Finance Exam 5

These are fees paid by firms to investment bankers for issuing new securities

flotation costs

This is used as a measure of the total amount of available cash flow from a project.

free cash flow

. This is the IRS convention that requires that all property placed in service during a given period is assumed to be placed in service at the midpoint of that period.

half-year convention

A local bank is contemplating adding a new ATM to their lobby. They will need another phone line to provide communications which has a monthly cost of $50 per month. This is an example of

incremental cash flow

A capital budgeting technique that generates decision rules and associated metrics for choosing projects based upon the implicit expected geometric average of a project's rate of return.

internal rate of return

The process of estimating expected future cash flows of a project using only the relevant parts of the balance sheet and income statements is referred to as the

pro forma analysis

This is the process of estimating expected future cash flows of a project using only the relevant parts of the balance sheet and income statements.

pro forma analysis

This is the concept that a unit's sales will follow an approximate bell-shaped curve versus a steady sales life.

product life cycle

Accelerated depreciation allows firms to

receive more of the dollars of depreciation earlier in the asset's life.

When looking at these types of projects, one must consider any cash flows that arise from surrendering old equipment before the end of its useful life

replacement

This is a principle of capital budgeting which states that the calculations of cash flows should remain independent of financing.

separation principle

Which of the following will directly impact the cost of equity?

stock price

The ____________ approach to computing a divisional weighted average cost of capital (WACC) requires only that WACCs for "risky" and "relatively safe" divisions be adjusted.

subjective

Coke is planning on marketing a new drink called Very Berry Coke which is a mixture of raspberry and blackberry flavors blended to perfection and added to the highly secret Coca-Cola formula. This new product is expected to reduce the sales of their existing product, Cherry Coke, by $10 million dollars per year. This is an example of a

substitutionary effect

Effects that arise from a new product or service that decrease sales of the firm's existing products or services are referred to as

substitutionary effects

If a firm has already paid an expense or is obligated to pay one in the future, regardless of whether a particular project is undertaken, that expense is a

sunk cost

If a firm has already paid an expense or is obligated to pay one in the future, regardless of whether a particular project is undertaken, that expense is a(n)

sunk cost

With regard to depreciation, the time value of money concept tells us that

taking the depreciation expense sooner is always better.

A proxy beta is

the average beta of firms that are only engaged in the proposed new line of business

Which statement makes this a false statement? When a firm pays commissions to underwriting firms that float the issuance of new stock,

the component cost will need to be integrated to figure project WACCs.

Which of the following makes this a true statement? If the new project does significantly increase the firm's overall risk,

the increased risk will be borne disproportionately by common stockholders.

When choosing between two mutually exclusive projects using the payback period method for evaluating capital projects, one would choose

the project that pays back the soonest if it is equal to or less than managers' maximum payback period.

Which of these makes this a true statement? When determining the appropriate weights used in calculating a WACC, it should reflect

the relative sizes of the total market capitalizations for each kind of security that the firm issues.

Which of these makes this a true statement? The WACC formula

uses the after-tax costs of capital to compute the firm's weighted average cost of debt financing.

All of the following can be included in the depreciable basis of an asset except _______.

variable costs

As new capital budgeting projects arise, we must estimate

when such projects will require cash flows.

Suppose a new project was going to be financed partially with retained earnings. What flotation costs should you use for retained earnings?

zero

The benchmark for the Profitability Index, PI, is the

zero or anything larger than zero

All of the following capital budgeting tools are suitable for non-normal cash flows except

. Discounted Payback

Which of the following statements is correct?

A decrease in NWC involves either a reduction in current assets, which generates cash, or an increase in current liabilities, thereby freeing up the shareholder's cash for other things.

Which of the following best describes the NPV profile?

A graph of a project's NPV as a function of possible capital costs.

Which of the following statements is correct?

A weakness of both payback and discounted payback is that neither accounts for cash flows received after the payback.

A disadvantage of the payback statistic is

A. It does not reflect the time value of moneyB. It does not give an indication of the project's riskinessC. It does not consider cash flows beyond the payback periodD. All of these are disadvantages of payback

Which of the following statements is correct with respect to Section 179 deductions?

A. It was designed to help small businesses.B. It allows the firm to expense the asset immediately in the year of purchase.C. Most businesses can expense up to $108,000 of property placed in service during each year.D. All of these are correct statements.

Which of the following will impact the cost of equity component in the weighted average cost of capital?

A. The risk-free rate B. Beta C. Expected return on the market D. All of these

We accept projects with a positive NPV because it means that ____________.

A. We have recovered all our costsB. We are creating wealth for shareholdersC. The project's expected return exceeds the cost of capitalD. All of these

Which of the following makes this a true statement? Ideally, when searching for a beta for a new line of business

A. one could find other firms engaged in the proposed new line of business and use their betas as proxies to estimate the project's risk.B. one would like to find at least three or four pure-play proxies.C. two, or even one, proxies might represent a suitable sample if their line of business resembles the proposed new project closely enough.D. All the answers make this a true statement.

something to know

An increase in the firm's marginal corporate tax rate will decrease the weighted average cost of capital.

Which of the following statements is correct?

An increase in the market risk premium is likely to increase the weighted average cost of capital.

Which of the following is most correct?

An increase in the risk-free rate will increase the cost of equity.

Which of the following is NOT included when calculating the depreciable basis for real property?

financing fees

Why do we use market-value weights instead of book-value weights?

Because we are interested in determining what the cost of financing the firm's assets would be given today's market situation and the component costs the firm currently faces, not what the historical prices would have been.

The Net Present Value decision technique uses a statistic denominated in

Currency

One way to account for flotation costs of raising capital is to

adjust the project's initial cash flow so that it will reflect the flotation costs

ABC Engineering just purchased a new machine. All of the following are examples of incremental cash flows except

Developmental costs to determine which machine would best work with their unique process

An estimated WACC computed using some sort of proxy for the average equity risk of the projects in a particular business unit is known as the

Divisional WACC

This is an estimated WACC computed using some sort of proxy for the average equity risk of the projects in a particular division.

Divisional WACC

When calculating operating cash flow for a project, one would calculate it as being mathematically equal to which of the following?

EBIT - Taxes + Depreciation

The best approach to convert an infinite series of asset purchases into a perpetuity is known as the

Equivalent annual cost approach

Section 179 allows a business, with certain restrictions, to do which of the following?

Expense the asset immediately in the year of purchase

Which of the following is incorrect regarding the IRR statistic?

For the IRR statistic to give a different accept/reject decision from NPV, the cash flows must be non-normal and the projects must be mutually exclusive.

.All of the following capital budgeting tools are suitable for non-normal cash flows except

IRR

Which of the following is a reason why the divisional cost of capital approach may cause problems if new projects are assigned to the wrong division?

If projects are assigned to the wrong division, the risk of that division may be significantly different than the risk of the project, implying that the project will be evaluated with a divisional cost of capital that is much different from what a project-specific cost of capital would be.

Which of the following statements is true?

If the new project is riskier than the firm's existing projects, then it should be charged a higher cost of capital.

5. Which of these statements is true regarding calculating weights for WACC?

If we are calculating WACC for the firm, then equity, preferred stock and debt would be the entire market value of each source of capital.

ABC Engineering just bought a new machine. All of the following are examples of incremental cash flows except

Interest expense on the loan used to purchase the machine

Suppose you have a project whose discounted payback is equal to its termination date. What can you say for sure about its PI?

It will have a PI and NPV of zero.

A capital budgeting method that converts a project's cash flows using a more consistent reinvestment rate prior to applying the IRR decision rule is referred to as

MIRR

The least-used capital budgeting technique in industry is

MIRR

All of the following are strengths of NPV except

Managers have a preference for using a statistic that is in percent instead of dollars

When calculating the weighted average cost of capital, weights are based on

Market Value

Under what conditions can a rate-based statistic yield a different accept/reject decision than NPV?

Mutually exclusive projects that exhibit differences in scale or timing.

. All of the following capital budgeting tools are suitable for firms facing time constraints except

NPV

A capital budgeting technique that generates a decision rule and associated metric for choosing projects based on the total discounted value of their cash flows is referred to as

NPV

Which of the following tools is suitable for choosing between mutually exclusive projects?

NPV

Of the capital budgeting techniques discussed, which works equally well with normal and non-normal cash flows and with independent and mutually exclusive projects?

Net Present Value

Which of the following is a true statement regarding the appropriate tax rate to be used in the WACC?

One would use the weighted average of the marginal tax rates that would have been paid on the taxable income shielded by the interest deduction.

A decision rule and associated methodology for converting the NPV statistic into a rate-based metric is referred to as

Profitability Index

Which rate-based decision statistic measures the excess return (the amount above and beyond the cost of capital for a project), rather than the gross return?

Profitability Index, PI

An average of which of the following will give a fairly accurate estimate of what a project's beta will be?

Proxy Beta

A local bank is contemplating opening a new branch bank in a large superstore across town from their main office. It is estimated that the new branch will generate $20,000 after expenses each month. The manager wonders if all these revenues should be considered an incremental cash flow. Given this information, which of the following statements is correct?

Some amount less than the $20,000 is incremental because of substitutionary effects.

AB Mining Company just commissioned a firm to identify if an unused portion of their mine contains any silver or gold at a cost of $125,000. This is an example of a(n)

Sunk cost

Which of the following statements is correct regarding the NPV profile?

The IRR appears as the intersection of the NPV profile with the x-axis.

The MIRR statistic is different from the IRR statistic in that

The MIRR assumes that the cash inflows can be reinvested at the cost of capital

Which of the following statements is correct?

The WACC measures the marginal cost of capital.

What is the theoretical minimum for the weighted average cost of capital?

The after-tax cost of debt

Neither payback period nor discounted payback period techniques for evaluating capital projects account for

cash flows that occur after payback.

Due to rapid growth, a computer superstore is contemplating expanding by adding another location. Which of the following items should the financial officer NOT include in estimating the cash flow associated with this expansion?

The company spent $100,000 six months ago in a major advertising campaign which will help the new store become profitable sooner.

Which of the following will increase the cost of equity?

The firm's share price falls 10%.

Which of the following statements is correct?

The flotation-adjusted cost of equity will always be more than the cost of equity that has not been adjusted for flotation costs.

A manufacturing firm is planning on expanding its existing operations. The expansion project is significant and will require the firm to house the expansion in a different location. The firm is considering building on a lot they own across town. The lot is currently vacant and it was paid for nearly 20 years ago. Given this information, which of the following statements is correct?

The lot is an incremental cash flow because it represents an opportunity cost.

Which of the following statements is correct

The reinvestment rate of NPV and MIRR is the same.

The Net Present Value decision technique may not be the only pertinent unit of measure if the firm is facing

Time or resource constraints

Which of the following is a true statement?

To estimate the before-tax cost of debt, we need to solve for the Yield to Maturity (YTM) on the firm's existing debt.

Which of these statements is true regarding divisional WACC?

Using a simple firmwide WACC to evaluate new projects would give an unfair advantage to projects that present more risk than the firm's average beta.

Which of the following is a situation in which you would want to use the constant growth model approach for estimating the component cost of equity?

When the firm's stock is expected to experience constant dividend growth.

Which of following is a situation in which you would want to use the CAPM approach for estimating the component cost of equity?

When you are able to estimate the firm's beta with certainty

A decrease in net working capital (NWC) is treated as a

cash inflow

A project has normal cash flows. Its IRR is 15 percent and its cost of capital is 10 percent. Given this, the project must have:

an NPV that is greater than zero

For which situation below would one need to "smooth out" the variation in each set of cash flows so that each becomes a perpetuity?

choosing between alternative assets with differing lives

Flotation costs are

commissions to the underwriting firm that floats the issue

The research chemists at MegaClean created a new cleaner that keeps car and truck tires shiny and clean for one year. They believe that this product will be highly successful and will attract customers to purchase their existing line of household cleaning products. This is an example

complementary effect

Effects that arise from a new product or service that increase sales of the firm's existing products or services are referred to as

complementary effects.

An objective approach to calculating divisional WACCs would be done by

computing the average beta per division, using these figures for each division in the CAPM formula, and then constructing divisional WACCs.

Which of the following will directly impact the cost of debt?

coupon rate

An asset's cost plus the amounts you paid for items such as sales tax, freight charges, and installation and testing fees is referred to as the

depreciable basis

This technique for evaluating capital projects tells how long it will take a firm to earn back the money invested in a project plus interest at market rates.

discounted payback

All capital budgeting techniques

exclude some crucial information.

All of the following are incremental cash flows attributable to the project except

financing

Concerning incremental project cash flow, this is a cost one would never count as an expense of the project.

financing costs

A project's IRR

is the average rate of return necessary to pay back the project's capital providers

A capital budgeting technique that converts a project's cash flows using a more consistent reinvestment rate prior to applying the Internal Rate of Return, IRR, decision rule.

modified internal rate of return

These are groups or pairs of projects where you can accept one but not all

mutually exclusive

A capital budgeting technique that generates a decision rule and associated metric for choosing projects based on the total discounted value of their cash flows

net present value

A graph of a project's ______ is a function of cost of capital

net present value

The reason that we do not use an after-tax cost of preferred stock

none of the answers are correct

These are sets of cash flows where all the initial cash flows are negative and all the subsequent ones are either zero or positive

normal cash flows

The ___________ approach to computing a divisional weighted average cost of capital (WACC) uses the average beta of projects in each division to calculate the WACC

objective

Which of these completes this statement to make it true? The constant growth model is

only going to be appropriate for the limited number of stocks that just happen to expect constant growth.

All of the following capital budgeting tools are suitable for non-normal cash flows except

payback

This technique for evaluating capital projects is particularly useful when firms face time constraints in repaying investors.

payback

This technique for evaluating capital projects tells how long it will take a firm to earn back the money invested in a project.

payback