FIN Test 3
A "round lot" consists of how many shares? A) 1 B) 10 C) 100 D) 1,000
C) 100
Firms should use the most accelerated depreciation scheme allowable.
True
Forecasting dividends requires forecasting the firm's earnings, dividend payout rate, and future share count.
True
Interest and other financing-related expenses are excluded when determining a project's unlevered net income.
True
The EBIT break-even point can be calculated using which of the following formulas? A) (Units Sold × Sale Price) - (Units Sold × Cost per unit) - SG&A - Depreciation = 0 B) (Units Sold × Sale Price) + (Units Sold × Cost per unit) - SG&A - Depreciation = 0 C) (Units Sold × Sale Price) - (Units Sold × Cost per unit) + SG&A + Depreciation = 0 D) (Units Sold × Sale Price) + (Units Sold × Cost per unit) + SG&A - Depreciation = 0
A) (Units Sold × Sale Price) - (Units Sold × Cost per unit) - SG&A - Depreciation = 0
Which of the following is an example of cannibalization? A) A toothpaste manufacturer adds a new line of toothpaste (that contains baking soda) to its product line. B) A grocery store begins selling T-shirts featuring the local university's mascot. C) A basketball manufacturer adds basketball hoops to its product line. D) A convenience store begins selling pre-paid cell phones.
A) A toothpaste manufacturer adds a new line of toothpaste (that contains baking soda) to its product line.
Which of the following is an example of cannibalization? A) A toothpaste manufacturer adds a new line of toothpaste (that contains baking soda) to its product line. B) A grocery store begins selling T-shirts featuring the local university's mascot. C) A basketball manufacturer adds basketball hoops to its product line. D) A convenience store begins selling pre-paid cell phones.
A) A toothpaste manufacturer adds a new line of toothpaste (that contains baking soda) to its product line.
Which of the following statements is FALSE regarding profitable and unprofitable growth? A) If a firm wants to increase its share price, it must diversify. B) If a firm retains more earnings, it will pay out less of those earnings, reducing its dividends. C) A firm can increase its growth rate by retaining more of its earnings. D) Cutting a firm's dividend to increase investment will raise the stock price if the new investment has a positive net present value (NPV).
A) If a firm wants to increase its share price, it must diversify.
Which of the following will NOT increase a company's dividend payments? A) It can issue more shares. B) It can increase its earnings. C) It can decrease the number of shares outstanding. D) It can increase its dividend payout rate.
A) It can issue more shares.
Which of the following is a limitation of the dividend-discount model? A) It cannot handle negative growth rates. B) It requires accurate dividend forecasts, which is not possible. C) It requires that the growth rate always be higher than the required rate of return, which is not realistic. D) It does not consider past earnings and performance.
A) It cannot handle negative growth rates.
Which of the following best describes the Net Present Value rule? A) Take any investment opportunity where the net present value (NPV) is not negative; turn down any opportunity when it is negative. B) Take any investment opportunity where the net present value (NPV) exceeds the opportunity cost of capital; turn down any opportunity where the cost of capital exceeds the net present value (NPV) C) When choosing among any list of investment opportunities where resources are limited, always choose those projects with the highest net present value (NPV). D) If the difference between the present cost of an investment and the present value (PV) of its benefits after a fixed number of years is positive the investment should be taken, otherwise it should be rejected.
A) Take any investment opportunity where the net present value (NPV) is not negative; turn down any opportunity when it is negative.
Which of the following statements is FALSE? A) The break-even level of an input is the level for which the investment has an internal rate of return (IRR) of zero. B) The most difficult part of capital budgeting is deciding how to estimate the cash flows and the cost of capital. C) When evaluating a capital budgeting project, financial managers should make the decision that maximizes net present value (NPV). D) Sensitivity analysis reveals those aspects of the project which are most critical when we are actually managing the project.
A) The break-even level of an input is the level for which the investment has an internal rate of return (IRR) of zero.
Which of the following statements is FALSE of the dividend-discount model? A) We cannot use the dividend-discount model to value the stock of a firm with rapid or changing growth. B) As firms mature, their growth slows to rates more typical of established companies. C) The dividend-discount model values the stock based on a forecast of the future dividends paid to shareholders. D) The simplest forecast for the firm's future dividends states that they will grow at a constant rate, i.e., forever.
A) We cannot use the dividend-discount model to value the stock of a firm with rapid or changing growth.
Joe pre-orders a non-refundable movie ticket. He then reads a number of reviews of the movie in question that make him realize that he will not enjoy it. He goes to see it anyway, rationalizing that otherwise his money will have been wasted. Is Joe succumbing to the Sunk Cost Fallacy, and why? A) Yes, since he invested a valuable asset, his time, in a project based on its previous costs. B) No, because the cost of the movie was not recoverable and would have been lost whatever action he took. C) No, because going to see the movie means that the product of his initial investment was realized as originally planned. D) Yes, because he incurred no further costs by going to see the movie.
A) Yes, since he invested a valuable asset, his time, in a project based on its previous costs.
Which of the following will cause the EBIT Break-Even for sales to increase? A) a decrease in the sales price B) a decrease in depreciation expense C) a decrease in selling, general, and administrative expenses D) a decrease in the number of units sold
A) a decrease in the sales price
A company spends $20 million researching whether it is possible to create a durable plastic from the process waste from feedstock preparation. The $20 million should best be considered ________. A) as a sunk cost B) as an opportunity cost C) as a fixed overhead expense D) as a capital cost
A) as a sunk cost
Which of the following is NOT a way that a firm can increase its dividend? A) by increasing its retention rate B) by decreasing its shares outstanding C) by increasing its earnings (net income) D) by increasing its dividend payout rate
A) by increasing its retention rate
The term "cannibalization" refers to ________. A) decrease in the sales of current project caused by the launching of new project B) decrease in the sunk cost caused by launching of new project C) decrease in overhead expenses incurred due to launch of new project D) cost of using a resource for the best value it could provide in its best alternative
A) decrease in the sales of current project caused by the launching of new project
You are trying to decide between three mutually exclusive investment opportunities. The most appropriate tool for identifying the correct decision is ________. A) net present value (NPV) B) profitability index C) internal rate of return (IRR) D) incremental internal rate of return (IRR)
A) net present value (NPV)
Jim owns a farm that he wants to sell. He learns that a highway will be built near the farm in the future, giving access to the farmland from a nearby city and thus making the land attractive to housing developers. Expecting the net present value (NPV) of the sale to be greater after the highway is built, he decides not to sell at this time. What real option is Jim taking? A) option to delay B) option to expand C) option to abandon D) option to switch
A) option to delay
Assuming that your capital is constrained, which investment tool should you use to determine the correct investment decisions? A) profitability Index B) incremental IRR C) net present value (NPV) D) internal rate of return (IRR)
A) profitability Index
An exploration of the effect of changing multiple project parameters on net present value (NPV) is called ________. A) scenario analysis B) internal rate of return (IRR) analysis C) accounting break-even analysis D) sensitivity analysis
A) scenario analysis
The manufacturer of a brand of kitchen knives is investigating the likely effects that an increase in the cost of the raw materials required to make these knives will have on the cost of manufacturing the knives, the selling price of the knives, the number of knives that will then be sold, and the project's net present value (NPV). Which of the following best describes what type of analysis the manager is performing? A) scenario analysis B) sensitivity analysis C) break-even analysis D) EBIT-break even analysis
A) scenario analysis
The present value (PV) of an investment is ________. A) the amount that an investment would yield if the benefit were realized today B) the difference between the cost of the investment and the benefit of the investment in dollars today C) the amount you need to invest at the current interest rate to re-create the cash flow from the investment D) the amount by which the cash flow of an investment exceeds or falls short of the cash flow generated by the same amount of money invested at market rate
A) the amount that an investment would yield if the benefit were realized today
Which of the following is usually NOT a factor that must be considered when estimating the revenues and costs arising from a new product? A) the fluctuations in the cost of capital over the period in question B) the sales of a new product will typically accelerate, plateau, and ultimately decline over time C) the prices of technology products generally fall over time D) competition tends to reduce profit margins over time in most industries
A) the fluctuations in the cost of capital over the period in question
Which of the following is NOT a factor that a manager should bear in mind when estimating a project's revenues and costs? A) Sales of a product will typically accelerate, stabilize, and then decline as the product becomes outdated or faces increased competition. B) A new product typically has its highest sales immediately after release as customers are attracted by the novelty of the product. C) The prices of technology products tend to fall over time as newer, superior technologies emerge and production costs decline. D) Prices and costs tend to rise with the general level of inflation in the economy.
B) A new product typically has its highest sales immediately after release as customers are attracted by the novelty of the product.
Which of the following statements is FALSE? A) The payback investment rule is based on the notion that an opportunity that pays back its initial investments quickly is a good idea. B) An internal rate of return (IRR) will always exist for an investment opportunity. C) A net present value (NPV) will always exist for an investment opportunity. D) In general, there can be as many internal rates of return (IRRs) as the number of times the project's cash flows change sign over time.
B) An internal rate of return (IRR) will always exist for an investment opportunity.
Which of the following formulas will correctly calculate Net Working Capital? A) Cash + Inventory + Receivables + Payables B) Cash + Inventory + Receivables - Payables C) Cash + Inventory - Receivables + Payables D) Cash - Inventory + Receivables + Payables
B) Cash + Inventory + Receivables - Payables
Which of the following models directly values all of the firm's equity, rather than a single share? I. Dividend-discount model II. Total payout model III. Discounted cash flow model A) I only B) II only C) III only D) II and III
B) II only
A company planning to market a new model of motor scooter analyzes the effect of changes in the selling price of the motor scooter, the number of units that will be sold, the cost of making the motor scooter, the effect on Net Working Capital, and the cost of capital for the project. They predict that the break-even point for sales price for the motor scooter is $2,480. What does this mean? A) If the motor scooter is sold for $2,480, then the project will make a profit. B) If the motor scooter is sold for $2,480, then the net present value (NPV) for the product will be zero. C) The predicted selling price of the motor scooter is $2,480. D) The maximum that the motor scooter can sell for and still make the project have a positive net present value (NPV) is $2,480.
B) If the motor scooter is sold for $2,480, then the net present value (NPV) for the product will be zero.
Which of the following is NOT a limitation of the payback period rule? A) It does not account for the time value of money. B) It is difficult to calculate. C) It ignores cash flows after payback. D) It does not account for changes in the discount rate.
B) It is difficult to calculate.
The owner of a hair salon spends $1,000,000 to renovate its premises, estimating that this will increase her cash flow by $220,000 per year. She constructs the above graph, which shows the net present value (NPV) as a function of the discount rate. If her discount rate is 6%, should she accept the project? A) Yes, because the NPV is positive at that rate. B) No, because the NPV is negative at that rate. C) No, because the NPV is positive at that rate. D) Cannot be determined from the information given.
B) No, because the NPV is negative at that rate.
Which of the following formulas is INCORRECT? A) Divt = EPSt × Dividend Payout Rate B) PN = (rE - g) × DivN+1 C) earnings growth rate = retention rate × return on new investment D) rE = (Divt / P0) + g
B) PN = (rE - g) × DivN+1
Which of the following statements regarding real options is NOT correct? A) Real options should only be exercised when they increase the NPV of a project. B) Real options enhance the forecast of a project's expected future cash flows by incorporating, at the start of the project, the effect of decisions that will be made at a later date. C) Real options give owners the right, but not the obligation, to exercise these opportunities at a later date. D) Real options build greater flexibility into a project and thus increase its net present value (NPV).
B) Real options enhance the forecast of a project's expected future cash flows by incorporating, at the start of the project, the effect of decisions that will be made at a later date.
A lawn maintenance company compares two ride-on mowers—the Excelsior, which has an expected working-life of six years, and the Grassassinator, which has a working life of four years. After examining the equivalent annual annuities of each mower, the company decides to purchase the Excelsior. Which of the following, if true, would be most likely to make them change that decision? A) Fuel prices are expected to rise and raise the annual running costs of all mowers. B) The mower is only expected to be needed for three years. C) The prices of equivalent mowers are expected to grow in the future as lawnmower manufacturers consolidate. D) The number of customers requiring lawn-mowing services is expected to sharply increase in the near future.
B) The mower is only expected to be needed for three years.
Which of the following statements is FALSE? A) The payback rule is useful in cases where the cost of making an incorrect decision might not be large enough to justify the time required for calculating the net present value (NPV). B) The payback rule is reliable because it considers the time value of money and depends on the cost of capital. C) For most investment opportunities, expenses occur initially and cash is received later. D) Fifty percent of firms surveyed reported using the payback rule for making decisions.
B) The payback rule is reliable because it considers the time value of money and depends on the cost of capital.
Which of the following statements is FALSE? A) As firms mature, their earnings exceed their investment needs and they begin to pay dividends. B) Total return equals earnings multiplied by the dividend payout rate. C) Cutting the firm's dividend to increase investment will raise the stock price if, and only if, the new investments have a positive net present value (NPV). D) We cannot use the constant dividend growth model to value the stock of a firm with rapid or changing growth.
B) Total return equals earnings multiplied by the dividend payout rate.
Which of the following statements is FALSE? A) Many projects use a resource that the company already owns. B) When evaluating a capital budgeting decision, we generally include interest expense. C) Only include as incremental expenses in your capital budgeting analysis the additional overhead expenses that arise because of the decision to take on the project. D) As a practical matter, to derive the forecasted cash flows of a project, financial managers often begin by forecasting earnings.
B) When evaluating a capital budgeting decision, we generally include interest expense.
Peter has a business opportunity that requires him to invest $10,000 today, and receive $12,000 in one year. He can either use $10,000 that he already has for this investment or borrow the money from his bank at an interest rate of 10%. However, the $10,000 he has right now is needed for urgent repairs to his home, repairs that will cost at least $15,000 if he delays them for a year. What is the best alternative for Peter out of the following choices? A) No, since the net present value (NPV) of the investment, should he take it, is less than the net present value (NPV) of the home repairs if he delays them for one year. B) Yes, since he can borrow the $10,000 from a bank, repair his home, invest $10,000 in the business opportunity, which, since it has a NPV > 0 will mean he will still come out ahead after repaying the loan. C) Yes, since the net present value (NPV) of the investment is greater than zero he can invest the $10,000 in the business opportunity, and then next year use this money plus the benefit from this money to make the necessary home repairs. D) Yes, since the net present value (NPV) of the investment, should he take it, is greater than the net present value (NPV) of the home repairs if he delays them for one year.
B) Yes, since he can borrow the $10,000 from a bank, repair his home, invest $10,000 in the business opportunity, which, since it has a NPV > 0 will mean he will still come out ahead after repaying the loan.
You placed an order to purchase stock where you specified the maximum price you were willing to pay. This type of order is known as a ________. A) maximum order B) limit order C) floor order D) market order
B) limit order
Which of the following costs would you consider when making a capital budgeting decision? A) sunk cost B) opportunity cost C) interest expense D) fixed overhead cost
B) opportunity cost
A manufacturer of peripheral devices for PCs decides to try and capture some of the PC gaming market by creating gaming versions of its traditional peripheral devices. It decides to start with a gaming version of its standard keyboard, increasing the number of macro keys, adding a small LCD screen to display game data, and giving the user the ability to backlight keys in different colors. If this device is a success, the manufacturer plans to release gaming versions of its trackballs and other peripherals. What option is the manufacturer gaining by the release of the new keyboard? A) option to delay B) option to expand C) option to abandon D) option to switch
B) option to expand
When comparing two projects with different lives, why do you compute an annuity with an equivalent present value (PV) to the net present value (NPV)? A) so that you can see which project has the greatest net present value (NPV) B) so that the projects can be compared on their cost or value created per year C) to reduce the danger that changes in the estimate of the discount rate will lead to choosing the project with a shorter timeframe D) to ensure that cash flows from the project with a longer life that occur after the project with the shorter life has ended are considered
B) so that the projects can be compared on their cost or value created per year
Which of the following best defines incremental earnings? A) cash flows arising from a particular investment decision B) the amount by which a firm's earnings are expected to change as a result of an investment decision C) the earnings arising from all projects that a company plans to undertake in a fixed time span D) the net present value (NPV) of earnings that a firm is expected to receive as the result of an investment decision
B) the amount by which a firm's earnings are expected to change as a result of an investment decision
Which of the following would you NOT consider when making a capital budgeting decision? A) the additional taxes a firm would have to pay in the next year B) the cost of a marketing study completed last year C) the opportunity to lease out a warehouse instead of using it to house a new production line D) the change in direct labor expense due to the purchase of a new machine
B) the cost of a marketing study completed last year
Which of the following is true regarding the profitability index? A) It does not use the net present value (NPV) to assess benefits. B) It is very simple to compute. C) Attention must be taken when using it to make sure that all of the constrained resource is utilized. D) It is unreliable when used for choosing between different projects.
C) Attention must be taken when using it to make sure that all of the constrained resource is utilized.
Which of the following will be a source of cash flows for a shareholder of a certain stock? I. Sale of the shares at a future date II. The firm in which the shares are held paying out cash to shareholders in the form of dividends III. The firm in which the shares are held increasing the total number of shares outstanding through a stock split A) I only B) II only C) I and II D) II and III
C) I and II
According to Graham and Harvey's 2001 survey (Figure 8.2 in the text), the most popular decision rules for capital budgeting used by CFOs are ________. A) NPV, IRR, MIRR B) MIRR, IRR, Payback period C) IRR, NPV, Payback period D) Profitability index, NPV, IRR
C) IRR, NPV, Payback period
Which of the following statements is FALSE? A) We begin the capital budgeting process by determining the incremental earnings of a project. B) The marginal corporate tax rate is the tax rate the firm will pay on an incremental dollar of pre-tax income. C) Investments in plant, property, and equipment are directly listed as expense when calculating earnings. D) The opportunity cost of using a resource is the value it could have provided in its best alternative use.
C) Investments in plant, property, and equipment are directly listed as expense when calculating earnings.
Which of the following is NOT a limitation of the payback rule? A) It does not consider the time value of money. B) Lacks a decision criterion that is economically based. C) It is difficult to calculate. D) It does not consider cash flows occurring after the payback period.
C) It is difficult to calculate.
Which of the following best describes why the predicted incremental earnings arising from a given decision are not sufficient in and of themselves to determine whether that decision is worthwhile? A) They do not tell how the decision affects the firm's reported profits from an accounting perspective. B) They are not easily predicted from historical financial statements of a firm and its competitors. C) These earnings are not actual cash flows. D) They do not show how the firm's earnings are expected to change as the result of a particular decision.
C) These earnings are not actual cash flows.
The capital budgeting process begins by ________. A) analyzing alternate projects B) evaluating the net present value (NPV) of each project's cash flows C) compiling a list of potential projects D) forecasting the future consequences for the firm of each potential project
C) compiling a list of potential projects
A firm is considering several mutually exclusive investment opportunities. The best way to choose between them is which of the following? A) profitability index B) payback period C) net present value (NPV) D) internal rate of return (IRR)
C) net present value (NPV)
After research into where to place a new restaurant, Burger Billies, a small fast-food chain, plans to open a new store near a small college. The anticipated customer base is students attending the college. They learn that a major fast food chain will be opening a franchise within the college, which leads the owners of Burger Billies to revise their estimate of sales to one below the break-even point. Which of the following is most likely the best real option for Burger Billies to take with regard to the proposed restaurant site? A) option to delay B) option to expand C) option to abandon D) option to switch
C) option to abandon
The difference between scenario analysis and sensitivity analysis is ________. A) scenario analysis is based upon the internal rate of return (IRR) and sensitivity analysis is based upon net present value (NPV) B) only sensitivity analysis allows us to change estimated inputs of net present value (NPV) analysis C) scenario analysis considers the effect on net present value (NPV) of changing multiple project parameters D) only scenario analysis breaks the net present value (NPV) calculation into its component assumptions
C) scenario analysis considers the effect on net present value (NPV) of changing multiple project parameters
Cameron Industries is purchasing a new chemical vapor depositor in order to make silicon chips. It will cost $6 million to buy the machine and $10,000 to have it delivered and installed. Building a clean room in the plant for the machine will cost an additional $3 million. The machine is expected to have a working life of six years. Which of these activities will be reported as an operating expense? A) the delivery and install cost only B) the cost of the depositor only C) the redesign of the plant only D) the delivery and install cost and the cost of the depositor
C) the redesign of the plant only
Owen Inc. has a current stock price of $15.00 and is expected to pay a $0.80 dividend in one year. If Owen's equity cost of capital is 12%, what price would its stock be expected to sell for immediately after it pays the dividend? A) $11.20 B) $12.80 C) $16.80 D) $16.00
D) $16.00
Which of the following statements is FALSE? A) Estimating dividends, especially for the distant future, is difficult. B) A firm can only pay out its earnings to investors or reinvest their earnings. C) Successful young firms often have high initial earnings growth rates. D) According to the constant dividend growth model, the value of the firm depends on the current dividend level, divided by the equity cost of capital plus the grow rate.
D) According to the constant dividend growth model, the value of the firm depends on the current dividend level, divided by the equity cost of capital plus the grow rate.
Which of the following situations can lead to IRR giving a different decision than NPV? A) delayed investment B) multiple IRRs C) differences in project scale D) All of the above can lead to IRR giving a different decision than NPV.
D) All of the above can lead to IRR giving a different decision than NPV.
Which of the following statements is FALSE about dividend payout and growth? A) A common approximation is to assume that in the long run, dividends will grow at a constant rate. B) The dividend each year is the firm's earnings per share (EPS) multiplied by its dividend payout rate. C) There is a tremendous amount of uncertainty associated with any forecast of a firm's future dividends. D) During periods of high growth, it is not unusual for firms to pay out 100% of their earnings to shareholders in the form of dividends.
D) During periods of high growth, it is not unusual for firms to pay out 100% of their earnings to shareholders in the form of dividends.
Which of the following statements is FALSE? A) In general, the difference between the cost of capital and the internal rate of return (IRR) is the maximum amount of estimation error in the cost of capital estimate that can exist without altering the original decision. B) The internal rate of return (IRR) can provide information on how sensitive your analysis is to errors in the estimate of your cost of capital. C) If you are unsure of your cost of capital estimate, it is important to determine how sensitive your analysis is to errors in this estimate. D) If the cost of capital estimate is more than the internal rate of return (IRR), the net present value (NPV) will be positive.
D) If the cost of capital estimate is more than the internal rate of return (IRR), the net present value (NPV) will be positive.
A maker of kitchenware is planning on selling a new chef-quality kitchen knife. The manufacturer expects to sell 1.6 million knives at a price of $120 each. These knives cost $80 each to produce. Selling, general, and administrative expenses are $500,000. The machinery required to produce the knives cost $1.4 million, depreciated by straight-line depreciation over five years. The maker determines that the EBIT break-even point for units sold and sale price is less than these estimates and that the EBIT break-even point for costs per unit, SG&A, and depreciation are greater than these estimates, so decides to go ahead with manufacturing the knife. Was this the correct decision? A) No, since the cost per unit should be greater than the EBIT break-even point for cost of goods if the project is to have a positive EBIT. B) Yes, since if the estimates for each parameter are correct , the EBIT will be positive. C) Yes, since a positive EBIT ensures that the project will have a positive net present value (NPV). D) It cannot be determined whether the decision was correct, since other factors contributing to the project's net present value (NPV), such as the upfront investment, have not been included in the analysis.
D) It cannot be determined whether the decision was correct, since other factors contributing to the project's net present value (NPV), such as the upfront investment, have not been included in the analysis.
A security firm is offered $80,000 in one year for providing CCTV coverage of a property. The cost of providing this coverage to the security firm is $74,000, payable now, and the interest rate is 8.5%. Should the firm take the contract? A) Yes, since net present value (NPV) is positive. B) It does not matter whether the contract is taken or not, since NPV = 0. C) Yes, since net present value (NPV) is negative. D) No, since net present value (NPV) is negative.
D) No, since net present value (NPV) is negative.
A convenience store owner is contemplating putting a large neon sign over his store. It would cost $50,000, but is expected to bring an additional $24,000 of profit to the store every year for five years. Would this project be worthwhile if evaluated using a payback period of two years or less and if the cost of capital is 10%? A) Yes, since it will pay back its initial investment in two years. B) Yes, since the value of the cash flows into the store, in present dollars, are greater than the initial investment. C) Yes, since the cash flows after two years are greater than the initial investment. D) No, since the value of the cash flows over the first two years are less than the initial investment.
D) No, since the value of the cash flows over the first two years are less than the initial investment.
Which of the following statements is FALSE? A) We can use scenario analysis to evaluate alternative pricing strategies for our project. B) Scenario analysis considers the effect on net present value (NPV) of changing multiple project parameters. C) The difference between the internal rate of return (IRR) of a project and the cost of capital tells you how much error in the cost of capital it would take to change the investment decision. D) Scenario analysis breaks the net present value (NPV) calculation into its component assumptions and shows how the net present value (NPV) varies as each one of the underlying assumptions changes.
D) Scenario analysis breaks the net present value (NPV) calculation into its component assumptions and shows how the net present value (NPV) varies as each one of the underlying assumptions changes.
Tanner is choosing between two investment options. He can invest $500 now and get (guaranteed) $550 in one year, or invest $500 now and get (guaranteed) $531.40 back later today. The risk-free rate is 3.5%. Which investment should Tanner prefer? A) $531.40 later today, since $1 today is worth more than $1 in one year. B) $550 in one year, since it is $50 more than he invested rather than $31.40 more than he invested. C) Neither - both investments have a negative NPV. D) Tanner should be indifferent between the two investments, since both are equivalent to the same amount of cash today.
D) Tanner should be indifferent between the two investments, since both are equivalent to the same amount of cash today.
Which of the following best explains why is it sensible for a firm to use an accelerated depreciation schedule such as MACRS rather than straight-line depreciation? A) The firm will substantially decrease its depreciation tax shield across all of the depreciation timeline. B) The firm can decide over how many years an item may be depreciated, thus allowing it full control of its depreciation expenses. C) The firm will have substantially fewer depreciation expenses later in the depreciation timeline. D) The firm will receive greater benefits to its cash flow earlier in the depreciation timeline and thus increase net present value (NPV).
D) The firm will receive greater benefits to its cash flow earlier in the depreciation timeline and thus increase net present value (NPV).
The owner of a hair salon spends $1,000,000 to renovate its premises, estimating that this will increase her cash flow by $220,000 per year. She constructs the above graph, which shows the net present value (NPV) as a function of the discount rate. At what dollar value should the NPV profile cross the vertical axis? A) $780,000 B) $1,000,000 C) Cannot be determined because inadequate information is given. D) The vertical axis crossing point cannot be calculated since the cash inflows are in perpetuity.
D) The vertical axis crossing point cannot be calculated since the cash inflows are in perpetuity.
Which of the following is NOT a valid method of modifying cash flows to produce a MIRR? A) Discount all of the negative cash flows to time 0 and leave the positive cash flows alone. B) Leave the initial cash flow alone and compound all of the remaining cash flows to the final period of the project. C) Discount all of the negative cash flows to the present and compound all of the positive cash flows to the end of the project. D) Turn multiple negative cash flows into a single negative cash flow by summing all negative cash flows over the project's lifetime.
D) Turn multiple negative cash flows into a single negative cash flow by summing all negative cash flows over the project's lifetime.
Which of the following statements is FALSE? A) Sensitivity analysis allows us to explore the effects of errors in our estimated inputs in our net present value (NPV) analysis for the project. B) To compute the net present value (NPV) for a project, you need to estimate the incremental cash flows and choose a discount rate. C) Estimates of the cash flows and cost of capital are often subject to significant uncertainty. D) When we are certain regarding the input to a capital budgeting decision, it is often useful to determine the break-even level of that input.
D) When we are certain regarding the input to a capital budgeting decision, it is often useful to determine the break-even level of that input.
What are dividend payments? A) payments made to a company by investors for a share of the ownership of that company B) incremental increases in the value of the stock held by an investor due to rises in share price C) the difference between the original cost price of a share and the price an investor receives when that share is sold D) a share of the profits paid to each shareholder on the basis of the number of shares they hold
D) a share of the profits paid to each shareholder on the basis of the number of shares they hold
The ultimate goal of the capital budgeting process is to ________. A) determine how the consequences of making a particular decision affects the firm's revenues and costs B) list the projects and investments that a company plans to undertake in the future C) forecast the consequences of a list of future projects for the firm D) determine the effect of the decision to accept or reject a project on the firm's cash flows
D) determine the effect of the decision to accept or reject a project on the firm's cash flows
Which of the following decision rules is best defined as the amount of time it takes to pay back the initial investment? A) internal rate of return (IRR) B) profitability index C) net present value (NPV) D) payback period
D) payback period
Which of the following decision rules might best be used as a supplement to net present value (NPV) by a firm that favors liquidity? A) profitability index B) MIRR C) equivalent annual annuity D) payback period
D) payback period
Most corporations measure the value of a project in terms of which of the following? A) discount value B) discount factor C) future value (FV) D) present value (PV)
D) present value (PV)
You are opening up a brand new retail strip mall. You presently have more potential retail outlets wanting to locate in your mall than you have space available. What is the most appropriate tool to use if you are trying to determine the optimal allocation of your retail space? A) internal rate of return (IRR) B) payback period C) net present value (NPV) D) profitability index
D) profitability index
Which of the following formulas is INCORRECT? A) g = Retention Rate × Return on New Investment B) Divt = EPSt × Dividend Payout Rate C) P0 = Div1 / (rE - g) D) rE = (Div1 / P0) - g
D) rE = (Div1 / P0) - g Explanation: D) rE = (Div1 / P0) + g
Which of the following is a disadvantage of the Net Present Value rule? A) can be misleading if inflows come before outflows B) not necessarily consistent with maximizing shareholder wealth C) ignores cash flows after the cutoff point D) relies on accurate estimate of the discount rate
D) relies on accurate estimate of the discount rate
An analysis that breaks the net present value (NPV) calculation into its component assumptions and shows how the net present value (NPV) varies as one of the underlying assumptions changes is called ________. A) scenario analysis B) internal rate of return (IRR) analysis C) accounting break-even analysis D) sensitivity analysis
D) sensitivity analysis
Which of the following adjustments should NOT be made when computing free cash flow from incremental earnings? A) adding depreciation B) adding all non-cash expenses C) subtracting increases in Net Working Capital D) subtracting depreciation expenses from taxable earnings
D) subtracting depreciation expenses from taxable earnings
An insurance office owns a large building downtown. The sixth floor of this building currently houses its entire Human Resources Department. After carrying out a survey to see whether the sixth floor could be rented and for what price, the company must decide whether to split the Human Resources Department between currently unoccupied spaces on several floors and rent out the entire sixth floor or to leave things as they currently are. Which of the following should NOT be considered when deciding whether to rent out the sixth floor? A) the amount obtained by renting the sixth floor B) the cost of refurbishing the new space to be occupied by the Human Resources Department C) cost involved with a loss of efficiency resulting from the Human Resources Department being split between several spaces D) the cost of the research into the feasibility of renting the sixth floor
D) the cost of the research into the feasibility of renting the sixth floor
A capital budget lists the potential projects a company may undertake in future years.
False
A floor broker is a person at the NASDAQ with a trading license who represents orders on the floor.
False
A real option is the obligation to take a particular business action.
False
An announcement by the government that they will decrease corporate marginal tax rates in the future would increase the attractiveness of MACRS depreciation.
False
Capital budgeting decisions use the Net Present Value rule so that those decisions maximize net present value (NPV).
False
Internal rate of return (IRR) can reliably be used to choose between mutually exclusive projects.
False
Preference for cash today versus cash in the future in part determines net present value (NPV).
False
Stocks that do not pay a dividend must have a value of $0.
False
The internal rate of return (IRR) rule will agree with the Net Present Value rule even when positive cash flows precede negative cash flows.
False
To evaluate a capital budgeting decision, it is sufficient to determine its consequences for the firm's earnings.
False
When different projects put different demands on a limited resource, then net present value (NPV) is always the best way to choose the best project.
False
When evaluating the effectiveness of an improved manufacturing process we should evaluate the total sales and costs generated by this process.
False
When using equivalent annual annuities to compare the costs of projects with different lives, you should not consider any changes in the expected replacement cost of equipment.
False
A firm can either pay its earnings to its investors, or it can keep them and reinvest them.
True
Net present value (NPV) is the difference between the present value (PV) of the benefits and the present value (PV) of the costs of a project or investment.
True
Net present value (NPV) is usefully supplemented by internal rate of return (IRR), since IRR gives a good indication of the sensitivity of any decision made to changes in the discount rate.
True
The Net Present Value rule implies that we should compare a project's net present value (NPV) to zero.
True
The Valuation Principle states that the value of a stock is equal to the present value (PV) of both the dividends and future sale price of that stock which the investor will receive.
True
The cash flow effect from a change in Net Working Capital is always equal in size and opposite in sign to the changes in Net Working Capital.
True
The most difficult part of the capital budgeting process is accurately estimating cash flows and cost of capital.
True
The ownership in a corporation is divided into shares of stock, which carry rights to a share in the profits of the firm through future dividend payments.
True
The payback rule is based on the idea that an opportunity that pays back its initial investment quickly is a worthwhile opportunity.
True
The profitability index can break down completely when dealing with multiple resource restraints.
True
When an alternative decision rule disagrees with the net present value (NPV), the NPV should be followed.
True
When comparing mutually exclusive projects which have different scales, you must know the dollar impact of each investment rather than percentage returns.
True
When different investment rules give conflicting answers, then decisions should be based on the Net Present Value rule, as it is the most reliable and accurate decision rule.
True
You can evaluate alternative projects with different lives by calculating and comparing their equivalent annual annuity.
True
