Finance II - Multiple choice (First Half)

The proposition that the value of the firm is independent of its capital structure is called: A) The Capital Asset Pricing Model. B) M&M Proposition I (without taxes). C) M&M Proposition II. D) The Law of One Price. E) The Efficient Markets Hypothesis.

B

The interest tax shield has no value for a firm when: I. the tax rate is equal to zero. II. the debt-equity ratio is exactly equal to 1. III. the firm is unlevered. IV. a firm elects 100% equity as its capital structure. A. I and III only B. II and IV only C. I, III, and IV only D. II, III, and IV only E. I, II, and IV only

C

105. The value of a firm is maximized when the: A. cost of equity is maximized. B. tax rate is zero. C. levered cost of capital is maximized. D. weighted average cost of capital is minimized. E. debt-equity ratio is minimized.

D

102. The costs of avoiding a bankruptcy filing by a financially distressed firm are classified as _____ costs. A. flotation B. direct bankruptcy C. indirect bankruptcy D. financial solvency E. capital structure

C

114. M&M Proposition I with no tax supports the argument that: A. business risk determines the return on assets. B. the cost of equity rises as leverage rises. C. it is completely irrelevant how a firm arranges its finances. D. a firm should borrow money to the point where the tax benefit from debt is equal to the cost of the increased probability of financial distress. E. financial risk is determined by the debt-equity ratio.

C

117. Which of the following statements are correct in relation to M&M Proposition II with no taxes? I. The return on assets is equal to the weighted average cost of capital. II. Financial risk is determined by the debt-equity ratio. III. Financial risk determines the return on assets. IV. The cost of equity declines when the amount of leverage used by a firm rises. A. I and III only B. II and IV only C. I and II only D. III and IV only E. I and IV only

C

Which of the following will tend to diminish the benefit of the interest tax shield? I. a reduction in tax rates II. a large tax loss carry forward III. a large depreciation tax deduction IV. a sizeable increase in taxable income A. I and II only B. I and III only C. II and III only D. I, II, and III only E. I, II, III, and IV

D

. Two types of batteries are being considered for use in electric golf carts. Burnout brand has a three year life, while Long-lasting brand has a five year life. You must choose between the two batteries and you expect to replace the brand you ultimately choose continuously. You should: A. Take the option with the greater NPV. B. Take the option with the lower NPV. C. Take the option with the greater EAC. D. Take the option with the smaller EAC. E. Take the option with the lowest accounting break-even.

D

Which one of the following should be included in a lease-purchase analysis? I. The amount of the lease payment II. The cost of the asset if purchased today III. The amount of the depreciation tax shield IV. The amount of the benefit to be derived from the use of the asset A. I and II only B. I and III only C. II and IV only D. I, II, and III only E. I, III, and IV only

D

89. Which of the following statements is (are) true concerning the internal rate of return (IRR)? I. The IRR is the most widely used capital budgeting technique. II. The IRR method can produce multiple rates of return if the cash flows are nonconventional. III. If the IRR rate is used as the discount rate, then the resulting profitability index must equal 1.0. IV. The crossover point occurs where the IRR of two projects are equal. A. II only B. II and III only C. II and IV only D. I, II, and III only E. I, II, and IV only

d

A new project will cause accounts payable to increase by $35,000, accounts receivable to increase by $40,000 and inventory to decrease by $5,000 Which one of the following statements is true? A. The project will not affect net working capital. B. The change in accounts payable is a use of cash. C. The change in inventory is a use of cash. D. The project will decrease the amount of cash provided to customers. E. Net working capital will decrease.

A

Which of the following calculations takes the time value of money into account? I. Payback II. Average accounting return III. Profitability index A. I only B. II only C. III only D. I and III only E. II and III only

C

The use of which of the following could lead to incorrect decisions in comparing mutually exclusive investments? I. Internal rate of return II. Profitability index III. Average accounting return A. I only B. II only C. III only D. I and II only E. I and III only

D

Which of the following is (are) biased in favour of liquid investments? I. Payback period II. AAR III. Discounted payback A. I only B. III only C. I and II only D. I and III only E. I, II, and III

D

Which of the following is NOT generally considered to be a problem when estimating the cost of equity? A) We must estimate beta using historical information. B) We must estimate a dividend growth rate. C) We must estimate the market risk premium. D) We must estimate the risk-free rate of interest. E) If we use the dividend growth model, we cannot adjust for differences in risk.

D

Which of the following is NOT required in order to calculate the net advantage to leasing (NAL)? A. The depreciation tax shield B. The cost of the leased asset C. The lease payment D. The lessee's cost of equity E. The lessee's after-tax borrowing rate

D

83. The primary idea behind the net present value rule is that an investment: A. Is worthwhile if it creates value for the owners. B. Must have total cash flows that equal zero. C. Should be accepted if it enhances management's position. D. Should break-even from an accounting point of view. E. Should earn a rate of return that is less than the discount rate.

A

A financial lease: A. Is classified as a capital lease by accountants. B. Is only partially amortized. C. Requires the lessor to pay the taxes. D. Has payments which are insufficient to cover the entire cost of the asset. E. Is a short-term tax-oriented lease.

A

A manager will prefer the IRR rule over the NPV rule if the manager: A. Prefers to talk in terms of rates of return. B. Can accurately forecast future cash flows. C. Dislikes the discounted payback analysis. D. Also prefers use of payback analysis. E. Is considering mutually exclusive projects

A

85. An advantage of the payback method is its: A. Time value of money considerations. B. Application of readily available accounting data. C. Cut-off point. D. Long-term perspective. E. Simplicity.

E

108. You have computed the break-even point between a capital structure that has no debt and one that has debt. Assume there are no taxes. At the break-even level, the: A. firm is just earning enough to pay for the cost of the debt. B. firm's earnings before interest and taxes are equal to zero. C. earnings per share for the levered option are exactly double those of the unlevered option. D. advantages of leverage exceed the disadvantages of leverage. E. firm has a debt-equity ratio of .50.

A

118. M&M Proposition I with tax supports the theory that: A. there is a positive linear relationship between the amount of debt in a levered firm and its value. B. the value of a firm is inversely related to the amount of leverage used by the firm. C. the value of an unlevered firm is equal to the value of a levered firm plus the value of the interest tax shield. D. a firm's cost of capital is the same regardless of the mix of debt and equity used by the firm. E. a firm's weighted average cost of capital increases as the debt-equity ratio of the firm rises

A

41. Without using formulas, provide a definition of internal rate of return (IRR). A. The rate of return provided by a project. The value is compared with a company's rate of return to determine viability of a project. B. A situation whereby a choice has to be made between two or more projects, and choosing multiple projects is not an option. C. A graphical representation of the relationship between varying rates of return and the corresponding NPV value. D. A project analysis tool that measures the acceptability of a project through the difference between a project's initial investment and whether the present value of its cash flow will repay the investment. E. A project analysis tool that measures the acceptability of a project by determining the amount of profit that can be expected based on an investment made.

A

For a firm with multiple business units, the cost of capital developed for each unit is called a: A) Divisional cost of capital. B) Pure play approach. C) Subjective risk adjustment. D) Stratified beta coefficient. E) Fundamental beta coefficient.

A

If an investment has a(n) ___________ of 1.2 it can be said that the investment generates $1.20 in present value benefits for each dollar of invested costs. A. profitability index B. net present value C. internal rate of return D. payback period E. average accounting return

A

If the only information from the statement of comprehensive income items known to you are net income and depreciation, which of the following methods for calculating project OCF would you use? I. Bottom-up approach II. Top-down approach III. Tax-shield approach A. I only B. II only C. III only D. I and II only E. I and III only

A

In setting the bid price, the firm seeks the price that will cause the project to "breakeven" in a financial sense. The lowest acceptable bid price results in all of the following EXCEPT: A. AAR = required return B. NPV = 0 C. Discounted payback = the life of the project D. IRR = required return E. PI = 1

A

One of the primary advantages of a sale and leaseback arrangement is the: A. Immediate positive effects on the cash flows and financial status of the lessee. B. Immediate positive effects on the cash flows of the lessor. C. Favourable loan terms available to the lessee. D. Immediate recognition of a capital gain by the lessor. E. Immediate write-off of the asset cost by the lessor.

A

Rank the following decision rules from worst to best in terms of their overall usefulness in capital budgeting analysis. I. NPV II. Payback III. IRR A. II, III, I B. II, I, III C. III, I, II D. I, III, II E. III, II, I

A

The _______________ approach to capital budgeting analysis is analogous to the net advantage to leasing (NAL) approach to evaluating lease agreements. A. net present value B. average accounting return C. payback period D. internal rate of return E. profitability index

A

The cost of debt capital for a firm _________________________. A) is the return that the firm's creditors demand for new borrowings B) can be calculated by estimating the beta of the firm's equity and then using the SML C) can be estimated by finding the yield on recently-issued bonds with lower bond ratings D) can be calculated by looking at the coupon rates on existing bonds of similar risk E) can be observed directly even if the firm's bonds are not publicly traded

A

The opportunity cost associated with the firm's capital investment in a project is called its: A) Cost of capital. B) Beta coefficient. C) Capital gains yield. D) Sunk cost. E) Internal rate of return.

A

The reason for "hiding" a financial lease is the hope that the lease: A. Will go unnoticed by analysts and investors. B. Payments can be hidden from the CRA. C. Can be resold without the lessor knowing. D. Term can be extended if the lessee continues to make payments such that the lessor does not realize the lease term has expired. E. Can be treated as an operating lease for tax purposes without the CRA realizing it is a financial lease.

A

The tax savings of the firm derived from the deductibility of interest expense is called the: A) Interest tax shield. B) Depreciable basis. C) Financing umbrella. D) Current yield. E) Tax-loss carry-forward savings.

A

We can estimate a firm's cost of debt by _____________________. A) observing the yield to maturity on the firm's outstanding bonds B) observing the coupon rate on the firm's outstanding bonds C) observing the yield to maturity on newly-issued debt of other firms without regard to risk D) observing the risk-free rate and adding a risk premium to the coupon rate of existing debt E) observing the firm's bank borrowing rate on short-term loans

A

Which of the following is generally true about a firm's cost of debt? A) It is equal to the yield to maturity on the firm's outstanding bonds. B) It is greater than the cost of equity. C) It normally cannot be observed, directly or indirectly, in the marketplace. D) It is greater than the average coupon payments on outstanding debt. E) It is equal to the coupon rate on the firm's outstanding bonds.

A

86. The payback method: A. Entails difficult computations. B. Is prejudiced towards short-term projects. C. Always applies a ten year cut-off point for cash flows. D. Adjusts for the risk level inherent in a project. E. Is generally used only for large projects.

B

When considering mutually exclusive investment projects with different lives that will be replaced once they terminate, it is best to evaluate them using _________________________. A. the discounted payback rule B. the profitability index rule C. the equivalent annual cost rule D. the internal rate of return rule E. the net present value rule

C

103. The legal proceeding for liquidating or reorganizing a firm operating in default is called a A. tender offer. B. bankruptcy. C. merger. D. takeover. E. proxy fight.

B

104. A firm should select the capital structure which: A. produces the highest cost of capital. B. maximizes the value of the firm. C. minimizes taxes. D. is fully unlevered. E. has no debt

B

A project has a required return of 15% and a five year life. Which of the following is inconsistent with the other four? A. The discounted payback is five years B. PI = 0 C. NPV = $0 D. IRR = 15% E. The present value of the future cash flows equals the initial outlay

B

For a project with conventional cash flows, if NPV is greater than zero, then: A. The IRR is equal to the firm's required rate of return. B. The profitability index is greater than 1. C. The payback period is faster than the firm's required cutoff point. D. The AAR exceeds the IRR. E. The project does not pay back on a discounted payback basis.

B

If a project with conventional cash flows has a profitability index less than one, then: A. The IRR is greater than the required return. B. The discounted payback period is greater than the project's life. C. The AAR is greater than the required return. D. The payback period is less than the maximum acceptable period. E. The NPV is positive.

B

Ignoring taxes, if a firm issues debt at par, then _____________________. I. the cost of debt is equal to its coupon rate II. the cost of debt is equal to its yield to maturity III. the YTM cannot be computed A) I only B) I and II only C) II only D) I and III only E) I, II, and III

B

The basic lesson of M&M Theory is that the value of a firm is dependent upon the: A. capital structure of the firm. B. total cash flows of the firm. C. percentage of a firm to which the bondholders have a claim. D. tax claim placed on the firm by the government. E. size of the stockholders claims on the firm.

B

The most commonly cited reason for leasing is that __________________. A. it allows the lessee to exploit the deductibility of lease payments B. it reduces the uncertainty associated with the residual value of the leased asset C. it facilitates the circumvention of capital expenditure control systems D. it reduces the cost of equity E. transactions costs are usually lower for leasing than for buying

B

The point where a lessee is indifferent between leasing and buying is the point where the: A. Total cash outlays for lease payments are equivalent to the purchase cost of the asset. B. Net present value from leasing is equal to zero. C. Total cash flows minus the depreciation tax shield are equal to zero. D. Tax savings from leasing equal the tax savings from buying. E. Net present value from leasing is positive.

B

The relevant discount rate to use in a lease-purchase analysis is the: A. Pre-tax borrowing rate. B. After-tax borrowing rate. C. Firm's weighted average cost of capital. D. Current risk-free rate of return. E. Firm's pre-tax weighted average cost of capital

B

The return that shareholders require on their investment in the firm is called the: A) Dividend yield. B) Cost of equity. C) Capital gains yield. D) Cost of capital. E) Income return.

B

The riskiness of leasing cash flows is most similar to the lessee's _____________ cash flows. A. unit sales B. debt financing C. employee labour cost D. common equity financing E. net income

B

The unlevered cost of capital is _________________. A) the cost of capital for a firm with no equity in its capital structure B) the cost of capital for a firm with no debt in its capital structure C) the interest tax shield times pretax net income D) the cost of preferred stock for a firm with equal parts debt and common stock in its capital structure E) equal to the profit margin for a firm with some debt in its capital structure

B

Which of the following methods for calculating project operating cash flow do (does) NOT require you to add back noncash deductions such as depreciation? I. Bottom-up approach II. Top-down approach III. Tax-shield approach A. I only B. II only C. III only D. II and III only E. I, II, and III

B

Which of the following must be met for a lease to be valid for tax purposes according to the CRA? I. The term of the lease must be less than 90% of the economic life of the asset II. The lease must have a bargain purchase option, transferring the residual value to the lessee III. The lease must be primarily for business purposes A. I only B. III only C. I and III only D. II and III only E. I, II, and III

B

120. M&M Proposition II is the proposition that: A. supports the argument that the capital structure of a firm is irrelevant to the value of the firm. B. the cost of equity depends on the return on debt, the debt-equity ratio and the tax rate. C. a firm's cost of equity capital is a positive linear function of the firm's capital structure. D. the cost of equity is equivalent to the required return on the total assets of a firm. E. supports the argument that the size of the pie does not depend on how the pie is sliced

C

81. According to the capital budgeting surveys cited in the text, in general, most financial managers of large Canadian firms: A. Prefer to rely exclusively on payback analysis to evaluate projects. B. Use the AAR as their primary method of evaluating capital budgeting projects. C. Who use payback analysis use it only in conjunction with some other type of analysis. D. Prefer to use NPV or IRR to analyze their investment projects. E. Make use of payback analysis more heavily than discounted cash flow methods.

C

90. As the required rate of return increases, the: A. Net present value increases. B. Payback period decreases. C. Profitability index decreases. D. Discounted payback period decreases. E. Average accounting return decreases.

C

94. Suppose that two firms, A and B, are considering the same project which has the same risk as firm B's overall operations. The project has an IRR of 14.0%. Firm A has a beta of 1.4, while firm B's beta is 1.1. If the risk-free rate is 5.25% and the market risk premium is 7.0%, which firm(s) should take the project? A. A only B. B only C. Both A and B D. Neither A nor B E. Cannot be determined without additional information

C

Based upon the standards issued by CICA, a financial lease must be capitalized if the lease meets any one of four criteria. Which of the following correctly represents one of these criteria? I. The PV of the lease payments is at least 75% of the fair market value of the asset at the commencement of the lease. II. The lease term is 75% or more of the estimated economic life of the asset. III. The lessee has the right to purchase the asset at its fair market value at the expiration of the lease. IV. The lessee receives title to the asset by the end of the lease term. A. I and II only B. I and III only C. II and IV only D. II and III only E. III and IV only

C

The explicit costs associated with corporate default, such as legal expenses, are the ________ of the firm. A) flotation costs B) default beta coefficients C) direct bankruptcy costs D) indirect bankruptcy costs E) default risk premia

C

The interest tax shield is a key reason why: A. the required rate of return on assets rises when debt is added to the capital structure. B. the value of an unlevered firm is equal to the value of a levered firm. C. the net cost of debt to a firm is generally less than the cost of equity. D. the cost of debt is equal to the cost of equity for a levered firm. E. firms prefer equity financing over debt financing.

C

The optimal capital structure of a firm _____ the marketed claims and _____ the nonmarketed claims against the cash flows of the firm. A. minimizes; minimizes B. minimizes; maximizes C. maximizes; minimizes D. maximizes; maximizes E. equates; (leave blank)

C

The proposition that the cost of equity is a positive linear function of capital structure is called: A) The Capital Asset Pricing Model. B) M&M Proposition I. C) M&M Proposition II. D) The Law of One Price. E) The Efficient Markets Hypothesis.

C

The return that lenders require on their loaned funds to the firm is called the: A) Coupon rate. B) Current yield. C) Cost of debt. D) Capital gains yield. E) Cost of capital.

C

Which of the following characteristics would NOT cause a lease to be declared a capital lease for accounting purposes? I. The present value of the lease payments is at least 90% of the fair market value at the start of the lease. II. The lease transfers ownership of the property to the lessee by the end of the lease term. III. The lessee can purchase the asset at a bargain price when the lease expires. IV. The lease term is at least 70% of the estimated economic life of the asset. A. II only B. III only C. IV only D. II and IV only E. I, II, III, and IV

C

Which of the following characteristics would cause a lease to be declared a capital lease for accounting purposes? A. The present value of the lease payments equals 60% of the fair market value at the start of the lease. B. The lease does not transfer ownership of the property to the lessee by the end of the lease term. C. The lessee can purchase the asset at a price below fair market value when the lease expires. D. The lease term is at least 50% of the estimated economic life of the asset. E. The lessor maintains the insurance and maintenance on the leased asset.

C

Which of the following correctly state a criterion that must be met in order for a lease to be deemed valid by the CRA for tax purposes? I. The lease should NOT include an option permitting the lessee to purchase the asset at the end of the lease term at a price that is less than the fair market value at that time. II. The lessee must NOT be required to purchase the asset from the lessor during or at the termination of the lease. III. The purpose of the lease must NOT be primarily for the purpose of tax avoidance. IV. The lease should NOT contain a payment schedule wherein the initial payments are very high and the latter payments are very low. A. I and III only B. II and IV only C. I, II, and III only D. I, III, and IV only E. I, II, III, and IV

C

Which of the following is NOT a true statement? A. The payback rule ignores the time value of money. B. The discounted payback rule requires a cutoff hurdle be set. C. The profitability index is closely related to the payback period. D. The AAR is based on accounting data. E. There may be multiple IRRs for an independent project.

C

Which of the following statements is false? A. If a project has a profitability index greater than one the project should be accepted. B. If a firm's target average accounting return is less than that calculated for a given project then the project should be accepted. C. If the cost of capital is greater than the IRR, the project should be accepted. D. If a project has a payback which is faster than the company requires the project should be accepted. E. If the NPV of a project is positive, it should be accepted.

C

You are considering a new project that will require an initial buildup of raw materials inventory. The expected life of the project's equipment is seven years. If all goes as you expect, you will replace the equipment at the end of the seven years. If not, you will terminate the project. You currently believe there is a 50-50 chance of either occurrence. How should you treat the raw material inventory in year seven of your present analysis and why? A. Treat half of it as a cash inflow because there is a 50% chance the project will terminate then B. Treat it as a cash outflow because it is expected that the machines will be replaced C. Treat it as a cash inflow because the replacement of the machines becomes a new capital budgeting decision at that point D. Treat it as both a cash inflow and outflow, net effect zero E. Treat half as a cash inflow in year seven, but also treat only half as a cash outflow at the beginning of the project

C

107. ABC, Inc. is comparing two capital structures to determine how to best finance the firm's operations. The first option consists of 100% equity financing. The second option is based on a debt-equity ratio of .40. What should ABC do if expected earnings before interest and taxes (EBIT) are less than the break-even level? Assume there are no taxes. A. select the leverage option because the debt-equity ratio is less than .50 B. select the leverage option since the expected EBIT is less than the break-even level C. select the unlevered option since the debt-equity ratio is less than .50 D. select the unlevered option since the expected EBIT is less than the break-even level E. cannot be determined from the information provided

D

119. M&M Proposition I with taxes is based on the concept that: A. the optimal capital structure is the one that is totally financed with equity. B. the capital structure of the firm does not matter because investors can use homemade leverage. C. the firm is better off with debt based on the weighted average cost of capital. D. the value of the firm increases as total debt increases because of the interest tax shield. E. the cost of equity increases as the debt-equity ratio of a firm increases.

D

The proportions of the market value of the firm's assets financed via debt, common stock, and preferred stock are called the firm's _____________________. A) financing costs B) portfolio weights C) beta coefficients D) capital structure weights E) costs of capital

D

84. Generally, the most difficult part of utilizing the net present value concept is: A. Determining the initial cash outflow required to start a project. B. Computing the net present value once the discount rate and cash flows are determined. C. Determining whether the discount rate used is higher or lower than the internal rate of return. D. Estimating the future cash flows given the initial investment in the project. E. Making the accept/reject decision once the net present value is computed

D

87. Which of the following statements is (are) true concerning the comparison between payback and discounted payback? I. From a financial point of view, the discounted payback method is preferred over the payback method. II. The discounted payback is more difficult to compute and thus is not as widely used as the payback method. III. Both methods are biased towards liquidity. IV. Both methods consider the time value of money. A. I and III only B. II and IV only C. I and II only D. I, II, and III only E. I, II, III, and IV

D

91. A project should be accepted when the: A. Profitability index is less than 1.0. B. AAR is less than the targeted AAR. C. Net present value is negative. D. IRR exceeds the required rate. E. Payback period is greater than the prescribed number of years.

D

92. The cost of preferred stock is based on the: A. Average yield-to-maturity of the outstanding securities. B. After tax average coupon rate. C. Annual stated dividend multiplied by (1 - Tc). D. Perpetuity rate of return on the security. E. Stated dividend adjusted for any flotation costs.

D

An operating lease usually: A. Normally has a payment structure such that the payments are sufficient to allow the lessor to recover the cost of the asset. B. Has a lease period of at least five years. C. Cannot be canceled. D. Requires the lessor to maintain the asset. E. Requires the lessee to insure the asset.

D

Billie Jo sent a letter inquiring about the cost of a piece of equipment for a project she is considering. The cost of the stamp to mail this letter is an example of a(n) _____ cost. A. Opportunity B. Relevant C. Erosion D. Sunk E. Incremental

D

In which of the following cases would the CRA disallow the lease? I. The lessee automatically acquires title to the property after payment of a specified amount in the form of rentals. II. The lease term is less than five years. III. The lessee has a bargain purchase price option. A. II only B. III only C. I and II only D. I and III only E. I, II, and III

D

One legitimate advantage to leasing is that: A. Leasing provides 100% financing. B. Leasing provides a source of off-statement of financial position financing. C. By leasing, the lessee's statement of comprehensive income will be stronger. D. Taxes may be reduced by leasing. E. Unlike borrowing and purchase, leasing decreases a firm's financial leverage.

D

The business risk of a firm: A. depends on the level of unsystematic risk associated with the assets of the firm. B. is inversely related to the required return on the firm's assets. C. is dependent upon the relative weights of the debt and equity used to finance the firm. D. has a positive relationship with the cost of equity for that firm. E. has no relationship with the required return on a firm's assets according to M&M Proposition II.

D

The equity risk derived from the firm's operating activities is called ____________ risk. A) market B) systematic C) extrinsic D) business E) financial

D

The implicit costs associated with corporate default, such as lost sales, are the __________ of the firm. A) flotation costs B) default beta coefficients C) direct bankruptcy costs D) indirect bankruptcy costs E) default risk premia

D

The optimal capital structure will tend to include more debt for firms with: A. the highest depreciation deductions. B. the lowest marginal tax rate. C. substantial tax shields from other sources. D. lower probability of financial distress. E. less taxable income.

D

Which of the following statements concerning financial risk are correct? I. Financial risk is the risk associated with the use of debt financing. II. As financial risk increases so too does the cost of equity. III. Financial risk is wholly dependent upon the financial policy of a firm. IV. Financial risk is the risk that is inherent in a firm's operations. A. I and III only B. II and IV only C. II and III only D. I, II, and III only E. I, II, III, and IV

D

Which of the following will NOT lead to ambiguous decision-making when considering mutually exclusive projects? I. AAR II. PI III. IRR IV. NPV A. I only B. II and III only C. II and IV only D. I and IV only E. IV only

D

106. The optimal capital structure has been achieved when the: A. debt-equity ratio is equal to 1. B. weight of equity is equal to the weight of debt. C. cost of equity is maximized given a pre-tax cost of debt. D. debt-equity ratio is such that the cost of debt exceeds the cost of equity. E. debt-equity ratio selected results in the lowest possible weighed average cost of capital

E

82. The internal rate of return on a project is 11.24%. Which of the following (is) are true if the project is assigned a 9.5% discount rate? I. The project will have a negative net present value. II. The profitability index will be greater than 1.0. III. The initial investment is less than the market value of the project. IV. The project will have a positive effect on shareholders if it is accepted. A. I only B. II and IV only C. I and III only D. II and III only E. II, III, and IV only

E

Assume that a firm does not have to pay income taxes due to a substantial loss carry- forward. The firm is debating between buying and leasing some equipment. In this situation, the firm will most likely be better off: A. Buying because there is no tax benefit to offset the cost of the lease payments. B. Buying because the loss carry-forward will offset the tax cost of purchasing. C. Leasing because the lessee can immediately enjoy the tax benefit of the purchase. D. Leasing and transferring the tax benefit of purchasing to the lessee. E. Leasing and thereby transferring at least a portion of the tax benefit to a lessor.

E

Big Land Development Co. purchased a tract of land last year for $1.2 million. At that time, the company spent $50,000 in legal fees to have the land rezoned for commercial use and another $175,000 to have the land graded so that it is usable. The company is now trying to decide if they want to build one large retail store on the property or a strip mall consisting of smaller stores. Which of the costs identified above should be included in the project analysis to determine the best use of the property? A. All of the identified costs B. Only the cost of the land and the grading C. Only the legal fees and the grading costs D. Only the cost of the grading E. None of the identified costs

E

From the viewpoint of the lessee, the relevant discount rate for evaluating a lease versus buy decision is _________________________. A. the cost of issuing new common stock B. the pretax cost of issuing debt C. the lessor's cost of debt D. the firm's cost of capital E. the after-tax cost of issuing debt

E

Generally speaking, a(n) _____________ must be disclosed on the firm's balance sheet, according to generally accepted accounting principles. I. leveraged lease II. operating lease III. conditional sales agreement lease IV. sale and leaseback arrangement A. II only B. III only C. I and III only D. II and IV only E. I, III, and IV only

E

Good reasons for leasing include all of the following EXCEPT that: A. Taxes may be reduced by leasing. B. Leasing transfers uncertainty about the future value of the leased asset to the lessor. C. Leasing may encumber fewer assets than borrowing. D. Leasing may not increase a firm's financial leverage. E. Leasing is a source of 100% financing for an asset.

E

If financial managers only invest in projects that have a profitability index greater than one: I. firm value will be maximized. II. shareholder wealth will be maximized. III. share price will be maximized. A. I only B. II only C. III only D. I and III only E. I, II, and III

E

In general, observed capital structures: A. tend to overweigh debt in relation to equity. B. are easily explained in terms of earnings volatility. C. are easily explained by analyzing the types of assets owned by the various firms. D. tend to be those which maximize the use of the firm's available tax shelters. E. vary significantly across industries.

E

Indirect bankruptcy costs: A. effectively limit the amount of equity a firm issues. B. serve as an incentive to increase the financial leverage of a firm. C. include direct costs such as legal and accounting fees. D. tend to increase as the debt-equity ratio decreases. E. include the costs incurred by a firm as it tries to avoid seeking bankruptcy protection.

E

The EAC method for evaluating projects applies when which of the following project characteristics exist? I. The projects are mutually exclusive. II. The projects have different economic lives. III. The projects will be replaced more or less indefinitely. A. III only B. I and II only C. I and III only D. II and III only E. I, II, and III

E

The Frank Edwards Co. is considering a lease wherein they would be responsible, as lessee, for providing the maintenance, taxes, insurance, and equipment operator. Given this scenario, which one of the following should be included in the lease-purchase analysis? A. The amount of the annual depreciation B. The amount of the annual insurance premium C. The cost of the weekly maintenance on the equipment D. The employee benefits provided to the machine operator E. The amount of the depreciation tax shield

E

The equity risk derived from the firm's capital structure policy is called ___________ risk. A) market B) systematic C) extrinsic D) business E) financial

E

The weighted average of the firm's costs of equity, preferred stock, and after-tax debt is the: A) Reward to risk ratio for the firm. B) Expected capital gains yield for the stock. C) Expected capital gains yield for the firm. D) Portfolio beta for the firm. E) Weighted average cost of capital (WACC).

E

When a firm is operating with the optimal capital structure: I. the debt-equity ratio will also be optimal. II. the weighted average cost of capital will be at its minimal point. III. the required return on assets will be at its maximum point. IV. the increased benefit from additional debt is equal to the increased bankruptcy costs of that debt. A. I and IV only B. II and III only C. I and II only D. II, III, and IV only E. I, II, and IV only

E

When you set the project NPV equal to zero in calculating a bid price you are: A. Going to earn zero net income on the project. B. Appropriately including opportunity costs in your analysis. C. Certain to be the low bidder since, if any firm does bid lower, they will be bidding based on a negative NPV project. D. Assured of earning your firm's highest possible IRR. E. Finding the price at which you expect to create zero wealth for your shareholders.

E

Which capital investment evaluation technique is described by the following characteristics? (1) Closely related to NPV; (2) Easy to understand and communicate; (3) May lead to incorrect decisions when comparing mutually exclusive investments; (4) May be useful when the available investment funds are limited. A. NPV B. IRR C. AAR D. Payback period E. PI

E

Which of the following are legitimate reasons for leasing rather than buying? I. Lack of other available financing II. High tax rate III. Fewer restrictive covenants IV. Asset only needed on a temporary basis A. I and II only B. III and IV only C. II and III only D. I, II, and IV only E. I, III, and IV only

E

Which of the following is NOT true regarding a firm's cost of debt? A) The cost of debt must be adjusted lower due to the firm's tax deductibility of interest expense. B) The firm's cost of debt based on its past borrowing is known as its embedded debt cost. C) It is possible to determine a firm's cost of debt by using the SML. D) The coupon rate on outstanding debt is not necessarily the firm's current cost of debt. E) A firm's cost of equity is generally easier to calculate than a firm's cost of debt.

E

Which of the following is true? I. Setting the bid price requires finding the point at which project NPV is zero. II. In a cost-cutting proposal the reduction in costs has the same effect as an increase in sales. III. EAC is used to evaluate mutually exclusive projects with different lives if the projects are expected to be continuously replicated. A. III only B. I and II only C. I and III only D. II and III only E. I, II, and III

E

Which one of the following statements concerning bankruptcy is correct? A. The administrative costs incurred in a bankruptcy are considered indirect bankruptcy costs. B. Bondholders have a greater incentive than stockholders to keep a firm from filing for bankruptcy. C. Bankruptcy is sometimes used as a means to increase payroll costs. D. The assets of a firm tend to increase in value when a firm is in financial distress. E. An implicit cost of bankruptcy is the loss of key employees.

E

88. Which one of the following statements is correct concerning the average accounting return (AAR)? A. The average book value used in the AAR formula will always equal one-half of the initial investment as long as straight-line depreciation over the life of the project is used. B. The average net income is the same as the total cash flows from the project minus the initial cash outflow to start the project. C. The AAR is similar to the profitability index in that both are based on accounting values rather than financial cash flows. D. Under the AAR rule, a project should be accepted if the targeted AAR is greater than the project's AAR. E. The AAR is a true financial rate of return, which is relatively easy to compute.

a