corp final
NPV can be negative if the IRR is positive.
TRUE
Which of the following events is likely to encourage a company to raise its target debt ratio? a. An increase in the corporate tax rate. b. An increase in the personal tax rate. c. An increase in the company's operating leverage. d. Statements a and c are correct. e. All of the statements above are correct.
a
A project has an up-front cost of $100,000. The project's WACC is 12 percent and its net present value is $10,000. Which of the following statements is most correct? a. The project should be rejected since its return is less than the WACC. b. The project's internal rate of return is greater than 12 percent. c. The project's modified internal rate of return is less than 12 percent. d. All of the above answers are correct. e. None of the above answers is correct.
b
Projects A and B each have an initial cost of $10,000, followed by a series of positive cash inflows. The total undiscounted cash inflows is $16,000 for A but $15,000 for B. At a discount rate of 10 percent, the two projects have identical NPVs. Which project's NPV will be more sensitive to changes in the discount rate? a. Project B. b. Project A. c. They are equally sensitive to changes in the discount rate since their NPVs are equal. d. Neither project is sensitive to changes in discount rate. e. The solution cannot be determined.
b
Which of the following statements is correct? a. Because discounted payback takes account of the cost of capital, a project's discounted payback is normally shorter than its regular payback. b. The NPV and IRR methods use the same basic equation, but in the NPV method the discount rate is specified and the equation is solved for NPV, while in the IRR method the NPV is set equal to zero and the discount rate is found. c. If the cost of capital is less than the crossover rate for two mutually exclusive projects' NPV profiles, a NPV/IRR conflict will not occur. d. If you are choosing between two projects which have the same life, and if their NPV profiles cross, then the smaller project will probably be the one with the steeper NPV profile. e. If the cost of capital is relatively high, this will favor larger, longer-term projects over smaller, shorter-term alternatives because it is good to earn high rates on larger amounts over longer periods.
b
A spin-off is a type of divestiture in which the assets of a division are sold to another firm.
FALSE
Assuming a project has normal cash flows, the NPV will be positive if the IRR is less than the cost of capital.
FALSE
Assuming that the total cash flows are equal, the NPV of a project whose cash flows accrue relatively rapidly is more sensitive to changes in the discount rate than is the NPV of a project whose cash flows come in more slowly.
FALSE
Discounted cash flow methods are not appropriate for evaluating mergers because the cash flows are uncertain and the discount rate can only be determined after the merger is consummated.
FALSE
Financial leverage affects both EPS and EBIT, while operating leverage only affects EBIT.
FALSE
Firm A has a higher degree of business risk than Firm B. Firm A can offset this by using less financial leverage. Therefore, the variability of both firms' expected EBITs could actually be identical.
FALSE
Given two mutually exclusive projects and a zero cost of capital, the payback method and NPV method of selecting investments will always lead to the same decision on which project to undertake
FALSE
If the two projects both have a single outlay at t = 0, followed by a series of positive cash inflows, and if their NPV profiles cross in the lower left quadrant, then one of the projects should be accepted, and both would be accepted if they were not mutually exclusive.
FALSE
If two mutually exclusive projects have the same investment cost, and if their NPV profiles cross once in the upper right quadrant, at a discount rate of 40 percent, this suggests that a NPV versus IRR conflict is not likely to exist.
FALSE
Normal Projects Q and R have the same NPV when the discount rate is zero. However, Project Q has larger early cash flows than R. Therefore, we know that at all discount rates greater than zero, Project R will have a greater NPV than Q.
FALSE
Since managers' central goal is to maximize stock price, managerial control issues do not interfere with mergers that would benefit the target firm's stockholders.
FALSE
The distribution of synergistic gains between the stockholders of 2 merged firms is almost always based strictly on their respective market values before the announcement of the merger
FALSE
The firm's business risk is largely determined by the financial characteristics of its industry.
FALSE
The phenomenon called "multiple internal rates of return" arises when two or more mutually exclusive projects which have different lives are being compared.
FALSE
The term "equity carve-out" refers to the situation where a firm's managers give themselves the right to purchase new stock at a price far below the going market price. Since this dilutes the value of the public stockholders, it "carves out" some of their value.
FALSE
The IRR of normal Project X is greater than the IRR of normal Project Y, and both IRRs are greater than zero. Also, the NPV of X is greater than the NPV of Y at the cost of capital. If the two projects are mutually exclusive, Project X should definitely be selected, and the investment made, provided we have confidence in the data. Put another way, it is impossible to draw NPV profiles that would suggest not accepting Project X.
FALSE (if r > IRR then project X may have a negative NPV. Wouldn't want to accept a project with a negative NPV.)
Financial risk refers to the extra risk stockholders bear as a result of the use of debt as compared with the risk they would bear if no debt were used.
TRUE
If IRR = r (cost of capital), then NPV = 0.
TRUE
If Miller and Modigliani had considered the cost of bankruptcy, it is unlikely that they would have concluded that 100 percent debt financing is optimal for the firm.
TRUE
If a petrochemical firm that used oil as feedstock merged with an oil producer that had large oil reserves and a drilling subsidiary, this would be a vertical merger.
TRUE
If the two projects' NPV profiles cross once, in the upper left quadrant, at a discount rate of minus 10 percent, then there will probably not be a NPV versus IRR conflict, irrespective of the relative sizes of the two projects, in any meaningful, practical sense (that is, a conflict which will affect the actual investment decision).
TRUE
In a merger with true synergies, the post-merger value exceeds the sum of the separate companies' pre-merger values.
TRUE
Leveraged buyouts (LBOs) occur when a firm's managers, generally backed by private equity groups, try to gain control of a publicly owned company by buying out the public shareholders using large amounts of borrowed money.
TRUE
Synergistic benefits can arise from a number of different sources, including operating economies of scale, financial economies, and increased managerial efficiency.
TRUE
The internal rate of return is that discount rate which equates the present value of the cash outflows (or costs) with the present value of the cash inflows.
TRUE
The present value of the free cash flows discounted at the unlevered cost of equity is the value of the firm's operations if it had no debt.
TRUE
The purchase of assets at below their replacement cost and tax considerations are two factors that motivate mergers.
TRUE
The trade-off theory tells us that the capital structure decision involves a tradeoff between the costs of debt financing and the benefits of debt financing.
TRUE
Whenever a conflict between NPV and IRR exist, then, if the two projects have the same initial cost, the one with the steeper NPV profile probably has less rapid cash flows.
TRUE
A company estimates that its weighted average cost of capital (WACC) is 10 percent. Which of the following independent projects should the company accept? a. Project A requires an up-front expenditure of $1,000,000 and generates a net present value of $3,200. b. Project B has a modified internal rate of return of 9.5 percent. c. Project C requires an up-front expenditure of $1,000,000 and generates a positive internal rate of return of 9.7 percent. d. Project D has an internal rate of return of 9.5 percent. e. None of the projects above should be accepted.
a
The pecking order (signaling) theory states how financing should be raised. In order to avoid asymmetric information problems and misinterpretation of whether management is sending a signal on security overvaluation the firm's first rule is to: a. finance with internally generated funds. b. always issue debt then the market won't know when management thinks the security is overvalued. c. issue new equity first. d. issue debt first. e. None of the above.
a
Which of the following statements is most correct? a. If a normal project's internal rate of return (IRR) exceeds the cost of capital, then the project's net present value (NPV) must be positive. b. If normal Project A has a higher IRR than normal Project B, then Project A must also have a higher NPV. c. The IRR calculation implicitly assumes that all cash flows are reinvested at a rate of return equal to the cost of capital. d. Answers a and c are correct. e. None of the answers above is correct
a
Projects L and S each have an initial cost of $10,000, followed by a series of positive cash inflows. Project L has total, un-discounted cash inflows of $16,000, while S has total un-discounted inflows of $15,000. Further, at a discount rate of 10 percent, the two projects have identical NPVs. Which project's NPV will be more sensitive to changes in the discount rate? (Hint: Projects with steeper NPV profiles are more sensitive to discount rate changes.) a. Project S. b. Project L. c. Both projects are equally sensitive to changes in the discount rate since their NPVs are equal at all costs of capital. d. Neither project is sensitive to changes in the discount rate, since both have NPV profiles which are horizontal. e. The solution cannot be determined unless the timing of the cash flows is known.
b
Which of the following is NOT a real option? a. The option to expand production if the product is successful. b. The option to buy shares of stock if its price goes up. c. The option to expand into a new geographic region. d. The option to abandon a project. e. The option to switch the type of fuel used in an industrial furnace.
b
Which of the following statements is most CORRECT? a. If a company that produces military equipment merges with a company that manages a chain of motels, this is an example of a horizontal merger. b. A defensive merger is one where the firm's managers decide to merge with another firm to avoid or lessen the possibility of being acquired through a hostile takeover. c. Acquiring firms send a signal that their stock is undervalued if they choose to use stock to pay for the acquisition. d. None of the statements above is correct. e. Answers a and c are correct.
b
Your assistant has just completed an analysis of two mutually exclusive projects. You must now take her report to a board of directors meeting and present the alternatives for the board's consideration. To help you with your presentation, your assistant also constructed a graph with NPV profiles for the two projects. However, she forgot to label the profiles, so you do not know which line applies to which project. Of the following statements regarding the profiles, which one is most reasonable? a. If the two projects have the same investment cost, and if their NPV profiles cross once in the upper right quadrant, at a discount rate of 40 percent, this suggests that a NPV versus IRR conflict is not likely to exist. b. If the two projects' NPV profiles cross once, in the upper left quadrant, at a discount rate of minus 10 percent, then there will probably not be a NPV versus IRR conflict, irrespective of the relative sizes of the two projects, in any meaningful, practical sense (that is, a conflict which will affect the actual investment decision). c. If one of the projects has a NPV profile which crosses the X-axis twice, hence the project appears to have two IRRs, your assistant must have made a mistake. d. Whenever a conflict between NPV and IRR exist, then, if the two projects have the same initial cost, the one with the steeper NPV profile probably has less rapid cash flows. However, if they have identical cash flow patterns, then the one with the steeper profile probably has the lower initial cost. e. If the two projects both have a single outlay at t = 0, followed by a series of positive cash inflows, and if their NPV profiles cross in the lower left quadrant, then one of the projects should be accepted, and both would be accepted if they were not mutually exclusive.
b
Project A has an IRR of 15 percent. Project B has an IRR of 18 percent. Both projects have the same risk. Which of the following statements is most correct? a. If the WACC is 10 percent, both projects will have a positive NPV, and the NPV of Project B will exceed the NPV of Project A. b. If the WACC is 15 percent, the NPV of Project B will exceed the NPV of Project A. c. If the WACC is less than 18 percent, Project B will always have a shorter payback than Project A. d. If the WACC is greater than 18 percent, Project B will always have a shorter payback than Project A. e. If the WACC increases, the IRR of both projects will decline.
b (If r = 15 and IRRA = 15 then NPVA = 0, If r = 15 and IRRB = 18, 18>15 so NPV would be positive.)
Assume that you are comparing two mutually exclusive projects. Which of the following statements is most correct? a. The NPV and IRR rules will always lead to the same decision unless one or both of the projects are "non-normal" in the sense of having only one change of sign in the cash flow stream, i.e., one or more initial cash outflows (the investment) followed by a series of cash inflows. b. If a conflict exists between the NPV and the IRR, the conflict can always be eliminated by dropping the IRR and replacing it with the MIRR. c. There will be a meaningful (as opposed to irrelevant) conflict only if the projects' NPV profiles cross, and even then, only if the cost of capital is to the left of (or lower than) the discount rate at which the crossover occurs. d. Statements a, b, and c are true
c
Company A and Company B have the same total assets, operating income (EBIT), tax rate, interest rate (cost of debt, rd), and business risk. Company A, however, has a much higher debt ratio than Company B. Company A's basic earning power (BEP) exceeds its cost of debt financing (rd). Which of the following statements is most correct? a. Company A has a higher return on assets (ROA) than Company B. b. Company A has a higher times interest earned (TIE) ratio than Company B. c. Company A has a higher return on equity (ROE) than Company B, and its risk, as measured by the standard deviation of ROE, is also higher than Company B's. d. Statements b and c are correct. e.All of the statements above are correct.
c
Project A has an internal rate of return of 18 percent, while Project B has an internal rate of return of 16 percent. However, if the company's cost of capital (WACC) is 12 percent, Project B has a higher net present value. Which of the following statements is most correct? a. The crossover rate for the two projects is less than 12 percent. b. Assuming the timing of the two projects is the same, Project A is probably of larger scale (initial investment cost) than Project B. c. Assuming that the two projects have the same scale (initial investment cost), Project A probably has a faster payback than Project B. d. Answers a and b are correct. e. Answers b and c are correct.
c
Which of the following statements is most correct? a. When dealing with independent projects, discounted payback (using a payback requirement of 3 or less years), NPV, IRR, and modified IRR always lead to the same accept/reject decisions for a given project. b. When dealing with mutually exclusive projects, the NPV and modified IRR methods always rank projects the same, but those rankings can conflict with rankings produced by the discounted payback and the regular IRR methods. c. Multiple rates of return are possible with the regular IRR method but not with the modified IRR method, and this fact is one reason given by the textbook for favoring MIRR (or modified IRR) over IRR. d. Statements a, b, and c are false. e. Statements a and c are true.
c
Which of the following statements is most correct? a. The MIRR method will always arrive at the same conclusion as the NPV method. b. The MIRR method can overcome the multiple IRR problem, while the NPV method cannot. c. The MIRR method uses a more reasonable assumption about reinvestment rates than the IRR method. d. Statements a and c are correct. e. All of the above statements are correct
c
Which one of the following is an example of a "flexibility" option? a. A company has an option to invest in a project today or to wait a year. b. A company has an option to close down an operation if it turns out to be unprofitable. c. A company agrees to pay more to build a plant in order to be able to change the plant's inputs and/or outputs at a later date if conditions change. d. A company invests in a project today to gain knowledge that may enable it to expand into different markets at a later date. e. A company invests in a jet aircraft so that its CEO, who must travel frequently, can arrive for distant meetings feeling less tired than if he had to fly commercial.
c
The optimal capital structure will tend to include more debt for firms with: a. the highest depreciation deductions. b. the lowest marginal tax rate. c. substantial tax shields from other sources. d. lower probability of financial distress. e. less taxable income
d
Which of the following statements is most CORRECT? a. Tax considerations often play a part in mergers. If one firm has excess cash, purchasing another firm exposes the purchasing firm to additional taxes. Thus, firms with excess cash rarely undertake mergers. b. The smaller the synergistic benefits of a particular merger, the greater the scope for striking a bargain in negotiations, and the higher the probability that the merger will be completed. c. Since mergers are frequently financed by debt rather than equity, a lower cost of debt or a greater debt capacity are rarely relevant considerations when considering a merger. d. Managers who purchase other firms often assert that the new combined firm will enjoy benefits from diversification, including more stable earnings. However, since shareholders are free to diversify their own holdings, and at what's probably a lower cost, diversification benefits is generally not a valid motive for a publicly held firm. e. None of the answers above is correct.
d
Project X has an internal rate of return of 20 percent. Project Y has an internal rate of return of 15 percent. Both projects have a positive net present value. Which of the following statements is most correct? a. Project X must have a higher net present value than Project Y. b. If the two projects have the same WACC, Project X must have a higher net present value. c. Project X must have a shorter payback than Project Y. d. Both answers b and c are correct. e. None of the above answers is correct.
e
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 cost of capital. d. Overcomes the problems of cash flow timing and project size that lead to criticism of the regular IRR method. e. Answers b and c are correct.
e
Which of the following is most correct? a. The NPV and IRR rules will always lead to the same decision in choosing between mutually exclusive projects, unless one or both of the projects are "non-normal" in the sense of having only one change of sign in the cash flow stream. b. The Modified Internal Rate of Return (MIRR) compounds cash outflows at the cost of capital. c. Conflicts between NPV and IRR rules arise in choosing between two mutually exclusive projects (that each have normal cash flows) when the cost of capital exceeds the crossover point (that is, the point at which the NPV profiles cross). d. The discounted payback method overcomes the problems that the payback method has with cash flows occurring after the payback period. e. None of the statements above is correct.
e
Which of the following is most correct? a. The NPV and IRR rules will always lead to the same decision in choosing between mutually exclusive projects, unless one or both of the projects are "non-normal" in the sense of having only one change of sign in the cash flow stream. b. The Modified Internal Rate of Return (MIRR) compounds cash outflows at the cost of capital. c. Conflicts between NPV and IRR rules arise in choosing between two mutually exclusive projects (that each have normal cash flows) when the cost of capital exceeds the crossover point (that is, the point at which the NPV profiles cross). d. The discounted payback method overcomes the problems that the payback method has with cash flows occurring after the payback period. e. None of the statements above is correct.
e
Which of the following statements about valuing a firm using the APV approach is most CORRECT? a. The horizon value is calculated by discounting the free cash flows beyond the horizon date and any tax savings at the levered cost of equity. b. The horizon value is calculated by discounting the free cash flows beyond the horizon date and any tax savings at the cost of debt. c. The horizon value is calculated by discounting the expected earnings at the WACC. d. The horizon value is calculated by discounting the free cash flows beyond the horizon date and any tax savings at the WACC. e. None of the statements above is correct.
e
Which of the following statements is false? As a firm increases its operating leverage for a given quantity of output, this a. changes its operating cost structure. b. increases its business risk. c. increases the standard deviation of its EBIT. d. increases the variability in earnings per share. e. decreases its financial leverage
e
Which of the following statements is most CORRECT? a. The acquiring firm's required rate of return in most horizontal mergers will not be affected, because the 2 firms will have similar betas. b. Financial theory says that the choice of how to pay for a merger is really irrelevant because, although it may affect the firm's capital structure, it will not affect its overall required rate of return. c. The basic rationale for any financial merger is synergy and, thus, the estimation of pro forma cash flows is the single most important part of the analysis. d. In most mergers, the benefits of synergy and the premium the acquirer pays over the market price are summed and then divided equally between the shareholders of the acquiring and target firms. e. The primary rationale for most operating mergers is synergy.
e
Which of the following statements is most correct? a. Since debt financing raises the firm's financial risk, raising a company's debt ratio will always increase the company's WACC. b. Since debt financing is cheaper than equity financing, raising a company's debt ratio will always reduce the company's WACC. c. Increasing a company's debt ratio will typically reduce the marginal cost of both debt and equity financing; however, it still may raise the company's WACC. d. Statements a and c are correct. e. None of the statements above is correct.
e
Which of the following statements 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 cost of capital. d. Overcomes the problems of cash flow timing and project size that lead to criticism of the regular IRR method. e. Answers b and c are correct
e
Your company has a cost of capital equal to 10%. If the following projects are mutually exclusive, and you only have the information that is provided, which should you accept? A B C E Payback 1 5 2 5 IRR 18% 20% 20% 12% NPV(mill) $40 $75 $35 $100 a. A b. B c. C d. B and C e. E
e
