Corporate Finance Quiz 3

______ cash ______ is the cash generated before making any payments to common and preferred stockholders, and bondholders, so it is available to all investors.

free, flow

If a(n) _____________ project is being evaluated, then the NPV and IRR criteria always lead to the same accept/reject decisions.

independent

_____________ projects are those whose cash flows are not affected by the acceptance or nonacceptance of other projects.

independent

The rate at which the firm has borrowed in the past is ____________ to its capital budgeting decisions.

irrelevant

A steeper NPV profile indicates that increases in the cost of capital lead to ________ declines in its NPV.

large

The shorter the payback period, other things held constant, the greater the project's ___________.

liquidity

The capital structure that minimizes a firm's weighted average cost of capital also __________ its stock price.

maximizes

A capital investment proposal should be accepted if its NPV is __________.

positive

Like other financial assets, the value of common stock is the _________ value of a future stream of cash flows.

present

A net present value _________ is a graph that shows the relationship between a project's _____ and the firm's cost of capital.

profile; NPV

Only at the _____________ price, where the expected and required rates of return are equal, will the stock's price be stable.

equilibrium

If two projects are mutually ___________, the one with the ________ positive NPV should be selected.

exclusive; higher

The cost of new outside equity capital is higher than the cost of internal equity (retained earnings) due to ___________ costs.

flotation

One important weakness of payback analysis is the fact that cash _______ beyond the payback period are _________.

flows; ignored

__________ shares are stock owned by the firm's creators that enable them to maintain control over the company without having to own a majority of stock.

founders'

A necessary condition of the constant growth model is that rs is _________ than g.

greater

Firms that are more profitable and retain a larger portion of their earnings for reinvestment in the firm will tend to have ________ growth rates than firms who are less profitable and pay out a greater portion of their earnings as ___________.

higher, dividends

The _________ or ____________ value is the value at the date when the growth rate becomes constant for all dividends expected thereafter.

horizon, continuing

The cost of capital is sometimes referred to as the ________ rate because projects must jump over it to be accepted.

hurdle

The three most important factors that affect the cost of capital and that the firm cannot directly control are __________ rates, the general level of stock ________, and _____ rates.

interest, prices, tax

The __________ rate of return is an estimate of the project's rate of return.

internal

The __________ investor is a representative investor whose actions reflect the beliefs of those people who are currently trading a stock and determines the equilibrium stock price.

marginal

The constant growth model is often appropriate for ________ companies with a(n) ________ history of growth and stable future expectations.

mature, stable

In general, failing to adjust for differences in risk would lead a firm to accept too many risky projects and reject too many safe ones. Over time, it will become ______ risky, its WACC will __________, and its shareholder value will suffer.

more, increase

__________ IRRs can result when the IRR criterion is used with a project that has nonnormal cash flows.

multiple

Assigning a cost to retained earnings is based on a(n) _____________ cost.

opportunity

A value-maximizing firm will establish a(n) _________ capital ___________ and then raise new capital in a manner designed to keep it on target over time.

optimal, structure

The discounted _________ period is the length of time required for an investment's cash flows, discounted at the investment's cost of capital, to cover its cost.

payback

The number of years necessary to return the original investment in a project is known as the _________ period.

payback

In the long run, growth in dividends depends primarily on the firm's ________ ratio and its _____.

payout; ROE

A zero growth stock can be thought of as a(n) ____________.

perpetuity

A(n) ________ pill makes a possible acquisition unattractive and wards off hostile takeover attempts.

poison

Investors always expect a(n) __________ return on stock investments, but in some years __________ returns may actually be earned

positive; negative

The ____________ right gives the current shareholders the right to purchase any new shares issued in proportion to their current holdings.

preemptive

Flotation cost adjustments can also be made for ___________ stock and ______, as well as for common stock.

preferred, debt

If a stockholder cannot vote in person, participation in the annual meeting is still possible through a(n) _______.

proxy

The cost of depreciation-generated funds is approximately equal to the weighted average cost of capital in the interval in which capital comes from __________ earnings and low-cost ______.

retaied, debt

Ideally, the hurdle rate for each project should reflect the ______ of the project itself, not necessarily those associated with the firm's _________ project as reflected in the firm's composite WACC.

risk, average

The cost of common equity may also be found by adding a(n) ______ premium to the interest rate on the firm's own ______ yield.

risk, bond

Using the Capital Asset Pricing Model (CAPM), the required rate of return on common equity is found as a function of the ______-______ rate, the firm's beta _____________, and the market risk _________.

risk-free, coefficient, premium

Two basic conditions can lead to conflicts between NPV and IRR: _______ and ________ differences.

scale; timing

Accepting a project whose IRR exceeds its cost of capital increases _______________ wealth.

shareholders'

A firm can affect its cost of capital by changing its capital ___________, changing its __________ ________ _______, and altering its _________ ___________ decisions.

structure, dividend payout ratio, capital budgeting

_____________ or _____________ growth firms are those that are in that part of their life cycle in which they grow much faster than the economy as a whole.

supernormal; nonconstant

A(n) __________ is an action whereby a person or group succeeds in ousting a firm's management and gaining control of the company.

takeover

In effect, the government pays part of the cost of debt because interest is _____ deductible.

tax

The MIRR is defined as the discount rate at which the present value of a project's cost is equal to the present value of its __________ value, which is found as the sum of the future values of the cash inflows, compounded at the firm's cost of capital.

terminal

The __________ or _________ date is the date when the growth rate becomes constant.

terminal; horizon

There are _______ approaches that can be used to determine the cost of common equity.

three

The NPV profile crosses the Y-axis at the ______________ NPV, while it crosses the X-axis at the _____.

undiscounted; IRR

Two approaches can be used to account for flotation costs: (1) Add the estimated dollar amount of flotation costs for each project to the project's ____-_______ cost and (2) ________ the cost of capital.

up-front, adjust

The firm should calculate its cost of capital as a(n) __________ average of the after-tax costs of the various types of funds it uses.

weighted

If the future growth rate of dividends is expected to be ______, the rate of return is simply the dividend yield.

zero

In the IRR approach, a discount rate is sought that makes the NPV equal to ______.

zero

According to the valuation model developed in this chapter, the value that an investor assigns to a share of stock is independent of the length of time the investor plans to hold the stock.

True

Projects A and B each have an initial cost of $5,000, followed by a series of cash inflows. Project A has total undiscounted cash inflows of $12,000, while B has total undiscounted inflows of $10,000. Further, at a discount rate of 10%, 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

Which of the following statements is correct? a. If Congress raised the corporate tax rate, this would lower the effective cost of debt but probably would also reduce the amount of retained earnings available to corporations, so the effect on the marginal cost of capital is uncertain. b. For corporate investors, 70% of the dividends received on both common and preferred stocks are exempt from taxes. However, neither preferred nor common dividends may be deducted by the issuing company. Therefore, the dividend exclusion has no effect on a company's cost of capital, so its WACC would probably not change at all if the dividend exclusion rule were rescinded by Congress. c. The calculation for a firm's WACC includes an adjustment to the cost of debt for taxes, since interest is deductible, and includes the cost of all current liabilities. d. Firms that have a large number of good investment opportunities generally minimize their retained earnings by paying out a larger percentage of income as dividends than firms with fewer good investment opportunities. e. In general, failing to adjust for differences in risk would lead a firm to accept too many safe projects and to reject too many higher-risk projects. Over time the firm's WACC would increase because shareholder value would be eroded.

A

Which of the following statements is correct? a. The IRR of a project whose cash flows accrue relatively rapidly is more sensitive to changes in the discount rate than is the IRR of a project whose cash flows come in more slowly. b. There are many conditions under which a project can have more than one IRR. One such condition is where an otherwise normal project has a negative cash flow at the end of its life. c. The phenomenon called "multiple internal rates of return" arises when two or more mutually exclusive projects that have different lives are being compared. d. The modified IRR (MIRR) method has wide appeal to professors, but most business executives prefer the NPV method to either the regular or modified IRR. e. Each of the above statements is false.

B

Which of the following statements could be true concerning the costs of debt and equity? a. The cost of debt for Firm A is greater than the cost of equity for Firm A. b. The cost of debt for Firm A is greater than the cost of equity for Firm B. c. The cost of retained earnings for Firm A is less than its cost of new outside equity. d. The cost of retained earnings for Firm A is less than its cost of debt. e. Both statements b and c could be true.

E

Other things held constant, a decrease in the cost of capital (discount rate) will cause an increase in a project's IRR.

False

Projects with nonnormal cash flows sometimes have multiple MIRRs.

False

The NPV and MIRR methods lead to the same decision for mutually exclusive projects regardless of the projects' relative sizes.

False

When you find the yield to maturity on a bond, you are finding the bond's net present value (NPV).

False

The equation for valuing a constant growth stock is often called the constant growth model, or the ________ Model, after the individual who developed it.

Gordon

______ is superior to the regular IRR as an indicator of a project's "true" rate of return, or "expected long-term rate of return."

MIRR

If two mutually exclusive projects are being evaluated and one project has a higher NPV while the other project has a higher IRR, the project with the higher _____ should be preferred.

NPV

Funds acquired by the firm through preferred stock have a cost to the firm equal to the preferred dividend divided by the current price of the preferred stock. If significant flotation costs are involved the cost of the preferred should be adjusted upward.

True

The IRR method can be used in place of the NPV method for all independent projects.

True

The NPV method is preferred over the IRR method because the NPV method's reinvestment rate assumption is better.

True

The NPV of a project with cash flows that accrue relatively slowly is more sensitive to changes in the discount rate than is the NPV of a project with cash flows that come in more rapidly.

True

The corporate valuation model discounts a firm's free cash flows at the ______ to determine the firm's total value.

WACC

Which of the following statements is correct? a. According to the text, the constant growth stock valuation model is especially useful in situations where g is greater than 15% and rs is 10% or less. b. According to the text, the constant growth model can be used as one part of the process of finding the value of a stock that is expected to experience a very rapid rate of growth for a few years and then to grow at a constant ("normal") rate. c. According to the text, the constant growth model cannot be used unless g is greater than zero. d. According to the text, the constant growth model cannot be used unless the constant g is greater than rs.

b

One of the fundamental rights of common stockholders is to elect a firm's __________ who in turn elect officers who manage the business.

board

The retained earnings ____________ represents the total amount of capital that can be raised before the firm is forced to sell new common stock.

breakpoint

The primary concern with the cost of capital is its use in capital ___________ decisions.

budgeting

Which of the following assumptions would cause the constant growth stock valuation model to be invalid? The constant growth model is given below: a. The growth rate is negative. b. The growth rate is zero. c. The required rate of return is less than the growth rate. d. The required rate of return is above 30%. e. None of the above assumptions would invalidate the model.

c

If the preferred dividend is not earned, the directors _____ omit it without throwing the company into ____________.

can; bankruptcy

A firm's _________ budget outlines its planned expenditures on fixed assets.

capital

The MIRR method assumes reinvestment at the cost of _________, making it a better indicator of a project's profitability than IRR.

capital

_________ ____________ are investor-supplied items on the right-hand side of the balance sheet used by firms to raise funds.

capital components

The NPV method implicitly assumes reinvestment at the project's cost of _________, while the IRR method implicitly assumes reinvestment at the __________ rate of ________.

capital; internal; return

The value of the firm's stock depends on after-tax ______ _______.

cash flows

Firms may find it desirable to separate the common stock into different _________ to meet special needs and circumstances.

classes

Common stock that is given a special designation is called ____________ stock.

classified

The corporation's ________ stockholders are the ________ of the corporation, and as such, they have certain rights and privileges

common; owners

The preemptive right protects stockholders against loss of _________ of the corporation as well as __________ of market value from the sale of new shares below market value.

control; dilution

The ___________ valuation model is used as an alternative to the discounted dividend model to determine a firm's value, especially one with no history of dividends, or to determine the value of a division of a larger firm.

corporate

The ___________ rate is the cost of capital at which the NPV profiles of two projects intersect and, thus, at which the projects' NPVs are equal.

crossover

When stockholders assign their right to vote to another party, this is called a. A privilege. b. A preemptive right. c. An ex right. d. A proxy. e. A takeover.

d

It is important to recognize that the retained earnings breakpoint is not written in stone. Rather than issuing new common stock, the company could use more ______, or it could increase its additional retained earnings by reducing its dividend ________ ratio.

debt, payout

The proportions of ______, ___________ stock, and ________ equity in the target capital structure should be used to calculate the weighted _________ cost of capital.

debt, preferred, common, average

Preferred stock is referred to as a hybrid because it is similar to ______ in some respects and to ________ stock in others.

debt; common

Capital components are investor-supplied items on the right-hand side of the balance sheet such as the following: (1) ______, (2) ___________ stock, and (3) ________ equity.

debt; preferred, common

The internal rate of return (IRR) is the __________ rate that equates the present value of a project's expected cash inflows to the present value of its _______.

discount, costs

The Net Present Value (NPV) method of evaluating investment proposals is a(n) ____________ cash flow technique.

discounted

The cash flow stream expected from a common stock consists of a(n) __________ yield and a capital gains yield.

dividend

The required rate of return on common equity may also be estimated as the expected __________ yield on the common stock plus the expected future ________ rate of the dividends.

dividend, growth

The component cost of preferred stock is calculated as the preferred ___________ divided by the preferred stock's _________ price.

dividends, current

Which of the following statements is correct? a. Underlying the MIRR is the assumption that cash flows can be reinvested at the firm's cost of capital. b. Underlying the IRR is the assumption that cash flows can be reinvested at the firm's cost of capital. c. Underlying the NPV is the assumption that cash flows can be reinvested at the firm's cost of capital. d. The discounted payback method always leads to the same accept/reject decisions as the NPV method. e. Statements a and c are correct.

e

If earnings are poor and stockholders are dissatisfied, an outside group may solicit the votes of stockholders, unable to attend the annual meeting, in an effort to overthrow management and take control of the business. This is known as a(n) _______ fight.

proxy

The cost of equity capital is defined as the ______ of ________ stockholders require on the firm's common stock.

rate, return

New common equity is raised in two ways: (1) by ___________ some of the firm's current year earnings and (2) by _________ new common stock.

retained, issuing