Chapter 14 Test Bank
Which one of the following statements is correct?
A project that is unacceptable today might be acceptable tomorrow given a change in market returns.
The weighted average cost of capital for a firm may be dependent upon the firm's I. rate of growth. II. debt-equity ratio. III. preferred dividend payment. IV. retention ratio.
ALL OF THE ABOVE
If a firm uses its WACC as the discount rate for all of the projects it undertakes then the firm will tend to: I. reject some positive net present value projects. II. accept some negative net present value projects. III. favor high risk projects over low risk projects. IV. increase its overall level of risk over time.
ALL of the above
A group of individuals got together and purchased all of the outstanding shares of common stock of DL Smith, Inc. What is the return rate that these individuals require on this investment called?
Cost of equity
Which of the following are correct? I. The SML approach is dependent upon a reliable measure of a firm's unsystematic risk. II. The SML approach can be applied to firms that retain all of their earnings. III. The SML approach assumes a firm's future risks are similar to its past risks. IV. The SML approach assumes the reward-to-risk ratio is constant.
II. The SML approach can be applied to firms that retain all of their earnings. III. The SML approach assumes a firm's future risks are similar to its past risks. IV. The SML approach assumes the reward-to-risk ratio is constant.
The dividend growth model can be used to compute of equity for a firm in which of the following situations
II. firms that pay a constant dividend III. firms that pay an increasing dividend IV. firms that pay a decreasing dividend
The aftertax cost of debt generally increases
II. the market rate of interest increases. III. tax rates decrease.
Which one of the following statements is correct?
Overall, a firm makes better decisions when it uses the subjective approach than when it uses its WACC as the discount rate for all projects.
Which one of the following statments related to the SML approach to equity valuation is correct? Assume the firm uses debt in its capital structure
THe model is dependent upon a reliable estimate of the market risk premium
Which one of the following statements is correct for a firm that uses debt in its capital structure
The WACC should decrease as the firm's debt-equity ratio increases
Morris Industries has a capital structure of 55 percent common stock, 10 percent preferred stock, and 45 percent. Given this, which of the following statements is correct?
The firms cost of equity is unaffected by change in the firms tax rate.
All else constant, which one of the following will increase a firm's cost of equity if the firm computes that cost using the security market line approach? Assume the firm currently pays an annual dividend of $1 a share and has a beta of 1.2
a reduction in the risk-free asset
The capital structure weights used in computing the weighted average cost of capital
are based on the market value of the firm's debt and equity securities
Preston Industries has two separate divisions. Each division is in a separate line of business. Division A is the largest division and represents 70 percent of the firm's overall sales. Division A is also the riskier of the two divisions. Division B is the smaller and least risky of the two. When management is deciding which of the various divisional projects should be accepted, the managers should:
assign appropriate, but differing, discount rates to each project and then select the projects with the highest net present values.
The subjective approach to project analysis:
assigns discount rates to projects based on the discretion of the senior managers of a firm.
Flotation costs for a levered firm should:
be weighted and included in the initial cash flow.
Phil's is a sit-down restaurant that specializes in home-cooked meals. Theresa's is a walk-in deli that specializes in specialty soups and sandwiches. Both firms are currently considering expanding their operations during the summer months by offering pre-wrapped donuts, sandwiches, and wraps at a local beach. Phil's currently has a WACC of 14 percent while Theresa's WACC is 10 percent. The expansion project has a projected net present value of $12,600 at a 10 percent discount rate and a net present value of -$2,080 at a 14 percent discount rate. Which firm or firms should expand and offer food at the local beach during the summer months?
both Phil's and Theresa's
Scholastic Toys is considering developing and distributing a new board game for children. The project is similar in risk to the firm's current operations. The firm maintains a debt-equity ratio of .40 and retainsall profits to fund the firm's rapid growth. How should the firm determine is cost of equity.
by using the capital asset pricing model
Textile Mills borrows money at a rate of 13.5 percent. This interest rate is referred to as the:
cost of debt
A firm's cost of capital:
depends upon how the funds raised are going to be spent
The aftertax cost of debt is:
has a greater effect on a firm's cost of capital when the debt-equity ratio increases
A firm's overall cost of equity is
highly dependent upon the growth rate and risk level of the firm
The cost of equity for a firm
ignores the firm;s risks when that cost is based on the dividend growth model
Incorporating flotation costs into the analysis of a project will:
increase the initial cash outflow of the project.
When a firm has flotation costs equal to 7 percent of the funding need, project analysts should
increase the initial project cost by dividing that cost by (1 - 0.07).
The pre-tax cost of debt
is based on the current yield to maturity of the firms outstanding bonds
The cost of preferred stock
is equal to the dividend yield
The dividend growth model
is only as reliable as the estimated rate of growth
The weighted average cost of capital for a wholesaler
is the return investors require on the total assets of the firm
Assigning discount rates to individual projects based on the risk level of each project:
may cause the firm's overall weighted average cost of capital to either increase or decrease over time.
Wilderness Adventures specializes in back-country tours and resort management. Travel Excitement specializes in making travel reservations and promoting vacation travel. Wilderness Adventures has an aftertax cost of capital of 13 percent and Travel Excitement has an aftertax cost of capital of 11 percent. Both firms are considering building wilderness campgrounds complete with man-made lakes and hiking trails. The estimated net present value of such a project is estimated at $87,000 at a discount rate of 11 percent and
neither Wilderness Adventures nor Travel Excitement
Markley and Stearns is a multi-divisional firm that uses its WACC as the discount rate for all proposed projects. Each division is in a separate line of business and each presents risks unique to those lines. Given this, a division within the firm will tend to:
prefer higher risk projects over lower risk projects.
When a manager develops a cost of capital for a specific project based on the cost of capital for another firm which has a similar line of business as the project, the manager is utilizing the _____ approach
pure play
The weighted average cost of capital for a firm is the
rate of return a firm must earn on its existing assets to maintain the current value of its stock
The cost of perferred stock is computed the same as the
return on a perpetuity
The discount rate assigned to an individual project should be based on:
the risks associated with the use of the funds required by the project.
The flotation cost for a firm is computed as:
the weighted average of the flotation costs associated with each form of financing.
Which of the following is the primary determinant of a firm's cost of capital
use of the funds
The average of a firm's cost of equity and aftertax cost of debt that is weighted based on the firm's capital structure is called the:
weighted average cost of capital
