FNCE 125 - Final Exam
EBIT break-even
(EBIT - I) x (1.0 - TR) / Equity number of shares
CAPM Model
Allows to determine expected return on stocks and incorporate risk Re= rf+ Beta(E(rm)-rf)
Which one of the following best illustrates that the management of a firm is adhering to the goal of financial management?
An increase in the market value per share
When calculating a firm's weighted average cost of capital, the capital structure weights:
Are based on the market values of the outstanding securities
Deciding which long-term investment a firm should make is a ________ decision
Capital Budgeting
A firm's aftertax cost of debt will increase if there is a(n):
Decrease in the company's tax rate
Sensitivity analysis determines the:
Degree to which the net present value reacts to changes in a single variable
Assume a manager determines the cost of capital for a specific project based on the cost of capital at another firm with a line of business that is similar to the project. Accordingly, the manager is using the _________ approach
Pure play
The cost of preferred tock is equivalent to the:
Rate of return on a perpetuity
Dividends Growth Model
Re= d1/p0+g
When evaluating the timing of a project's projected cash flows, a financial managers is analyzing:
When each cash flow is expected to occur
M&M Proposition II, without taxes, is the proposition that:
A company's cost of equity is a linear function with a slope equal to (Ra - Rd)
Assume a firm utilizes the security market line approach to determine the cost of equity. If the firm currently pays an annual dividend of $2.40 per share and has a beta of 1.42, all else constant, which of the following actions will decrease the firm's cost of equity?
A decrease in the firm's beta
Assume a firm utilizes the security market line approach to determine the cost of equity. If the firm currently pays an annual dividend of $3.36 per share and has a beta of 1.38 all else constant, which of the following actions will increase the firm's cost of equity?
A decrease in the risk-free rate
With respect to evaluating capital projects, which of the following statements is accurate?
A project that is unacceptable today might be acceptable tomorrow given a change in market returns
Velasquez Manufacturing has two vastly different lines of business: Alpha and Omega. The Alpha line is the riskiest of the two, and accounts for 72 percent of the firm's sales. When deciding which project proposals should be accepted, the managers should:
Assign appropriate, but differing rates to each business line and then select the projects with the highest net present values
When using the subjective approach to project analysis, a firm:
Assigns discount rates to projects based on the discretion of the senior managers of a firm
Which one of the following statements is correct concerning the relationship between a levered and an unlettered capital structure? Ignore taxes.
At the break-even point, there is no advantage to debt
A firm's mixture of debt and equity financing is the result of its _______ decisions
Capital structure
Jimmy's Car Rentals INC is analyzing whether to purchase new EV cars to rent to customers. This require purchasing $210,00 of new EVs (fixed assets). The EVs have an expected after-tax salvage value of $22,000. How is the $22,000 after-tax salvage value handled when computing the net present value in the project? (Hint: Think of where it would appear in the pro-forma).
Cash inflow in the final year of the project
When evaluating any capital project proposal, the cost of capital:
Depends upon how the funds raised for that project are going to be spent
The explicit costs, such as legal and administrative expenses, associated with corporate default are classified as _____ costs
Direct bankruptcy
Assume a firm has a debt-equity ratio of 0.48. The firm's cost of equity is:
Directly related to the risk level of the firm
Value of a firm
EBIT(1-T) / WACC
According to the static theory of capital structure, the optimal capital structure for a company:
Equates marginal tax savings from additional debt to the marginal increased bankruptcy costs of that debt
Machlab Equipment is comparing three machines to determine which one to purchase. Each machine has a unique price, annual operating cost, and life span. Which one of the following computational methods should Machlab use as the basis for its decision?
Equivalent Annual Cost
As the degree of sensitivity of a project to a single variable rises, the:
Greater the importance of accurately predicting the value of that variable
Assumer you are reviewing a graph that plots earnings per share (EPS) on the vertical axis, against earnings before interest and taxes (EBIT) on the horizontal axis. The steeper the slope of the plotted line the:
Greater the sensitivity of EPS to changes in EBIT
When analyzing a project, scenario analysis is best suited to accomplish which one of the following?
Identifying the potential range of reasonable outcomes
Forecasting risk is defined as the possibility that:
Incorrect decisions will be made due to erroneous / inaccurate cash flow projections
Assume a firm utilizes its WACC as the discount rate for every capital project it implements. Accordingly, the firm will tend to:
Increase the average risk level of the company over time
The difference between a company's future cash flows if it accepts a project and the company's future cash flows if it does not accept the project is referred to as the project's:
Incremental cash flows
According to the pecking-order theory, firms prefer to use __________ before any other form of financing
Internal funds
Homemade leverage is employed when a(n) __________:
Investor uses debt to change his or her exposure to financial leverage
Which of the following statements regarding a firm's pretax cost of debt is accurate?
It is based on the current yield to maturity of the company's outstanding bonds
Which of the following statements is accurate regarding the dividend growth model?
It is only as reliable as the estimated rate of growth
Which of the following statements regarding the weighted average cost of capital is accurate?
It is the return investors require on the total assets of the firm.
A company that has a(n) ________ would be most likely to have a high percentage of debt in its optimal capital structure
Low probability of financial distress
According to ________, the value of a company is unrelated to its capital structure
M&M Proposition I, no tax
The Sarbanes-Oxley Act of 2002 is a government response to:
Management greed and abuses revealed by several corporate scandals in the early 2000s
Which one of the following best states the primary goal of financial management?
Maximize the current value per share
MACRS
Modified Accelerated Cost Recovery System - a type of depreciation method, typically used by the IRS.
You are viewing a graph that plots the NPVs of a project against various discount rates that can be applied to the project's cash flows. What is the name of this graph?
NPV Profile
Depreciation tax shield
Reduction in taxes attributable to depreciation (tax rate x depreciation expense)
Humberto is a business analyst at Deloitte. When analyzing a new project, he projects the most optimistic, the most realistic, and the most pessimistic outcome using reasonably expected scenarios underlying his assumptions. high type of analysis is he using?
Scenario analysis
Financial managers should primarily focus on the interests of:
Shareholders
Which one of the following questions involves a capital budgeting decision?
Should the firm purchase a new machine for the production line?
The fact that a proposed project is analyzed based on the project's incremental cash flows is the assumption behind which one of the following principles
Stand-alone principle
In a typical corporate organizational structure:
The controller reports to the chief financial officer
Which one of the following statements is accurate? Capital structure has no effect on shareholder value The optimal capital structure occurs when the cost of equity is minimized The optimal capital structure maximizes shareholder value Shareholder value is maximized when WACC is also maximized Unlevered firms have more value than levered firms when firms are profitable
The optimal capital structure maximizes shareholder value
A project has a net present value of zero. Given this information:
The project's cash inflows equal its cash outflows in current (i.e. present) dollar terms
According to M&M Proposition II, without taxes, which of the following statements is accurate?
The required return on assets is equal to the weighted average cost of capital
To determine a firm's cost of capital, one must include:
The returns currently required by both debt holders and stockholders
Which of the following is the main advantage of using the dividend growth model to estimate a firm's cost of equity?
The simplicity of the model
According to ________, a company borrows up to the point where the marginal benefit of the interest tax shield derived from increased debt is just equal to the marginal expense of the resulting increase in financial distress costs
The static theory of capital structure
M&M Proposition I with taxes is based on the concept that:
The value of a taxable company increases as the level of debt increases
Which one of the following statements related to Chapter 7 bankruptcy is correct?
Under a Chapter 7 bankruptcy, a trustee will assume control of the company's assets until those assets can be liquidated
You are considering two mutually exclusive projects. Project A has cash flows of -$125,000, $51,400, $52,900, and $63,00 for Years 0 to 3, respectively. Project B has cash flows of -$85,000, $23,100, $28,200, and $69,800 for Years 0 to 3, respectively. ., Project A has a required return of 9 percent while Project B's required return is 11 percent. Should you accept or reject these mutually exclusive projects based on IRR Analysis?
You should not use IRR; use a different method of analysis
The symbol "Ru" refers to the cost of capital for a(n) ________ while "Ra" represents the ________:
all-equity company; weighted average cost of capital
WACC formula
cost of equity*%equity + weighted cost of debt*%debt(1-TR)
Pecking Order Theory
firms prefer to issue debt rather than equity if internal finance is insufficient
M&M Proposition II with taxes:
has the same general implications as M&M Proposition II without taxes.
Interest Tax Shield
tax savings resulting from deductibility of interest payments Interest Expense Deduction x Effective Tax Rate
Incremental Cash Flows
the difference between a firm's future cash flows with a project and those without the project
Capital Structure
the mixture of debt and equity maintained by a firm
If a project has a net present value equal to zero, then:
the project earns a return exactly equal to the discount rate
M&M Proposition II
the proposition that a firm's cost of equity capital is a positive linear function of the firm's capital structure
Cost of Equity
the return that equity investors require on their investment in the firm
Cost of Debt
the return that lenders require on the firm's debt
homemade leverage
the use of personal borrowing to change the overall amount of financial leverage to which the individual is exposed
In general, the capital structures of U.S. firms:
vary significantly across industries
The value of a firm is maximized when the:
weighted average cost of capital is minimized
The optimal capital structure:
will vary over time as taxes and market conditions change
