corp finance quiz

If two companies have identical unit sales volume and operating risk, they are most likely to also have identical: sales risk. business risk. sensitivity of operating earnings to changes in the number of units produced and sold.

sensitivity of operating earnings to changes in the number of units produced and sold.

A company has decided to switch to using accelerated depreciation from straight-line depreciation. Holding other factors constant, the degree of total leverage (DTL) will most likely: increase. not change. decrease.

A is correct. Based on the equation: The change to accelerated depreciation increases the fixed costs making DTL increase (i.e., the numerator does not change and the denominator decreases).

When computing the cash flows for a capital project, which of the following is least likely to be included? Financing costs Opportunity costs Tax effects

A is correct. Financing costs are not included in a cash flow calculation but are considered in the calculation of the discount rate.

Shirley Shea has evaluated an investment proposal and found that its payback period is one year, it has a negative NPV, and it has a positive IRR. Is this combination of results possible? Yes. No, because a project with a positive IRR has a positive NPV. No, because a project with such a rapid payback period has a positive NPV.

A is correct. If the cumulative cash flow in one year equals the outlay and additional cash flows are not very large, this scenario is possible. For example, assume the outlay is 100, the cash flow in Year 1 is 100 and the cash flow in Year 2 is 5. The required return is 10 percent. This project would have a payback of 1.0 years, an NPV of −4.96, and an IRR of 4.77 percent.

Which method of calculating the firm's cost of equity is most likely to incorporate the long-run return relationship between the firm's stock and the market portfolio? Capital asset pricing model Dividend discount model Bond yield plus risk premium approach

A is correct. The capital asset pricing model uses the firm's equity beta, which is computed from a market model regression of the company's stock returns against market returns.

With regard to capital budgeting, an appropriate estimate of the incremental cash flows from a project is least likely to include: externalities. interest costs. opportunity costs.

B is correct. Costs to finance the project are taken into account when the cash flows are discounted at the appropriate cost of capital; including interest costs in the cash flows would result in double-counting the cost of debt

Erin Chou is reviewing a profitable investment project that has a conventional cash flow pattern. If the cash flows for the project, initial outlay, and future after-tax cash flows all double, Chou would predict that the IRR would: increase and the NPV would increase. stay the same and the NPV would increase. stay the same and the NPV would stay the same.

B is correct. The IRR would stay the same because both the initial outlay and the after-tax cash flows double, so that the return on each dollar invested remains the same. All of the cash flows and their present values double. The difference between total present value of the future cash flows and the initial outlay (the NPV) also doubles.

A company's optimal capital budget most likely occurs at the intersection of the: net present value and internal rate of return profiles. marginal cost of capital and investment opportunity schedule. marginal cost of capital and net present value profiles.

B is correct. The point at which the marginal cost of capital intersects the investment opportunity schedule is the optimal capital budget.

With regard to net present value (NPV) profiles, the point at which a profile crosses the vertical axis is best described as: the point at which two projects have the same NPV. the sum of the undiscounted cash flows from a project. a project's internal rate of return when the project's NPV is equal to zero.

B is correct. The vertical axis represents a discount rate of zero. The point where the profile crosses the vertical axis is simply the sum of the cash flows.

When computing the weighted average cost of capital (WACC) and assuming a fixed-rate non-callable bond is currently selling above par value, the before-tax cost of debt is closest to the: coupon rate. yield to maturity. current yield.

B is correct. With a fixed-rate non-callable bond, the before-tax cost of debt is the bond's yield to maturity. A is incorrect because the coupon rate is higher than the yield-to-maturity based on the bond selling above par value. C is incorrect because the current yield is the coupon divided by the bond price which does not equal the yield-to-maturity.

Which of the following statements is the most appropriate treatment of flotation costs for capital budgeting purposes? Flotation costs should be: expensed in the current period. incorporated into the estimated cost of capital. deducted as one of the project's initial-period cash flows.

C is correct. Flotation costs are an additional cost of the project and should be incorporated as an adjustment to the initial-period cash flows in the valuation computation. A is incorrect because expensing is an accounting treatment of the costs, not a capital budgeting treatment. B is incorrect because including the flotation cost in the estimated cost of capital is theoretically incorrect. By doing so we are adjusting the present value of the future cash flows by a fixed percentage, i.e., the adjusted cost of capital.

Given two mutually exclusive projects with normal cash flows, the point at which their net present value profiles intersect the horizontal axis is most likely the projects': weighted average cost of capital. crossover rate. internal rate of return.

C is correct. For a project with normal cash flows, the NPV profile intersects the horizontal axis at the point where the discount rate equals the IRR. The crossover rate is the discount rate at which the NPVs of the projects are equal. Although it is possible that the crossover rate is equal to each project's IRR, it is not a likely event. It is also possible that the IRR is equal to the WACC, but that scenario is not the most likely one.

For a 90-day US Treasury bill selling at a discount, which of the following methods most likely results in the highest yield? Discount-basis yield (DBY) Money market yield (MMY) Bond equivalent yield (BEY)

C is correct. Note: the face value is greater than the purchase price because the T-Bill sells at a discount. A & B are incorrect because bond equivalent yield is the highest yield by construction.

Which of the following is least likely to be a component of a developing country's equity premium? Annualized standard deviation of the developing country's equity index Sovereign yield spread Annualized standard deviation of the sovereign bond market in terms of the developing country's currency

C is correct. The annualized standard deviation of the sovereign bond market in terms of the developing country's currency is not part of the equity premium calculation. Country equity premium = Sovereign yield spread × (Annualized standard deviation of equity index/Annualized standard deviation of the sovereign bond market in terms of the developed market currency)

The cost of debt can be determined using the yield-to-maturity and the bond rating approaches. If the bond rating approach is used, the: coupon is the yield. yield is based on the interest coverage ratio. company is rated and the rating can be used to assess the credit default spread of the company's debt.

C is correct. The bond rating approach depends on knowledge of the company's rating and can be compared with yields on bonds in the public market.

With regard to net present value (NPV) profiles, the point at which a profile crosses the horizontal axis is best described as: the point at which two projects have the same NPV. the sum of the undiscounted cash flows from a project. a project's internal rate of return when the project's NPV is equal to zero.

C is correct. The horizontal axis represents an NPV of zero. By definition, the project's IRR equals an NPV of zero.