FINA EXAM 3

12. Western Inc. purchases a machine for $15,000. This machine qualifies as a five-year recovery asset under MACRS with the fixed depreciation percentages as follows: year 1 = 20.00%; year 2 = 32.00%; year 3 = 19.20%; year 4 = 11.52%. Western has a tax rate of 33%. If the machine is sold at the end of four years for $4,000, what is the cash flow from disposal? A) $3,535.36 B) $3,408.22 C) $2,592.00 D) $1,408.0013.

A) $3,535.36

1. ________ refers to the way a company finances itself through some combination of loans, bond sales, preferred stock sales, common stock sales, and retention of earnings. A) Capital structure B) Cost of capital C) Working capital management D) NPV

A) Capital structure

Which of the statements below is TRUE of the payback period method? A) It ignores the cash flow after the initial outflow has been recovered. B) It is biased against projects with early-term payouts. C) It incorporates time-value-of-money principles. D) It focuses on cash flows after the initial outflow has been recovered.

A) It ignores the cash flow after the initial outflow has been recovered.

1. A major metric of a company's health and its prospects for a long life is how much ________ it can generate. A) cash flow B) depreciation C) tax deferral D) net income

A) cash flow

6. Whenever a new product competes against a company's already existing products and reduces the sales of those products, ________ occur. A) erosion costs B) opportunity costs C) sunk costs D) working capital costs

A) erosion costs

7. Which of the statements below is TRUE? A) The increase in working capital accounts necessary to support a project also provides for cost increases at the end of the project. B) An increase in working capital can be brought about by an increase in inventory. C) Decreases in accounts receivables constitute a use of cash flow because you are helping your customers finance their purchases. D) Decreases in accounts payable constitute a source of cash flow because you are using your suppliers to help finance your business operations.

B) An increase in working capital can be brought about by an increase in inventory.

11. Which of the statements below is FALSE? A) The current book value of an asset serves as the basis for determining the gain or loss at disposal. B) Book value is the original cost of the asset plus the accumulated depreciation. C) A gain on disposal is recognized when the selling price of the asset is greater than the book value. D) A loss on disposal is recognized when the selling price of the asset is less than the book value.

B) Book value is the original cost of the asset plus the accumulated depreciation.

3. In capital budgeting, the appropriate decision rule for an average-risk project is to accept if the ________ is greater than the WACC. A) NPV B) IRR C) cost of equity D) cost of debt

B) IRR

2. Consider the case of a business that has had a very profitable year and earned a million dollars in profits. Can it distribute a million dollars to its owners (via dividends)? A) Yes, definitely B) Maybe, maybe not C) Definitely not D) It can certainly distribute over a million dollars.

B) Maybe, maybe not

3. Which of the statements below is FALSE? A) To account for the time value of money with the Payback Period Model, the future cash flow needs to be restated in current dollars. B) The Discounted Payback Period method is the time it takes to recover the initial investment in future dollars. C) When we discount a future cash flow with our standard time-value-of-money concepts, we inherently assume that the entire cash flow was received at the end of the year. D) The Discounted Payback Period method does not correct for the cash flow after the recovery of the initial outflow.

B) The Discounted Payback Period method is the time it takes to recover the initial investment in future dollars.

16. Under which of the following circumstances is the pure play method of estimating a project's beta particularly useful? A) The firm is looking to expand its current business operations, doing essentially the same work. B) The firm is looking to expand its current business operations into a brand-new area unlike any of its internal projects. C) The firm is looking to expand its current business operations. The work will be essentially the same as current operations but there is no obvious outside provider of the same service or product. D) The pure play method works equally effectively under each and all of these scenarios.

B) The firm is looking to expand its current business operations into a brand-new area unlike any of its internal projects

9. Which of the statements below is FALSE? A) The NPV decision criterion is true when all projects are independent and the company has a sufficient source of funds to accept all positive NPV projects. B) Two projects are mutually exclusive if the acceptance of one project has no bearing on the acceptance or rejection of the other project. C) Projects are mutually exclusive if picking one project eliminates the ability to pick the other project. D) If a company has constrained capital, then it can only take on a limited number of projects.

B) Two projects are mutually exclusive if the acceptance of one project has no bearing on the acceptance or rejection of the other project.

9. Which of the statements below is FALSE? A) Under the modified accelerated cost recovery system (MACRS) system of depreciation, the government classifies all assets into groups that are assigned specific "lives" for the purpose of depreciation. B) Under the modified accelerated cost recovery system (MACRS) system of depreciation, once the assigned class life is established, an adjustable percentage of the cost is expensed each year as depreciation. C) Under the modified accelerated cost recovery system (MACRS) system of depreciation, it can be assumed that an asset's assigned life class is the shortest allowable recovery period for allocating the capital expenditure costs and reducing taxes. D) Depreciation or "expired" costs each year do not reflect cash flows because the actual purchase and installation (outflow of dollars) of the machines have already taken place.

B) Under the modified accelerated cost recovery system (MACRS) system of depreciation, once the assigned class life is established, an adjustable percentage of the cost is expensed each year as depreciation.

4. A/An ________ facilitates the issuing and sale of bonds and for this service is paid a fee. A) commercial banker B) investment banker C) dealer D) broker

B) investment banker

3. The revenue is $24,000, the cost of goods sold is $12,000, other expenses (from selling and administration) are $6,000, and depreciation is $2,000. What is the EBIT? A) $12,000 B) $6,000 C) $4,000 D) $2,000

C) 4,000 EBIT = sales - costs - other expenses - depreciation

6. Which of the following is an advantage of the dividend growth approach over the SML in estimating the required return on equity? A) The dividend growth model uses market information but the SML does not. B) Dividend growth is known, whereas estimating beta for the SML is an art form. C) It is easy to fit flotation costs into the dividend growth model but not the SML. D) All are advantages of the dividend growth model for estimating the required return on equity.

C) It is easy to fit flotation costs into the dividend growth model but not the SML.

12. The best rule for choosing projects when a firm has a limited amount of funds is to accept the group of projects with the greatest combined ________. A) number of projects B) IRR C) NPV D) time to completion

C) NPV

We assume no ________ costs for a project if a competitor is also introducing a competing product. A) sunk B) buyback C) erosion D) corrosion

C) erosion

8. In the NPV model, all cash flows are stated ________. A) in future value dollars, and the total inflow is "netted" against the outflow to see if the net amount is positive or negative B) in present value or current dollars, and the outflow is "netted" against the total inflow to see if the gross amount is positive or negative C) in present value or current dollars, and the total inflow is "netted" against the initial outflow to see if the net amount is positive or negative D) in future dollars, and the initial outflow is "netted" against the total inflow to see if the net amount is positive

C) in present value or current dollars, and the total inflow is "netted" against the initial outflow to see if the net amount is positive or negative

10. Investors ________ for estimating the WACC. A) are indifferent between using market and book value B) prefer book value to market value C) prefer market value to book value D) prefer a mix of book and market value

C) prefer market value to book value

4. ________ of a project are those that have already been incurred and cannot be reversed. A) Erosion costs B) Opportunity costs C) Sunk costs D) Working capital costs

C) sunk costs

10.Which of the following may be TRUE regarding mutually exclusive capital budgeting projects? A) There is need for only one project, and both projects can fulfill that current need. B) By using funds for one project, there are not enough funds available for the other project. C) There is a scarce resource that both projects would need. D) All of the above

D) All of the above

13. If all projects are assigned the same discount rate for purposes of evaluation, which of the following could occur? A) Low-risk projects could be rejected when in fact they are good investment choices. B) High-risk projects could be accepted when in fact they are poor investment choices .C) High-risk projects could be accepted when in fact they are good investment choices. D) All of the choices could occur when using a single discount rate for all projects.

D) All of the choices could occur when using a single discount rate for all projects.

5. ________ involve(s) a cash flow that never occurs, but we need to add it as a cost or outflow of a new project. A) Cost recovery of divested assets B) Capital expenditures C) Sunk costs D) Opportunity costs

D) Opportunity costs

7. The ________ model determines at what point in time cash outflow is recovered by the corresponding future cash inflow. A) NPV B) buyback C) net present value D) payback period

D) Payback period

2. Which of the following would be classified as debt lenders for a firm? A) Preferred shareholders, banks, and nonbank lenders B) Nonbank lenders, common shareholders, and commercial banks C) Preferred shareholders, common shareholders, and suppliers D) Suppliers, nonbank lenders, and commercial banks

D) Suppliers, nonbank lenders, and commercial banks

15. Using the WACC to evaluate all projects has the effect of making low-risk projects look MORE attractive and high-risk projects look LESS attractive.

FALSE

Flotation costs reduce the cost of borrowing funds for the firms. TRUE OR FALSE?

FALSE