FIN3400 Chapter 9, 10, 11, 12 Quizzes

The coupon rate on a debt issue is 6%. If the yield to maturity on the debt is 9%, what is the after-tax cost of debt in the weighted average cost of capital if the firm's tax rate is 34%?

.09(1-.34) = 5.94%

As the discount rate becomes higher and higher, the present value of inflows approaches

0

Which of the following does NOT influence the yield to maturity for a security?

Historic yields

The price of a bond is equal to the present value of all future interest payments added to the present value of the principal.

True

If an individual's cost of capital were 6%, the person would prefer to receive $110 at the end of one year rather than $100 right now.

True PV = FV × PVIF (App. B: 6%, 1 period)= $110 × 0.943 = $104

A 5-year zero-coupon bond was issued with a $1,000 par value to yield 8%. What is the approximate market value of the bond?

Using PV of $1 table to find the PV of the principal: i=8%, n=5 years. Factor = 0.681 * 1000 = $681.

A firm in a stable industry should use

a large amount of debt to lower the cost of capital.

Capital rationing assumes that

a limited amount of capital is available.

An annuity may best be defined as

a series of consecutive payments of equal amounts.

The weighted average cost of capital is used as a discount rate because

as long as the cost of capital is earned, the common stock value of the firm will be maintained.

A bond that has a "yield to maturity" greater than its coupon interest rate will sell for a price

below par

Within the capital asset pricing model

beta measures the volatility of an individual stock relative to a stock market index.

Which of the following financial assets is likely to have the highest required rate of return based on risk?

common stock

New common stock is more expensive than required rate of return (Ke) because new common stock has to

cover distribution costs.

Capital budgeting is primarily concerned with

evaluating investment alternatives.

The market allocates capital to companies based on

expected returns. risk. efficiency. answer: all of these options are true.

"Business risk" relates to the inability of the firm to meet its debt obligations as they come due.

false

A firm should always be at a single optimum debt-to-equity ratio to minimize its cost of capital.

false

As time to maturity increases, bond price sensitivity decreases.

false

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.

false

In the capital asset pricing model (CAPM), beta measures the volatility of the market.

false

Preferred stock may not having the same ownership privileges as common stock, but preferred stock is offered a fixed dividend stream supported by a binding contractual obligation.

false

Taking on additional debt will reduce the cost of equity.

false

The cost of debt, preferred stock, and common equity must all be adjusted for tax implications.

false

The financial managers of the firm decide on its cost of capital for financing projects.

false

The time value of money concept becomes less critical as the prime rate of lending increases.

false

The yield to maturity is always equal to the interest payment of a bond.

false

When the inflation rate is zero, the present value of $1 is identical to the future value of $1.

false

If an investment project has a positive net present value, then the internal rate of return is

greater than the cost of capital.

The first step in the capital budgeting process is

idea development

A common stock that pays a constant dividend can be valued as if it were

preferred stock

As the cost of capital increases

project selection remains unchanged.

If the flotation cost goes up, the cost of retained earnings will

stay the same

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 if a new loan is taken out yielding 11%.

tax rate is (8-6) / 8 = 25% .11(1-.25) = 8.25

If a firm is experiencing no capital rationing, it should accept all investment proposals

that return an amount equal to or greater than the cost of capital.

The after-tax cost of debt will almost always be below

the cost of equity. the weighted average cost of capital. the before-tax cost of debt. Answer: all of these options are true.

A dollar today is worth more than a dollar to be received in the future because

the dollar can be invested today and earn interest.

The shorter the length of time between a present value and its corresponding future value,

the higher the present value, relative to the future value.

A characteristic of capital budgeting is that

the internal rate of return must be greater than the cost of capital.

In using the internal rate of return method, it is assumed that cash flows can be reinvested at

the internal rate of return.

The longer the life of an investment

the more significant the discount rate.

With non-mutually exclusive projects,

the net present value and the internal rate of return methods will usually accept or reject the same project.

If the yield to maturity on a bond is greater than the coupon rate, you can assume

the sales price is below par.

Retained earnings has a cost associated with it because

there is an opportunity cost associated with stockholder funds.

An annuity is a series of consecutive payments of equal amount.

true

Cash flow decisions that ignore time value of money will probably not be as accurate as those decisions that do consider time value of money.

true

Compounding refers to the growth process that turns $1 today into a greater value several periods in the future.

true

Even though one project may have superior cash flows, top management may sometimes choose a project that inflates earnings instead of cash flow.

true

In determining the future value of an ordinary annuity, the final payment is not compounded at all.

true

Most bonds promise both a periodic return and a lump-sum payment.

true

The discount rate depends on the market's perceived level of risk associated with an individual security.

true

The price-earnings ratio is another tool used to measure the value of common stock.

true

The required rate of return is the payment demanded by the investors for foregoing their ability to use the funds themselves.

true

The time value of money concept is fundamental to the analysis of cash inflow and outflow decisions covering multiple periods of time.

true

The use of the optimum capital structure minimizes the cost of capital.

true

The valuation of a financial asset is based on the concept of determining the present value of future cash flows that this financial asset will accumulate.

true

Using semi-annual compounding rather than annual compounding will increase the future value of an annuity.

true

Financial capital does not include

working capital

The net present values' weakness is that it does not provide a decision for mutually exclusive investments.

False

The cost of capital refers to the cost that a company takes on to purchase a big project.

True

The selection of a mutually exclusive project means that all other projects with a positive net present value may also be selected.

False

There is a negative correlation between risk and the return investors demand.

False

It is standard practice to evaluate investment decisions using the cost of the specific financing method involved.

False

A firm's stock is selling for $65. The dividend yield is 6%. A 7% growth rate is expected for the common stock. The firm's tax rate is 40%. What is the firm's cost of retained earnings?

(0.06)(65) / 65 + 0.7 = 13.0%

Which statement, or statements, are true about depreciation?

* Depreciation is a non-cash expense that provides tax shield benefits. * The greater the depreciation expenses in earlier years, the higher the present value of the project. *For tax purposes, the MACRS depreciation schedules supersede the old methods of sum-of-the-years' digits, double declining balance, and so on. ALL OF THESE ARE TRUE

The concept of time value of money is important to financial decision making because

* it can be applied to future cash flows in order to compare different streams of income. *it emphasizes earning a return on invested capital. *it recognizes that earning a return makes $1 today worth more than $1 received in the future. Answer: All of these options are true.

A firm's cost of financing, in an overall sense, is equal to its

*weighted average cost of capital. *required rate of return that investors seek for various kinds of securities. *required yield that investors seek for various kinds of securities. Answer all of these options are true.

To determine the current worth of four annual payments of $1,000 at 4% annual interest, one would refer to a time value of money table for the present value of $1.

False

A firm's preferred stock pays an annual dividend of $2, and the stock sells for $65. 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%?

2.00 / 65-(.05)(65) = 3.20%

A firm is paying an annual dividend of $2.65 for its preferred stock that is selling for $57.00. 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%?

2.65 / 57.00 - 3.30 = 4.93%

The growth rate for the firm's common stock is 7%. The firm's preferred stock is paying an annual dividend of $3. What is the preferred stock price if the required rate of return is 8%?

3.00 / 0.08 = $37.50

If Gerry makes a deposit of $1,500 at the end of each quarter for five years, how much will he have at the end of the five years assuming a 12% annual return and quarterly compounding?

4*5 = 20 interest 12/4= 3 FVA = A × FVIFA (App. C: 3%, 20 periods) = $1,500 × 26.870 = $40,305

Possibly the most overlooked part of the capital budgeting process is the search for new opportunities through innovation and creative thinking.

True

Preferred stock would be valued the same as a common stock with a zero dividend growth rate.

True

After 10 years, some shares of stock originally purchased for $500 total were sold for $900 total. What was the yield on the investment? Choose the closest answer.

500/900 = 0.555 ans is aprox. 6%

The required return by investors is directly influenced by all of the following except:

Answer: Dividends Inflation U.S. Treasury rates Risk

The cost of capital generally varies inversely with the size of the capital structure.

False

Assume a project has earnings before depreciation and taxes of $15,000, depreciation of $25,000, and that the firm has a 30% tax bracket. What are the after-tax cash flows for the project?

Earnings before depreciation and taxes $15,000 Depreciation - $25,000 ___________________________________________ Earnings before taxes (10,000) Taxes @ 30% $3,000 ____________________________________________ Earnings after taxes ($7,000) Depreciation 25,000 ___________________________________________ Cash flow = a positive $18,000

If you invest $10,000 today at 10% interest, how much will you have in 10 years?

FV = PV × FVIF (App. A: 10%, 10 years) = $10,000 × 2.594 = $25,940

Mr. Nailor invests $5,000 in a money market account at his local bank. He receives annual interest of 8% compounded for four years. How much total return will his investment earn during this time period?

FV = PV × FVIF (App. A: 8%, 4 periods) = $5,000 × 1.360 = $6,800 $6,800 - Initial investment of $5,000 = $1,800

The future value of a $500 investment today at 8% annual interest compounded semiannually for five years is ______.

FV = PV × FVIF (App. A: 8%/2=4%, 5*2=10 periods) = $500 × 1.480 = $740

Pedro Gonzalez will invest $5,000 at the end of each year. If the interest rate is 8%, what will the value be after three years?

FVA = A × FVIFA (App. C: 8%, 3periods) = $5,000 × (3.246) = $16,230

A firm that does not earn the cost of capital in the short run will probably be in bankruptcy.

False

An increase in the yield of a bond compared to the coupon rate would be associated with an increase in the price of a bond.

False

Capital budgeting is only a concern of finance and accounting personnel.

False

For high-internal rate of return investments, it is perfectly acceptable to assume that reinvestment will occur at an equally high, if not higher, rate.

False

If a firm's bonds are currently yielding 6% in the marketplace, why would the firm's cost of debt be lower?

Interest is tax-deductible, so tax savings are considered.

Why is the cost of debt normally lower than the cost of preferred stock?

Interest on debt is tax deductible.

Which of the following is NOT true about debt financing and the weighted average cost of capital?

No debt in the firm's capital structure will minimize the firm's weighted average cost of capital.

Each project should be judged against

None of these options are true. the cost of new common stock equity. the specific means of financing used to support its implementation. the exiting interest rate at that point in time.

Babe Ruth Jr. has agreed to play for the Cleveland Indians for $3 million per year for the next 10 years. What table would you use to calculate the value of this contract in today's dollars?

Present value of an annuity

Which of the following does MACRS depreciation provide to corporations?

Shortens the lives of assets for depreciation purposes.

Which of the following statements about the "payback method" is true?

The payback method does not consider the time value of money.

Football player Walter Johnson signs a contract calling for payments of $250,000 per year, which begins 10 years from now and then continue for five more years after that. To find the value of this contract today, which table or tables should you use?

The present value of an annuity of $1 and the present value of $1

Preferred stock has all but which of the following characteristics?

The same binding contractual obligation as debt.

Although the after-tax cost of debt is below the cost of equity, firms cannot increase their use of debt to endless amounts.

True

For a small business, it is possible for the purchase price of an asset to be expensed rather than depreciated.

True

If an asset is sold for a price above its book value, the difference is considered taxable income to the firm.

True

It is more likely for financial managers to focus on cash flow and corporate executives to focus on earnings of the company.

True