one answer. | a. 1. 4655 | | | b. 1. 8600 | | | c. 1. 2704 | | | d. 1. 6909 | | | e. 0. 5345 | | Correct Marks for this submission: 1/1. ————————————————- Top of Form Bottom of Form

You are logged in as Ashley Johnson (Logout)FINA5103Z01-13809| | You are logged in as Ashley Johnson (Logout)|  | You are here * Home * / > FINA5103Z01-13809 * / > Quizzes * / > Self-Test Chapter 12 * / > Review of attempt 2 Self-Test Chapter 12 Review of attempt 2 ————————————————- Top of Form Bottom of Form Started on| Sunday, 23 October 2011, 11:38 PM| Completed on| Sunday, 23 October 2011, 11:39 PM| Time taken| 59 secs| Grade| 10 out of a maximum of 10 (100%)| Question 1 Marks: 1 Which of the following is NOT a cash flow and thus should not be reflected in the analysis of a capital budgeting project?

Choose one answer. | a. Changes in net operating working capital. | | | b. Shipping and installation costs. | | | c. Cannibalization effects. | | | d. Opportunity costs. | | | e. Sunk costs that have been expensed for tax purposes. | | Correct Marks for this submission: 1/1. Question 2 Marks: 1 Which of the following statements is CORRECT? Choose one answer. | a. Using MACRS depreciation rather than straight line would normally have no effect on a project’s total projected cash flows but it would affect the timing of the cash flows and thus the NPV. | | | b.

Under current laws and regulations, corporations must use straight-line depreciation for all assets whose lives are 5 years or longer. | | | c. Corporations must use the same depreciation method (e. g. , straight line or MACRS) for stockholder reporting and tax purposes. | | | d. Since depreciation is not a cash expense, it has no affect on cash flows and thus no affect on capital budgeting decisions. | | | e. Under MACRS depreciation rules, higher depreciation charges occur in the early years, and this reduces the early cash flows and thus lowers a project’s projected NPV. | | Correct Marks for this submission: 1/1. Question 3 Marks: 1

Which of the following does NOT have incremental cash flow effects and thus should NOT be considered in capital budgeting decisions? Choose one answer. | a. A firm has a parcel of land that can be used for a new plant site, be sold, or be used for agricultural purposes. | | | b. A new product will generate new sales, but some of those new sales will be from customers who switch from one of the firm’s current products. | | | c. A firm must obtain new equipment for the project, and $1 million of costs for shipping and installing the new machinery will be required. | | | d. A firm has spent $2 million on R&D associated with a new product.

These costs have been expensed for tax purposes, and they cannot be recovered if the new project is rejected. | | | e. A firm can produce a new product, and the existence of that product will stimulate sales of some of the firm’s other products. | | Correct Marks for this submission: 1/1. Question 4 Marks: 1 Which of the following rules is CORRECT for capital budgeting analysis? Choose one answer. | a. The interest paid on funds borrowed to finance a project must be included in the project’s estimated cash flows. | | | b. Only incremental cash flows are relevant when making accept/reject decisions. | | c. Sunk costs are not included in the annual cash flows, but they must be deducted from the PV of the project’s other costs when reaching the accept/reject decision. | | | d. A proposed project’s estimated net income as determined by the firm’s accountants, using generally accepted accounting principles (GAAP), is discounted at the WACC, and if the PV of this income stream exceeds the project’s cost, the project should be accepted. | | | e. If a product is competitive with some of the firm’s other products, this fact should be incorporated into the estimate of the relevant cash flows.

However, if the new product is complementary to some of the firm’s other products, this will have no effect on the cash flows used in the analysis. | | Correct Marks for this submission: 1/1. Question 5 Marks: 1 Which of the following statements is CORRECT? Choose one answer. | a. Sensitivity analysis is a good way to measure market risk because it explicitly takes into account diversification effects. | | | b. One advantage of sensitivity analysis relative to scenario analysis is that it explicitly takes into account the probability of specific effects occurring, whereas scenario analysis cannot account for probabilities. | | c. Well-diversified stockholders do not need to consider market risk when determining required rates of return. | | | d. Market risk is important, but it does not have a direct effect on stock prices because it only affects beta. | | | e. Simulation analysis is a computerized version of scenario analysis where input variables are selected randomly on the basis of their probability distributions. | | Correct Marks for this submission: 1/1. Question 6 Marks: 1 Your company, Omega Corporation, is considering a new project which you must analyze. Based on the following data, what is the project’s Year 1 operating cash flow?

Sales revenues| $25,000| Depreciation| $8,000| Other operating costs| $12,000| Tax rate| 35. 0%| | | Choose one answer. | a. $10,585 | | | b. $10,913 | | | c. $11,250 | | | d. $11,588 | | | e. $11,935 | | Sales revenues| $25,000| ? Operating costs (x-depr)| 12,000| ? Depreciation expense|     8,000| Operating income (EBIT)| $5,000| ? Taxes| Rate = 35%|     1,750| After-tax EBIT| $3,250| + Depreciation|     8,000| Operating cash flow| $11,250| | | | Correct Marks for this submission: 1/1. Question 7 Marks: 1 Bing Services is now in the final year of a project. The equipment originally cost $20,000, of which 75% has been depreciated.

Bing can sell the used equipment today for $6,000, and its tax rate is 40%. What is the equipment’s net after-tax salvage value for use in a capital budgeting analysis? Note that if the equipment’s final market value is less than its book value, Bing will receive a tax credit as a result of the sale. Choose one answer. | a. $5,320 | | | b. $5,600 | | | c. $5,880 | | | d. $6,174 | | | e. $6,483 | | % depreciated on equip. | 75%| Tax rate| 40%| |  | Equipment cost| $20,000| ? Accumulated depr’n|   15,000| Current book value of equipment| $5,000| Market value|     6,000| Gain (or loss): Market value ?

Book value| $1,000| Taxes paid on gain or credited on loss|      ? 400| Net AT salvage value = market value +/? taxes =| $  5,600| | | Correct Marks for this submission: 1/1. Question 8 Marks: 1 A firm is considering a new project whose risk is greater than the risk of the firm’s average project, based on all methods for assessing risk. In evaluating this project, it would be reasonable for management to do which of the following? Choose one answer. | a. Increase the estimated IRR of the project to reflect its greater risk. | | | b. Increase the estimated NPV of the project to reflect its greater risk. | | | c.

Reject the project, since its acceptance would increase the firm’s risk. | | | d. Ignore the risk differential if the project would amount to only a small fraction of the firm’s total assets. | | | e. Increase the cost of capital used to evaluate the project to reflect the project’s higher-than-average risk. | | Correct Marks for this submission: 1/1. Question 9 Marks: 1 California Hideaways is considering a new project whose data are shown below. The equipment that would be used has a 3-year tax life, would be depreciated by the straight-line method over its 3-year life, and would have zero salvage value.

No new working capital would be required. Revenues and other operating costs are expected to be constant over the project’s 3-year life. What is the project’s NPV? (Hint: Cash flows are constant in Years 1-3. ) WACC| 10. 0%| Net investment cost (depreciable basis)| $65,000| Straight-line depr’n rate| 33. 3333%| Sales revenues, each year| $60,000| Operating costs excl. depr’n, each year| $25,000| Tax rate| 35. 0%| | | Choose one answer. | a. $8,499 | | | b. $8,946 | | | c. $9,417 | | | d. $9,913 | | | e. $10,434 | | WACC 10%| Years| 0| 1| 2| 3| Investment cost| ? $65,000|  |  |  | Sales revenues|  | $60,000| $60,000| $60,000| Operating costs (x-depr)|  |   25,000|   25,000|   25,000| ? Depreciation| Rate = 33. 333%|  |   21,667|   21,667|   21,667| Operating income (EBIT)|  | $13,333| $13,333| $13,333| ? Taxes| Rate = 35%|  |     4,667|     4,667|     4,667| After-tax EBIT|  |   $8,667|   $8,667|   $8,667| + Depreciation|                |   21,667|   21,667|   21,667| Operating cash flow| ? $65,000| $30,333| $30,333| $30,333|  |  |  |  |  | NPV = $10,434|  |  |  |  | | | | | | | Correct Marks for this submission: 1/1. Question 10 Marks: 1 Majestic Theaters is considering investing in some new projection equipment whose data are shown below.

The required equipment has a 3-year tax life and would be fully depreciated by the straight-line method over the 3 years, but it would have a positive pre-tax salvage value at the end of Year 3, when the project would be closed down. Also, some new working capital would be required, but it would be recovered at the end of the project’s life. Revenues and other operating costs are expected to be constant over the project’s 3-year life. What is the project’s NPV? WACC| 10. 0%| Net investment in fixed assets (depreciable basis)| $65,000| Required new working capital| $10,000| Straight line depr’n rate| 33. 333%|

Sales revenues, each year| $70,000| Operating costs excl. depr’n, each year| $25,000| Expected pretax salvage value| $5,000| Tax rate| 35. 0%| | | Choose one answer. | a. $23,965 | | | b. $25,226 | | | c. $26,554 | | | d. $27,882 | | | e. $29,276 | | WACC = 10%| t = 0| t = 1| t = 2| t = 3| Investment in fixed assets| ? $65,000|  |  |  | Investment in net working capital|   ? 10,000|  |  |  | Sales revenues|  | $70,000| $70,000| $70,000| ? Operating costs (x-depr)|  |   25,000|   25,000|   25,000| Depreciation| Rate = 33. 333%|  |   21,667|   21,667|   21,667| Operating income (EBIT)|  | $23,333| $23,333| $23,333| ?

Taxes| Rate = 35%|  |     8,167|     8,167|     8,167| After-tax EBIT|  | $15,167| $15,167| $15,167| + Depreciation|                |   21,667|   21,667|   21,667| Operating cash flow| ? $75,000| $36,833| $36,833| $36,833| Recovery of working capital|  |  |  |   10,000| Salvage value, pre-tax|  |  |  |     5,000| ? Tax on salvage value| Rate = 35%|                |              |              |     1,750| Total cash flows| ? $75,000| $36,833| $36,833| $50,083|  |  |  |  |  | NPV = $26,554|  |  |  |  | | | | | | | Correct Marks for this submission: 1/1. ————————————————-

Top of Form Bottom of Form You are logged in as Ashley Johnson (Logout)FINA5103Z01-13809| 1 Marks: 1 Two important issues in corporate governance are (1) the rules that cover the board’s ability to fire the CEO and (2) the rules that cover the CEO’s ability to remove members of the board. Choose one answer. | a. True | | | b. False | | Correct Marks for this submission: 1/1. Question 2 Marks: 1 If a company’s expected return on invested capital is less than its cost of equity, then the company must also have a negative market value added (MVA). Choose one answer. | a. True | | | b. False | | Correct

Marks for this submission: 1/1. Question 3 Marks: 1 A poison pill is also known as a corporate restructuring. Choose one answer. | a. True | | | b. False | | Correct Marks for this submission: 1/1. Question 4 Marks: 1 The CEO of D’Amico Motors has been granted some stock options that have provisions similar to most other executive stock options. If D’Amico’s stock underperforms the market, these options will necessarily be worthless. Choose one answer. | a. True | | | b. False | | Correct Marks for this submission: 1/1. Question 5 Marks: 1 Which of the following statements is NOT CORRECT? Choose one answer. a. The corporate valuation model can be used both for companies that pay dividends and those that do not pay dividends. | | | b. The corporate valuation model discounts free cash flows by the required return on equity. | | | c. The corporate valuation model can be used to find the value of a division. | | | d. An important step in applying the corporate valuation model is forecasting the firm’s pro forma financial statements. | | | e. Free cash flows are assumed to grow at a constant rate beyond a specified date in order to find the horizon, or terminal, value. | | Correct Marks for this submission: 1/1.

Question 6 Marks: 1 Akyol Corporation is undergoing a restructuring, and its free cash flows are expected to be unstable during the next few years. However, FCF is expected to be $50 million in Year 5, i. e. , FCF at t = 5 equals $50 million, and the FCF growth rate is expected to be constant at 6% beyond that point. If the weighted average cost of capital is 12%, what is the horizon value (in millions) at t = 5? Choose one answer. | a. $719 | | | b. $757 | | | c. $797 | | | d. $839 | | | e. $883 | | FCF5:| $50| g:| 6%| WACC:| 12%| | | HV5| = FCF6 / (WACC – g) = FCF5(1 + g) / (WACC – g)| | = $50(1 + 0. 6) / (0. 12 – 0. 06) = $53 / 0. 06 = $883| | | Correct Marks for this submission: 1/1. Question 7 Marks: 1 Suppose Yon Sun Corporation’s free cash flow during the just-ended year (t = 0) was $100 million, and FCF is expected to grow at a constant rate of 5% in the future. If the weighted average cost of capital is 15%, what is the firm’s value of operations, in millions? Choose one answer. | a. $948 | | | b. $998 | | | c. $1,050 | | | d. $1,103 | | | e. $1,158 | | FCF0:| $100| g:| 5%| WACC:| 15%| | | Value Ops| = FCF1 / (WACC – g) = FCF0(1 + g) / (WACC – g)|  | = $100(1 + 0. 05) / (0. 15 – 0. 5) = $105 / 0. 1 = $1,050| | | Correct Marks for this submission: 1/1. Question 8 Marks: 1 Zhdanov Inc. forecasts that its free cash flow in the coming year, i. e. , at t = 1, will be –$10 million, but its FCF at t = 2 will be $20 million. After Year 2, FCF is expected to grow at a constant rate of 4% forever. If the weighted average cost of capital is 14%, what is the firm’s value of operations, in millions? Choose one answer. | a. $158 | | | b. $167 | | | c. $175 | | | d. $184 | | | e. $193 | | FCF1:| –$10| FCF2:| $20| g:| 4%| WACC:| 14%| | | First, find the horizon, or terminal, value:

HV2 = FCF2(1 + g) / (WACC – g) = $20(1. 04) / (0. 14 – 0. 04) = $20. 8/0. 10 = $208. 00 Then find the PV of the free cash flows and the horizon value: Value of operations| = –$10 / (1. 14)1 + ($20 + $208) / (1. 14)2|  | = –$8. 772 + $175. 439 = $167| | | Correct Marks for this submission: 1/1. Question 9 Marks: 1 Which of the following is NOT normally regarded as being a barrier to hostile takeovers? Choose one answer. | a. Abnormally high executive compensation. | | | b. Targeted share repurchases. | | | c. Shareholder rights provisions. | | | d. Restricted voting rights. | | | e. Poison pills. | |

Correct Marks for this submission: 1/1. Question 10 Marks: 1 Which of the following is NOT normally regarded as being a good reason to establish an ESOP? Choose one answer. | a. To increase worker productivity. | | | b. To enable the firm to borrow at a below-market interest rate. | | | c. To make it easier to grant stock options to employees. | | | d. To help prevent a hostile takeover. | | | e. To help retain valued employees. | | Statement c is the correct answer, because firms can easily grant stock options to employees without an ESOP. Correct Marks for this submission: 1/1. Question 11 Marks: 1

Based on the corporate valuation model, Bernile Inc. ‘s value of operations is $750 million. Its balance sheet shows $50 million of short-term investments that are unrelated to operations, $100 million of accounts payable, $100 million of notes payable, $200 million of long-term debt, $40 million of common stock (par plus paid-in-capital), and $160 million of retained earnings. What is the best estimate for the firm’s value of equity, in millions? Choose one answer. | a. $429 | | | b. $451 | | | c. $475 | | | d. $500 | | | e. $525 | | Value of operations:| $750| Short-term investments:| $50| Notes payable:| $100|

Long-term debt:| $200| | | Assuming that the book value of debt is close to its market value, the total market value of the company is: Total market value| = Value of operations + Value of non-operating assets|  | = $750 + $50 = $800. | | | Value of Equity = Total MV – Long- and Short-term debt = $500. The book value of equity figures are irrelevant for this problem. Also, the accounts payable are not relevant because they were netted out when the FCF was calculated. Correct Marks for this submission: 1/1. Question 12 Marks: 1 Based on the corporate valuation model, Hunsader’s value of operations is $300 million.

The balance sheet shows $20 million of short-term investments that are unrelated to operations, $50 million of accounts payable, $90 million of notes payable, $30 million of long-term debt, $40 million of preferred stock, and $100 million of common equity. The company has 10 million shares of stock outstanding. What is the best estimate of the stock’s price per share? Choose one answer. | a. $13. 72 | | | b. $14. 44 | | | c. $15. 20 | | | d. $16. 00 | | | e. $16. 80 | | Value of operations:| $300| Short-term investments:| $20| Notes payable:| $90| Long-term debt:| $30| Preferred stock| $40|

Shares outstanding:| 10| | | Assuming that the book value of debt is close to its market value, the total market value of the company is: Total market value| = Value of operations + Value of non-operating assets|  | = $300 + $20 = $320. | | | Value of Equity = Total MV – Long- and Short-term debt and preferred = $160 Stock price = Value of Equity/Shares outstanding = $16. 00 The book value of equity figures are irrelevant for this problem. Also, the working capital account numbers are not relevant because they were netted out when the FCF was calculated. Correct Marks for