Business Finance Exam 3 Chapters 10-12
All of the following is information required to create a net present value profile except: A. NPV at a 0 discount rate B. NPV at the risk-free rate C. NPV at the cost of capital D. IRR of investment
B
The price of preferred stock may react strongly to a change in kpbecause A. preferred stock may be cumulative. B. preferred stock dividends have to be paid before common stock dividends. C. there is no maturity date. D. corporate recipients of preferred stock dividends may receive a partial tax exemption.
C
The internal rate of return assumes that funds are reinvested at the: A. cost of capital. B. yield on the investment. C. minimal acceptable rate to the corporation. D. yield to maturity.
B
The modified internal rate of return assumes: A. inflows are invested at the traditional interest rate of return. B. inflows are reinvested at the cost of capital. C. outflows must be funded with debt. D. outflows must be funded with equity.
B
The relationship between a bond's price and the yield to maturity A. changes at a constant level for each percentage change of yield to maturity. B. is an inverse relationship. C. is a linear relationship. D. a and b.
B
The weighted average cost of capital is used as a discount rate because A. it is an indication of how much the firm is earning overall. B. as long as the cost of capital is earned, the common stock value of the firm will be maintained. C. it is comparable to the prevailing market interest rates. D. returns below the cost of capital will cover all fixed costs associated with capital and provide an excess return to stockholders.
B
Which of the following is not a time-adjusted method for ranking investment proposals? A. Net present value method B. Payback method C. Internal rate of return method D. All of these are time-adjusted methods
B
Which of the following regarding preferred stock is true? A. If the price decreases, required rate of return has decreased B. If the required rate of return increases, the price decreases C. If the required rate of return increases, the price increases D. The price in the market remains at par
B
Which of the following statements about the "payback method" is true? A. The payback method considers cash flows after the payback has been reached. B. The payback method does not consider the time value of money. C. The payback method uses discounted cash-flow techniques. D. The payback method generally leads to the same decision as other investment selection methods.
B
Will an increase in inflation have a larger impact on the price of a bond or preferred stock? A. The bond. B. The preferred stock. C. The impact will be the same. D. There is not enough information to determine the relative impact.
B
The required return by investors is important to financial managers for all of the following reasons except: A. It influences the firm's cost of financing B. It influences their stock price C. It is the primary driver of their financial ratios D. It helps when pricing new issues of securities
C
The risk premium is likely to be highest for A. U.S. government bonds. B. corporate bonds. C. utility company stock. D. either b or c.
C
Which of the following does not influence the yield to maturity for a security? A. required real rate of return. B. risk free rate. C. business risk. D. historic yields.
D
Which of the following financial assets is likely to have the highest required rate of return based on risk? A. Corporate bond. B. Treasury bill. C. Certificate of Deposit. D. Common stock
D
Which of the following is not a step in creating the net present value profile? A. determining the net present value at a zero discount rate. B. determining the net present value at a normal discount rate. C. determining the project's internal rate of return D. determining the payback for the project.
D
Which of the following is not one of the components that makes up the required rate of return on a bond? A. risk premium B. real rate of return C. inflation premium D. maturity payment
D
Which statement, or statements, are true about depreciation? A. Depreciation is a non-cash expense that provides tax shield benefits. B. The greater the depreciation expenses in earlier years, the higher the present value of the project. C. The MACRS depreciation schedules supersede the old methods of sum-of-the-years' digits, double declining balance, etc. D. All these are true.
D
With non-mutually exclusive projects. A. the payback method will select the best project. B. the net present value is not acceptable C. the internal rate of return method will always select the best project. D. the net present value and the internal rate of return methods will accept or reject the same project.
D
You require an IRR of 13% to accept a project. If the project will yield $10,000 per year for 6 years, what is the maximum amount that you would be willing to invest in the project? A. less than $25,000 B. more than $25,000 and less than $30,000 C. more than $30,000 and less than $35,000 D. more than $35,000
D
If a firm's bonds are currently yielding 8% in the marketplace, why would the firm's cost of debt be lower? A. Interest rates have changed. B. Additional debt can be issued more cheaply than the original debt. C. There should be no difference; cost of debt is the same as the bond's market yield. D. Interest is tax-deductible.
d
The amount of debt capital used by a corporation is not related to the availability of equity funds from retained earnings and new common stock
F
The calculation of the cost of capital depends upon historical costs of funds
F
The dollar amount of losses incurred when an old asset is sold below book value is added to the purchase price of a new asset in calculating the base for depreciation
F
The drawback of the future stock value procedure is that it does not consider dividend income..
F
The fact that small businesses are usually illiquid does not affect their valuation process..
F
The first administrative consideration in any capital budgeting process is collection of data
F
The higher the yield to maturity on a bond, the closer to par the bond will trade.
F
The inflation premium is based on past and current inflation levels.
F
The modified internal rate of return assumes that inflows are reinvested at 80 percent of the internal rate of return
F
The net present value profile allows a firm to examine the project's net present value over time
F
The net present value profile's primary advantage over the internal rate of return method is that it does not require the time consuming trial and error calculations of the IRR
F
The net present value profile's weakness is that it does not provide a decision for mutually exclusive investments
F
The out-of-pocket cost of common stock is a good approximation of the cost of common stock equity
F
The payback method considers all cash inflows
F
The prices of financial assets are based on the expected value of future cash flows, discount rate, and past dividends.
F
The profitability index is calculated by dividing the project's net present value by the present value of the projected cash outflows
F
The reinvestment assumption is a downside of the IRR method of analysis because it assumes that cash flows are reinvested at the cost of capital
F
The risk premium is primarily concerned with business risk, financial risk, and inflation risk.
F
The selection of a mutually exclusive project means that all other projects with a positive net present value may also be selected
F
The total required real rate of return is equal to the real rate of return plus the inflation premium.
F
The use of common stock equity in the weighted average cost of capital is always (Ke) and not (Kn), the cost of new common stock
F
The yield to maturity is always equal to the interest payment of a bond.
F
There is a negative correlation between risk and the return the investors demand.
F
To find the exact internal rate of return for projects with uneven cash flows, we can interpolate between two present value annuity factors from Appendix D
F
To use a dividend valuation model, a firm must have a constant growth rate and the discount rate must not exceed the growth rate..
F
Under MACRS depreciation, taxes paid in the first year of an asset's life are subtracted from the base used to calculate depreciation expense
F
Under MACRS depreciation, the tax life of an asset and its economically useful life are assumed to be the same
F
Under capital rationing, a firm will maximize profitability
F
Using the payback method can be appropriate when the time value of money is very low
F
We add depreciation to net income to arrive at a true earnings picture
F
When NPV and IRR analysis provide inconsistent rankings of projects, the financial manager should generally select the project with the highest IRR
F
When a bond trades at a discount to par, the yield to maturity on the bond will exceed the required return.
F
The net present value profile A. doesn't work if projects have a negative net present value. B. is a substitute for the IRR. C. graphically portrays the relationship between the discount rate and the net present value. D. two of the above.
C
The payback method has several disadvantages, among them: A. payback fails to choose the optimum or most economic solution to a capital budgeting problem. B. payback ignores cash inflows after the payback period. C. a and b. D. none of these.
C
If an asset is sold for a price above its book value, the difference is considered taxable income to the firm
T
In a replacement decision, a book loss on an old asset can be a valuable feature
T
In determining the cost of debt, yields and prices of outstanding bonds are used
T
In determining the cost of preferred stock, the earnings on outstanding preferred stock may be used as a proxy
T
It is more likely for financial managers to focus on cash flow and corporate executives to focus on earnings of the company
T
It is not unusual for a corporate president, who deals with security analysts, to be as sensitive to after-tax income as to cash flow
T
It is the difference in the reinvestment assumptions that can be significant in determining when to use the net present value or internal rate of return methods
T
Ke represents an expected return to stockholders as well as a cost to the firm
T
Market values rather than book values should be used for determining the optimal capital structure, though in practice, book value is commonly used
T
Most bonds promise both a periodic return and a lump-sum payment.
T
Non-mutually exclusive alternatives can be accepted at the same time
T
Possibly the most overlooked part of the capital budgeting process is the search for new opportunities through innovation and creative thinking
T
Preferred stock would be valued the same as a common stock with a zero dividend growth rate.
T
Regardless of the particular source of funds utilized for a project, the required rate of return, or discount rate, will be the weighted average cost of capital
T
Risk premiums are higher for riskier securities, but the risk premium cannot be higher than the required return.
T
The appropriate discount rate for bonds is called the yield to maturity.
T
The base for depreciation expense calculations is equal to the cost of a new asset
T
The constant dividend growth valuation formula is Po= D1/(ke g).
T
The cost of capital for each source of funds is dependent on current market conditions and expected rates of return
T
The cost of debt is equal to the current bond yield on bonds of similar risk class and adjusted for the corporate tax rate
T
The cost of new common stock is greater than the cost of outstanding common stock
T
The cost of retained earnings is equal to the required rate of return on a firm's outstanding common stock
T
The discount rate depends on the market's perceived level of risk associated with an individual security.
T
The discount rate that equates a future stream of expected dividends to the current price is a good approximation of the cost of common stock
T
The further the yield to maturity of a bond moves away from the bond's coupon rate the greater the price-change effect will be.
T
The internal rate of return is the interest rate that equates the cash outflows of an investment with the subsequent inflows
T
The longer the maturity of a bond, the greater the impact on price to changes in market interest rates.
T
The market determined required rate of return is also called the discount rate.
T
The net present value profile examines the relationship of the discount rate to the net present value
T
The only difference in the cost of retained earnings (Ke) and the cost of new common stock (Kn) is the flotation cost on new common stock
T
The payback method is easy to understand and places a heavy emphasis on liquidity
T
The payback method is not really a theoretically correct approach
T
The price of a bond is equal to the present value of all future interest payments added to the present value of the principal.
T
The price of preferred stock is determined by dividing the fixed dividend payment by the required rate of return.
T
The price-earnings ratio is another tool used to measure the value of common stock..
T
The required rate of return is payment demanded by the investor for foregoing present consumption.
T
The risk premium is equal to the required yield to maturity minus both the real rate of return and the inflation premium.
T
The risk-free rate of return is equal to the inflation premium plus the real rate of return.
T
The use of the optimum capital structure minimizes the cost of capital
T
The use of the weighted average cost of capital assumes that the firm is in its optimum capital structure range and the cost of each component stays constant over the range of financing
T
The valuation of a financial asset is based on the concept of determining the present value of future cash flows..
T
The value of a share of stock is the present value of the expected stream of future dividends.
T
The variable growth dividend model can be used for both constant and variable growth stocks..
T
The variable growth model is useful for firms in emerging industries.
T
Under MACRS depreciation, there are no tax credits for the purpose of calculating the base for depreciation expenses
T
Under the modified accelerated-cost-recovery system of depreciation, cash flow tends to decline with the passage of time
T
Under the net present value method, cash flows are assumed to be reinvested at the firm's weighted average cost of capital
T
Valuation of a common stock with no dividend growth potential is treated in the same manner as preferred stock.
T
Weights used to calculate the weighted average cost of capital Kaare derived from the optimum capital structure
T
When inflation rises, bond prices fall.
T
When inflation rises, preferred stock prices fall.
T
When the interest rate on a bond and its yield to maturity are equal, the bond will trade at par value.
T
When using accelerated depreciation, the present value of future cash flows increases
T
With non-mutually exclusive events and no capital rationing, we will usually arrive at the same conclusions using either the net present value or internal rate of return methods
T
You hold a long-term bond yielding ten percent. If interest rates fall shortly before you sell the bond, you will sell at a higher price than if interest rates had been constant.
T
For many firms, the cheapest and most important source of equity capital is in the form of A. debt. B. common stock. C. preferred stock. D. retained earnings.
d
In determining the cost of retained earnings A. the dividend valuation model is inappropriate. B. flotation costs are included. C. growth is not considered. D. the capital asset pricing model can be used.
d
Klein Corp. can issue $1,000 par value bond that pays $100 per year in interest at a price of $980. The bond will have a 5-year life. The firm is in a 35% tax bracket. What is the after-tax cost of debt? A. 9.14% B. 9.03% C. 5.87% D. 6.8%
d
New common stock is more expensive than ke A. to compensate for risk. B. to compensate for more dividends. C. to compensate for expansionary problems. D. to cover distribution costs.
d
The after-tax cost of debt will almost always be below A. the before-tax cost of debt. B. the weighted average cost of capital. C. the cost of equity. D. all of these.
d
The cost of debt is determined by taking the A. present value of the interest payments and principal times one minus the tax rate. B. historical yield on bonds times one minus the tax rate. C. estimated yield on new bond issues of the same risk times one minus the shareholder marginal tax rate. D. none of these.
d
51. Cash flow can be said to equal A. operating income less taxes plus depreciation B. operating income less taxes C. operating income before depreciation and taxes plus depreciation D. operating income after taxes minus depreciation
A
A 10-year bond pays 8% on a face value of $1,000. If similar bonds are currently yielding 10%, what is the market value of the bond? Use annual analysis. A. Less than $900 B. More than $900 and less than $1100 C. More than $1100 D. Not enough information to tell
A
A 30-year zero-coupon bond that yields 12% percent is issued with a $1000 par value. What is the issuance price of the bond (round to the nearest dollar)? A. $33 B. $83 C. $8333 D. $none of these
A
A bond which has a yield to maturity greater than its coupon interest rate will sell for a price A. below par. B. at par. C. above par. D. what is equal to the face value of the bond plus the value of all interest payments
A
A characteristic of capital budgeting is A. a large amount of money is always involved. B. the internal rate of return must be less than the cost of capital. C. the internal rate of return must be greater than the cost of capital. D. the time horizon is at least five years.
A
A firm purchases an asset falling into the 3-year MACRS category for $78,000. The second year's depreciation expense for this asset would be A. $34,710 B. $26,000 C. $78,000 D. cannot be determined without knowing second-year earnings before depreciation and taxes.
A
A firm utilizes a strategy of capital rationing, which is currently $250,000 and is considering the following 2 projects: Project A has a cost of $150,000 and the following cash flows: year 1 $30,000; year 2 $110,000; and year 3 $100,000. Project B has a cost of $225,000 and the following cash flows: year 1 $120,000; year 2 $90,000; year 3 $50,000; and year 4 $50,000. Using a 12% cost of capital, which decision should the financial manager make? A. Select project A B. Select project B C. Do not select either project D. Select both projects
A
An appropriate capital budgeting process requires that the following steps are taken in which order? a) collection of data b) reevaluation and adjustment c) evaluation and decision making d) search for and discovery of investment opportunities A. d, a, c, b B. d, a, b, c C. d, b, a, c D. b, d, a, c
A
An asset fitting into the 5-year MACRS category was purchased 2 years ago for $60,000. The book value of this asset is now A. $28,800 B. $31,200 C. $48,000 D. $60,000
A
An issue of preferred stock is paying an annual dividend of $5. The growth rate for the firm's common stock is 14%. What is the preferred stock price if the required rate of return is 11%? A. $45.45 B. $41.67 C. $35.71 D. none of these
A
As the cost of capital increases A. fewer projects are accepted. B. more projects are accepted. C. project selection remains unchanged. D. None of these.
A
Assume a corporation has earnings before depreciation and taxes of $100,000, depreciation of $40,000, and that it has a 30 percent tax bracket. What are the after-tax cash flows for the company? A. $82,000 B. $110,000 C. $42,000 D. none of these
A
At higher tax rates, depreciation is A. more beneficial. B. less beneficial. C. unaffected. D. none of these.
A
Capital rationing assumes: A. a limited amount of capital is available. B. a limited amount of investments are available. C. maximum profitability will be obtained. D. B and C.
A
A firm is selling an old asset below book value in a replacement decision. As the firm's tax rate is raised, the net cash outflow (purchase price less proceeds from the sale of the old asset) would: A. go up. B. go down. C. remain the same. D. more information required.
B
Firm X is considering the replacement of an old machine with one that has a purchase price of $70,000. The current market value of the old machine is $25,000 but the book value is $32,000. The firm's tax rate for ordinary income is 30%. What is the net cash outflow for the new machine after considering the sale of the old machine? A. $42,900 B. $38,000 C. $45,000 D. $40,100
A
For acceptable investments, the reinvestment assumption under the internal rate of return is generally A. higher than under the net present-value method. B. lower than under the net present-value method. C. at the cost of capital. D. below the cost of capital.
A
Marginal cost of capital A. recognizes that cost of capital does not stay constant as more funds are raised. B. usually provides the same capital budgeting choices as the use of weighted average cost of capital. C. can be defined as the cost of capital when no retained earnings are available for expansion. D. none of these apply.
A
Market Enterprises would like to issue bonds and needs to determine the approximate rate they would need to pay investors. A firm with similar risk recently issued bonds with the following current features a 7% coupon rate, 20 years until maturity, and a current price of $1,150. At what rate would Market Enterprises expect to issue their bonds, assuming annual interest payments? A. 5.7% B. 5.9% C. 7% D. 7.1%
A
Stock valuation models are dependent upon A. expected dividends, future dividend growth and an appropriate discount rate. B. past dividends, flotation costs and bond yields. C. historical dividends, historical growth and an appropriate discount rate. D. all of these.
A
Suppose that interest rates (and, therefore, the firm's Weighted Average Cost of Capital) increase. This WOULD NOT CHANGE the capital budgeting choices a firm would make if it A. uses payback period analysis. B. uses net present value analysis. C. uses internal rate of return analysis. D. uses profitability indexes.
A
The dividend on preferred stock is most similar to: A. common stock with no growth in dividends. B. common stock with constant growth in dividends. C. common stock with variable growth in dividends. D. certificate of Deposit.
A
The general rule for using the weighted average cost of capital (WACC) in capital budgeting decisions is accept all projects with A. rates of return greater than or equal to the WACC. B. rates of return less than the WACC. C. rates of return equal to or less than the WACC. D. positive rates of return.
A
The longer the life of an investment A. the more significant the discount rate. B. the less significant the discount rate. C. Makes no difference. D. None of these.
A
The market allocates capital to firms based on all of the following except: A. Higher risk requires lower returns due to higher expectations B. Level of efficiency C. Expected returns D. Degree of past performance
A
The return measure that an investor demands for giving up current use of funds, without adjusting for purchasing power changes or the real rate of return, is the A. risk premium. B. inflation premium. C. dividend yield. D. discount rate.
A
There are several disadvantages to the payback method, among them: A. payback ignores the time value of money. B. payback emphasizes receiving money back as fast as possible for reinvestment. C. payback is easy to use and to understand. D. payback can be used in conjunction with time adjusted methods of evaluation.
A
Two years ago, Maple Enterprises issued 6%, 20 years bonds and Temple Corp issued 6%, 10 year bonds. Since their time of issue, interest rates have increased. Which of the following statements is true of each firm's bond prices in the market, assuming they have equal risk? A. Maple's decreased more than Temple's B. Temple's decreased more than Maple's C. Maple's increased more than Temple's D. They are both priced the same
A
Using higher discount rates, A. accelerated cost recovery depreciation is more valuable than straight line. B. straight-line depreciation is more valuable than the accelerated cost recovery system of depreciation. C. depreciation policy makes no difference. D. later year depreciation has a higher net present value.
A
You buy a new piece of equipment for $5,535, and you receive a cash inflow of $1,000 per year for 8 years. What is the internal rate of return? A. less than 10% B. between 10% and 11% C. between 11% and 12% D. more than 12%
A
A 14-year zero-coupon bond was issued with a $1000 par value to yield 12%. What is the approximate market value of the bond? A. $597. B. $205. C. $275. D. $482.
B
Historically the real rate of return has been 2 to 3%.
T
An equipment replacement decision, under incremental analysis, requires A. calculating the present value of all cash flows associated with the new equipment minus the salvage value of the old asset. B. calculating the present value of all changes in cash flows from the old equipment to the new equipment. C. subtracting the purchase price of the old equipment from the purchase price of the new equipment. D. two of the above.
B
An increase in the riskiness of a particular security would NOT affect A. the risk premium for that security. B. the premium for expected inflation. C. the total required return for the security. D. investors' willingness to buy the security.
B
An issue of common stock is selling for $57.20. The year end dividend is expected to be $2.32 assuming a constant growth rate of 6%. What is the required rate of return? A. 10.3%. B. 10.1%. C. 4.1%. D. none of these.
B
Assume a project has earnings before depreciation and taxes of $10,000, depreciation of $40,000, and that the firm has a 30 percent tax bracket. What are the after-tax cash flows for the project? A. $47,000 B. $19,000 C. a loss of $21,000 D. none of these
B
Assuming that a firm has no capital rationing constraint and that a firm's investment alternatives are not mutually exclusive, the firm should accept all investment proposals A. for which it can obtain financing. B. that have a positive net present value. C. that have positive cash flows. D. that provide returns greater than the after-tax cost of debt.
B
Capital rationing A. is a way of preserving the assets of the firm over the long term. B. is a less than optimal way to arrive at capital budgeting decisions. C. assures stockholder wealth maximization. D. assures maximum potential profitability.
B
For MACRS depreciation, automobiles and light trucks fit into the A. 3-year MACRS category. B. 5-year MACRS category. C. 7-year MACRS category. D. 10-year MACRS category.
B
If a company's stock price (Po) goes up, and nothing else changes, Ke(the required rate of return) should A. go up. B. go down. C. remain unchanged. D. need more information.
B
If a firm is experiencing no capital rationing, it should accept all investment proposals A. as long as it has available funds. B. that return an amount equal to or greater than the cost of capital. C. that return an amount greater than the cost of equity. D. that are available, regardless of return.
B
If an investment project has a positive net present value, then the internal rate of return is A. less than the cost of capital. B. greater than the cost of capital. C. equal to the cost of capital. D. indeterminate; it depends on the length of the project.
B
If projects are mutually exclusive A. they can only be accepted under capital rationing. B. the selection of one alternative precludes the selection of other alternatives. C. the payback method should be used. D. the net present-value should be used.
B
If the capital budgeting decision includes a replacement analysis, then A. a gain from the sale of the old asset will represent a tax savings inflow. B. only incremental cash flows should be looked at. C. the sale price and tax savings will increase the cash inflows throughout the asset's life. D. two of the above.
B
If the inflation premium for a bond goes up, the price of the bond A. is unaffected. B. goes down. C. goes up. D. need more information.
B
If the yield to maturity on a bond is greater than the coupon rate, you can assume: A. interest rates have decreased. B. the price is below the par. C. the price is above the par. D. risk premiums have decreased.
B
In a general sense, the value of any asset is the A. value of the dividends received from the asset. B. present value of the cash flows received from the asset. C. value of past dividends and price increases for the asset. D. future value of the expected earnings discounted by the asset's cost of capital
B
In a replacement decision, if an old asset sells below book value, from a tax standpoint A. there is a decrease in cash flow. B. there is an increase in cash flow. C. there is no effect on cash flow. D. there is a decrease in net present value.
B
Oak Enterprises has a beta of 1.2, the market return is 11%, and the T-bill rate is 4%. What is their expected required return of common equity? A. between 11% and 12% B. between 12% and 13% C. between 7% and 8% D. between 4% and 5%
B
Star Corp. issued bonds 2 years ago with a 9% coupon rate. Their bonds are currently trading for $928 in the market. Which of the following most likely has occurred since the time of issue? A. Interest rates decreased B. Inflation increased C. Risk decreased D. Real rates of return decreased
B
Stone Inc. is evaluating a project with an initial cost of $8,450. Cash inflows are expected to be $1,000, $1,000 and $10,000 in the three years over which the project will produce cash flows. If the discount rate is 13%, what is the net present value of the project? A. less than $0 B. between $0 and $400 C. between $400 and $800 D. more than $800
B
Technology Corp. is considering a $125,000 investment in a new marketing campaign which they anticipate will provide annual cash flows of $51,500 for the next 3 years. The firm has a 12% cost of capital. What should the analysis indicate to the firm's managers? A. IRR between 11% and 12% - accept the project B. IRR between 11% and 12% - reject the project C. IRR between 12% and 13% - accept the project D. Not enough information to determine
B
The first step in the capital budgeting process is A. collection of data. B. idea development. C. assign probabilities. D. determine cashflow.
B
The following adjustments must be made when interest is paid semi-annually vs. annually except: A. Annual Interest rate divided by 2 B. Total Number of years divided by 2 C. Annual yield to maturity divided by 2 D. Annual Coupon payment divided by 2
B
The growth rate for the firm's common stock is 7%. The firm's preferred stock is paying an annual dividend of $5. What is the preferred stock price if the required rate of return is 8%? A. $5 B. $62.5 C. $500 D. none of these
B
A 15-year bond pays 11% on a face value of $1,000. If similar bonds are currently yielding 8%, what is the market value of the bond? Use annual analysis. A. Over $1,000 B. Under $1,000 C. Over $1,200 D. Not enough information to tell
C
A 20-year bond pays 12% on a face value of $1,000. If similar bonds are currently yielding 9%, What is the market value of the bond? Use annual analysis. A. over $1,000 B. under $1,000 C. over $1,200 D. not enough information given to telll
C
A common stock which pays a constant dividend can be valued as if it were A. corporate bond. B. stock paying a growing dividend. C. preferred stock. D. discount bond.
C
A ten-year bond, with par value equals $1000, pays 10% annually. If similar bonds are currently yielding 6% annually, what is the market value of the bond? Use semi-annual analysis. A. $1000.00 B. $1127.50 C. $1297.85 D. $2549.85..
C
An issue of common stock has just paid a dividend of $4.00. Its growth rate is equal to 8%. If the required rate of return is 13%, what is its current price? A. $19.04 B. $80 C. $86.40 D. none of these.
C
An issue of common stock is expected to pay a dividend of $4 at the end of the year. Its growth rate is equal to 3%, and the current share price is $40. What is the required rate of return on the stock? A. between 7% and 10%. B. between 10% and 12%. C. between 12% and 14%. D. between 14% and 17%.
C
An issue of common stock is expected to pay a dividend of $4.80 at the end of the year. Its growth rate is equal to 8%. If the required rate of return is 13%, what is its current price? A. $103.68 B. $36.92 C. $96.00 D. none of these.
C
An issue of common stock's most recent dividend is $3.75. Its growth rate is 8%. What is its price if the market's rate of return is 16%? A. $25.01. B. $46.88. C. $50.63. D. none of these.
C
Capital budgeting is primarily concerned with A. capital formation in the economy. B. planning future financing needs. C. evaluating investment alternatives. D. minimizing the cost of capital.
C
Elective expensing has the following characteristic: A. it is primarily beneficial to large businesses. B. it is exclusively used for financial reporting. C. it allows a more rapid write-off than MACRS depreciation. D. a and c.
C
In using the internal rate of return method, it is assumed that cash flows can be reinvested at A. the cost of equity. B. the cost of capital. C. the internal rate of return. D. the prevailing interest rate.
C
Preferred stock has all but which of the following characteristics? A. no stated maturity B. a fixed dividend payment that carries a higher precedence than common stock dividends C. the same binding contractual obligation as debt D. preferred lacks the ownership privilege of common stock
C
Required return by investors is directly influenced by all of the following except: A. Inflation B. U.S. Treasury rates C. Dividends D. Risk
C
The Net Present Value Method is a more conservative technique for selecting investment projects than the Internal Rate of Return method because the NPV method A. assumes that cash flows are reinvested at the project's internal rate of return. B. concentrates on the liquidity aspects of investment projects. C. assumes that cash flows are reinvested at the firm's weighted average cost of capital. D. none of these.
C
The Wet Corp. has an investment project that will reduce expenses by $15,000 per year for 3 years. The project's cost is $20,000. If the asset is part of the 3-year MACRS category (33% first year depreciation) and the company's tax rate is 34%, what is the cash flow from the project in year 1? A. $6,800 B. $5,100 C. $12,144 D. $16,667
C
The _________ assumes returns are reinvested at the cost of capital. A. payback method B. internal rate of return C. net present value D. capital rationing
C
The dividend valuation model stresses the A. importance of earnings per share. B. importance of dividends and legal rules for maximum payment. C. relationship of dividends to market prices. D. relationship of dividends to earnings per share.
C
The internal rate of return and net present value methods: A. always give the same investment decision answer. B. never give the same investment decision answer. C. usually give the same investment decision answer. D. always give answers different from the payback method.
C
The longer the time to maturity: A. the greater the price increase from an increase in interest rates. B. the less the price increase from an increase in interest rates. C. the greater the price increase from a decrease in interest rates. D. the less the price decrease from a decrease in interest rates.
C
The net present value method is a better method of evaluation than the internal rate of return method because the NPV method A. assumes cash flows are reinvested at the internal rate of return. B. is a more liberal method of analysis. C. assumes that cash flows can be reinvested at the firm's more conservative cost of capital. D. None of these.
C
Use of the marginal cost of capital A. acknowledges that when retained earnings is used up as a source of equity the cost of capital rises as new common stock is sold to support more growth. B. recognizes that the return from the last dollar of funds generated should be equal to the cost of the last dollar of funds raised. C. both a and b are correct. D. none of these are correct.
C
Which is a characteristic of the price of preferred stock? A. Since preferred stock dividends are fixed, they are tax deductible. B. Because preferred stock has no maturity, the price analysis is similar to that of debt. C. Preferred stock is valued as a perpetuity. D. None of these.
C
Which of the following does MACRS depreciation provide to corporations A. increases total depreciation. B. lengthens the lives of assets for depreciation purposes. C. shortens the lives of assets for depreciation purposes. D. full-year vs. half-year convention
C
With the exception of real estate investments, MACRS depreciation is beneficial to corporations because it A. increases total depreciation. B. lengthens the lives of assets for depreciation purposes. C. shortens the lives of assets for depreciation purposes. D. classifies assets into specific, well-understood groups for depreciation purposes.
C
A bond pays 9% yearly interest in semi-annual payments for 6 years. The current yield on similar bonds is 12%. To determine the market value of this bond, you must A. find the interest factors (IFs) for 12 periods at 12%. B. find the interest factors (IFs) for 6 periods at 9%. C. find the interest factors (IFs) for 6 periods at 6%. D. find the interest factors (IFs) for 12 periods at 6%.
D
A firm may adopt capital rationing because A. it is hesitant to use external sources of financing. B. it wishes to maximize profits. C. it is fearful of too much growth. D. a and c.
D
A higher interest rate (discount rate) would A. reduce the price of corporate bonds. B. reduce the price of preferred stock. C. reduce the price of common stock. D. all of these.
D
A project requires an investment of $1000 and has a net present value of $430. If the IRR is 12%, what is the profitability index for the project? A. 0.25 B. 2.33 C. 0.70 D. none of these.
D
A ten year bond pays 11% interest on a $1000 face value annually. If it currently sells for $1,195, what is its approximate yield to maturity? A. 9.33%. B. 7.94%. C. 12.66%. D. 8.10%.
D
All of the following are important considerations for minimizing the cost of capital except: A. future inflation rates B. industry debt ratios C. future economic conditions D. current coupon rates of outstanding debt
D
All of the following would likely cause a firm to raise capital at a lower cost except: A. Higher times interest earned. B. Higher profit margin. C. Increased market share. D. Higher debt to asset ratio.
D
Doug has been approached by his broker to purchase a bond for $850. He believes the bond should yield 10%. The bond pays 7% annual coupon rate and has 12 years left until maturity. What should Doug's analysis of the bond indicate to him? A. The bond is undervalued, purchase B. The bond is undervalued, do not purchase C. The bond is overvalued, purchase D. The bond is overvalued, do not purchase
D
If expected dividends grow at 8% and the appropriate discount rate is 12%, what is the value of a stock with an expected dividend of $2.33? A. $62.88. B. $19.41. C. $29.12. D. $58.25.
D
Project X has a cost of $230,000 and provides the following annual earnings: year 1 $35,000; year 2 $140,000; year 3 $175,000; and year 4 $50,000. Under the payback method, in which year is the investment recouped? A. year 2 B. year 3 C. year 4 D. not enough information to determine
D
The cost of capital for common stock is ke= (D1/Po) + g. What are the assumptions of the model? A. Growth (g) is constant to infinity. B. The price earnings ratio stays the same. C. The firm must pay a dividend to use this model. D. All of these are assumptions of the model.
D
The market allocates capital to companies based on A. risk. B. efficiency. C. expected returns. D. all of these
D
The reason cash flow is used in capital budgeting is because A. cash rather than income is used to purchase new machines. B. cash outlays need to be evaluated in terms of the present value of the resultant cash inflows. C. to ignore the tax shield provided from depreciation ignores the cash flow provided by the machine which should be reinvested to replace old worn out machines. D. all of these.
D
The value of a common stock is based on its A. past performance. B. historic dividends. C. current earnings. D. value of future benefits to the holder.
D
Valuation of financial assets requires knowledge of A. future cash flows. B. appropriate discount rate. C. past asset performance. D. a and b..
D
What is the approximate yield to maturity for a seven-year bond that pays 11% interest on a $1000 face value annually if the bond sells for $952 A. 10.5% B. 10.6% C. 11.5% D. 12.1%
D
A firm should always be at a single optimum debt to equity ratio to minimize its cost of capital
F
A firm that does not earn the cost of capital in the short run will probably be in bankruptcy
F
A firm's cost of preferred stock is equal to the preferred dividend divided by market price plus the dividend growth rate (Kp= D/Po+ g)
F
A good capital budgeting program requires that a number of steps be taken in the decision making process. The first step is the explanation of data
F
A stock that has a high required rate of return because of its risky nature will usually have a high P/E ratio..
F
All firms within particular industries have similar optimum capital structures
F
An increase in yield to maturity would be associated with an increase in the price of a bond.
F
As time to maturity increases, bond price sensitivity decreases.
F
Business risk relates to the inability of the firm to meet its debt obligations as they come due.
F
Capital budgeting decisions involve a minimum time horizon of five years
F
Capital budgeting is only a concern of finance and accounting personnel
F
Capital rationing is generally a positive action for a firm because it prevents rapid growth which can drive up the cost of capital
F
Cash flow is used for a net present value analysis and earnings are used for an IRR and payback analysis
F
Firms in stable industries are advised to keep debt levels very low so that shareholders, rather than creditors, receive the benefits of steady cash flows.
F
Firms with an expectation for great potential tend to trade at low P/E ratios..
F
For high-IRR investments, it is perfectly acceptable to assume that reinvestment will occur at an equally high, if not higher, rate
F
Future stock value is equal to Po= D1/(ke g), assuming constant growth in dividends..
F
In determining the optimum capital structure it is assumed that the firm will raise capital in the optimum proportions every year
F
In estimating the market value of a bond, the coupon rate should be used as the discount rate.
F
In most capital budgeting decisions the emphasis should be on reported earnings rather than cash flows
F
In most cases, asset lives are shorter under MACRS depreciation than they would be with straight-line depreciation
F
Investors discount the later years of a long-term project at a lower rate because they are generally less precise
F
It is standard practice to evaluate investment decisions using the cost of the specific financing method involved
F
Most firms are able to use 60%-70% debt in their capital structure without exceeding norms acceptable to most creditors and investors
F
Most real estate property is depreciated over a 10 year period
F
Preferred stock is compensated for not having ownership privileges by offering a fixed dividend stream supported by a binding contractual obligation.
F
Retained earnings represent an internal source of funds that is raised without the payment of interest, or cost to the firm's stockholders
F
Taking on additional debt will reduce the cost of equity
F
A 20-year bond pays 12% annual interest in semi-annual payments. The current market yield to maturity is 10%. The appropriate interest factors should be in the tables under 5% for 40 periods.
T
A firm that does not earn the cost of capital in the long run will not maximize shareholder wealth
T
A firm's cost of preferred stock is equal to the preferred dividend divided by the net price after flotation costs
T
A rapid payback may be important to firms having rapid technological development
T
A tax loss on the sale of a depreciable asset used in business or trade may be written off against income
T
According to traditional financial theory, the cost of capital curve is U-shaped over the range of debt-equity mixes
T
Although firms can elect to use straight-line depreciation, the MACRS depreciation schedules have superseded other depreciation methods for tax purposes
T
Although the after-tax cost of debt is below the cost of equity, firms cannot increase their use of debt without limit
T
An increase in inflation will cause a bond's required return to rise.
T
By using different discount rates, the market allocates capital to companies based on their risk, efficiency, and expected returns.
T
Companies prefer to maintain some financing flexibility in order to choose the lowest cost source of funds at a single point in time
T
Depreciation is important in calculating projected cash flows because it generates a tax deduction
T
Even though one project may have superior cash flows, top management may sometimes choose a project that inflates earnings instead of cash flow
T
Even though the IRS tries to minimize occurrences, small business owners often intermingle business and personal expenses in order to minimize taxable income..
T
Firm's with bright expectations for the future, tend to trade at high P/E ratios..
T
For a small business, it is possible for the purchase price of an asset to be expensed rather than depreciated
T
High-risk corporate bonds are as risky as junk bonds.
T
A firm in a stable industry should use A. a large amount of debt to lower the cost of capital. B. no debt at all. C. preferred stock in place of debt. D. a limited amount of debt to lower the cost of capital.
a
Firm X has a tax rate of 30%. The price of its new preferred stock is $63 and its flotation cost is $3.15. The cost of new preferred stock is 12%. What is the firm's dividend? A. $7.18 B. $5.03 C. $7.56 D. none of these.
a
Most firms are able to use _____ percent debt in their capital structure without exceeding norms acceptable to creditors and investors. A. 30-50 B. 40-60 C. 50-70 D. 60-80
a
The after-tax cost of preferred stock to the issuing corporation A. is the same as the before-tax cost. B. is usually lower than the cost of debt. C. is dependent on the firm's tax bracket. D. none of these.
a
Tobin's Barbeque has a bank loan at 8% interest and an after-tax cost of debt of 6%. What will the after-tax cost of debt be when the loan is due if a new loan is taken out yielding 10%. A. 7.5% B. 6% C. 13.3% D. none of these
a
Using the constant growth model, a firm's expected (D1) dividend yield is 3% of the stock price, and its growth rate is 7%. If the tax rate is .35%, what is the firm's cost of equity? A. 10% B. 6.65% C. 8.95% D. More information is required
a
A firm has $25 million in assets and its optimal capital structure is 60% equity. If the firm has $18 million in retained earnings, at what asset level will the firm need to issue additional stock? (Assume no growth in retained earnings.) A. The firm should have already issued additional stock. B. The firm can increase assets to $30 million. C. The firm can increase assets to $41.67 million. D. There is insufficient information to determine an answer.
b
A firm's stock is selling for $78. The next annual dividend is expected to be $2.70. The growth rate is 9%. The flotation cost is $5.00. What is the cost of retained earnings? A. 13.09% B. 12.46% C. 12.7% D. none of these
b
A firm's stock is selling for $85. The dividend yield is 5%. A 7% growth rate is expected for the common stock. The firm's tax rate is 32%. What is the firm's cost of retained earnings? A. 8.16% B. 12.00% C. 12.35% D. can not be determined.
b
Debreu Beverages has an optimal capital structure that is 50% common equity, 40% debt, and 10% preferred stock. Debreu's pretax cost of equity is 12%. Its pretax cost of preferred equity is 7%, and its pretax cost of debt is also 7%. If the corporate tax rate is 35%, what is the weighed average cost of capital? A. between 7% and 8% B. between 8% and 9% C. between 9% and 10% D. between 10% and 12%
b
Expected cash dividends are $2.50, the dividend yield is 6%, flotation costs are 4% of price, and the growth rate is 3%. Compute cost of new common stock. A. 9.00% B. 9.25% C. 9.18% D. 9.44%
b
For a firm paying 7% for new debt, the higher the firm's tax rate A. the higher the after-tax cost of debt. B. the lower the after-tax cost of debt. C. after-tax cost is unchanged. D. Not enough information to judge.
b
Given an optimal capital structure that is 50% debt and 50% common stock, calculate the weighted average cost of capital for Stone Corp given the following additional information: A. less than 9.5%. B. more than 9.5% and less than 10.25%. C. more than 10.25% and less than 11%. D. more than 11%.
b
If flotation costs go down, the cost of new preferred stock will A. go up. B. go down. C. stay the same. D. slowly increase.
b
In computing the cost of common equity, if D1 goes downward and Po goes up, Ke will A. go up. B. go down. C. stay the same. D. slowly increase
b
Lewis, Schultz and Nobel Development Corp. has an after-tax cost of debt of 6.3 percent. With a tax rate of 30 percent, what is the yield on the debt? A. 4.41% B. 9.0% C. 1.89% D. 21%
b
Retained earnings has a cost associated with it because: A. new funds must be raised. B. There is an opportunity cost associated with stockholder funds. C. Ke> g D. flotation costs increase the cost of funding. : 3
b
The cost of equity capital in the form of new common stock will be higher than the cost of retained earnings because of A. the existence of taxes. B. the existence of flotation costs. C. investors' unwillingness to purchase additional shares of common stock. D. the existence of financial leverage.
b
The optimal capital structure for firms in cyclical industries should contain ________________ than firms in stable industries. A. more debt B. less debt C. an equal amount of debt D. none of these. There is no relationship between the cyclical nature of an industry and optimal capital structure.
b
There may be a change in the marginal cost of capital curve because A. the tax rate charged to investors changes. B. the firm has exhausted its supply of retained earnings. C. the firm is limited in the amount of depreciation it can take. D. a and b.
b
Using the constant dividend growth model for common stock, if Pogoes up A. the assumed cost goes up. B. the assumed cost goes down. C. the assumed cost remains unchanged. D. Need further information.
b
Why is the cost of debt normally lower than the cost of preferred stock? A. preferred stock dividends are tax deductions. B. interest is tax deductible. C. preferred stock dividends must be paid before common stock dividends. D. common stock dividends are not tax deductible.
b
Although debt financing is usually the cheapest component of capital, it cannot be used in excess because A. interest rates may change. B. the firm's stock price will increase and raise the cost of equity financing. C. the financial risk of the firm may increase and thus drive up the cost of all sources of financing. D. underwriting costs may change.
c
If the flotation cost goes up, the cost of retained earnings will A. go up. B. go down. C. stay the same. D. slowly increase.
c
Ten years ago, Stigler Company issued $100 par value preferred stock yielding 8 percent. The preferred stock is now selling for $97 per share. What is the current yield or cost of the preferred stock? (Disregard flotation costs.) A. 7.76%. B. 8%. C. 8.25%. D. There is not enough information to answer the question.
c
The component parts of the cost of capital should be weighted by their proportion in the firm's A. current capital structure. B. historical capital structure. C. optimum capital structure. D. expected capital structure.
c
The coupon rate on a debt issue is 12%. If the yield to maturity on the debt is 9.33%, what is the after-tax cost of debt in the weighted average cost of capital if the firm's tax rate is 34%? A. 3.17% B. 4.08% C. 6.16% D. 7.92%
c
The coupon rate on an issue of debt is 12%. The yield to maturity on this issue is 14%. The corporate tax rate is 31%. What would be the approximate after-tax cost of debt for a new issue of bonds? A. 4.34% B. 3.72% C. 9.66% D. 8.28%
c
The pre-tax cost of debt for a new issue of debt is determined by A. the investor's required rate of return on issued stock. B. the coupon rate of existing debt. C. the yield to maturity of outstanding bonds. D. all of these.
c
Which is not true about debt financing and the weighted average cost of capital? A. Debt is usually the cheapest source of financing. B. As the level of debt increases beyond the optimum capital structure, the cost of capital increases. C. No debt in the firm's capital structure will minimize the firm's weighted-average cost of capital. D. None of these.
c
within the capital asset pricing model A. the risk-free rate is usually higher than the return in the market. B. the higher the beta the lower the required rate of return. C. beta measures the volatility of an individual stock relative to a stock market index. D. two of the above are true.
c
A firm in a cyclical industry should use A. a large amount of debt to lower the cost of capital. B. no debt at all. C. preferred stock in place of debt. D. a limited amount of debt to lower the cost of capital.
d
A firm is paying an annual dividend of $3.63 for its preferred stock which is selling for $62.70. There is a selling cost of $3.30. What is the after-tax cost of preferred stock if the firm's tax rate is 33%? A. 2.02% B. 4.09% C. 5.79% D. 6.11%
d
A firm's cost of financing, in an overall sense, is equal to its A. weighted average cost of capital. B. required yield that investors seek for various kinds of securities. C. required rate of return that investors seek for various kinds of securities. D. all of these.
d
A firm's debt to equity ratio varies at times because A. a firm will want to sell common stock when prices are high and bonds when interest rates are low. B. a firm will want to take advantage of timing its fund raising in order to minimize costs over the long run. C. the market allows some leeway in the debt to equity ratio before penalizing the firm with a higher cost of capital. D. all of these are accurate statements.
d
A firm's preferred stock pays an annual dividend of $4, and the stock sells for $80. Flotation costs for new issuances of preferred stock are 5% of the stock value. What is the after-tax cost of preferred stock if the firm's tax rate is 30%? A. 1.2% B. 1.58% C. 3.68% D. 5.26%
d
Each project should be judged against A. the specific means of financing used to support its implementation. B. the going interest rate at that point in time. C. the cost of new common stock equity. D. none of these.
d
Financial capital does not include A. stock. B. bonds. C. preferred stock. D. working capital.
d
The overall weighted average cost of capital is used instead of costs for specific sources of funds because A. use of the cost for specific sources of capital would make investment decisions inconsistent. B. a project with the highest return would always be accepted under the specific cost criteria. C. investments funded by low cost debt would have an advantage over other investments. D. both a and c are correct.
d
Although debt financing is generally cheaper than equity financing, financial managers should not use debt financing significantly above the industry standard because it can increase the firm's overall cost of capital
f
As the risk-free rate increases, the required rate of return for common stock decreases
f
In the capital asset pricing model (CAPM), beta measures the volatility of the market
f
Per the capital asset pricing model, the slope of the security market line (SML) must be 1.0
f
The cost of capital generally varies inversely with the size of the capital structure
f
The cost of debt, preferred stock, and common equity must all be adjusted for tax implications
f
The financial managers of the firm decide on it's cost of capital for financing projects
f
The slope of the security market line (SML) will often increase when the economy is in a boom period
f
A firm with a higher beta than another firm will have a higher required rate of return
t
Individual common stocks' betas have a tendency to move toward 1.0 over time
t
The capital asset pricing model (CAPM) relates the risk-return tradeoffs of individual assets to market returns
t
The pretax cost of debt is less than the pretax cost of equity
t