FIN 125: Exam 3 MC

Rossdale Co. stock currently sells for $72.87 per share and has a beta of 1.22. The market risk premium is 7.10 percent and the risk-free rate is 2.90 percent annually. The company just paid a dividend of $4.29 per share, which it has pledged to increase at an annual rate of 3.45 percent indefinitely. What is your best estimate of the company's cost of equity? Select one: 8.02% 9.69% 9.29% 10.55% 11.36%

10.55%

Piedmont Hotels is an all-equity company. Its stock has a beta of 1.17. The market risk premium is 6.6 percent and the risk-free rate is 2.4 percent. The company is considering a project that it considers riskier than its current operations so it wants to apply an adjustment of 1.6 percent to the project's discount rate. What should the firm set as the required rate of return for the project? Select one: 10.12% 8.52% 11.72% 7.31% 8.91%

11.72%

Smathers Corp. stock has a beta of 1.18. The market risk premium is 7.50 percent and the risk-free rate is 3.06 percent annually. What is the company's cost of equity? Select one: 10.10% 11.91% 8.07% 7.84% 8.30%

11.91%

Ignoring taxes, Pewter & Glass has a weighted average cost of capital of 10.82 percent. The company can borrow at 7.4 percent. What is the cost of equity if the debt-equity ratio is .68? Select one: 12.87% 13.15% 11.09% 15.85% 12.49%

13.15%

Home Decor has a pretax cost of debt is 6.8 percent and a tax rate of 22 percent. What is the cost of equity if the debt-equity ratio is .65? WACC is 12.05% Select one: 16.89 percent 17.07 percent 14.70 percent 15.69 percent 16.44 percent

16.44%

Lamont Corp. is debt-free and has a weighted average cost of capital of 12.7 percent. The current market value of the equity is $2.3 million and there are no taxes. According to M&M Proposition I, what will be the value of the company if it changes to a debt-equity ratio of .85? Select one: $18,110,236 $1,955,000 $15,393,701 $2,705,882 $2,300,000

2,300,00

Charlotte's Crochet Shoppe has 13,100 shares of common stock outstanding at a price per share of $71 and a rate of return of 11.45 percent. The company also has 400 bonds outstanding, with a par value of $1,000 per bond. The pretax cost of debt is 6.05 percent and the bonds sell for 96 percent of par. What is the firm's WACC if the tax rate is 39 percent? Select one: 10.30% 9.18% 9.87% 8.70% 8.87%

9.18

M&M Proposition II with taxes: Select one: A. has the same general implications as M&M Proposition II without taxes. B. states that capital structure is irrelevant to shareholders. C. supports the argument that business risk is determined by the capital structure decision. D. supports the argument that the cost of equity decreases as the debt-equity ratio increases. E. concludes that the capital structure decision is irrelevant to the value of a firm.

A

The concept of homemade leverage is most associated with: Select one: M&M Proposition I with no tax. M&M Proposition II with no tax. M&M Proposition I with tax. M&M Proposition II with tax. the static theory proposition.

A

Pro forma financial statements can best be described as financial statements: Select one: A. expressed in a foreign currency. B. where the assets are expressed as a percentage of total assets and costs are expressed as a percentage of sales. C. showing projected values for future time periods. D. expressed in real dollars, given a stated base year. E. where all accounts are expressed as a percentage of last year's values.

C

The costs incurred by a business in an effort to avoid bankruptcy are classified as _____ costs. Select one: flotation direct bankruptcy indirect bankruptcy financial solvency capital structure

C

Which one of the following best describes the concept of erosion? Select one: A. Expenses that have already been incurred and cannot be recovered B. Change in net working capital related to implementing a new project C. The cash flows of a new project that come at the expense of a firm's existing cash flows D. The alternative that is forfeited when a fixed asset is utilized by a project E. The differences in a firm's cash flows with and without a particular project

C

Which one of the following is a correct method for computing the operating cash flow of a project assuming that the interest expense is equal to zero? Select one: A. EBIT + Depreciation B. EBIT(1 + Taxes) C. Net income + Depreciation D. (Sales − Costs)(1 − Depreciation)(1 − Taxes) E. (Sales − Costs)(1 − Taxes)

C

Which one of the following is a project cash inflow? Ignore any tax effects. Select one: Decrease in accounts payable Increase in accounts receivable Decrease in inventory Depreciation expense Equipment acquisition

C

Which one of the following statements is correct in relation to M&M Proposition II, without taxes? Select one: A. The cost of equity remains constant as the debt-equity ratio increases. B. The cost of equity is inversely related to the debt-equity ratio. C. The required return on assets is equal to the weighted average cost of capital. D. Financial risk determines the return on assets. E. Financial risk is unaffected by the debt-equity ratio

C

The operating cash flow for a project should exclude which one of the following? Select one: Taxes Variable costs Fixed costs Interest expense Depreciation tax shield

D

The option that is forgone so that an asset can be utilized by a specific project is referred to as which one of the following? Select one: Salvage value Wasted value Sunk cost Opportunity cost Erosion

D

SLG Corp. is an all-equity firm with a weighted average cost of capital of 10.02 percent. The current market value of the equity is $13.4 million and the total tax rate is 22 percent. What is EBIT? Select one: $1,966,667 $2,021,194 $1,721,385 $2,095,385 $1,943,182

1,721,385

The Corner Bakery has a debt-equity ratio of .53. The required return on assets is 13.5 percent and its cost of equity is 15.8 percent. What is the pretax cost of debt based on M&M Proposition II with no taxes? Select one: 8.78 percent 10.68 percent 9.16 percent 7.56 percent 8.40 percent

9.16

The basic lesson of M&M theory is that the value of a company is dependent upon: Select one: A. the total cash flows of that company B. the company's capital structure. C. minimizing the marketed claims. the amount of the company's marketed claims. D. size of the stockholders' claims.

A

Which one of the following costs was incurred in the past and cannot be recouped? Select one: Incremental Side Sunk Opportunity Erosion

C

The present value of the interest tax shield is expressed as: Select one: TCD/RA. VU + TCD. TCDRA. [EBIT(TCD)]/RA. TCD.

E

Dyrdek Enterprises has equity with a market value of $12.3 million and the market value of debt is $4.30 million. The company is evaluating a new project that has more risk than the firm. As a result, the company will apply a risk adjustment factor of 1.6 percent. The new project will cost $2.50 million today and provide annual cash flows of $651,000 for the next 6 years. The company's cost of equity is 11.67 percent and the pretax cost of debt is 5.03 percent. The tax rate is 40 percent. What is the project's NPV? Select one: $525,187 $383,370 $251,795 $210,989 $201,730

$251,795

Saint Nick Enterprises has 17,900 shares of common stock outstanding at a price of $71 per share. The company has two bond issues outstanding. The first issue has 9 years to maturity, a par value of $1,000 per bond, and sells for 102.5 percent of par. The second issue matures in 23 years, has a par value of $2,000 per bond, and sells for 107.5 percent of par. The total face value of the first issue is $270,000, while the total face value of the second issue is $370,000. What is the capital structure weight of debt? Select one: .3467 .4185 .3920 .2045 .3189

.3467

Kim's Bridal Shoppe has 11,600 shares of common stock outstanding at a price of $50 per share. It also has 285 shares of preferred stock outstanding at a price of $92 per share. There are 320 bonds outstanding that have a coupon rate of 6.9 percent paid semiannually. The bonds mature in 31 years, have a face value of $2,000, and sell at 109 percent of par. What is the capital structure weight of the common stock? Select one: .4448 .5350 .3989 .4864 .4654

.4448

Kountry Kitchen has a cost of equity of 12.4 percent, a pretax cost of debt of 5.9 percent, and the tax rate is 40 percent. If the company's WACC is 9.13 percent, what is its debt-equity ratio? Select one: .58 1.55 1.71 .71 .37

.58

An unlevered company has a cost of capital of 14.6 percent and earnings before interest and taxes of $240,090. A levered company with the same operations and assets has a face value of debt of $85,000 with a coupon rate of 7.5 percent that sells at par. The applicable tax rate is 22 percent. What is the value of the levered company? Select one: a. $1,085,338 b. $1,398,257 c. $1,402,509 d. $1,301,373 e. $1,001,010

1,301,373

Ornaments, Inc., is an all-equity firm with a total market value of $542,000 and 20,700 shares of stock outstanding. Management believes the earnings before interest and taxes (EBIT) will be $76,400 if the economy is normal. If there is a recession, EBIT will be 20 percent lower, and if there is a boom, EBIT will be 30 percent higher. The tax rate is 35 percent. What is the EPS in a recession? Select one: $1.92 $1.68 $2.40 $3.12 $2.88

1.92

Judy's Boutique just paid an annual dividend of $2.83 on its common stock. The firm increases its dividend by 3.55 percent annually. What is the company's cost of equity if the current stock price is $40.36 per share? Select one: 9.98% 10.27% 10.56% 11.20% 10.81%

10.81%

D. L. Tuckers has $57,000 of debt outstanding that is selling at par and has a coupon rate of 7.15 percent. The tax rate is 21 percent. What is the present value of the tax shield? Select one: $11,647 $12,791 $13,106 $12,200 $11,970

11,970

ABC and XYZ are identical firms in all respects except for their capital structures. ABC is all-equity financed with $530,000 in stock. XYZ has the same total value but uses both stock and perpetual debt; its stock is worth $310,000 and the interest rate on its debt is 7.9 percent. Both firms expect EBIT to be $62,222. Ignore taxes. The cost of equity for ABC is _____ percent and for XYZ it is ______ percent. Select one: 11.74; 9.82 11.74; 12.48 11.74; 14.47 12.09; 9.82 12.09; 12.48

11.74;14.47

Georga's Restaurants has 7,000 bonds outstanding with a face value of $1,000 each, a market price of $982, and a coupon rate of 6.95 percent. The interest is paid semiannually. What is the amount of the annual interest tax shield if the tax rate is 23 percent? Select one: $111,895 $113,323 $107,750 $110,420 $113,006

111,895

KN Stitches has debt of $26,000, a leveraged value of $78,400, a pretax cost of debt of 7.05 percent, a cost of equity of 15.3 percent, and a tax rate of 21 percent. What is the weighted average cost of capital? Select one: 11.47 percent 12.12 percent 11.69 percent 12.07 percent 12.02 percent

12.07%

Jamison's has expected earnings before interest and taxes of $11,900. Its unlevered cost of capital is 12.8 percent and its tax rate is 21 percent. The company has debt with both a book and a face value of $12,500. This debt has a coupon rate of 7.6 percent and pays interest annually. What is the weighted average cost of capital? Select one: 12.48 percent 12.36 percent 12.87 percent 12.09 percent 11.38 percent

12.36

Lamey Co. has an unlevered cost of capital of 12.3 percent, a total tax rate of 25 percent, and expected earnings before interest and taxes of $32,840. The company has $60,000 in bonds outstanding that sell at par and have a coupon rate of 7.2 percent. What is the cost of equity? Select one: 13.78 percent 13.36 percent 13.94 percent 14.07 percent 14.29 percent

13.78

Bruce & Co. expects its EBIT to be $165,000 every year forever. The company currently has no debt but can borrow at 8.6 percent while its cost of equity is 14.7 percent. The tax rate is 21 percent. The company is planning to borrow $55,000 and use the loan proceeds to repurchase shares. What will be the WACC after recapitalization? Select one: 14.57 percent 15.07 percent 14.51 percent 14.11 percent 14.58 percent

14.51%

Southwest Sands currently has 22,000 shares of stock outstanding. It is considering issuing $128,000 of debt at an interest rate of 7.5 percent. The break-even level of EBIT between these two capital structure options is $74,000. How many shares of stock will be repurchased if the company undergoes the recapitalization? Ignore taxes. Select one: 2,711.35 shares 2,854.05 shares 2,242.47 shares 3,091.89 shares 2,446.33 shares

2,854.05 shares

Hanover Tech is currently an all-equity company that has 145,000 shares of stock outstanding with a market price of $22 a share. The current cost of equity is 13.9 percent and the tax rate is 21 percent. The company is considering adding $1.5 million of debt with a coupon rate of 7.5 percent to its capital structure. The debt will be sold at par value. What is the levered value of the equity? Select one: $2.209 million $2.005 million $2.312 million $2.012 million $2.108 million

2.005 million

Simple Foods has a zero coupon bond issue outstanding that matures in 14 years. The bonds are selling at 56 percent of par value. What is the company's aftertax cost of debt if the combined tax rate is 23 percent? (Use semiannual compounding.) Select one: 4.48 percent 3.13 percent 3.22 percent 3.73 percent 2.88 percent

3.22%

Great Lakes Packing has two bond issues outstanding. The first issue has a coupon rate of 3.58 percent, a par value of $1,000 per bond, matures in 6 years, has a total face value of $4.0 million, and is quoted at 105 percent of face value. The second issue has a coupon rate of 6.26 percent, a par value of $2,000 per bond, matures in 25 years, has a total face value of $8.3 million, and is quoted at 93 percent of face value. Both bonds pay interest semiannually. The company's tax rate is 35 percent. What is the firm's weighted average aftertax cost of debt? Select one: 3.50% 3.09% 4.44% 5.38% 3.29%

3.50%

L.A. Clothing has expected earnings before interest and taxes of $63,300, an unlevered cost of capital of 14.7 percent, and a combined tax rate of 23 percent. The company also has $11,000 of debt that carries a coupon rate of 7 percent. The debt is selling at par value. What is the value of this company? Select one: $342,579 $273,333 $284,108 $334,101 $305,476

334,101

Galvatron Metals has a bond outstanding with a coupon rate of 6.5 percent and semiannual payments. The bond currently sells for $951 and matures in 23 years. The par value is $1,000 and the company's tax rate is 35 percent. What is the company's aftertax cost of debt? Select one: 4.77% 4.50% 3.46% 4.16% 3.23%

4.50%

Bethesda Water has an issue of preferred stock outstanding with a coupon rate of 4.90 percent that sells for $93.10 per share. If the par value is $100, what is the cost of the company's preferred stock? Select one: 4.90% 5.70% 5.04% 5.26% 4.97%

5.26%

The June Bug has a $565,000 bond issue outstanding. These bonds have a coupon rate of 6.65 percent, pay interest semiannually, and sell at 98.7 percent of face value. The tax rate is 21 percent. What is the amount of the annual interest tax shield? Select one: $7,573 $6,907 $8,333 $7,890 $8,250

7,890

Katlin Markets is debating between a levered and an unlevered capital structure. The all-equity capital structure would consist of 60,000 shares of stock. The debt and equity option would consist of 45,000 shares of stock plus $250,000 of debt with an interest rate of 7.25 percent. What is the break-even level of earnings before interest and taxes between these two options? Ignore taxes. Select one: $50,500 $68,200 $81,400 $66,667 $72,500

72,500

The Greenbriar is an all-equity firm with a total market value of $599,000 and 23,300 shares of stock outstanding. Management is considering issuing $217,000 of debt at an interest rate of 10 percent and using the proceeds on a stock repurchase. Ignore taxes. How many shares will the firm repurchase if it issues the debt securities? Select one: 10,231 shares 9,379 shares 59,900 shares 8,441 shares 844 shares

8,441 shares

The Two Dollar Store has a cost of equity of 12.1 percent, the YTM on the company's bonds is 5.9 percent, and the tax rate is 39 percent. If the company's debt-equity ratio is .56, what is the weighted average cost of capital? Select one: 8.58% 6.65% 9.05% 9.65% 7.87%

9.05%

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: Select one: incremental cash flows. internal cash flows. external cash flows. erosion effects. financing cash flows.

A

Westover Mills reduced its taxes last year by $210 by increasing its interest expense by $1,000. Which one of the following terms is used to describe this tax savings? Select one: Interest tax shield Interest credit Homemade leverage shield Current tax yield Tax-loss interest

A

You have computed the break-even point between a levered and an unlevered capital structure. Ignore taxes. At the break-even level, the: Select one: A. company is earning just enough to pay for the cost of the debt. B. company'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. company has a debt-equity ratio of .50.

A

A firm should select the capital structure that: Select one: A. produces the highest cost of capital. B. maximizes the value of the firm. C. minimizes taxes. D. is fully unlevered. E. equates the value of debt with the value of equity.

B

A project's cash flow is equal to the project's operating cash flow: Select one: A. plus the project's depreciation expense minus both the project's taxes and capital spending. B. minus both the project's change in net working capital and capital spending. C. minus the project's change in net working capital plus all of the depreciation expenses. D. plus the project's depreciation expenses minus the project's taxes. E. minus the project's taxes.

B

All of the following are related to a proposed project. Which one of these should be included in the cash flow at Time 0? Select one: A. Loan obtained to finance the project B. Initial investment in inventory to support the project C. Annual depreciation tax shield D. Aftertax salvage value E. Net working capital recovery

B

If a company has the optimal amount of debt, then the: Select one: A. direct financial distress costs must equal the present value of the interest tax shield. B. value of the levered company will exceed the value of the unlevered company. C. company has no financial distress costs. D. Value of the firm is equal to VL + TCD. E. debt-equity ratio is equal to 1.

B

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? Select one: Underlying value principle Stand-alone principle Equivalent cost principle Salvage principle Fundamental principle

B

Which one of the following is an example of a sunk cost? Select one: A. $1,500 of lost sales because an item was out of stock B. $1,200 paid to repair a machine last year C. $20,000 project that must be forfeited if another project is accepted D. $4,500 reduction in current shoe sales if a store commences selling sandals E. $1,800 increase in comic book sales if a store ceases selling puzzles

B

Which one of the following states that the value of a company is unrelated to the company's capital structure? Select one: Homemade leverage M&M Proposition I, no tax M&M Proposition II, no tax Pecking-order theory Static theory of capital structure

B

Kelley's Baskets makes handmade baskets and is currently considering making handmade wreaths as well. Which one of the following is the best example of an incremental operating cash flow related to the wreath project? Select one: A. Storing supplies in the same space currently used for materials storage B. Utilizing the basket manager to oversee wreath production C. Hiring additional employees to handle the increased workload should the firm accept the wreath project D. Researching the market to determine if wreath sales might be profitable before deciding to proceed E. Planning on lower interest expense by assuming the proceeds of the wreath sales will be used to reduce the firm's currently outstanding debt

C

Which one of the following best illustrates erosion as it relates to a hot dog stand located on the beach? Select one: A. Providing both ketchup and mustard for customers' use B. Repairing the roof of the hot dog stand because of water damage C. Selling fewer hot dogs because hamburgers were added to the menu D. Offering french fries but not onion rings E. Losing sales due to bad weather

C

A company's current cost of capital is based on: Select one: A. Only the return required by the company's current shareholders. B. The current market rate of return on equity shares. C. The weighted costs of all future funding sources. D. Both the returns currently required by its debt holders and stockholders. E. The company's original debt-equity ratio.

D

M&M Proposition I with taxes is based on the concept that: Select one: A. the optimal capital structure is the one that is totally financed with equity. B. capital structure is irrelevant because investors and companies have differing tax rates. C. WACC is unaffected by a change in the company's capital structure. D. the value of a taxable company increases as the level of debt increases. E. the cost of equity increases as the debt-equity ratio increases.

D

Which one of the following should not be included in the analysis of a new product? Select one: A. Increase in accounts payable for inventory purchases of the new product B. Reduction in sales for a current product once the new product is introduced C. Market value of a machine owned by the firm which will be used to produce the new product D. Money already spent for research and development of the new product E. Increase in accounts receivable needed to finance sales of the new product

D

GL Plastics spent $1,200 last week repairing a machine. This week the company is trying to decide if the machine could be better utilized if they assigned it a proposed project. When analyzing the proposed project, the $1,200 should be treated as which type of cost? Select one: Opportunity Fixed Incremental Erosion Sunk

E

Pro forma statements for a proposed project should generally do all of the following except: Select one: A. be compiled on a stand-alone basis. B. include all project-related fixed asset acquisitions and disposals. C. include all the incremental cash flows related to the project. D. include taxes. E. include interest expense

E

Shelton Co. purchased a parcel of land six years ago for $861,500. At that time, the firm invested $133,000 in grading the site so that it would be usable. Since the firm wasn't ready to use the site itself at that time, it decided to lease the land for $48,000 a year. The company is now considering building a warehouse on the site as the rental lease is expiring. The current value of the land is $913,000. What value should be included in the initial cost of the warehouse project for the use of this land? Select one: $0 $1,046,000 $861,500 $994,500 $913,000

E

The cost of capital for a new project: Select one: A. Is determined by the overall risk level of the firm. B. Is dependent upon the source of the funds obtained to fund that project. C. Is dependent upon the firm's overall capital structure. D. Should be applied as the discount rate for all other projects considered by the firm. E. Depends upon how the funds raised for that project are going to be spent.

E

The discount rate assigned to an individual project should be based on: Select one: A. The company's overall weighted average cost of capital. B. The actual sources of funding used for the project. C. An average of the company's overall cost of capital for the past five years. D. The current risk level of the overall firm. E. The risks associated with the use of the funds required by the project.

E

The optimal capital structure has been achieved when the: Select one: 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 pretax cost of debt. D. debt-equity ratio is such that the cost of debt exceeds the cost of equity. E. debt-equity ratio results in the lowest possible weighted average cost of capital.

E

Which form of financing do companies prefer to use first according to the pecking-order theory? Select one: Regular debt Convertible debt Common stock Preferred stock Internal funds

E

Which one of the following is the primary determinant of a firm's cost of capital? Select one: A. Debt-equity ratio of any new funds raised B. Marginal tax rate C. Pretax cost of equity D. Aftertax cost of equity E. Use of the funds raised

E

Which one of the following makes the capital structure of a company irrelevant? Select one: A. Taxes B. Interest tax shield C. 100 percent dividend payout ratio D. Debt-equity ratio that is greater than 0 but less than 1 E. Homemade leverage

E

You own a house that you rent for $1,400 per month. The maintenance expenses on the house average $260 per month. The house cost $231,000 when you purchased it 4 years ago. A recent appraisal on the house valued it at $253,000. If you sell the house you will incur $20,240 in real estate fees. The annual property taxes are $3,100. You are deciding whether to sell the house or convert it for your own use as a professional office. What value should you place on this house when analyzing the option of using it as a professional office? Select one: $0 $253,000 $231,000 $228,000 $232,760

E