BA 323 Exam 2 Concept Questions

Of the following new product expansion situations, only one would not result in incremental cash flows so it should not be included in the capital budgeting analysis. Which situation is it? a. A firm can produce a new product, and the existence of that product will stimulate sales of some of the firm's other products. b. A new product will generate new sales, but some of those new sales will be to customers who switch from one of the firm's current products. c. A firm must obtain new equipment for the project, and $1 million is required for shipping and installing the new machinery. d. A firm has spent $2 million on research and development associated with a new product. These costs have been expensed for tax purposes, and they cannot be recovered regardless of whether the new project is accepted or rejected. e. A firm has a parcel of land that can be used for a new plant site or sold, rented, or used for agricultural purposes.

A firm has spent $2 million on research and development associated with a new product. These costs have been expensed for tax purposes, and they cannot be recovered regardless of whether the new project is accepted or rejected.

Which of the following statements is CORRECT? a. A sunk cost is a cost that was incurred and expensed in the past and cannot be recovered if the firm decides not to go forward with the project. b. A sunk cost is any cost that must be expended in order to complete a project and bring it into operation. c. A sunk cost is any cost that was expended in the past but can be recovered if the firm decides not to go forward with the project. d. Sunk costs were formerly hard to deal with, but once the NPV method came into wide use, it became possible to simply include sunk costs in the cash flows and then calculate the project's NPV. e. A good example of a sunk cost is a situation where Home Depot opens a new store, and that leads to a decline in sales of one of the firm's existing stores.

A sunk cost is a cost that was incurred and expensed in the past and cannot be recovered if the firm decides not to go forward with the project.

Which of the following should NOT be included when calculating the weighted average cost of capital (WACC) for use in capital budgeting? Common stock. Retained earnings. Long-term debt. Preferred stock. Accounts payable.

Accounts payable.

The relative risk of a proposed project is best accounted for by which of the following procedures? a. Adjusting the discount rate upward if the project is judged to have below-average risk. b. Adjusting the discount rate upward if the project is judged to have above-average risk. c. Reducing the NPV by 10% for risky projects. d. Picking a risk factor equal to the average discount rate. e. Ignoring risk because project risk cannot be measured accurately.

Adjusting the discount rate upward if the project is judged to have above-average risk.

The CFO of Rambler Retail Concepts is considering a new project, so she plans to calculate the project's NPV by estimating the relevant cash flows for each year of the project's life (i.e., the initial investment cost, the annual operating cash flows, and the terminal cash flows), then discounting those cash flows at the company's overall WACC. Which one of the following factors should the CFO be sure to INCLUDE in the cash flows when estimating the relevant cash flows? a. All interest expenses on debt used to help finance the project. b. The additional investment in net operating working capital required to operate the project, even if that investment will be recovered at the end of the project's life. c. Sunk costs that have been incurred relating to the project, but only if those costs were incurred prior to the current year. d. Effects of the project on other divisions of the firm, but only if those effects lower the project's own direct cash flows. e. All sunk costs that have been incurred relating to the project.

All interest expenses on debt used to help finance the project.

Which of the following statements is CORRECT? a. An externality is a situation where a project would have an adverse effect on some other part of the firm's overall operations. If the project would have a favorable effect on other operations, then this is not an externality. b. An example of an externality is a situation where a bank opens a new office, and that new office causes deposits in the bank's other offices to decline. c. Both the NPV and IRR methods deal correctly with externalities, even if the externalities are not specifically identified. However, the payback method does not. d. The NPV method automatically deals correctly with externalities, even if the externalities are not specifically identified, but the IRR method does not. This is another reason to favor the NPV. e. Identifying an externality can never lead to an increase in the calculated NPV.

An example of an externality is a situation where a bank opens a new office, and that new office causes deposits in the bank's other offices to decline.

Which of the following statements is CORRECT? a. The discounted cash flow method of estimating the cost of equity cannot be used unless the growth rate, g, is expected to be constant forever. b. An advantage shared by both the DCF and CAPM methods when they are used to estimate the cost of equity is that they are both "objective" as opposed to "subjective," hence little or no judgment is required. c. The specific risk premium used in the CAPM is the same as the risk premium used in the bond-yield-plus-risk-premium approach. d. If the calculated beta underestimates the firm's true investment risk—i.e., if the forward-looking beta that investors think exists exceeds the historical beta—then the CAPM method based on the historical beta will produce an estimate of rs and thus WACC that is too high. e. Beta measures market risk, which is, theoretically, the most relevant risk measure for a publicly-owned firm that seeks to maximize its intrinsic value. This is true even if not all of the firm's stockholders are well diversified.

Beta measures market risk, which is, theoretically, the most relevant risk measure for a publicly-owned firm that seeks to maximize its intrinsic value. This is true even if not all of the firm's stockholders are well diversified.

Four of the following statements are truly disadvantages of the regular payback method, but one is not a disadvantage of this method. Which one is NOT a disadvantage of the payback method? a. Does not provide any indication regarding a project's liquidity or risk. b. Does not directly account for the time value of money. c. Does not take account of differences in size among projects. d. Ignores cash flows beyond the payback period. e. Lacks an objective, market-determined benchmark for making decisions.

Does not provide any indication regarding a project's liquidity or risk.

T/F An investor using the DCF stock valuation model would assign a value based on the length of time he or she plans to hold the stock.

FALSE

T/F As a general rule, firms should use their weighted average cost of capital (WACC) to evaluate capital budgeting projects. After all, most projects are funded with general corporate funds, which come from a variety of sources. However, if the firm plans to use only debt or only equity to fund a particular project, it should use the after-tax cost of that specific type of capital to evaluate that project.

FALSE

T/F 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.

FALSE

T/F Because "present value" refers to the value of cash flows that occur at different points in time, a series of present values of cash flows should not be summed to determine the value of a capital budgeting project.

FALSE

T/F If a firm has zero cost of capital and two mutually exclusive projects, the payback method and NPV method would always lead to the same decision on which project to undertake.

FALSE

T/F If a project would lead to an increase a firm's cost of capital (its' WACC), it should not be accepted.

FALSE

T/F If debt is to be used to finance a project, then when cash flows for a project are estimated, interest payments should be included in the analysis.

FALSE

T/F Projects with nonnormal cash flows sometimes have multiple MIRRs.

FALSE

T/F Superior analytical techniques, such as NPV, used in combination with risk-adjusted cost of capital estimates, can overcome the problem of poor cash flow estimation and lead to generally correct accept/reject decisions for capital budgeting projects.

FALSE

T/F Suppose a firm's CFO thinks that an externality is present in a project, but that it cannot be quantified with any precision--estimates of its effect would really just be guesses. In this case, the externality should be ignored--i.e., not considered at all--because if it were considered it would make the analysis appear more precise than it really is.

FALSE

T/F Suppose the debt ratio is 50%, the interest rate on new debt is 8%, the current cost of equity is 16%, and the tax rate is 40%. An increase in the debt ratio to 60% would have to decrease the weighted average cost of capital (WACC).

FALSE

T/F The IRR method is based on the assumption that projects' cash flows are reinvested at the project's risk-adjusted cost of capital.

FALSE

T/F The before-tax cost of debt, which is lower than the after-tax cost, is used as the component cost of debt for purposes of developing the firm's WACC.

FALSE

T/F The corporate valuation model can be used only when a company doesn't pay dividends.

FALSE

T/F The cost of debt is equal to one minus the marginal tax rate multiplied by the average coupon rate on all outstanding debt.

FALSE

T/F The regular payback method is deficient in that it does not take account of cash flows beyond the payback period. The discounted payback method corrects this fault.

FALSE

T/F The text identifies three methods for estimating the cost of common stock from retained earnings: the CAPM method, the DCF method, and the bond-yield-plus-risk-premium method. However, only the CAPM method always provides an accurate and reliable estimate.

FALSE

T/F The total return on a share of stock refers to the dividend yield less any commissions paid when the stock is purchased and sold.

FALSE

T/F The use of accelerated versus straight-line depreciation causes net income reported to stockholders to be lower, and cash flows higher, during every year of a project's life, other things held constant.

FALSE

T/F To find the total return on a share of stock, find the dividend yield and subtract any commissions paid when the stock is purchased and sold.

FALSE

Stocks A and B have the same price and are in equilibrium, but Stock A has the higher required rate of return. Which of the following statements is CORRECT?: a. Stock A must have both a higher dividend yield and a higher capital gains yield than Stock B. b. Stock B must have a higher dividend yield than Stock A. c. Stock A must have a higher dividend yield than Stock B. d. If Stock A has a lower dividend yield than Stock B, its expected capital gains yield must be higher than Stock B's. e. If Stock A has a higher dividend yield than Stock B, its expected capital gains yield must be lower than Stock B's

If Stock A has a lower dividend yield than Stock B, its expected capital gains yield must be higher than Stock B's.

Which of the following statements is CORRECT? a. WACC calculations should be based on the before-tax costs of all the individual capital components. b. If a company's tax rate increases, then, all else equal, its weighted average cost of capital will decline. c. A change in a company's target capital structure cannot affect its WACC. d. Flotation costs associated with issuing new common stock normally reduce the WACC. e. An increase in the risk-free rate will normally lower the marginal costs of both debt and equity financing.

If a company's tax rate increases, then, all else equal, its weighted average cost of capital will decline.

Which of the following statements is CORRECT?: a. When the WACC is calculated, it should reflect the costs of new common stock, retained earnings, preferred stock, long-term debt, short-term bank loans if the firm normally finances with bank debt, and accounts payable if the firm normally has accounts payable on its balance sheet. b. Since its stockholders are not directly responsible for paying a corporation's income taxes, corporations should focus on before-tax cash flows when calculating the WACC. c. If a firm has been suffering accounting losses that are expected to continue into the foreseeable future, and therefore its tax rate is zero, then it is possible for the after-tax cost of preferred stock to be less than the after-tax cost of debt. d. Since the costs of internal and external equity are related, an increase in the flotation cost required to sell a new issue of stock will increase the cost of retained earnings. e. An increase in a firm's tax rate will increase the component cost of debt, provided the YTM on the firm's bonds is not affected by the change in the tax rate.

If a firm has been suffering accounting losses that are expected to continue into the foreseeable future, and therefore its tax rate is zero, then it is possible for the after-tax cost of preferred stock to be less than the after-tax cost of debt.

Which of the following statements is CORRECT? a. If equipment is expected to be sold for more than its book value at the end of a project's life, this will result in a profit. In this case, despite taxes on the profit, the end-of-project cash flow will be greater than if the asset had been sold at book value, other things held constant. b. Only incremental cash flows are relevant in project analysis, the proper incremental cash flows are the reported accounting profits, and thus reported accounting income should be used as the basis for investor and managerial decisions. c. Changes in net operating working capital refer to changes in current assets and current liabilities, not to changes in long-term assets and liabilities, hence they should not be considered in a capital budgeting analysis. d. If an asset is sold for less than its book value at the end of a project's life, it will generate a loss for the firm, hence its terminal cash flow will be negative. e. It is unrealistic to believe that any increases in net operating working capital required at the start of an expansion project can be recovered at the project's completion. Operating working capital like inventory is almost always used up in operations. Thus, cash flows associated with operating working capital should be included only at the start of a project's life.

If equipment is expected to be sold for more than its book value at the end of a project's life, this will result in a profit. In this case, despite taxes on the profit, the end-of-project cash flow will be greater than if the asset had been sold at book value, other things held constant.

Which of the following statements about capital budgeting is CORRECT? a. If one of the assets to be used by a potential project is already owned by the firm but is not being used, then any costs associated with that asset is a sunk cost and should be ignored. b. In a capital budgeting analysis where part of the funds used to finance the project would be raised as debt, failure to include interest expense as a cost when determining the project's cash flows will lead to a downward bias in the NPV. c. The existence of any type of "externality" will reduce the calculated NPV versus the NPV that would exist without the externality. d. If one of the assets to be used by a potential project is already owned by the firm, and if that asset could be sold or leased to another firm if the new project were not undertaken, then the net proceeds that could be obtained should be charged as a cost to the project under consideration. e. In a capital budgeting analysis where part of the funds used to finance the project would be raised as debt, failure to include interest expense as a cost when determining the project's cash flows will lead to an upward bias in the NPV.

If one of the assets to be used by a potential project is already owned by the firm, and if that asset could be sold or leased to another firm if the new project were not undertaken, then the net proceeds that could be obtained should be charged as a cost to the project under consideration.

Suppose a firm relies exclusively on the payback method when making capital budgeting decisions, and it sets a 4-year payback regardless of economic conditions. Other things held constant, which of the following statements is most likely to be true? a. The firm will accept too many projects in all economic states because a 4-year payback is too low. b. The firm will accept too few projects in all economic states because a 4-year payback is too high. c. It will accept too many short-term projects and reject too many long-term projects (as judged by the NPV). d. It will accept too many long-term projects and reject too many short-term projects (as judged by the NPV). e. If the 4-year payback results in accepting just the right set of projects under average economic conditions, then this payback will result in too few long-term projects when the economy is weak.

If the 4-year payback results in accepting just the right set of projects under average economic conditions, then this payback will result in too few long-term projects when the economy is weak.

You are considering two mutually exclusive, equally risky, projects. Both have IRRs that exceed the WACC. Which of the following statements is CORRECT? Assume that the projects have normal cash flows, with one outflow followed by a series of inflows. a. If the cost of capital is less than the crossover rate, then the IRR and the NPV criteria will not result in a conflict between the projects. One project will rank higher by both criteria. b. If the cost of capital is greater than the crossover rate, then the IRR and the NPV criteria will not result in a conflict between the projects. One project will rank higher by both criteria. c. For a conflict to exist between NPV and IRR, the initial investment cost of one project must exceed the cost of the other. d. For a conflict to exist between NPV and IRR, one project must have an increasing stream of cash flows over time while the other has a decreasing stream. If both sets of cash flows are increasing or decreasing, then it would be impossible for a conflict to exist, even if one project is larger than the other. e. If the two projects' NPV profiles do not cross, then there will be a sharp conflict as to which one should be selected.

If the cost of capital is greater than the crossover rate, then the IRR and the NPV criteria will not result in a conflict between the projects. One project will rank higher by both criteria.

The required returns of Stocks X and Y are rX = 10% and rY = 12%. Which of the following statements is CORRECT?: a. If Stock Y and Stock X have the same dividend yield, then Stock Y must have a lower expected capital gains yield than Stock X. b. Stock Y must have a higher dividend yield than Stock X. c. If Stock X and Stock Y have the same current dividend and the same expected dividend growth rate, then Stock Y must sell for a higher price. d. The stocks must sell for the same price. e. If the market is in equilibrium, and if Stock Y has the lower expected dividend yield, then it must have the higher expected growth rate.

If the market is in equilibrium, and if Stock Y has the lower expected dividend yield, then it must have the higher expected growth rate.

Which of the following statements is CORRECT? a. For a project with normal cash flows, any change in the WACC will change both the NPV and the IRR. b. If two projects have the same cost, and if their NPV profiles cross in the upper right quadrant, then the project with the higher IRR probably has more of its cash flows coming in the later years. c. The NPV and IRR methods both assume that cash flows can be reinvested at the WACC. However, the MIRR method assumes reinvestment at the MIRR itself. d. If two projects have the same cost, and if their NPV profiles cross in the upper right quadrant, then the project with the lower IRR probably has more of its cash flows coming in the later years. e. To find the MIRR, we first compound cash flows at the regular IRR to find the TV, and then we discount the TV at the WACC to find the PV.

If two projects have the same cost, and if their NPV profiles cross in the upper right quadrant, then the project with the lower IRR probably has more of its cash flows coming in the later years.

Global Spice Co. is considering a new project, but all methods for assessing risk indicate that the project's risk is greater than the risk of the firm's average project. In evaluating this project, it would be reasonable for Global Spice's management to do which of the following? a. Increase the cost of capital used to evaluate the project to reflect its higher-than-average risk. b. Increase the estimated NPV of the project to reflect its greater risk. c. Reject the project, as 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 estimated IRR of the project to reflect its greater risk.

Increase the cost of capital used to evaluate the project to reflect its higher-than-average risk.

In capital budgeting decisions, corporate risk will be of least interest to: Employees. Institutional investors. Creditors. The local community. Stockholders with few shares.

Institutional investors.

Which of the following statements is CORRECT? a. Its cost of retained earnings is the rate of return stockholders require on a firm's common stock. b. We should use historical measures of the component costs from prior financings that are still outstanding when estimating a company's WACC for capital budgeting purposes. c. 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. d. 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. e. 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.

Its cost of retained earnings is the rate of return stockholders require on a firm's common stock.

Which of the following statements about IRR and WACC is CORRECT? a. Multiple IRRs can only occur if the signs of the cash flows change more than once. b. Two projects are likely to have multiple IRRs if they are mutually exclusive. c. If a project has two IRRs, then the smaller one is the one that is most relevant, and it should be accepted and relied upon. d. A project cannot have multiple IRRs if it is independent. e. For a project to have more than one IRR, then both IRRs must be greater than the WACC.

Multiple IRRs can only occur if the signs of the cash flows change more than once.

Which of the following statements is CORRECT? a. One advantage of the NPV over the MIRR method is that NPV takes account of cash flows over a project's full life whereas MIRR does not. b. One advantage of the NPV over the IRR is that NPV assumes that cash flows will be reinvested at the WACC, whereas IRR assumes that cash flows are reinvested at the IRR. The NPV assumption is generally more appropriate. c. One advantage of the NPV over the MIRR method is that NPV discounts cash flows whereas the MIRR is based on undiscounted cash flows. d. Since cash flows under the IRR and MIRR are both discounted at the same rate (the WACC), these two methods always rank mutually exclusive projects in the same order. e. One advantage of the NPV over the IRR is that NPV takes account of cash flows over a project's full life whereas IRR does not.

One advantage of the NPV over the IRR is that NPV assumes that cash flows will be reinvested at the WACC, whereas IRR assumes that cash flows are reinvested at the IRR. The NPV assumption is generally more appropriate.

Which of the following statements is CORRECT? 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 cost of capital. c. 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 sometime in the future. d. One defect of the IRR method is that it does not take account of the time value of money. 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.

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.

When evaluating a new project, firms should include in the projected cash flows all of the following EXCEPT: a. The salvage value of assets used for the project that will be recovered at the end of the project's life. b. Changes in net operating working capital attributable to the project. c. A decline in the sales of an existing product, provided that decline is directly attributable to this project. d. Previous expenditures associated with a market test to determine the feasibility of the project, provided those costs have been expensed for tax purposes. e. The value of a building owned by the firm that will be used for this project.

Previous expenditures associated with a market test to determine the feasibility of the project, provided those costs have been expensed for tax purposes.

Which of the following statements is CORRECT? a. Projects with "nonnormal" cash flows are almost never encountered in the real world. b. Projects with "normal" cash flows must have two changes in the sign of the cash flows, e.g., from negative to positive to negative. If there are more than two sign changes, then the cash flow stream is "nonnormal." c. The "multiple IRR problem" can arise if a project's cash flows are "normal." d. Projects with "normal" cash flows can have two or more real IRRs. e. Projects with "normal" cash flows can have only one real IRR.

Projects with "normal" cash flows can have only one real IRR.

Which of the following statements about sensitivity analysis and simulation analysis is CORRECT? a. Simulation analysis is better than scenario analysis because scenario analysis requires a relatively powerful computer, coupled with an efficient financial planning software package, whereas simulation analysis can be done efficiently using a PC with a spreadsheet program or even with just a calculator. b. In comparing two projects using sensitivity analysis, the one with the steeper lines would be considered less risky, because a small error in estimating a variable such as unit sales would produce only a small error in the project's NPV. c. Sensitivity analysis is a type of risk analysis that considers both the sensitivity of NPV to changes in key input variables and the probability of occurrence of these variables' values. d. As computer technology advances, simulation analysis becomes increasingly obsolete and thus less likely to be used than sensitivity analysis. e. Sensitivity analysis as it is generally employed is incomplete in that it fails to consider the probability of occurrence of the key input variables.

Sensitivity analysis as it is generally employed is incomplete in that it fails to consider the probability of occurrence of the key input variables.

Which of the following statements about risk evaluation is CORRECT? a. Stockholders do not need to consider market risk when determining required rates of return as long as their portfolios are diversified. 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. Market risk does not have a direct effect on stock prices because it only affects beta, so it may not be as important as you think. d. Simulation analysis is a computerized version of scenario analysis where input variables are selected randomly on the basis of their probability distributions. e. Sensitivity analysis is a good way to measure market risk because it explicitly takes into account diversification effects.

Simulation analysis is a computerized version of scenario analysis where input variables are selected randomly on the basis of their probability distributions.

Which of the following is NOT a relevant cash flow and thus should NOT be reflected in the analysis of a capital budgeting project? a. Cannibalization effects. b. Opportunity costs. c. Sunk costs that have been expensed for tax purposes. d. Shipping and installation costs for machinery acquired. e. Changes in net operating working capital.

Sunk costs that have been expensed for tax purposes.

T/F A conflict will exist between the NPV and IRR methods, when used to evaluate two equally risky but mutually exclusive projects, if the projects' cost of capital is less than the rate at which the projects' NPV profiles cross.

TRUE

T/F A firm that bases its capital budgeting decisions on either NPV or IRR will be more likely to accept a given project if it uses accelerated depreciation than if it uses straight-line depreciation, other things being equal.

TRUE

T/F According to the nonconstant growth model discussed in the textbook, the discount rate used to find the present value of the expected cash flows during the initial growth period is the same as the discount rate used to find the PVs of cash flows during the subsequent constant growth period.

TRUE

T/F An increase in a firm's marginal tax rate would lower the cost of debt used to calculate its WACC, other things held constant.

TRUE

T/F If investors' aversion to risk rose, causing the slope of the SML to increase, this would have a greater impact on the required rate of return on equity, rs, than on the interest rate on long-term debt, rd, for most firms. Other things held constant, this would lead to an increase in the use of debt and a decrease in the use of equity. However, other things would not stay constant if firms used a lot more debt, as that would increase the riskiness of both debt and equity and thus limit the shift toward debt.

TRUE

T/F In theory, capital budgeting decisions should depend solely on forecasted cash flows and the opportunity cost of capital. Managers' tastes, choice of accounting method, or the profitability of other independent projects should not be considered.

TRUE

T/F In theory, capital budgeting decisions should depend solely on forecasted cash flows and the opportunity cost of capital. The decision criterion should not be affected by managers' tastes, choice of accounting method, or the profitability of other independent projects.

TRUE

T/F It is extremely difficult to estimate the revenues and costs associated with large, complex projects that take several years to develop. This is why subjective judgment is often used for such projects along with discounted cash flow analysis.

TRUE

T/F The NPV method's assumption that cash inflows are reinvested at the cost of capital is generally more reasonable than the IRR's assumption that cash flows are reinvested at the IRR. This is an important reason why the NPV method is generally preferred over the IRR method.

TRUE

T/F The cost of perpetual preferred stock is found as the preferred's annual dividend divided by the market price of the preferred stock. No adjustment is needed for taxes because preferred dividends, unlike interest on debt, are not deductible by the issuing firm.

TRUE

T/F The marginal investor determines the price at which a new issue of stock will trade when it is brought to market.

TRUE

Which of the following statements is CORRECT?: a. Two firms with the same expected dividend and growth rate must also have the same stock price. b. The constant growth model takes into consideration the capital gains investors expect to earn on a stock. c. It is appropriate to use the constant growth model to estimate a stock's value even if its growth rate is never expected to become constant. d. If a stock has a required rate of return rs = 12%, and if its dividend is expected to grow at a constant rate of 5%, this implies that the stock's dividend yield is also 5%. e. The price of a stock is the present value of all expected future dividends, discounted at the dividend growth rate

The constant growth model takes into consideration the capital gains investors expect to earn on a stock.

For a company whose target capital structure calls for 50% debt and 50% common equity, which of the following statements is CORRECT? a. The interest rate used to calculate the WACC is the average after-tax cost of all the company's outstanding debt as shown on its balance sheet. b. The cost of equity is always equal to or greater than the cost of debt. c. The cost of retained earnings typically exceeds the cost of new common stock. d. The WACC exceeds the cost of equity. e. The WACC is calculated on a before-tax basis.

The cost of equity is always equal to or greater than the cost of debt.

Which of the following factors should be included in the cash flows used to estimate a project's NPV? a. All costs associated with the project that have been incurred prior to the time the analysis is being conducted. b. Cannibalization effects, but only if those effects increase the project's projected cash flows. c. Interest on funds borrowed to help finance the project. d. Expenditures to date on research and development related to the project, provided those costs have already been expensed for tax purposes. e. The end-of-project recovery of any additional net operating working capital required to operate the project.

The end-of-project recovery of any additional net operating working capital required to operate the project.

If a project being considered has normal cash flows, with one outflow followed by a series of inflows, which of the following statements is CORRECT? a. The higher the WACC used to calculate the NPV, the lower the calculated NPV will be. b. The NPVs of relatively risky projects should be found using relatively low WACCs. c. If a project's NPV is greater than zero, then its IRR must be less than zero. d. A project's NPV is generally found by compounding the cash inflows at the WACC to find the terminal value (TV), then discounting the TV at the IRR to find its PV. e. If a project's NPV is greater than zero, then its IRR must be less than the WACC.

The higher the WACC used to calculate the NPV, the lower the calculated NPV will be.

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. a. If a project's NPV is greater than zero, then its IRR must be less than zero. b. The higher the WACC used to calculate the NPV, the lower the calculated NPV will be. c. If a project's NPV is greater than zero, then its IRR must be less than the WACC. d. The NPVs of relatively risky projects should be found using relatively low WACCs. e. A project's NPV is generally found by compounding the cash inflows at the WACC to find the terminal value (TV), then discounting the TV at the IRR to find its PV.

The higher the WACC used to calculate the NPV, the lower the calculated NPV will be.

Which of the following statements is CORRECT?: a. If a stock has a required rate of return rs = 12% and its dividend is expected to grow at a constant rate of 5%, this implies that the stock's dividend yield is also 5%. b. The stock valuation model, P0 = D1/(rs - g), can be used to value firms whose dividends are expected to decline at a constant rate, i.e., to grow at a negative rate. c. The price of a stock is the present value of all expected future dividends, discounted at the dividend growth rate. d. The constant growth model cannot be used for a zero growth stock, where the dividend is expected to remain constant over time. e. The constant growth model is often appropriate for evaluating start-up companies that do not have a stable history of growth but are expected to reach stable growth within the next few years.

The stock valuation model, P0 = D1/(rs - g), can be used to value firms whose dividends are expected to decline at a constant rate, i.e., to grow at a negative rate.

Which of the following statements is CORRECT? a. Using accelerated depreciation rather than straight line normally has the effect of slowing down cash flows and thus reducing a project's forecasted NPV. b. Corporations must use the same depreciation method for both stockholder reporting and tax purposes. c. Using accelerated depreciation rather than straight line normally has the effect of speeding up cash flows and thus increasing a project's forecasted NPV. d. Since depreciation is a cash expense, the faster an asset is depreciated, the lower the projected NPV from investing in the asset. e. Under current laws and regulations, corporations must use straight-line depreciation for all assets whose lives are 5 years or longer.

Using accelerated depreciation rather than straight line normally has the effect of speeding up cash flows and thus increasing a project's forecasted NPV.

For a stock to be in equilibrium, that is, for there to be no long-term pressure for its price to depart from its current level, then: a. the expected future return must be equal to the required return. b. the past realized return must be equal to the expected return during the same period. c. the expected return must be equal to both the required future return and the past realized return. d. the expected future return must be less than the most recent past realized return. e. the required return must equal the realized return in all periods.

the expected future return must be equal to the required return.