Finance Exam 2

6.87%

A company's perpetual preferred stock currently sells for $122.50 per share, and it pays an $8.00 annual dividend. If the company were to sell a new preferred issue, it would incur a flotation cost of 5.00% of the issue price. What is the firm's cost of preferred stock? Answers: a.5.98% b.7.01% c.6.26% d.6.60% e.6.87%

0.9680

A currency trader observes the following quotes in the spot market: 1 U.S. dollar = 1.32 Japanese yen1 British pound = 2.25 Swiss francs1 British pound = 1.65 U.S. dollars Given this information, how many yen can be purchased for 1 Swiss franc? Do not round the intermediate calculations and round the final answer to four decimal places. Answers: a. 0.9680 b. 0.9486 c. 0.9583 d. 0.9970 e. 0.8518

c. Business risk

An increase in the debt ratio will generally have no effect on which of these items? Answers: a. Total risk. b. Financial risk. c. Business risk. d. The firm's beta.

c. A project's NPV increases as the cost of capital declines.

Assume a project has normal cash flows. All else equal, which of the following statements is CORRECT? Answers: a. A project's discounted payback increases as the cost of capital declines. b. A project's IRR increases as the cost of capital declines. c. A project's NPV increases as the cost of capital declines. d. A project's regular payback increases as the cost of capital declines. e. A project's MIRR is unaffected by changes in the cost of capital.

9.12%

Assume that you are a consultant to Broske Inc., and you have been provided with the following data: D1 = $0.67; P0 = $60.00; and g = 8.00% (constant). What is the cost of equity from retained earnings based on the DCF approach? Answers: a. 11.40% b. 8.11% c. 9.75% d. 9.21% e. 9.12%

6.44%

Bosio Inc.'s perpetual preferred stock sells for $137.50 per share, and it pays an $8.50 annual dividend. If the company were to sell a new preferred issue, it would incur a flotation cost of 4.00% of the price paid by investors. What is the company's cost of preferred stock for use in calculating the WACC? Answers: a. 5.02% b. 6.83% c. 6.44% d. 6.18% e. 7.92%

c. The extent to which interest rates on the firm's debt fluctuate.

Business risk is affected by a firm's operations. Which of the following is NOT directly associated with (or does not directly contribute to) business risk? Answers: a. Demand variability. b. The extent to which operating costs are fixed. c. The extent to which interest rates on the firm's debt fluctuate. d. Sales price variability. e. Input price variability.

14.20%

Computer Consultants Inc. is considering a project that has the following cash flow and cost of capital (r) data. What is the project's MIRR? Note that a project's MIRR can be less than the cost of capital (and even negative), in which case it will be rejected. r =10.00% Year 0 1 2 3 Cash flows −$1,000 $450 $450 $450 Answers: a. 11.50% b. 12.78% c. 10.35% d. 14.20% e. 9.32%

A Division A project with an 11% return.

Duval Inc. uses only equity capital, and it has two equally-sized divisions. Division A's cost of capital is 10.0%, Division B's cost is 14.0%, and the corporate (composite) WACC is 12.0%. All of Division A's projects are equally risky, as are all of Division B's projects. However, the projects of Division A are less risky than those of Division B. Which of the following projects should the firm accept? Answers: a. A Division B project with an 11% return. b. A Division B project with a 12% return. c. A Division A project with an 11% return. d. A Division A project with a 9% return. e. A Division B project with a 13% return.

a. 0.97

El Capitan Foods has a capital structure of 43% debt and 57% equity, its tax rate is 35%, and its beta (leveraged) is 1.45. Based on the Hamada equation, what would the firm's beta be if it used no debt, i.e., what is its unlevered beta, bU? Answers: a. 0.97 b. 1.25 c. 0.72 d. 1.07 e. 0.91

$265.65

Ellmann Systems is considering a project that has the following cash flow and cost of capital (r) data. What is the project's NPV? Note that if a project's expected NPV is negative, it should be rejected. r:9.00% Year 0 1 2 3 Cash flows −$1,000 $500 $500 $500 Answers: a. $292.88 b. $322.90 c. $307.52 d. $265.65 e. $278.93

True

Financial risk refers to the extra risk borne by stockholders as a result of a firm's use of debt as compared with their risk if the firm had used no debt.

13.21%

Hart Corp. is considering a project that has the following cash flow data. What is the project's IRR? Note that a project's IRR can be less than the cost of capital or negative, in both cases it will be rejected. Year 0 1 2 3 Cash flows −$1,000 $425 $425 $425 Answers: a. 14.56% b. 13.87% c. 15.29% d. 12.55% e. 13.21%

67.65

Holt Enterprises recently paid a dividend of $2.75. It expects to have nonconstant growth of 18% for 2 years followed by a constant rate of 6% thereafter. The firm's required return is 12%. What is the firm's horizon value?

59.88

Holt Enterprises recently paid a dividend of $2.75. It expects to have nonconstant growth of 18% for 2 years followed by a constant rate of 6% thereafter. The firm's required return is 12%. What is the firm's intrinsic value today (P0)?

6

If D1= $2.00, g=6%, and P0 = $40.00, what are the stock's capital gains yield (%)?

5

If D1= $2.00, g=6%, and P0 = $40.00, what are the stock's expected dividend yield (%)?

11

If D1= $2.00, g=6%, and P0 = $40.00, what are the stock's total expected return for the coming year (%)?

d.$0.6369

If one U.S. dollar buys 1.57 Canadian dollars, how many U.S. dollars can you purchase for one Canadian dollar (CAD)? Answers: a. $0.7006 b. $0.5732 c. $0.5669 d. $0.6369 e. $0.7898

d. appreciate against the U.S. dollar.

If the inflation rate in the United States is greater than the inflation rate in Britain, other things held constant, the British pound will Answers: a. appreciate against the dollar and other major currencies. b. appreciate against other major currencies. c. remain unchanged against the U.S. dollar. d. appreciate against the U.S. dollar. e. depreciate against the U.S. dollar.

b. The yen-dollar spot exchange rate equals the yen-dollar exchange rate in the 90-day forward market.

In Japan, 90-day securities have a 4% annualized return and 180-day securities have a 5% annualized return. In the United States, 90-day securities have a 4% annualized return and 180-day securities have an annualized return of 4.5%. All securities are of equal risk, and Japanese securities are denominated in terms of the Japanese yen. Assuming that interest rate parity holds in all markets, which of the following statements is most CORRECT? Answers: a. The yen-dollar exchange rate in the 90-day forward market equals the yen-dollar exchange rate in the 180-day forward market. b. The yen-dollar spot exchange rate equals the yen-dollar exchange rate in the 90-day forward market. c. The yen-dollar spot exchange rate equals the yen-dollar exchange rate in the 180-day forward market. d. The relationship between spot and forward interest rates cannot be inferred. e. The yen-dollar exchange rate in the 180-day forward market equals the yen-dollar exchange rate in the 90-day spot market.

Project B, which is of below-average risk and has a return of 8.5%.

LaPango Inc. estimates that its average-risk projects have a WACC of 10%, its below-average risk projects have a WACC of 8%, and its above-average risk projects have a WACC of 12%. Which of the following projects (A, B, and C) should the company accept? Answers: a. Project B, which is of below-average risk and has a return of 8.5%. b.Project C, which is of above-average risk and has a return of 11%. c.None of the projects should be accepted. d.Project A, which is of average risk and has a return of 9%. e.All of the projects should be accepted.

2.30 years

McGlothin Inc. is considering a project that has the following cash flow data. What is the project's payback? Year 0 1 2 3 Cash flows −$1,150 $500 $500 $500 Answers: 2.78 years b. 2.53 years c. 2.07 years d. 2.30 years e. 1.86 years

c. the effects of changing currency values be included in financial analyses.

Multinational financial management requires that Answers: a. political risk should be excluded from multinational corporate financial analyses. b. cultural differences need not be accounted for when considering firm goals and employee management. c. the effects of changing currency values be included in financial analyses. d. legal and economic differences need not be considered in financial decisions because these differences are insignificant. e. traditional U.S. and European financial models incorporating the existence of a competitive marketplace not be recast when analyzing projects in other parts of the world.

15.20%

O'Brien Inc. has the following data: rRF = 5.00%; RPM = 6.00%; and b = 1.70. What is the firm's cost of equity from retained earnings based on the CAPM? Answers: a.15.35% b.17.33% c.15.05% d.15.20% e.13.68%

The market risk premium declines

Schalheim Sisters Inc. has always paid out all of its earnings as dividends, hence the firm has no retained earnings. This same situation is expected to persist in the future. The company uses the CAPM to calculate its cost of equity, its target capital structure consists of common stock, preferred stock, and debt. Which of the following events would REDUCE its WACC? Answers: a. The flotation costs associated with issuing preferred stock increase. b. The company's beta increases. c. The market risk premium declines. d. The flotation costs associated with issuing new common stock increase. e. Expected inflation increases.

2.22 years

Shannon Co. is considering a project that has the following cash flow and cost of capital (r) data. What is the project's discounted payback? r = 10.00% Year 0 1 2 3 4 Cash flows −$950 $525 $485 $445 $405 Answers: a. 2.44 years b. 1.61 years c. 1.79 years d. 2.22 years e. 1.99 years

c. -$40,680.00

Suppose one year ago, Hein Company had inventory in Britain valued at 226,000 pounds. The exchange rate for dollars to pounds was 1£ = 2.00 U.S. dollars. This year the exchange rate is 1£ = 1.82 U.S. dollars. The inventory in Britain is still valued at 226,000 pounds. What is the U.S. dollar gain or loss in inventory value as a result of the change in exchange rates? Answers: a. -$46,375.20 b. -$39,052.80 c. -$40,680.00 d. -$46,782.00 e. -$32,544.00

False

T/F A firm's business risk is largely determined by the financial characteristics of its industry, especially by the amount of debt the average firm in the industry uses.

True

T/F Calculating a currency cross rate involves determining the exchange rate for two currencies by using a third currency as a base.

True

T/F Exchange rate risk is the risk that the cash flows from a foreign project, when converted to the parent company's currency, will be worth less than was originally projected because of exchange rate changes.

False

T/F Individuals and corporations can buy or sell forward currencies to hedge their exchange rate exposure. Essentially, the process involves simultaneously selling the currency expected to appreciate in value and buying the currency expected to depreciate.

True

T/F One advantage of the payback method for evaluating potential investments is that it provides information about a project's liquidity and risk.

False

T/F Other things held constant, an increase in the cost of capital will result in a decrease in a project's IRR.

True

T/F The cost of perpetual preferred stock is found as the preferred's annual dividend divided by the market price of the preferred stock. No adjustment is needed for taxes because preferred dividends, unlike interest on debt, are not deductible by the issuing firm.

True

T/F The internal rate of return is that discount rate that equates the present value of the cash outflows (or costs) with the present value of the cash inflows.

True

T/F When the value of the U.S. dollar appreciates against another country's currency, we may purchase more of the foreign currency with the U.S. dollar.

5.39%

To help finance a major expansion, Castro Chemical Company sold a noncallable bond several years ago that now has 20 years to maturity. This bond has a 9.25% annual coupon, paid semiannually, sells at a price of $1,025, and has a par value of $1,000. If the firm's tax rate is 40%, what is the component cost of debt for use in the WACC calculation? Do not round your intermediate calculations. Answers: a.5.39% b.6.20% c.5.66% d.6.41% e.4.63%

d. If a project with normal cash flows has an IRR greater than the cost of capital, the project must also have a positive NPV.

Which of the following statements is CORRECT? Answers: a. If a project with normal cash flows has an IRR less than the cost of capital, the project must have a positive NPV. b. If Project A's IRR exceeds Project B's, then A must have the higher NPV. c. A project's MIRR can never exceed its IRR. d. If a project with normal cash flows has an IRR greater than the cost of capital, the project must also have a positive NPV. e. If the NPV is negative, the IRR must also be negative.

e. One defect of the IRR method is that it assumes that the cash flows to be received from a project can be reinvested at the IRR itself, and that assumption is often not valid.

Which of the following statements is CORRECT? Answers: a. One defect of the IRR method is that it does not take account of cash flows over a project's full life. b. One defect of the IRR method is that it does not take account of the cost of capital. c. One defect of the IRR method is that it values a dollar received today the same as a dollar that will not be received until sometime in the future. d. One defect of the IRR method is that it does not take account of the time value of money. e. One defect of the IRR method is that it assumes that the cash flows to be received from a project can be reinvested at the IRR itself, and that assumption is often not valid.

c. The capital structure that minimizes the WACC also maximizes the price per share of common stock.

Which of the following statements is CORRECT? Answers: a. The capital structure that gives the firm the best bond rating also maximizes the stock price. b. The capital structure that minimizes the required return on equity also maximizes the stock price. c. The capital structure that minimizes the WACC also maximizes the price per share of common stock. d. The capital structure that minimizes the interest rate on debt also maximizes the expected EPS. e. The capital structure that maximizes expected EPS also maximizes the price per share of common stock.

a. The factors that affect a firm's business risk include industry characteristics and economic conditions, both of which are generally beyond the firm's control.

Which of the following statements is CORRECT? Answers: a. The factors that affect a firm's business risk include industry characteristics and economic conditions, both of which are generally beyond the firm's control. b. A firm's financial risk can be minimized by diversification. c. One of the benefits to a firm of being at or near its target capital structure is that this generally minimizes the risk of bankruptcy. d. The amount of debt in its capital structure can under no circumstances affect a company's EBIT and business risk. e. A firm's business risk is determined solely by the financial characteristics of its industry.

b. Increasing a company's debt ratio will typically increase the marginal costs of both debt and equity financing. However, this action still may lower the company's WACC.

Which of the following statements is CORRECT? Answers: a. Increasing a company's debt ratio will typically reduce the marginal costs of both debt and equity financing. However, this action still may raise the company's WACC. b. Increasing a company's debt ratio will typically increase the marginal costs of both debt and equity financing. However, this action still may lower the company's WACC. c. Since debt financing raises the firm's financial risk, increasing the target debt ratio will always increase the WACC. d. Since a firm's beta coefficient is not affected by its use of financial leverage, leverage does not affect the cost of equity. e. Since debt financing is cheaper than equity financing, raising a company's debt ratio will always reduce its WACC.

b. When calculating the cost of debt, a company needs to adjust for taxes, because interest payments are deductible by the paying corporation.

Which of the following statements is CORRECT? Answers: a. If a company's beta increases, this will increase the cost of equity used to calculate the WACC, but only if the company does not have enough retained earnings to take care of its equity financing and hence must issue new stock. b. When calculating the cost of debt, a company needs to adjust for taxes, because interest payments are deductible by the paying corporation. c. Higher flotation costs reduce investors' expected returns, and that leads to a reduction in a company's WACC. d. Because of tax effects, an increase in the risk-free rate will have a greater effect on the after-tax cost of debt than on the cost of common stock as measured by the CAPM. e. When calculating the cost of preferred stock, companies must adjust for taxes, because dividends paid on preferred stock are deductible by the paying corporation.

b. The regular payback is useful as an indicator of a project's liquidity because it gives managers an idea of how long it will take to recover the funds invested in a project.

Which of the following statements is CORRECT? Answers: a. The discounted payback method recognizes all cash flows over a project's life, and it also adjusts these cash flows to account for the time value of money. b. The regular payback is useful as an indicator of a project's liquidity because it gives managers an idea of how long it will take to recover the funds invested in a project. c. The regular payback method was, years ago, widely used, but virtually no companies even calculate the payback today. d. The regular payback method recognizes all cash flows over a project's life. e. The regular payback does not consider cash flows beyond the payback year, but the discounted payback overcomes this defect.

b. If a project's NPV is less than zero, then its IRR must be less than the cost of capital.

Which of the following statements is CORRECT? Assume that the project being considered has normal cash flows, with one outflow followed by a series of inflows. Answers: a. The lower the cost of capital used to calculate a project's NPV, the lower the calculated NPV will be. b. If a project's NPV is less than zero, then its IRR must be less than the cost of capital. c. The NPV of a relatively low-risk project should be found using a relatively high cost of capital. d. If a project's NPV is greater than zero, then its IRR must be less than zero. e. A project's NPV is found by compounding the cash inflows at the IRR to find the terminal value (TV), then discounting the TV at the cost of capital.

e. 66,667

our uncle is considering investing in a new company that will produce high quality stereo speakers. The sales price would be set at 1.20 times the variable cost per unit; the variable cost per unit is estimated to be $75.00; and fixed costs are estimated at $1,000,000. What sales volume would be required to break even, i.e., to have EBIT = zero? Answers: a. 77,333 b. 55,333 c. 57,333 d. 60,000 e. 66,667 Question 5