FIN CHAPTER 13

Sunland Insurance Ltd. issued a fixed-rate perpetual preferred stock three years ago and placed it privately with institutional investors. The stock was issued at $25 per share with a $1.94 dividend. If the company were to issue preferred stock today, the yield would be 6.4 percent. The stock's current value is: $42.17. $42.63. $30.31. $25.00.

$30.31. 1.94/6.4%=

An investment of $75 generates after-tax cash flows of $30 in Year 1, $60 in Year 2, and $90 in Year 3. The required rate of return is 20 percent. The net present value is closest to $52.50. $43.75. $33.88. $57.31.

$43.75.

An investment of $155397 is expected to generate an after-tax cash flow of $79800 in one year and another $145008 in two years. The cost of capital is 10 percent. What is the internal rate of return? 25.43 percent 25.63 percent 25.23 percent 25.03 percent

25.63 percent

What is the payback period for a $20,000 project that is expected to return $6,000 for the first two years and $3,000 for years three through five? (Round your answer to two decimal places.) 4.50 years 4.76 years 4.67 years 3.67 years

4.67 years

The Sunland Company has an after-tax cost of debt capital of 4 percent, a cost of preferred stock of 7 percent, a cost of equity capital of 10 percent, and a weighted average cost of capital of 6 percent. Sunland intends to maintain its current capital structure as it raises additional capital. In making its capital-budgeting decisions for the average-risk project, the relevant cost of capital is: 10 percent. 4 percent. 7 percent. 6 percent.

6 percent.

Wally's War Duds has a preferred share issue outstanding with a current price of $26.57. The firm is expected to pay a dividend of $1.86 per share a year from today. What is the firm's cost of preferred equity? Round your final answer to two decimal places. 6.50% 7.00% 7.50% 8.00%

7.00%

Bellamee, Inc. has semiannual bonds outstanding with five years to maturity, and the bonds are priced at $920.87. If the bonds have a coupon rate of 7 percent, then what is the YTM for the bonds? Round your final percentage answer to one decimal place. A. 4.5% B. 9.0% C. 9.2% D. 7.0%

9.0%

Which of the following is one of the steps necessary for conducting a capital budgeting analysis of a project? Estimating the project's future cash flows Deciding on how the capital required will be raised Computing the debt-to-equity ratio of the firm Determining the systematic risk of the project

Estimating the project's future cash flows

Which of the following methods is typically used to estimate a firm's cost of equity? NPV method The CAPM The perpetuity model Discounted payback method

The CAPM

When the discount rate estimated is too low, firms run the risk of accepting a negative NPV project. True False

True

The appropriate risk-free rate to use when calculating the cost of equity for a firm is a long-term Treasury rate. a short-term Treasury rate. an equal mix of short-term and long-term Treasury rates. none of the above.

a long-term Treasury rate.

Of the four capital budgeting techniques, the one that managers use the least is: payback period. net present value. accounting rate of return. IRR.

accounting rate of return.

Two projects are considered to be mutually exclusive if none of these. both selecting one would automatically eliminate accepting the other and the projects perform the same function. the projects perform the same function. selecting one would automatically eliminate accepting the other.

both selecting one would automatically eliminate accepting the other and the projects perform the same function.

Contingent projects would imply that none of these. both the acceptance of one project is dependent on the acceptance of the other and the projects can be either mandatory or optional. the projects can be either mandatory or optional. the acceptance of one project is dependent on the acceptance of the other.

both the acceptance of one project is dependent on the acceptance of the other and the projects can be either mandatory or optional.

To accept a capital project when using NPV, the project NPV should be greater than zero. both the project NPV should be greater than zero and the project NPV should be less than zero. the project NPV should be less than zero. none of these.

the project NPV should be greater than zero.

The value of the cash flows that the assets of a firm are expected to generate must equal A. the value of the cash flows claimed by the debt investors. B. the revenue produced by the firm. C. the value of the cash flows claimed by the equity investors. D. the value of the cash flows claimed by both the equity and debt investors.

the value of the cash flows claimed by both the equity and debt investors.

A situation where a firm would not want to use its own WACC to evaluate a risky project would be when: the systematic risk of the project is similar to the beta of the firm. the firm cannot estimate its own cost of capital. the cost of capital of a pure-play comparable that is similar to the project can be found. when the capital used in the project is similar to that used by the firm as a whole. Save for Later

the cost of capital of a pure-play comparable that is similar to the project can be found.

The cost of capital is the return the firm had earned on a previous project. the maximum return a project can earn. the minimum return that a capital project must earn to be accepted. none of the these.

the minimum return that a capital project must earn to be accepted.

The Classic Car Co. has a before-tax cost of debt capital of 9%, a cost of preferred stock of 10%, a cost of equity capital of 14%, and a marginal tax rate of 40%. The market values of its debt, preferred stock and common stock are $40 million, $20 million, and $60 million respectively. Therefore, for evaluating average risk projects, the manager should use a discount rate of _____. (Do not round intermediate calculations. Round final answer to two decimal places.) 9.27%. 12.37%. 14.47%. 10.47%.

10.47%

Maloney's, Inc. has found that its cost of common equity capital is 17 percent and its cost of debt capital is 6 percent. The firm is financed with $3,000,000 of common shares (market value) and $2,000,000 of debt. What is the after-tax weighted average cost of capital for Maloney's, if it is subject to a 40 percent marginal tax rate? 8.96% 11.16% 11.64% 12.60%

11.64%

Suppose the cost of capital of the Blossom Company is 10 percent. If Blossom has a capital structure that is 50 percent debt and 50 percent equity, its before-tax cost of debt is 4 percent, and its marginal tax rate is 20 percent, then its cost of equity capital is closest to: 16.8 percent. 12.8 percent. 10.8 percent. 14.8 percent.

14.8 percent.

Gangland Water Guns, Inc. is expected to pay a dividend of $2.10 one year from today. If the firm's growth in dividends is expected to remain at a flat 3 percent forever, what is the cost of equity capital for Gangland if the price of its common shares is currently $17.50? 15.00% 12.00% 15.36% 14.65%

15.00%

You are analyzing the cost of capital for a firm that is financed with 65 percent equity and 35 percent debt. The cost of debt capital is 8 percent, while the cost of equity capital is 20 percent for the firm. What is the overall cost of capital for the firm? 14.0% 12.2% 15.8% 20.0%

15.8%

Initial Outlay Cash Flow in Period CF0 CF1 CF2 CF3 CF4 -20,0007,730.857,730.857,730.857,730.85 The IRR is approximately: 18%. 16%. 14%. 20%.

20%.

Which of the following cash flow patterns is NOT an unconventional cash flow pattern? A cash flow stream looks similar to a conventional cash flow stream except for a final negative cash flow. A negative initial cash flow is followed by positive future cash flows. A cash flow pattern in which there are alternate inflows and outflows. A positive initial cash flow is followed by negative future cash flows.

A negative initial cash flow is followed by positive future cash flows.

Which of the following is a disadvantage of the payback method? It is inconsistent with the goal of maximizing shareholder wealth. It ignores cash flows beyond the payback period. It ignores the time value of money. All of these.

All of these.

Which of the following capital component costs must be adjusted for taxes? Cost of common stock. Cost of debt. Cost of preferred stock. All of the above.

Cost of debt.

The cost of equity is equal to the: Expected market return. Rate of return required by stockholders. Cost of retained earnings plus dividends. Risk the company incurs when financing.

Rate of return required by stockholders.

The Capital Asset Pricing Model is an appropriate method of calculating a firm's cost of equity when no dividends are being paid. True False

True

The cost of equity for a firm is a weighted average of the costs of the different types of stock that the firm has outstanding at a particular point in time. True False

True

The cost of capital of a company that uses 45 percent debt that has an after-tax cost of debt of 10 percent and 55 percent equity that has a cost of 15 percent is: 12.75%. 12.25%. 12.5%. 13%.

WACC = After tax cost of Debt* Weight of Debt + Cost of Equity*Weight of Equity = 10*0.45 + 15*0.55 = 12.75%

Which of the following is a key disadvantage of the IRR method? With mutually exclusive projects, the IRR method can lead to incorrect investment decisions. With conventional cash flows, the IRR method can yield multiple answers. The IRR method is not based on a discounted cash flow technique. The IRR method ignores all cash flows after the arbitrary cutoff period.

With mutually exclusive projects, the IRR method can lead to incorrect investment decisions.

If a company's weighted average cost of capital is less than the required return on equity, then the firm A. must have preferred stock in its capital structure. B. is financed with more than 50% debt. C. is perceived to be safe. D. has debt in its capital structure.

has debt in its capital structure.

The NPV and IRR methods will always agree when you are evaluating _____ projects and the project's cash flows are _____. independent; unconventional independent; conventional mutually exclusive; unconventional mutually exclusive; conventional

independent; conventional