Finance chapters 11, 12, 13
Which of the following statements is correct? A. Discounted payback solves all the shortcomings of payback. B. The reinvestment rate of NPV and MIRR is the same. C. The MIRR and IRR have the same reinvestment rate. D. All of these are correct statements.
B
The least-used capital budgeting technique in industry is ____________.
MIRR
The MIRR statistic is different from the IRR statistic in that _____________.
The MIRR assumes that the cash inflows can be reinvested at the cost of capital
What is the theoretical minimum for the weighted average cost of capital?
The after-tax cost of debt
which of the following statements is correct? A. A weakness of both payback and discounted payback is that neither accounts for cash flows received after the payback. B. Discounted payback uses a more aggressive reinvestment rate assumption than payback. C. Neither payback nor discounted payback uses time value of money concepts. D. None of these statements is correct.
a
One way to account for flotation costs of raising capital is to
adjust the project's initial cash flow so that it will reflect the flotation costs.
A project has normal cash flows. Its IRR is 15 percent and its cost of capital is 10 percent. Given this, the project must have:
an NPV that is greater than zero
All of the following are strengths of NPV except _______________. A. It works equally well for independent and mutually exclusive projects B. Managers have a preference for using a statistic that is in percent instead of dollars C. It uses a conservative reinvestment rate assumption D. These are all strengths of the NPV statistic
b
Suppose you have a project whose discounted payback is equal to its termination date. What can you say for sure about its PI?
it will have a PI and NPV of zero
A manufacturing firm is planning on expanding its existing operations. The expansion project is significant and will require the firm to house the expansion in a different location. The firm is considering building on a lot they own across town. The lot is currently vacant and it was paid for nearly 20 years ago. Given this information, which of the following statements is correct? A. The lot is not an incremental cash flow because it is not being utilized at this time. B. The lot is an incremental cash flow because it represents an opportunity cost. C. The lot is an incremental cash flow because it represents a sunk cost. D. The lot is not an incremental cash flow because it has already been paid for.
B
All of the following capital budgeting tools are suitable for non-normal cash flows except ____. A. MIRR B. Profitability Index C. Discounted Payback D. NPV
C
All of the following can be included in the depreciable basis of an asset except _______. A. Freight charges B. Installation fees C. Sales tax D. Variable costs
D
The reason that we do not use an after-tax cost of preferred stock is __________. A. because preferred dividends are paid out of before-tax income B. because most of the investors in preferred stock do not pay tax on the dividends C. because we can only estimate the marginal tax rate of the preferred stockholders D. None of these answers is correct.
D
Which of the following makes this a true statement? Ideally, when searching for a beta for a new line of business A. one could find other firms engaged in the proposed new line of business and use their betas as proxies to estimate the project's risk. B. one would like to find at least three or four pure-play proxies. C. two, or even one, proxies might represent a suitable sample if their line of business resembles the proposed new project closely enough. D. All the answers make this a true statement.
D
Under what conditions can a rate-based statistic yield a different accept/reject decision than NPV?
Mutually exclusive projects that exhibit differences in scale or timing.
A capital budgeting technique that generates a decision rule and associated metric for choosing projects based on the total discounted value of their cash flows is referred to as ______________.
NPV
Which of the following is incorrect regarding the IRR statistic? A. For independent projects, IRR will give the same accept/reject decision as NPV. B. For the IRR statistic to give a different accept/reject decision from NPV, the cash flows must be non-normal and the projects must be mutually exclusive. C. To solve for the IRR, one can simply solve the NPV formula for the rate that will make the NPV equal to zero. D. None of these statements is incorrect.
b
A decrease in net working capital (NWC) is treated as a
cash inflow
1. When calculating the weighted average cost of capital, weights are based on
market values
A capital budgeting technique that converts a project's cash flows using a more consistent reinvestment rate prior to applying the Internal Rate of Return, IRR, decision rule.
modified internal rate of return
These are groups or pairs of projects where you can accept one but not all.
mutually exclusive
This technique for evaluating capital projects is particularly useful when firms face time constraints in repaying investors.
payback
This technique for evaluating capital projects tells how long it will take a firm to earn back the money invested in a project.
payback
This is the process of estimating expected future cash flows of a project using only the relevant parts of the balance sheet and income statements.
pro forma analysis
This is the concept that a unit's sales will follow an approximate bell-shaped curve versus a steady sales life.
product life cycle
The ____________ approach to computing a divisional weighted average cost of capital (WACC) requires only that WACCs for "risky" and "relatively safe" divisions be adjusted.
subjective
Coke is planning on marketing a new drink called Very Berry Coke which is a mixture of raspberry and blackberry flavors blended to perfection and added to the highly secret Coca-Cola formula. This new product is expected to reduce the sales of their existing product, Cherry Coke, by $10 million dollars per year. This is an example of a _______________.
substitutionary effect
Effects that arise from a new product or service that decrease sales of the firm's existing products or services are referred to as
substitutionary effects.
Suppose a new project was going to be financed partially with retained earnings. What flotation costs should you use for retained earnings?
zero
The benchmark for the Profitability Index, PI, is the
zero or anything larger than zero
The process of estimating expected future cash flows of a project using only the relevant parts of the balance sheet and income statements is referred to as the _________________.
Pro forma analysis
Which of the following statements is correct regarding the NPV profile? A. The IRR appears as the intersection of the NPV profile with the x-axis. B. The IRR appears at the crossover point or where the two profiles intersect. C. NPV profiles for independent projects with normal cash flows will intersect. D. All of these statements are correct.
a
Flotation costs are _______________.
commissions to the underwriting firm that floats the issue
An objective approach to calculating divisional WACCs would be done by
computing the average beta per division, using these figures for each division in the CAPM formula, and then constructing divisional WACCs.
The Net Present Value decision technique uses a statistic denominated in
currency
We accept projects with a positive NPV because it means that ____________. A. We have recovered all our costs B. We are creating wealth for shareholders C. The project's expected return exceeds the cost of capital D. All of these
d
A capital budgeting technique that generates decision rules and associated metrics for choosing projects based upon the implicit expected geometric average of a project's rate of return.
internal rate of return
a project's IRR ____________________.
is the average rate of return necessary to pay back the project's capital providers
Which of the following statements is correct? A. If a new project is riskier than the firm's existing projects, then it should be expect to be "charged" a higher cost of capital than the firm's overall WACC. B. If a new project is riskier than the firm's existing projects, then it should be expect to be "charged" a lower cost of capital than the firm's overall WACC. C. The project's risk and the cost of capital to which it is compared are independent. D. None of these answers is correct.
A
Which statement makes this a false statement? When a firm pays commissions to underwriting firms that float the issuance of new stock, A. the component cost will need to be integrated to figure project WACCs. B. the component cost will need to be integrated only for the firm's WACC. C. the firm can increase the project's WACC to incorporate the flotation costs' impact. D. the firm can leave the WACC alone and adjust the project's initial investment upwards.
A
A decision rule and associated methodology for converting the NPV statistic into a rate-based metric is referred to as _______________________. A. NPV B. Profitability Index C. MIRR D. Discounted Payback
B
Which of the following statements is correct? A. The WACC measures the before-tax cost of capital. B. An increase in the firm's marginal corporate tax rate will decrease the weighted average cost of capital. C. Flotation costs can decrease the weighted average cost of capital. D. None of these statements is correct.
B
Which of the following statements is correct? A. The flotation-adjusted cost of equity will always be less than the cost of equity that has not been adjusted for flotation costs. B. The flotation-adjusted cost of equity will always be more than the cost of equity that has not been adjusted for flotation costs. C. The flotation-adjusted cost of equity may be more than or less than the cost of equity that has not been adjusted for flotation costs. D. None of these statements is correct.
B
Which of the following statements is correct? A. The weighted average cost of capital is calculated on a before-tax basis. B. An increase in the market risk premium is likely to increase the weighted average cost of capital. C. The weights of debt and equity should be based on the balance sheet because this is the most accurate assessment of the valuation. D. All of these statements are correct.
B
Why do we use market-value weights instead of book-value weights?
Because we are interested in determining what the cost of financing the firm's assets would be given today's market situation and the component costs the firm currently faces, not what the historical prices would have been.
All of the following capital budgeting tools are suitable for non-normal cash flows except ____. A. MIRR B. Profitability Index C. IRR D. NPV
C
All of the following capital budgeting tools are suitable for non-normal cash flows except ____. A. MIRR B. Profitability Index C. Payback D. NPV
C
Which of the following best describes the NPV profile? A. A graph of a project's NPV as a function of possible IRRs. B. A graph of a project's NPV over time. C. A graph of a project's NPV as a function of possible capital costs. D. None of these statements is correct.
C
Which of the following is a true statement regarding the appropriate tax rate to be used in the WACC? A. One would use the marginal tax rate that the firm paid the prior year. B. One would use the average tax rate that the firm paid the prior year. C. One would use the weighted average of the marginal tax rates that would have been paid on the taxable income shielded by the interest deduction. D. One would use the marginal tax rates that would have been paid on the taxable income shielded by the interest deduction.
C
Which of the following is most correct? A. When comparing two firms within the same industry, most analysts calculate the weighted average cost of capital on a before-tax basis to facilitate comparisons. B. Firms should use historical costs rather than marginal costs of capital. C. An increase in the risk-free rate will increase the cost of equity. D. All of these statements are equally correct.
C
Which of these completes this statement to make it true? The constant growth model is A. always going to have assumptions that will hold true. B. able to be adjusted for stocks that don't expect constant growth without sizeable errors. C. only going to be appropriate for the limited number of stocks that just happen to expect constant growth. D. only going to be appropriate for the limited number of stocks that just happen to expect nonconstant growth.
C
A disadvantage of the payback statistic is that ___________. A. It does not reflect the time value of money B. It does not give an indication of the project's riskiness C. It does not consider cash flows beyond the payback period D. All of these are disadvantages of payback
D
Which of the following statements is correct with respect to Section 179 deductions? A. It was designed to help small businesses. B. It allows the firm to expense the asset immediately in the year of purchase. C. Most businesses can expense up to $108,000 of property placed in service during each year. D. All of these are correct statements.
D
Which of the following will impact the cost of equity component in the weighted average cost of capital? A. The risk-free rate B. Beta C. Expected return on the market D. All of these
D
This is an estimated WACC computed using some sort of proxy for the average equity risk of the projects in a particular division.
Divisional WACC
When calculating operating cash flow for a project, one would calculate it as being mathematically equal to which of the following?
EBIT - Taxes + Depreciation
The best approach to convert an infinite series of asset purchases into a perpetuity is known as the
Equivalent annual cost approach
Section 179 allows a business, with certain restrictions, to do which of the following?
Expense the asset immediately in the year of purchase.
A capital budgeting method that converts a project's cash flows using a more consistent reinvestment rate prior to applying the IRR decision rule is referred to as ______________.
MIRR
Which rate-based decision statistic measures the excess return (the amount above and beyond the cost of capital for a project), rather than the gross return?
Profitability Index, PI
All of the following capital budgeting tools are suitable for firms facing time constraints except ______. A. NPV B. PaybackC. Discounted payback D. All of these answers are suitable for firms facing time constraints.
a
For which situation below would one need to "smooth out" the variation in each set of cash flows so that each becomes a perpetuity? A. choosing between projects with differing risks B. choosing between independent project C. choosing between alternative assets with differing lives D. choosing between alternative assets with equal lives
c
The research chemists at MegaClean created a new cleaner that keeps car and truck tires shiny and clean for one year. They believe that this product will be highly successful and will attract customers to purchase their existing line of household cleaning products. This is an example of ___________.
complementary effect
All of the following are strengths of payback except ____________________. A. Its benchmark is not determined by a relevant external constraint B. It incorporates the time value of money C. It uses a conservative reinvestment rate D. None of these
d
All capital budgeting techniques
exclude some crucial information.
A capital budgeting technique that generates a decision rule and associated metric for choosing projects based on the total discounted value of their cash flows.
net present value
A graph of a project's ______ is a function of cost of capital.
net present value
Of the capital budgeting techniques discussed, which works equally well with normal and non-normal cash flows and with independent and mutually exclusive projects?
net present value
An average of which of the following will give a fairly accurate estimate of what a project's beta will be?
proxy beta
Effects that arise from a new product or service that increase sales of the firm's existing products or services are referred to as
complementary effects.
Concerning incremental project cash flow, this is a cost one would never count as an expense of the project.
financing costs
These are fees paid by firms to investment bankers for issuing new securities.
flotation costs
This is used as a measure of the total amount of available cash flow from a project.
free cash flow
This is the IRS convention that requires that all property placed in service during a given period is assumed to be placed in service at the midpoint of that period.
half-year convention
This is a principle of capital budgeting which states that the calculations of cash flows should remain independent of financing.
separation principle
AB Mining Company just commissioned a firm to identify if an unused portion of their mine contains any silver or gold at a cost of $125,000. This is an example of a(n) _______________.
sunk cost
If a firm has already paid an expense or is obligated to pay one in the future, regardless of whether a particular project is undertaken, that expense is a
sunk cost
If a firm has already paid an expense or is obligated to pay one in the future, regardless of whether a particular project is undertaken, that expense is a(n) ________________.
sunk cost
With regard to depreciation, the time value of money concept tells us that
taking the depreciation expense sooner is always better.
As new capital budgeting projects arise, we must estimate
when such projects will require cash flows.
Which of the following will directly impact the cost of equity? A. Expected growth rate in sales B. Expected future tax rates C. Stock price D. Profit margins
C
Which of the following statements is true? A. If the new project is riskier than the firm's existing projects, then it should be charged a higher cost of capital. B. If the new project is riskier than the firm's existing projects, then it should be charged a lower cost of capital. C. If the new project is riskier than the firm's existing projects, then it should be charged the firm's cost of capital. D. The new project's risk is not a factor in determining its cost of capital.
A
ABC Engineering just bought a new machine. All of the following are examples of incremental cash flows except _______________. A. Interest expense on the loan used to purchase the machine B. Installation costs on the new machine C. Increase in costs as a result of the new machine D. Increases in depreciation expenses as a result of the new machine
A
Which of the following is a true statement? A. To estimate the before-tax cost of debt, we need to solve for the Yield to Maturity (YTM) on the firm's existing debt. B. To estimate the before-tax cost of debt, we need to solve for the Yield to Call (YTC) on the firm's existing debt. C. To estimate the before-tax cost of debt, we use the coupon rate on the firm's existing debt. D. To estimate the before-tax cost of debt, we use the average rate on the firm's existing debt.
A
ABC Engineering just purchased a new machine. All of the following are examples of incremental cash flows except _______________. A. Freight charged to ship the machine B. Developmental costs to determine which machine would best work with their unique process C. Increase in electric bill to run the machine D. Reduction in maintenance expense associated with the new machine
B
All of the following are incremental cash flows attributable to the project except _____. A. Opportunity costs B. Financing costs C. Substitutionary effects D. Complementary effects
B
Which of the following statements is correct? A. The WACC is a measure of the before-tax cost of capital. B. The WACC measures the marginal cost of capital. C. It is common that the after-tax cost of debt exceeds the cost of equity. D. None of these statements is correct.
B
Which of these makes this a true statement? The WACC formula A. is not impacted by taxes. B. uses the after-tax costs of capital to compute the firm's weighted average cost of debt financing. C. uses the pre-tax costs of capital to compute the firm's weighted average cost of debt financing. D. focuses on operating costs only to keep them separate from financing costs.
B
Which of these makes this a true statement? When determining the appropriate weights used in calculating a WACC, it should reflect A. the relative sizes of the total book capitalizations for each kind of security that the firm issues. B. the relative sizes of the total market capitalizations for each kind of security that the firm issues. C. only the market after-tax cost of debt. D. only the market after-tax cost of equity.
B
Which of these statements is true regarding calculating weights for WACC? A. If we are calculating WACC for the firm, then equity, preferred stock and debt would be the entire book value of each source of capital. B. If we are calculating WACC for the firm, then equity, preferred stock and debt would be the entire market value of each source of capital. C. If we are calculating WACC for a project, then equity, preferred stock and debt would be the entire book value of each source of capital. D. If we are calculating WACC for a project, then equity, preferred stock and debt would be the entire market value of each source of capital.
B
Which of these statements is true regarding divisional WACC? A. Using a divisional WACC vs a WACC for the firm's current operations will result in quite a few incorrect decisions. B. Using a simple firmwide WACC to evaluate new projects would give an unfair advantage to projects that present more risk than the firm's average beta. C. Using a simple firmwide WACC to evaluate new projects would give an unfair advantage to projects that present less risk than the firm's average beta. D. Using a firmwide WACC to evaluate new projects would have no impact on projects that present less risk than the firm's average beta.
B
A local bank is contemplating opening a new branch bank in a large superstore across town from their main office. It is estimated that the new branch will generate $20,000 after expenses each month. The manager wonders if all these revenues should be considered an incremental cash flow. Given this information, which of the following statements is correct? A. $20,000 is generated by the new branch bank and therefore it is an incremental cash flow. B. We would first need to assess the opportunity cost of placing a branch in a different location to answer this question. C. Some amount less than the $20,000 is incremental because of substitutionary effects. D. Some amount less than the $20,000 is incremental because of complementary effects.
C
Due to rapid growth, a computer superstore is contemplating expanding by adding another location. Which of the following items should the financial officer NOT include in estimating the cash flow associated with this expansion? A. The company owns the land of the future site of the new location. B. The new location is expected to take sales away from the existing location. C. The company spent $100,000 six months ago in a major advertising campaign which will help the new store become profitable sooner. D. All of these items should be included in the analysis.
C
Which of following is a situation in which you would want to use the CAPM approach for estimating the component cost of equity? A. When you are able to estimate the market risk premium with certainty. B. When you are able to estimate the risk-free rate with certainty. C. When you are able to estimate the firm's beta with certainty. D. When the firm pays a constant dividend.
C
Which of the following is NOT included when calculating the depreciable basis for real property? A. freight charges for item B. sales tax paid for item C. financing fees D. installation and testing fees
C
Which of the following is a reason why the divisional cost of capital approach may cause problems if new projects are assigned to the wrong division? A. Managers in different divisions may use different methods to calculate the WACC. B. The expected return of the new project may be incorrect. C. If projects are assigned to the wrong division, the risk of that division may be significantly different than the risk of the project, implying that the project will be evaluated with a divisional cost of capital that is much different from what a project-specific cost of capital would be. D. None of these answers is correct.
C
Which of the following is a situation in which you would want to use the constant growth model approach for estimating the component cost of equity? A. When the firm has a low beta. B. When the firm has multiple divisions. C. When the firm's stock is expected to experience constant dividend growth. D. When the firm has a high level of financial leverage.
C
Which of the following will directly impact the cost of debt? A. Capital Structure B. Debt Ratio C. Coupon Rate D. Competition within the industry
C
Which of the following makes this a true statement? If the new project does significantly increase the firm's overall risk, A. the increased risk will be borne equally amongst the bond holders, preferred stockholders, and common stockholders. B. the increased risk will be borne disproportionately by bond holders. C. the increased risk will be borne disproportionately by preferred stockholders. D. the increased risk will be borne disproportionately by common stockholders.
D
Which of the following statements is correct? A. A decrease in the firm's marginal corporate tax rate will decrease the weighted average cost of capital. B. Flotation costs can decrease the weighted average cost of capital. C. The cost of debt is based on the cost of all liabilities, including accounts payable and accruals. D. None of these statements is correct.
D
Which of the following statements is correct? A. If the risk-free rate increases, it will have no impact on the weighted average cost of capital. B. Investor returns are reduced when float costs increase, and therefore float costs reduce the weighted average cost of capital. C. The weighted average cost of capital is a historical cost. D. None of these statements is correct.
D
Which of the following tools is suitable for choosing between mutually exclusive projects? A. Profitability Index B. IRR C. MIRR D. NPV
D
An estimated WACC computed using some sort of proxy for the average equity risk of the projects in a particular business unit is known as the ____________.
Divisional WACC
Which of the following will increase the cost of equity?
The firm's share price falls 10%.
Neither payback period nor discounted payback period techniques for evaluating capital projects account for
cash flows that occur after payback
An asset's cost plus the amounts you paid for items such as sales tax, freight charges, and installation and testing fees is referred to as the ___________________.
depreciable basis
This technique for evaluating capital projects tells how long it will take a firm to earn back the money invested in a project plus interest at market rates.
discounted payback
A local bank is contemplating adding a new ATM to their lobby. They will need another phone line to provide communications which has a monthly cost of $50 per month. This is an example of _____________.
incremental cash flow
These are sets of cash flows where all the initial cash flows are negative and all the subsequent ones are either zero or positive.
normal cash flows
The ___________ approach to computing a divisional weighted average cost of capital (WACC) uses the average beta of projects in each division to calculate the WACC.
objective
Accelerated depreciation allows firms to
receive more of the dollars of depreciation earlier in the asset's life.
When looking at these types of projects, one must consider any cash flows that arise from surrendering old equipment before the end of its useful life.
replacement
A proxy beta is _________________.
the average beta of firms that are only engaged in the proposed new line of business
When choosing between two mutually exclusive projects using the payback period method for evaluating capital projects, one would choose
the project that pays back the soonest if it is equal to or less than managers' maximum payback period.
The Net Present Value decision technique may not be the only pertinent unit of measure if the firm is facing
time or resource constraints