FIN 125 Exam 3

Which one of the following should not be included in the analysis of a new product? Select one: Increase in accounts payable for inventory purchases of the new product Reduction in sales for a current product once the new product is introduced Market value of a machine owned by the firm which will be used to produce the new product Money already spent for research and development of the new product Increase in accounts receivable needed to finance sales of the new product

Money already spent for research and development of the new product

Which one of the following is a correct method for computing the operating cash flow of a project assuming that the interest expense is equal to zero? Select one: EBIT + Depreciation EBIT(1 + Taxes) Net income + Depreciation (Sales − Costs)(1 − Depreciation)(1 − Taxes) (Sales − Costs)(1 − Taxes)

Net income + Depreciation

The option that is forgone so that an asset can be utilized by a specific project is referred to as which one of the following? Select one: Salvage value Wasted value Sunk cost Opportunity cost Erosion

Opportunity cost

The fact that a proposed project is analyzed based on the project's incremental cash flows is the assumption behind which one of the following principles? Select one: Underlying value principle Stand-alone principle Equivalent cost principle Salvage principle Fundamental principle

Stand-alone principle

GL Plastics spent $1,200 last week repairing a machine. This week the company is trying to decide if the machine could be better utilized if they assigned it a proposed project. When analyzing the proposed project, the $1,200 should be treated as which type of cost? Select one: Opportunity Fixed Incremental Erosion Sunk

Sunk

Which one of the following best describes the concept of erosion? Select one: Expenses that have already been incurred and cannot be recovered Change in net working capital related to implementing a new project The cash flows of a new project that come at the expense of a firm's existing cash flows The alternative that is forfeited when a fixed asset is utilized by a project The differences in a firm's cash flows with and without a particular project

The cash flows of a new project that come at the expense of a firm's existing cash flows

Which one of the following statements is correct in relation to M&M Proposition II, without taxes? Select one: The cost of equity remains constant as the debt-equity ratio increases. The cost of equity is inversely related to the debt-equity ratio. The required return on assets is equal to the weighted average cost of capital. Financial risk determines the return on assets. Financial risk is unaffected by the debt-equity ratio.

The required return on assets is equal to the weighted average cost of capital.

Which one of the following is the primary determinant of a firm's cost of capital? Select one: Debt-equity ratio of any new funds raised Marginal tax rate Pretax cost of equity Aftertax cost of equity Use of the funds raised

Use of the funds raised

The optimal capital structure has been achieved when the: Select one: debt-equity ratio is equal to 1. weight of equity is equal to the weight of debt. cost of equity is maximized given a pretax cost of debt. debt-equity ratio is such that the cost of debt exceeds the cost of equity. debt-equity ratio results in the lowest possible weighted average cost of capital.

debt-equity ratio results in the lowest possible weighted average cost of capital.

Pro forma statements for a proposed project should generally do all of the following except: Select one: be compiled on a stand-alone basis. include all project-related fixed asset acquisitions and disposals. include all the incremental cash flows related to the project. include taxes. include interest expense.

include interest expense.

The difference between a company's future cash flows if it accepts a project and the company's future cash flows if it does not accept the project is referred to as the project's: Select one: incremental cash flows. internal cash flows. external cash flows. erosion effects. financing cash flows.

incremental cash flows.

The costs incurred by a business in an effort to avoid bankruptcy are classified as _____ costs. Select one: flotation direct bankruptcy indirect bankruptcy financial solvency capital structure

indirect bankruptcy

Pro forma financial statements can best be described as financial statements: Select one: expressed in a foreign currency. where the assets are expressed as a percentage of total assets and costs are expressed as a percentage of sales. showing projected values for future time periods. expressed in real dollars, given a stated base year. where all accounts are expressed as a percentage of last year's values.

showing projected values for future time periods.

The discount rate assigned to an individual project should be based on: Select one: the company's overall weighted average cost of capital. the actual sources of funding used for the project. an average of the company's overall cost of capital for the past five years. the current risk level of the overall firm. the risks associated with the use of the funds required by the project.

the risks associated with the use of the funds required by the project.

The basic lesson of M&M theory is that the value of a company is dependent upon: Select one: the total cash flows of that company.the company's capital structure. the total cash flows of that company. minimizing the marketed claims. the amount of the company's marketed claims. size of the stockholders' claims.

the total cash flows of that company.

M&M Proposition I with taxes is based on the concept that: Select one: the optimal capital structure is the one that is totally financed with equity. capital structure is irrelevant because investors and companies have differing tax rates. WACC is unaffected by a change in the company's capital structure. the value of a taxable company increases as the level of debt increases. the cost of equity increases as the debt-equity ratio increases.

the value of a taxable company increases as the level of debt increases.

If a company has the optimal amount of debt, then the: Select one: direct financial distress costs must equal the present value of the interest tax shield. company has no financial distress costs. Value of the firm is equal to VL + TCD. debt-equity ratio is equal to 1.

value of the levered company will exceed the value of the unlevered company.

Which one of the following is an example of a sunk cost? Select one: $1,500 of lost sales because an item was out of stock $1,200 paid to repair a machine last year $20,000 project that must be forfeited if another project is accepted $4,500 reduction in current shoe sales if a store commences selling sandals $1,800 increase in comic book sales if a store ceases selling puzzles

$1,200 paid to repair a machine last year

Which one of the following is a project cash inflow? Ignore any tax effects. Select one: Decrease in accounts payable Increase in accounts receivable Decrease in inventory Depreciation expense Equipment acquisition

Decrease in inventory

All of the following are related to a proposed project. Which one of these should be included in the cash flow at Time 0? Select one: Loan obtained to finance the project Initial investment in inventory to support the project Annual depreciation tax shield Aftertax salvage value Net working capital recovery

Initial investment in inventory to support the project

The operating cash flow for a project should exclude which one of the following? Select one: Taxes Variable costs Fixed costs Interest expense Depreciation tax shield

Interest expense

Which form of financing do companies prefer to use first according to the pecking-order theory? Select one: Regular debt Convertible debt Common stock Preferred stock Internal funds

Internal funds

he concept of homemade leverage is most associated with: Select one: M&M Proposition I with no tax. M&M Proposition II with no tax. M&M Proposition I with tax. M&M Proposition II with tax. the static theory proposition.

M&M Proposition I with no tax.

Which one of the following states that the value of a company is unrelated to the company's capital structure? Select one: Homemade leverage M&M Proposition I, no tax M&M Proposition II, no tax Pecking-order theory Static theory of capital structure

M&M Proposition I, no tax

Kelley's Baskets makes handmade baskets and is currently considering making handmade wreaths as well. Which one of the following is the best example of an incremental operating cash flow related to the wreath project? Select one: Storing supplies in the same space currently used for materials storage Utilizing the basket manager to oversee wreath production Hiring additional employees to handle the increased workload should the firm accept the wreath project Researching the market to determine if wreath sales might be profitable before deciding to proceed Planning on lower interest expense by assuming the proceeds of the wreath sales will be used to reduce the firm's currently outstanding debt

Hiring additional employees to handle the increased workload should the firm accept the wreath project

Which one of the following makes the capital structure of a company irrelevant? Select one: Taxes Interest tax shield 100 percent dividend payout ratio Debt-equity ratio that is greater than 0 but less than 1 Homemade leverage

Homemade leverage

Westover Mills reduced its taxes last year by $210 by increasing its interest expense by $1,000. Which one of the following terms is used to describe this tax savings? Select one: Interest tax shield Interest credit Homemade leverage shield Current tax yield Tax-loss interest

Interest tax shield

Which one of the following best illustrates erosion as it relates to a hot dog stand located on the beach? Select one: Providing both ketchup and mustard for customers' use Repairing the roof of the hot dog stand because of water damage Selling fewer hot dogs because hamburgers were added to the menu Offering french fries but not onion rings Losing sales due to bad weather

Selling fewer hot dogs because hamburgers were added to the menu

Which one of the following costs was incurred in the past and cannot be recouped? Select one: Incremental Side Sunk Opportunity Erosion

Sunk

The present value of the interest tax shield is expressed as: Select one: TCD/RA. VU + TCD. TCDRA. [EBIT(TCD)]/RA. TCD.

TCD.

A company's current cost of capital is based on: Select one: only the return required by the company's current shareholders. the current market rate of return on equity shares. the weighted costs of all future funding sources. both the returns currently required by its debtholders and stockholders. the company's original debt-equity ratio.

both the returns currently required by its debtholders and stockholders. Correct

You have computed the break-even point between a levered and an unlevered capital structure. Ignore taxes. At the break-even level, the: Select one: company is earning just enough to pay for the cost of the debt. company's earnings before interest and taxes are equal to zero. earnings per share for the levered option are exactly double those of the unlevered option. advantages of leverage exceed the disadvantages of leverage. company has a debt-equity ratio of .50.

company is earning just enough to pay for the cost of the debt.

The cost of capital for a new project: Select one: is determined by the overall risk level of the firm. is dependent upon the source of the funds obtained to fund that project. is dependent upon the firm's overall capital structure. should be applied as the discount rate for all other projects considered by the firm. depends upon how the funds raised for that project are going to be spent.

depends upon how the funds raised for that project are going to be spent.

M&M Proposition II with taxes: Select one: has the same general implications as M&M Proposition II without taxes. states that capital structure is irrelevant to shareholders. supports the argument that business risk is determined by the capital structure decision. supports the argument that the cost of equity decreases as the debt-equity ratio increases. concludes that the capital structure decision is irrelevant to the value of a firm.

has the same general implications as M&M Proposition II without taxes.

A firm should select the capital structure that: Select one: produces the highest cost of capital. maximizes the value of the firm. minimizes taxes. is fully unlevered. equates the value of debt with the value of equity.

maximizes the value of the firm.

A project's cash flow is equal to the project's operating cash flow: Select one: plus the project's depreciation expense minus both the project's taxes and capital spending. minus both the project's change in net working capital and capital spending. minus the project's change in net working capital plus all of the depreciation expenses. plus the project's depreciation expenses minus the project's taxes. minus the project's taxes.

minus both the project's change in net working capital and capital spending.