Final

MeFirst Corporation has a cumulative preferred share issue that is suppose to pay a quarterly dividend of $2. MeFirst failed to pay 4 consecutive dividends to investors and then managed to pay a common share dividend the very next quarter. How much cash must MeFirst have paid to each preferred share holder at that time? a. $2 per share b. $10 per share c. $6 per share d. $8 per share

Preferred stocks must pay a dividend to preferred shareholders. If the company cannot pay a dividend at a point in time, the dividends keep getting accumulated. When the company decides to pay dividends to common shareholders, it must pay first everything that they owe in preferred shareholders first. In this case, the company has not paid 4 consecutive dividends to preferred shareholders. This means that they owe them 4 x $2 = $8. So, when they decided to distribute dividends to common shareholders, they must have paid first what they owe the preferred shareholders $8 + $2 (which is the current dividend that they have to pay anyway) = $10.

Which is the best measure of risk for a single asset held in isolation, and which is the best measure for an asset held in a diversified portfolio? a. Coefficient of Variation; Beta b. Beta; Beta c. Beta; Variance d. Coefficient of Variation; Standard Deviation

a. Coefficient of Variation; Beta

You are considering buying a stock whose expected return lies below the Security Market Line (SML). What should you do? a. Don't buy the stock. b. Don't buy the stock only if its beta < 1. c. Buy the stock. d. Buy the stock only if its beta > 1.

a. Don't buy the stock.

Projects Alpha and Beta are normal projects whose NPV profiles cross at 14%. Project Alpha has an IRR of 34% and Project Beta has an IRR of 25%. Which of the following is true if projects Alpha and Beta are mutually exclusive? a. Project Beta should be selected if the cost of capital = 12%. b. Project Beta should be selected if the cost of capital = 16%. c. Project Alpha should be selected if the cost of capital = 10%. d. Project Alpha should be selected if the cost of capital = 35%.

a. Project Beta should be selected if the cost of capital = 12%.

If we are able to eliminate all of the unsystematic risk in a portfolio then, what is the result? a. a portfolio that contains only systematic risk b. a portfolio that has an expected return of zero c. a risk-free portfolio d. such a portfolio cannot be constructed since there will always be unsystematic risk in any portfolio

a. a portfolio that contains only systematic risk

The constant growth valuation model cannot be used under which of the following conditions? a. A negative growth rate. b. A growth rate greater than the required return. c. A growth rate less than the required return. d. A zero growth rate.

b. A growth rate greater than the required return.

What is the relevant and best measure of relative risk in a stand-alone risk situation where an investor will only hold one stock? a. Beta b. Coefficient of Variation c. Standard Deviation d. Mean

b. Coefficient of Variation

Other things held constant, (1) if the expected inflation rate decreases, and (2) investors become more risk averse, the Security Market Line would shift a. Up and have less steep slope. b. Down and have steeper slope. c. Down and have less steep slope. d. Down and keep same slope.

b. Down and have steeper slope.

A major disadvantage of the discounted payback period is that it a. Does not directly account for the time value of money. b. Ignores cash flows beyond the payback period. c. Is useless as a risk and liquidity indicator. d. All of the statements above are correct.

b. Ignores cash flows beyond the payback period.

LaPango Inc. estimates that its average-risk projects have a WACC of 10%, its below-average risk projects have a WACC of 8%, and its above-average risk projects have a WACC of 12%. Which of the following projects (A, B, and C) should the company accept? a. Project A, which is of average risk and has a return of 9%. b. Project B, which is of below- average risk and has a return of 8.5%. c. Project C, which is of above-average risk and has a return of 11%. d. None of the projects should be accepted.

b. Project B, which is of below- average risk and has a return of 8.5%.

Which of the following (all other factors held constant) will cause an increase in a stock's value? a. An increase in the risk-free rate b. A decrease in the constant growth rate in dividends c. A decrease in the stock's beta d. An increase in the market risk premium

c. A decrease in the stock's beta

Which of the following statements is most correct? a. If the IRR of Project A exceeds the IRR of Project B, then Project A must also have a higher NPV. b. The modified internal rate of return (MIRR) can never exceed the IRR. c. If a project with normal cash flows has an IRR that exceeds the cost of capital, then the project must have a positive NPV. d. None of the statements above is correct.

c. If a project with normal cash flows has an IRR that exceeds the cost of capital, then the project must have a positive NPV.

Estimating the cost of common equity using the discounted cash flow approach may be difficult to evaluate because a. the dividend yield is extremely difficult to estimate. b. the current price of the common equity is always changing making it difficult to determine. c. the proper growth rate is difficult to establish. d. all of the above are difficult to estimate.

c. the proper growth rate is difficult to establish.

Duval Inc. uses only equity capital, and it has two equally-sized divisions. Division A's cost of capital is 10.0%, Division B's cost is 14.0%, and the corporate (composite) WACC is 12.0%. All of Division A's projects are equally risky, as are all of Division B's projects. However, the projects of Division A are less risky than those of Division B. Which of the following projects should the firm accept? a. A Division A project with a 9% return. b. A Division B project with a 12% return. c. A Division B project with a 13% return. d. A Division A project with an 11% return.

d. A Division A project with an 11% return.

Smith Brothers has no retained earnings. The company uses the CAPM to calculate the cost of equity capital. The company's capital structure consists of common stock, preferred stock, and debt. Which of the following events will reduce the company's WACC? a. An increase in the flotation costs associated with issuing new common stock. b. An increase in risk aversion. c. An increase in the company's beta. d. A decrease in expected inflation.

d. A decrease in expected inflation.

Other things held constant, which of the following would increase the NPV of a project being considered? a. Making the initial investment in the first year rather than spreading it over the first three years. b. A shift from MACRS to straight-line depreciation. c. An increase in required net working capital. d. A decrease in the discount rate associated with the project.

d. A decrease in the discount rate associated with the project.

Assume a project has normal (conventional) cash flows. All else equal, which of the following state- ments is CORRECT? a. A project's MIRR is unaffected by changes in the WACC. b. A project's IRR increases as the WACC declines. c. A project's discounted payback increases as the WACC declines. d. A project's NPV increases as the WACC declines.

d. A project's NPV increases as the WACC declines

If a company uses the same cost of capital for evaluating all projects, which of the following results is likely? a. Accepting only good, low-risk projects. b. Accepting no projects. c. Rejecting good, average-risk projects. d. Accepting poor, high-risk projects.

d. Accepting poor, high-risk projects.

Which of the following is not considered a capital component for the purpose of calculating the weighted average cost of capital (WACC) as it applies to capital budgeting? a. Preferred stock b. Common stock c. Long-term debt d. Accounts payable and accruals

d. Accounts payable and accruals

Which of the following will decrease the WACC of a firm? a. An increase in the beta of the common stock. b. An increase in the expected dividend growth rate of the common stock, holding D1 constant. c. An increase in the preferred stock's required return. d. An increase in the firm's marginal tax rate.

d. An increase in the firm's marginal tax rate.

Assume a project has conventional cash flows (i.e., initial cash flow is negative, and all other cash flows are positive). Which of the following statements is most correct? a. All else equal, a project's IRR increases as the required rate of return declines. b. All else equal, a project's NPV increases as the required rate of return declines. c. All else equal, a project's IRR is unaffected by changes in the required rate of return. d. Answers B and C are both correct.

d. Answers B and C are both correct.

Which of the following is most correct? The modified IRR (MIRR) method: a. Always leads to the same ranking decision as NPV for independent projects. b. Overcomes the problem of multiple rates of return. c. Compounds cash flows at the required rate of return (WACC). d. Answers b and c are both correct.

d. Answers b and c are both correct.

The weighted average cost of capital, or WACC, is the company's a. Cost of Selling New Common Stock b. Historical Cost of Financing c. Current Cost of Financing d. Cost of Raising Additional Financing

d. Cost of Raising Additional Financing

What method should a firm use in order to make a decision between two mutually exclusive projects with unequal lives? a. Modified internal rate of return b. Discounted payback period c. Internal rate of return d. Equivalent Annual Annuity

d. Equivalent Annual Annuity

If the calculated NPV of a normal project is negative, then which of the following must be true? The discount rate (WACC) used is a. Too low. b. Too high. c. Less than the internal rate of return. d. Greater than the internal rate of return.

d. Greater than the internal rate of return.

If investors become less risk adverse, what would happen to required returns according to the CAP- M/SML Equation? a. Low beta stock returns would fall, and high beta stock returns would rise. b. All stock returns would fall by the same amount. c. Low beta stock returns would fall more than high beta stock returns. d. High beta stock returns would fall more than low beta stock returns.

d. High beta stock returns would fall more than low beta stock returns.

Question 3

d. Home Depot

Moynihan Motors has a cost of capital of 10.25 percent. The firm has two normal projects of equal risk. Project A has an internal rate of return of 14 percent, while Project B has an internal rate of return of 12.25 percent. Which of the following statements is most correct? a. Both projects have a negative net present value. b. If the crossover rate is 8 percent, Project B will have a higher net present value than Project A at the cost of capital given above. c. If the projects are mutually exclusive, the firm should always select Project A. d. If the crossover rate is 11 percent, Project B will have a higher net present value than Project A at the cost of capital given above.

d. If the crossover rate is 11 percent, Project B will have a higher net present value than Project A at the cost of capital given above.

Which of the following should be excluded from the cash flows for a potential new project? a. Opportunity costs b. Externalities c. Cannibalization d. Interest expense

d. Interest expense

Which of the following measures increases when the cost of capital increases? a. Payback Period b. Internal Rate of Return c. Net Present Value d. Modified Internal Rate of Return

d. Modified Internal Rate of Return

An investment's internal rate of return a. Is always higher than the investment's modified internal rate of return (MIRR). b. Changes when the cost of capital changes. c. Is equal to the annual net cash flows divided by one half of the project's cost when the cash flows are an annuity. d. Must exceed the cost of capital in order for the firm to accept the investment.

d. Must exceed the cost of capital in order for the firm to accept the investment.

Which of the following are correct if a normal project has a negative net present value (NPV)? a. The project's modified internal rate of return will be greater than its cost of capital. b. The project's payback period will be greater than its discounted payback period. c. The project's internal rate of return will be greater than its cost of capital. d. None of the above is correct.

d. None of the above is correct.

A major disadvantage of the payback period method is it a. Is useless as a risk indicator. b. Ignores cash flows beyond the payback period. c. Does not directly account for the time value of money d. Only answers b and c are correct.

d. Only answers b and c are correct.

A firm is evaluating a new machine to replace an existing, older machine. The old (existing) machine is being depreciated at $22,000 per year, whereas the new machine's depreciation will be $21,000. The firm's marginal tax rate is 35 percent. Everything else equal, if the new machine is purchased, what effect will the change in depreciation have on the firm's incremental operating cash flows? a. There should be no effect on the firm's cash flows, because depreciation is a noncash expense. b. Operating cash flows will increase by $650. c. Operating cash flows will increase by $1,000. d. Operating cash flows will decrease by $350.

d. Operating cash flows will decrease by $350.

If a company uses the same cost of capital for evaluating all projects, which of the following results is likely? a. Accepting no projects. b. Rejecting good, high-risk projects. c. Accepting poor, average-risk projects. d. Rejecting good, low-risk projects.

d. Rejecting good, low-risk projects.

Two firms evaluated the same capital budgeting project to determine whether to purchase it. The CFO of Anchor Weights Corporation (AWC) reported that she determined that the project's internal rate of return equals 9 percent, and she recommended that the project be purchased. The CFO of Sectional Spas Incorporated (SSI) simply reported that the project was unacceptable to his firm when he evaluated it using one of the capital budgeting techniques that considers the time value of money. Given this information, which of the following statements is correct? a. If the project is acceptable (unacceptable) to one firm, it must be acceptable (unacceptable) to both firms. As a result, one of the CFOs made a mistake when evaluating the project. b. AWC's CFO must have used the traditional payback period method to evaluate the project. c. If the SSI's CFO computes the IRR for the project, he will find that it is less than 9 percent for his company. d. SSI's must have a required rate of return (WACC) that is greater than 9 percent.

d. SSI's must have a required rate of return (WACC) that is greater than 9 percent.

Project A and Project B are mutually exclusive projects with equal risk. Project A has an internal rate of return of 12 percent, while Project B has an internal rate of return of 15 percent. The two projects have the same net present value when the cost of capital is 7 percent. (In other words, the crossover rate is 7 percent.) Assume each project has an initial cash outflow followed by a series of inflows. Which of the following statements is most correct? a. If the cost of capital is 10 percent, each project will have a positive net present value. b. If the cost of capital is 6 percent, Project B has a higher net present value than Project A. c. If the cost of capital is 13 percent, Project B has a higher net present value than Project A. d. Statements A and C are correct.

d. Statements A and C are correct.

Which of the following statements is incorrect concerning cash flow estimation? a. Any increases in interest payments incurred as a result of issuing bonds to finance the project will not be included. b. Savings in labor or material are included. c. Incremental after tax cash flow must be estimated. d. Sunk costs are included.

d. Sunk costs are included.

Project X's IRR is 19% and Project Y's IRR is 17%. The projects have the same risk and the same lives, and each has constant cash flows during each year of their lives. If the WACC is 10%, Project Y has a higher NPV than X. Given this information, which of the following statements is CORRECT? a. If the WACC is 18%, Project Y will have the higher NPV. b. The crossover rate must be less than 10%. c. If the WACC is 8%, Project X will have the higher NPV. d. The crossover rate must be greater than 10%.

d. The crossover rate must be greater than 10%.

Which of the following factors should be included in the cash flows used to estimate a project's NPV? a. Interest on funds borrowed to help finance the project. b. Cannibalization effects, but only if those effects increase the project's projected cash flows. c. All costs associated with the project that have been incurred prior to the time the analysis is being conducted. d. The end-of-project recovery of any additional net operating working capital required to operate the project.

d. The end-of-project recovery of any additional net operating working capital required to operate the project.

Stock A has a beta of 1.5 and Stock B has a beta of 0.5. Which of the following statements must be true about these securities? (Assume the market is in equilibrium.) a. When held in isolation, Stock A has greater risk than Stock B. b. Stock A would be a more desirable addition to a portfolio than Stock B. c. Stock B would be a more desirable addition to a portfolio than Stock A. d. The expected return on Stock A will be greater than that on Stock B.

d. The expected return on Stock A will be greater than that on Stock B.

If the expected rate of return on a stock exceeds the required rate, a. Dividends are not being declared. b. The stock is experiencing supernormal growth. c. The stock should be sold. d. The stock is a good buy.

d. The stock is a good buy.

The firm's weighted average cost of capital (WACC) is a. the same as the firm's internal rate of return (IRR). b. set by the board of directors of the firm because it is the benchmark they use to evaluate upper management. c. the total net present value (NPV) of all the capital budgeting projects in which the firm invests in any year. d. determined by the financial markets because investors provide the funds used by firms and these funds have costs, which are the returns demanded by investors.

d. determined by the financial markets because investors provide the funds used by firms and these funds have costs, which are the returns demanded by investors.

When evaluating the cash flows associated with a capital budgeting project, shipping and installation costs associated with the purchase of an asset are considered part of the: a. terminal cash flows, because these expenses aren't paid until the end of the asset's life. b. incremental operating cash flows because shipping and installation costs represent expenses that have to be written off over the life of the asset. c. sunk costs because these expenses do not affect any current or future cash flows associated with investing in the asset. d. initial investment outlay because these expenses effectively are part of the asset's purchase price.

d. initial investment outlay because these expenses effectively are part of the asset's purchase price.

According to the CAPM (capital asset pricing model), what is the single factor that explains differences in returns across securities? a. the risk-free rate b. the market risk premium c. the return on the market portfolio d. the beta of a security

d. the beta of a security

The slope of the security market line is: a. the return on the market. b. Beta c. the risk-free rate d. the market risk premium

d. the market risk premium

An asset has a beta of 2.0 and an expected return of 20%. The market risk premium is 5% and the risk-free is 7%. The stock is a. Overpriced b. cannot tell from the given information c. appropriately priced d. underpriced

d. underpriced

See Question 47

e. Nike