Financial Managment Final Exam
Business risk refers to the relative dispersion of a firm's earnings before interest and taxes. True Your answer is correct. False
True
Dividends per share divided by earnings per share equal the dividend payout ratio. True Your answer is correct. False
True
SEC regulations require that corporate stock repurchases must be done in the open market so that all shareholders have an equal opportunity to sell their shares. True False
False
Exchange rate risk exists for a party to a contract if the contract is denominated in a foreign currency. True Your answer is correct. False
True
Exchange rate risk exists in International Trade Contracts, Foreign Portfolio Investments, and in Direct Foreign Investments. True Your answer is correct. False
True
Identify the following three different dividend policies. a. Under the ________________________ policy, the percentage of earnings paidout in dividends is held constant. Although the dividend-to-earnings ratio is stable, the dollar amount of the dividend naturally fluctuates from year to year as profits vary. (Select from the drop-down menu.) Part 2 b. The ________________________________ policy maintains a relatively stable dollar dividend over time. An increase in the dollar dividend usually does not occur until management is convinced that the higher dividend level can be maintained in the future. Conversely, a lower dollar dividend will not be paid until the evidence clearly indicates that a continuation of the current dividend cannot be supported. (Select from the drop-down menu.) Part 3 c. A corporation following the small, _______________________ policy pays a small, regular dollar dividend plus a year-end extra dividend in prosperous years. The extra dividend is declared toward the end of the fiscal year after the company's profits for the period can be estimated. The objective is to avoid the connotation of a permanent dividend being paid. However, this purpose may be defeated if recurring extra dividends come to be expected by investors. (Select from the drop-down menu.)
(a) constant dividend payout ratio (b) stable dollar dividend per share (c) regular dividend plus a year-end extra
Stock repurchases do not alter a company's capital structure since all of the purchased shares are retired and no longer outstanding. True False
False
a. Which firm appears to be excessively leveraged? b. Which firm appears to be employing financial leverage to the most appropriate degree? c. What explanation can you provide for the higher price/earnings ratio enjoyed by firm B as compared with firm A? MEASURE FIRM A FIRM B FIRM C INDUSTRY NORM Debt ratio 20% 25% 40% 20% Times interest earned 8 times 10 times 7 times 9 times Price/earnings ratio 9 times 11 times 6 times 10 times
A) Firm C B) Firm B C) Firm B employs financial leverage to the most appropriate degree and investors must perceive it to have higher growth potential and/or lower risk compared to firm A.
(Business and financial risk) Which of the following sources of new earnings volatility demonstrates the effect of business versus financial risk (discuss the rationale for your decisions): a. Bowson Mfg, Inc. recently constructed a new office building and borrowed 100 percent of the money needed to fund the project. b. In the past, Clarkson Resources has hired an outside firm to prepare all of its printed documents. However, last year the firm acquired its own printing press (paying cash). c. Merriwether Heating and AC Company is located in Chicago. The firm's sole business has been installing and maintaining office heating and cooling systems. However, recently the company's owner, who is an avid skier, decided to purchase a golf course. a. Bowson Mfg, Inc. recently constructed a new office building and borrowed 100 percent of the money needed to fund the project. The fact that the firm borrowed 100% of the cost of the new investment suggests that the firm's ________________ risk has risen. (Select from the drop-down menu.) Part 2 b. In the past, Clarkson Resources has hired an outside firm to prepare all of its printed documents. However, last year the firm acquired its own printing press (paying cash). In this instance, an outsourcing firm has entered into a new business related to printing. Also, the firm paid cash for the asset acquisition. One might think that the firm's _____________________ risk may have changed. (Select from the drop-down menu.) Part 3 c. Merriwether Heating and AC Company is located in Chicago. The firm's sole business has been installing and maintaining office heating and cooling systems. However, recently the company's owner, who is an avid skier, decided to purchase a golf course. It would appear that this firm may have changed its overall _________________ risk since the firm was a specialty retailer and now combines this business with that of a golf course. (Select from the drop-down menu.)
A) financial B) business C) business
If a firm's operating and financial leverage are such that a 10 percent change in sales revenue produced a 20 percent change in EBIT, and a 10 percent change in EBIT led to a 20 percent change in earnings per share, what percentage change in earnings would you expect should revenues decline by 25 percent? If sales revenues will decline by 25 percent, what percentage change in earnings would you expect? (Select the best choice below.) A. -100% Your answer is correct. B. +100% C. +50% D. -50%
A. -100%
All of the following are potential benefits of stock repurchases EXCEPT A. an approach for maintaining the existing capital structure while still making a distribution to shareholders. Your answer is correct. B. a means for providing an internal investment opportunity. C. a favorable impact on earnings per share. D. the elimination of a minority ownership group of stockholders.
A. an approach for maintaining the existing capital structure while still making a distribution to shareholders.
Buying and selling in more than one market to make a riskless profit is called A. arbitrage. Your answer is correct. B. cannot be determined from the above information C. profit−maximization. D. international trading.
A. arbitrage.
What is the objective of capital structure management? The objective of capital structure management is to: (Select the best choice below.) A. determine the optimal capital structure. Your answer is correct. B. maximize the net income. C. minimize the common stock price. D. maximize the composite cost of capital.
A. determine the optimal capital structure
If you are an importer of goods and you will make payment for the purchase of inventory on 90−day terms, which of the below is the correct term for the exchange rate that you will use? A. forward rate Your answer is correct. B. direct rate C. spot rate D. indirect rate
A. forward rate
If you are an importer of goods and you need to make payment for the purchase of inventory before the close of business today, which of the below is the correct term for the exchange rate that you will use? A. spot rate Your answer is correct. B. direct rate C. forward rate D. indirect rate
A. spot rate
The final approval of a dividend payment comes from A. the board of directors. Your answer is correct. B. the president of the company. C. the controller. D. It is a joint decision requiring approval from all of the above.
A. the board of directors.
A firm's dividend payout ratio is A. the ratio of dividends to earnings. Your answer is correct. B. the ratio of dividends to sales. C. the ratio of dividends to market equity. D. the ratio of dividends to book equity.
A. the ratio of dividends to earnings
Based on the data contained in Table A, what is the break−even point in units produced and sold? $18.00 Variable cost per unit $13.00 Units sold 400,000 Fixed costs $650,000 Interest expense $50,000 Question content area bottom Part 1 A. 130,000 Your answer is correct. B. 150,000 C. 140,000 D. 180,000
A. 130,000
The spot exchange rate is 1.57 dollars per pound. The 30−day forward exchange rate is .6211 pounds per dollar. Therefore, pounds in the forward market are selling at a ________ to the current spot rate. A. .958 premium B. .04 premium Your answer is correct. C. .04 discount D. .958 discount
B. .04 premium
The act of buying and selling in more than one market to make a riskless profit is referred to as _____. (Select the best choice below.) A. cannot be determined from the above information. B. arbitrage. Your answer is correct. C. international trading. D. profit maximization.
B. arbitrage.
If the exchange rate quotes in two different countries were out of line with each other, an enterprising trader could make a profit by buying in the market where the currency was cheaper and simultaneously selling it in the market where the currency was more expensive. Such a person would be known as a(n) A. cross trader. B. arbitrageur. Your answer is correct. C. capitalist. D. spot trader.
B. arbitrageur.
A corporation announces a significant increase in its annual dividend and its stock price increases on the news. This could be explained most directly by A. MM"s indifference theorem. B. bird−in−the−hand theory. Your answer is correct. C. perfect capital markets. D. residual dividend theory.
B. bird−in−the−hand theory.
A spot transaction occurs when one currency is ______. (Select the best choice below.) A. deposited in a foreign bank B. immediately exchanged for another currency Your answer is correct. C. traded for another at an agreed-upon future price
B. immediately exchanged for another currency
A Spot transaction occurs when A. one currency is deposited in a foreign bank. B. one currency is immediately exchanged for another currency. Your answer is correct. C. one currency is exchanged for another currency in 30, 60, or 90 days. D. one currency is exchanged for another currency at a specified price.
B. one currency is immediately exchanged for another currency.
Statutory restrictions on dividend payments include all of the following EXCEPT A. if the dividend is being paid from capital invested in the firm. B. if, because of the dividend payment, the firm intends to sell new common stock to fund its capital budget. Your answer is correct. C. if liabilities exceed assets. D. if the amount of the dividend exceeds the firm's retained earnings.
B. if, because of the dividend payment, the firm intends to sell new common stock to fund its capital budget.
Forward rate contracts are used in international transactions to: (Select the best choice below.) A. reduce the risk for the buyer. B. reduce the risk for the seller. C. Both A and B Your answer is correct. D. Neither A nor B
C. Both A and B
Why do U.S. companies invest overseas? (Select the best choice below.) A. To obtain returns higher than those obtainable in the domestic capital markets. B. To reduce portfolio risk through international diversification. C. Both A and B. Your answer is correct. D. None of the above.
C. Both A and B.
Dividends generally A. are guaranteed by the SEC. B. fluctuate more than earnings. C. are more stable than earnings. Your answer is correct. D. are paid as a fixed percentage of earnings.
C. are more stable than earnings.
The law of one price suggests that all of the following will have the same price in different countries EXCEPT A. grain. B. silver. C. fresh vegetables. Your answer is correct. D. oil.
C. fresh vegetables.
Flotation costs A. are encountered whenever a firm fails to pay a dividend. B. are incurred when investors fail to cash their dividend check. C. include the fees paid to the investment bankers, lawyers, and accountants involved in selling a new security issue. Your answer is correct. D. encourage firms to pay large dividends.
C. include the fees paid to the investment bankers, lawyers, and accountants involved in selling a new security issue.
The dividend irrelevance hypothesis is based on all of the following assumptions EXCEPT A. perfect capital markets. B. borrowing decisions will not be altered by the amount of dividend payments. C. investors do not need cash dividends to supplement their current income. Your answer is correct. D. investment decisions will not be altered by the amount of dividend payments.
C. investors do not need cash dividends to supplement their current income
Who are MM and what did they have to say about capital structure? According to the Modigliani and Miller hypothesis, the value of a firm: (Selct the best choice below.) A. decreases as the debt financing in the firm's capital structure increases. B. is maximized as the firm uses 99.9% of equity financing in its capital structure. C. is independent of the firm's capital structure. Your answer is correct. D. increases as the debt financing in the firm's capital structure increases.
C. is independent of the firm's capital structure
How frequently do corporations generally pay dividends? A. semiannually B. monthly C. quarterly Your answer is correct. D. annually
C. quarterly
Which of the following is a reason for international investment? A. to increase P/E ratio B. to gain access to foreign currency C. to reduce portfolio risk Your answer is correct. D. to gain an advantage in a foreign country
C. to reduce portfolio risk
The direct quote in New York is .015 dollar per Pakistani rupee. The direct quote in Pakistan is 60 rupees per dollar. This imbalance in rates can be corrected by arbitrage. A trader will ________ rupees in New York and ________ rupees in Pakistan, causing the direct quote in New York to ________. A. sell; buy; decrease B. buy; sell; decrease C. buy; sell; increase Your answer is correct. D. sell; buy; increase
C. buy; sell; increase
The calculation of incremental free cash flows over a project's life should include A. labor and material saving. B. additional revenue. C. interest to bondholders. D. A and B.
D. A and B.
The following factors may influence the dividend policy that a firm undertakes: (Select the best choice below.) A. The liquidity of the firm. B. Capital structure. C. Legal restrictions. D. A and C Your answer is correct. E. A and B
D. A and C
(Capital structure theory) Which of the following statements most appropriately describes how agency costs affect a firm's choice of capital structure? Explain. (Select the best choice below.) A. When firm owners borrow money they have an incentive to engage in excessive risk taking (that is, investing in very risky projects) since they are managing someone else's money. B. When firms have very limited investment opportunities and little debt financing combined with healthy profits that provide them with free cash flow, their management team might squander the firm's earnings on questionable investments. C. Neither A nor B. D. Both A and B.
D. Both A and B.
An American manufacturer with its corporate headquarters in New York City is purchasing goods from a French supplier. Which of the following statements is true regarding the exchange rate risk for this contract? A. The American company will bear all of the exchange rate risk if the contract is denominated in dollars. B. Both companies could bear exchange rate risk if the contract is denominated in British pounds. C. The French company will bear all of the exchange rate risk if the contract is denominated in dollars. D. Both B and C are correct.
D. Both B and C are correct.
Stock dividends A. decrease stock prices because no cash goes to shareholders but companies pay transactions costs. B. may increase stock prices if investors perceive the dividend as containing favorable information about the firm's future prospects. C. may increase stock prices if the dividend is used to maintain on optimal trading range for the common stock. D. Both B and C are true.
D. Both B and C are true.
Assume that the tax on dividends and the tax on capital gains is the same. All else equal, what would a prudent investor prefer? A. The prudent investor would prefer dividends−a dollar today is always worth more than a dollar to be received in the future. B. The prudent investor would be indifferent between receiving dividends or capital gains. C. More information is needed. D. The prudent investor would prefer capital gains−the capital gain tax liability can be deferred until gains are realized.
D. The prudent investor would prefer capital gains−the capital gain tax liability can be deferred until gains are realized.
One potential reason for a share repurchase is A. to increase the power of a minority group of shareholders. B. maximize the dilution in earnings associated with a merger. C. to signal the market that the firm's stock price is too high. D. a reduction in the firm's cost associated with servicing small stockholders.
D. a reduction in the firm's cost associated with servicing small stockholders.
Dividend policy is influenced by A. a firm's capital structure mix. B. a company's investment opportunities. C. a company's availability of internally generated funds. D. all of the above.
D. all of the above.
Exchange rate risk A. exists also in direct foreign investments and foreign portfolio investments. B. does not exist if the international trade contract is written in terms of the domestic currency. C. exists when the contract is written in terms of the foreign currency. D. all of the above.
D. all of the above.
All of the following may influence a firm's dividend payment EXCEPT A. investment opportunities. B. flotation costs. C. investor transaction costs. D. common stock par value.
D. common stock par value.
The correct order of dividend process dates is A. date of record, declaration date, ex−dividend date, payment date. B. declaration date, date of record, ex−dividend date, payment date. C. ex−dividend date, date of record, declaration date, payment date. D. declaration date, ex−dividend date, date of record, payment date.
D. declaration date, ex−dividend date, date of record, payment date.
If your firm held liabilities in a strong currency, it would be wise to: (Select the best choice below.) A. engage in money market hedging. B. lag or delay the payments against the liability until the currency depreciates. C. engage in forward hedging. D. lead or reduce the liabilities earlier than required. Your answer is correct. E. All of the above.
D. lead or reduce the liabilities earlier than required.
A corporation announces a large increase in its annual dividend, but its stock price declines. This could result from A. bird−in−the−hand theory. B. perfect capital markets. C. MM's indifference theorem. D. residual dividend theory.
D. residual dividend theory.
The spot exchange rate is 1.57 dollars per pound. The 30−day forward exchange rate is .6211 pounds per dollar. The percent−per−year discount on the 30−day pound is A. 32.77%. B. 48.00%. C. 45.93%. D. 30.57%.
D. 30.57%.
Which of the following do not provide a hedge against some risk? (Select the best choice below.) A. Money market hedge B. Currency options C. Futures contracts D. Forward contract E. All are forms of hedging
E. All are forms of hedging
A U.S. corporation investing in a foreign corporation by purchasing stock on a foreign stock exchange is an example of direct foreign investment. True False
False
A direct quote is always denominated in U.S. dollars, since the dollar is the medium of exchange in international business. True False
False
According to the bird−in−the−hand dividend theory, investors value a dollar of expected capital gain more highly than a dollar of expected dividends because capital gains are more unpredictable than dividends. True False
False
As long as a firm has a positive level of retained earnings, it can pay a dividend. True False
False
A firm's dividend policy includes two basic components: the dividend payout ratio and the profit retention ratio. True False
False
Compared with other developed countries, the U.S. is particularly reliant on foreign trade for self−subsistence. True False
False
Interest Rate Parity theory states that interest rates must be the same in all countries using floating exchange rates or else international markets will not be in equilibrium. True False
False
Investor A owns 10% of the common stock of IDE Corporation. After IDE completes a 2−for−1 stock split, Investor A will own 20% of the common stock of the corporation. True False
False
The residual dividend theory implies that internally generated funds (i.e., retained earnings) should be used to fund all new investment projects before the company uses any additional debt. True False
False
The risk−adjusted discount rate method implicitly assumes that distant cash flows have the same risk as near cash flows. True False
False
What is the typical frequency with which cash dividends are paid to investors?
Quarterly
Argentina experienced a period of extremely high inflation relative to its trading partners and Argentina's currency decreased in value. This is an example of purchasing power parity theory. True Your answer is correct. False
True
A firm's dividend policy includes two basic components: the dividend payout ratio and dividend stability. True Your answer is correct. False
True
A project's annual free cash flow is the change in operating cash flow less any change in net working capital and less any change in capital spending. True Your answer is correct. False
True
A cross rate is the computation of an exchange rate for a currency from the exchange rates of two other currencies. True Your answer is correct. False
True
A stock split is defined as a stock dividend exceeding 25%. True Your answer is correct. False
True
After a stock split of 2:1, each investor will have twice the number of shares, but the same percentage ownership in the firm that he had before the split. True Your answer is correct. False
True
An investor who pays no tax would be more likely to accept the view that high dividends increase stock values rather than the view that low dividends increase stock values. True Your answer is correct. False
True
Arbitrage is the process of buying in one market and selling in another market in order to make a riskless profit. True Your answer is correct. False
True
Interest rate parity theory states that the forward premium or discount should be equal and opposite in sign to the difference in the national interest rates for securities of the same maturity. True Your answer is correct. False
True
International expansion often occurs because it is generally easier for firms to expand the market for their products rather than to develop new products. True Your answer is correct. False
True
Other things equal, individuals in high−income tax brackets should have a preference for firms that retain their earnings rather than pay dividends. True Your answer is correct. False
True
Shareholders may prefer a share repurchase program to dividends because dividends are subject to taxation and increasing value per share due to repurchase programs is tax deferred. True Your answer is correct. False
True
Statutory restrictions may prevent a company from paying dividends if the firm's assets are less than the firm's liabilities. True Your answer is correct. False
True
The U.S. dollar is the most frequently traded currency in foreign currency markets, accounting for over 40% of total trading. True Your answer is correct. False
True
The higher the dividend payout ratio, the more a company must rely on external financing. True Your answer is correct. False
True
The three major components responsible for variation in a company's income stream are business risk, operating risk, and financial risk. True Your answer is correct. False
True
a. Which firm appears to be excessively leveraged? b. Which firm appears to be employing financial leverage to the most appropriate degree? c. What explanation can you provide for the higher price/earnings ratio enjoyed by firm B as compared with firm A? Question content area bottom Part 1 a. Which firm appears to be excessively leveraged? (Select the best choice below.) A. Firm A B. Firm B C. Firm C Your answer is correct. Part 2 b. Which firm appears to be employing financial leverage to the most appropriate degree? (Select the best choice below.) A. Firm A B. Firm B Your answer is correct. C. Firm C Part 3 c. What explanation can you provide for the higher price-earnings ratio enjoyed by firm B as compared with firm A? (Select the best choice below.) A. Firm B employs financial leverage to the extremely high degree and investors must perceive it to have higher growth potential and/or lower risk compared to firm A. B. Firm B employs financial leverage to the lower than average degree and investors must perceive it to have lower growth potential and/or higher risk compared to firm A. C. Firm B employs financial leverage to the most appropriate degree and investors must perceive it to have higher growth potential and/or lower risk compared to firm A. Your answer is correct. D. Firm B employs financial leverage to the most appropriate degree and investors must perceive it to have lower growth potential and/or higher risk compared to firm A. MEASURE FIRM A FIRM B FIRM C INDUSTRY NORM Debt ratio 10% 15% 30% 10% Times interest earned 8 times 10 times 7 times 9 times Price/earnings ratio 9 times 11 times 6 times 10 times
Which firm appears to be excessively leveraged? C. Firm C Which firm appears to be employing financial leverage to the most appropriate degree? (Select the best choice below.) B. Firm B Your answer is correct. What explanation can you provide for the higher price-earnings ratio enjoyed by firm B as compared with firm A? C. Firm B employs financial leverage to the most appropriate degree and investors must perceive it to have higher growth potential and/or lower risk compared to firm A.
(Dividend policy and stock prices) The question as to whether dividend policy has an effect on share prices raises a question as to whether dividends paid out to stockholders are any more "certain" than the expected future dividends the stockholders hope to receive from the retention of firm earnings. This is known as the __________________________ theory of dividend policy. (Select from the drop-down menu.)
bird-in-the-hand
A U.S. firm needs to pay 29,000 Swiss francs to a firm in Switzerland, how much is this in U.S. dollars? The data for this problem are given in the following table: Switzerland—franc Spot 0.5145 30-day 0.5171 90-day 0.5322 The dollar payment of 29,000 Swiss francs is $14921. (Round to the nearest dollar.)
$14921
Which of the following would NOT be included in a project's initial cash outflow? (Select the best choice below.) A. A marketing survey that was completed last year to determine the project's feasibility. Your answer is correct. B. Additional funds needed to support increased inventory levels due to expected increased sales if the firm adopts the project. C. The cost or expense of installing the asset. D. The purchase price of the asset.
A. A marketing survey that was completed last year to determine the project's feasibility.
A wildcat oil driller has enough capital to invest in only one project, that is, to drill one well in an East Texas oil field. A major oil company is drilling 100 wells in the same field. The probability of successfully striking oil is 10% for any well drilled in this field. Which of the following statements is MOST correct concerning the risk involved in these capital budgeting projects? A. The best measure of risk for the wildcat oil driller is project standing alone risk. Your answer is correct. B. The appropriate risk for the wildcat driller is systematic risk. C. The appropriate risk for the major oil company is contribution−to−firm risk, if all shareholders of the firm are well diversified. D. The risk for the wildcat driller is the same as the risk for the major oil company since they are both drilling in the same oil field.
A. The best measure of risk for the wildcat oil driller is project standing alone risk
A major corporation is considering a capital budgeting project that involves the development of a new technology. The controller estimates the net present value to be negative, yet argues that the company should invest in the project. Which of the following statements is MOST correct? A. The controller may be considering the option to expand or modify the project in the future. Your answer is correct. B. The profitability index may be greater than one, giving an accept decision. C. The controller should be fired for making such a poor decision. D. Capital rationing may exist for the current year.
A. The controller may be considering the option to expand or modify the project in the future.
Give an example of an option to delay a project. Which of the following is an example of an option to delay a project? (Select the best choice below.) A. The option to wait for one year to open a restaurant. Your answer is correct. B. The option to shut down a mining operation due to the depletion of the ore reserves. C. The option to increase production if the new product launches successfully. D. The option to enter into the foreign markets.
A. The option to wait for one year to open a restaurant.
Tillamook Farms invests in a new kind of frozen dessert called polar cream that becomes very popular. So many new customers come to the store that the sales of existing ice cream products are increased. The extra sales revenue Question content area bottom Part 1 A. are synergistic effects that should be counted as incremental revenues for the polar cream project. Your answer is correct. B. should not be counted as incremental revenue for the polar cream project because the sales come from existing products. C. are cannibalized sales that should be excluded from the analysis. D. should be included in the analysis, but not the cost of the ice cream that is sold as that is a recurring expense.
A. are synergistic effects that should be counted as incremental revenues for the polar cream project.
Which of the following would be considered a fixed cost in a manufacturing setting? A. depreciation Your answer is correct. B. sales commissions C. direct materials D. direct labor
A. depreciation
The break−even model enables the manager of the firm to A. determine the quantity of output that must be sold to cover all operating costs. Your answer is correct. B. determine the optimal amount of debt financing to use. C. set appropriate equilibrium thresholds. D. calculate the minimum price of common stock for certain situations.
A. determine the quantity of output that must be sold to cover all operating costs.
Kohler Manufacturing typically achieves one of three production levels in any given year: 8 million pounds of steel, 10 million pounds of steel, or 16 million pounds of steel. In tracking some of its costs, Kohler's controller discovered one cost that was $10 per pound at a production level of 8 million pounds, $8 per pound at a production level of 10 million pounds, and $5 per pound at a production level of 16 million pounds. This is an example of a A. fixed cost. Your answer is correct. B. semifixed cost. C. variable cost. D. semivariable cost.
A. fixed cost.
The break−even point is equal to A. fixed costs divided by (sales price per unit − variable cost per unit). Your answer is correct. B. fixed costs divided by unit variable costs. C. fixed costs divided by selling price per unit. D. (sales price per unit − variable cost per unit) times the fixed costs.
A. fixed costs divided by (sales price per unit − variable cost per unit).
A plant may remain operating when sales are depressed A. if the selling price per unit exceeds the variable cost per unit. Your answer is correct. B. to help the local economy. C. unless variable costs are zero when production is zero. D. in an effort to cover at least some of the variable cost.
A. if the selling price per unit exceeds the variable cost per unit.
When terminating a project for capital budgeting purposes, the working capital outlay required at the initiation of the project will A. increase the terminal cash flow because it is recaptured. Your answer is correct. B. decrease the terminal cash flow because it is a historical cost. C. decrease the terminal cash flow because it is an outlay. D. not affect the terminal cash flow.
A. increase the terminal cash flow because it is recaptured.
Which of the following should NOT be included as investment costs in evaluating a capital asset? A. interest payments and other financing cash flows that result from raising funds to finance a project Your answer is correct. B. shipping expenses C. installation expenses D. employee training expenses
A. interest payments and other financing cash flows that result from raising funds to finance a project
If depreciation expense in year one of a project increases for a highly profitable company, A. net income decreases and incremental free cash flow increases. Your answer is correct. B. net income decreases and incremental free cash flow decreases. C. the book value of the depreciating asset increases at the end of year one. D. net income increases and incremental free cash flow increases.
A. net income decreases and incremental free cash flow increases.
Sunk costs are A. not relevant in capital budgeting. Your answer is correct. B. recoverable. C. not deductible for tax purposes. D. incremental.
A. not relevant in capital budgeting.
The "threat hypothesis" A. reduces management's tendency to spend freely. Your answer is correct. B. encourages management to use debt to further their own interests. C. increases the agency problem. D. increases agency monitoring costs.
A. reduces management's tendency to spend freely
Assuming no corporate taxes, the independence hypothesis suggests that a firm's weighted average cost of capital will A. remain constant because the cost of equity will be increasing as the amount of debt increases due to the increased risk. Your answer is correct. B. remain constant regardless of capital structure because the cost of debt and the cost of equity are the same. C. increase proportionally with the increase in the amount of debt a firm uses. D. decrease proportionally with the increase in the amount of debt a firm uses.
A. remain constant because the cost of equity will be increasing as the amount of debt increases due to the increased risk.
Operating leverage has to do with A. the incurrence of fixed operating costs in the firm's income stream. Your answer is correct. B. financing with fixed cost sources of capital. C. using preferred stock to increase sales volume. D. borrowing money to finance a firm's growth.
A. the incurrence of fixed operating costs in the firm's income stream
Redrock Inc. is a household products firm that is considering developing a new detergent. In evaluating whether to go ahead with the new detergent project, which of the following statements is MOST correct? Question content area bottom Part 1 A. The company will need to hire 10 new workers whose salaries and benefits will total $400,000 per year. Labor costs are not part of capital budgeting and should be excluded. B. The company will produce the detergent in a building that it renovated 2 years ago for $300,000. The $300,000 should be excluded from the analysis. Your answer is correct. C. The company will produce the detergent in a building that they already own. The cost of the building is therefore zero and should be excluded from the analysis. D. The company will need to use some equipment that it could have leased to another company. This equipment lease could have generated $200,000 per year in after−tax income. The $200,000 should be excluded because the equipment can no longer be leased.
B. The company will produce the detergent in a building that it renovated 2 years ago for $300,000. The $300,000 should be excluded from the analysis.
Give an example of an option to expand a project. Which of the following is an example of an option to expand a project? (Select the best choice below.) A. The option to wait for one year to open a restaurant. B. The option to increase production if the new product launches successfully. Your answer is correct. C. The option to refinance at a lower rate to prepay the home mortgage. D. The option to shut down a mining operation due to the depletion of the ore reserves.
B. The option to increase production if the new product launches successfully.
A high degree of variability in a firm's earnings before interest and taxes refers to A. operating leverage. B. business risk. Your answer is correct. C. financial risk. D. financial leverage.
B. business risk.
Bill and Mary own a small chain of high fashion boutiques that represent almost 100% of their net worth. When considering capital budgeting projects for their boutiques, the appropriate measure of risk is A. systematic risk. B. contribution−to−firm risk. Your answer is correct. C. project standing alone risk. D. beta risk.
B. contribution−to−firm risk.
Which of the following cash flows are NOT considered in the calculation of the initial outlay for a capital investment proposal? A. installation costs B. cost of issuing new bonds if the project is financed by a new bond issue Your answer is correct. C. increase in accounts receivable D. None of the above−all are considered.
B. cost of issuing new bonds if the project is financed by a new bond issue
Financing a portion of a firm's assets with securities bearing a fixed rate of return in hopes of increasing the return to stockholders refers to A. business risk. B. financial leverage. Your answer is correct. C. combined leverage. D. operating leverage.
B. financial leverage.
A firm that uses large amounts of debt financing in an industry characterized by a high degree of business risk would have ________ earnings per share fluctuations resulting from changes in levels of sales. A. no B. large Your answer is correct. C. small D. constant
B. large
The optimal capital structure is the funds mix that will A. maximize total leverage. B. minimize the firm's composite cost of capital. Your answer is correct. C. minimize the use of debt. D. achieve an equal proportion of debt, preferred stock, and common equity.
B. minimize the firm's composite cost of capital.
Variable costs include all of the following EXCEPT A. sales commissions. B. property taxes. Your answer is correct. C. direct labor. D. annual rent.
B. property taxes.
Business risk refers to A. the risk associated with financing a firm with debt. B. the variability of a firm's expected earnings before interest and taxes. Your answer is correct. C. the uncertainty associated with a firm's CAPM. D. the variability of a firm's stock price.
B. the variability of a firm's expected earnings before interest and taxes.
Kohler Manufacturing typically achieves one of three production levels in any given year: 8 million pounds of steel, 10 million pounds of steel, or 16 million pounds of steel. In tracking some of its costs, Kohler's controller discovered one cost that was $10 per pound no matter what the production level for the year. This is an example of a A. fixed cost. B. variable cost. Your answer is correct. C. semivariable cost. D. semifixed cost.
B. variable cost.
A new machine can be purchased for $1,200,000. It will cost $35,000 to ship and $15,000 to modify the machine. A $12,000 recently completed feasibility study indicated that the firm can employ an existing factory owned by the firm, which would have otherwise been sold for $180,000. The firm will borrow $750,000 to finance the acquisition. Total interest expense for 5−years is expected to approximate $350,000. What is the investment cost of the machine for capital budgeting purposes? A. $1,442,000 B. $1,430,000 Your answer is correct. C. $2,180,000 D. $1,780,000
B. $1,430,000
Which of the following transactions will lower a company's financial leverage? A. A mortgage loan is obtained and the proceeds are used to pay off existing short−term debt. B. Short−term debt is obtained to get the company through a period of negative net income and cash flow. C. Common stock is sold and the proceeds are used to pay off existing short−term debt. Your answer is correct. D. Preferred stock is sold and the proceeds are used to pay off existing short−term debt.
C. Common stock is sold and the proceeds are used to pay off existing short−term debt.
Which of the following statements about project standing alone risk is true? A. It takes into consideration the effects of diversification of the firm's shareholders. B. It provides the best measure of project risk for a large, widely−held company. C. It ignores the fact that much of the risk of a project will be diversified away as the project is combined with the firm's other projects. Your answer is correct. D. It ignores the cash flows that are associated with a project that occur beyond the payback period.
C. It ignores the fact that much of the risk of a project will be diversified away as the project is combined with the firm's other projects.
One component of a firm's financial structure which is NOT a component of its capital structure is A. long−term debt. B. common stock. C. accounts payable. Your answer is correct. D. preferred stock.
C. accounts payable.
Which of the following should be excluded in an analysis of a new project's cash flows? A. additional investment in inventory B. additional investment in accounts receivable C. additional interest expenses on debt financing Your answer is correct. D. additional investment in fixed assets
C. additional interest expenses on debt financing
The Modigliani and Miller hypothesis suggests that capital structure doesn't matter. All of the following conditions need to be met for this hypothesis to be true EXCEPT A. corporate income is not subject to taxation. B. securities are traded in perfect or efficient markets. C. all corporate net income is paid out as dividends. Your answer is correct. D. capital structure consists only of stocks and bonds.
C. all corporate net income is paid out as dividends.
If bankruptcy costs and/or shareholder under diversification are an issue, what measure of risk is relevant when evaluating project risk in capital budgeting? A. systematic risk B. capital rationing risk C. contribution−to−firm risk Your answer is correct. D. total project risk
C. contribution−to−firm risk
Break−even analysis is used to study the effect on EBIT of changes in all of the following EXCEPT A. cost structure. B. prices. C. corporate taxes. Your answer is correct. D. volume.
C. corporate taxes.
Which of the following would be considered a variable cost in a manufacturing setting? A. rent B. insurance C. direct labor Your answer is correct. D. administrative salaries
C. direct labor
As production levels increase, A. fixed costs per unit stay the same and variable costs per unit increase. B. fixed costs per unit increase. C. fixed costs per unit decrease and variable costs per unit stay the same. Your answer is correct. D. variable costs per unit decrease.
C. fixed costs per unit decrease and variable costs per unit stay the same.
The recapture of net working capital at the end of a project will Question content area bottom Part 1 A. increase terminal year free cash flow by the change in net working capital times the corporate tax rate. B. have no effect on the terminal year free cash flow because the net working capital change has already been included in a prior year. C. increase terminal year free cash flow. Your answer is correct. D. decrease terminal year free cash flow by the change in net working capital times the corporate tax rate.
C. increase terminal year free cash flow.
Which of the following is a fixed cost? A. direct material B. direct labor C. insurance Your answer is correct. D. freight costs on products
C. insurance
Salvage value would most likely NOT be considered by Question content area bottom Part 1 A. net present value. B. internal rate of return. C. payback. Your answer is correct. D. A and B.
C. payback.
Which of the following would NOT be a part of a firm's capital structure? A. common stock B. preferred stock C. short−term notes payable Your answer is correct. D. long−term bonds
C. short−term notes payable
Incremental cash flows refer to A. the cash flows that are foregone if a firm does not undertake a project. B. the cash flows of a project, minus financing costs. C. the new cash flows that will be generated if a project is undertaken. Your answer is correct. D. the difference between after−tax cash flows and before−tax accounting profits.
C. the new cash flows that will be generated if a project is undertaken.
Financial leverage has to do with A. using common stock to finance a portion of a firm's assets. B. a high gross profit margin. C. the usage of fixed cost financial securities to finance a portion of a firm's assets. Your answer is correct. D. the incurrence of fixed operating costs in the firm's income stream.
C. the usage of fixed cost financial securities to finance a portion of a firm's assets.
Which of the following SHOULD be included as incremental costs when evaluating capital projects? (Select the best choice below.) A. Expenses associated with the modification of the firm's production facility in order to invest in a project. B. Investment in working capital that is directly related to a project. C. Opportunity costs that are directly related to a project. D. All of the above.
D. All of the above.
Which of the following would be included in the calculation of the differential cash flows over a project's life? (Select the best choice below.) A. Labor and material savings. B. Investment in net working capital. C. Additional revenues attributable to the project. D. All of the above.
D. All of the above.
Which of the following is NOT considered in the calculation of incremental cash flows? A. tax saving due to increased depreciation expense B. increased dividend payments if additional preferred stock is issued C. interest payments if new debt is issued D. B and C
D. B and C
Amalgamated Mining, Inc. has very high operating leverage due to the capital intensive nature of the steel business. The firm's CEO is concerned about the variability in the firm's EPS if sales should drop, and decides to take action. Which of the following will reduce the variability in the firm's EPS for a given change in sales? A. The CEO may issue more corporate bonds and use the proceeds to pay off short−term liabilities. B. The CEO may increase the firm's financial leverage and hence reduce the variability by using non−shareholder money to support the business. C. The CEO may increase the firm's total leverage by raising money from the sale of common stock. D. The CEO may decrease the firm's financial leverage, thus lowering the firm's total leverage.
D. The CEO may decrease the firm's financial leverage, thus lowering the firm's total leverage.
In looking at the following cash flows, which one would NOT be considered or used in the calculation of the initial outlay for a capital investment proposal? (Select the best choice below.) A. The cost of shipping new equipment. B. The cost of installing new equipment. C. Increase in accounts receivable. D. The cost of issuing new bonds if the project is financed by a new bond issue.
D. The cost of issuing new bonds if the project is financed by a new bond issue
Which of the following are included in the terminal cash flow? A. the expected salvage value of the asset B. recapture of any working capital increase included in the initial outlay C. any tax payments or receipts associated with the salvage value of the asset D. all of the above
D. all of the above
The Modigliani and Miller hypothesis does NOT work in the "real world" because A. interest expense is tax deductible, providing an advantage to debt financing. B. higher levels of debt increase the likelihood of bankruptcy, and bankruptcy has real costs for any corporation. C. dividend payments are fixed and tax deductible for the corporation. D. both A and B.
D. both A and B.
Question content area top Part 1 Increased depreciation expenses affect tax−related cash flows by A. pushing a corporation into a higher tax bracket. B. increasing taxable income, thus increasing taxes. C. decreasing taxable income, with no effect on cash flow since depreciation is a non−cash expense. D. decreasing taxable income, thus reducing taxes.
D. decreasing taxable income, thus reducing taxes.
Dakota Oil, Inc. reported that its sales and EBIT increased by 10%, but its EPS increased by 30%. The much larger change in earnings per share could be the result of A. a high percentage of credit sale collections from prior years. B. high fixed costs of production. C. high operating leverage. D. high financial leverage.
D. high financial leverage.
Which of the following should be included in the initial outlay? A. preexisting firm overhead reallocated to the new project B. first year depreciation expense on any new equipment purchased C. taxable gain on the sale of old equipment being replaced D. increased investment in inventory and accounts receivable
D. increased investment in inventory and accounts receivable
All of the following are likely to result in the use of less debt in a company's capital structure EXCEPT A. a decrease in a company's marginal tax rate. B. desire to maintain financial flexibility. C. desire to maintain a high credit rating. D. insufficient internal funds
D. insufficient internal funds.
Financial leverage could mean financing some of a firm's assets with A. sales revenues. B. retained earnings. C. private equity capital. D. preferred stock
D. preferred stock.
The four basic determinants of business risk include all of the following EXCEPT A. competitive pressures in the firm's industry. B. the stability of the domestic economy. C. sensitivity to the business cycle. D. the level of fixed cost used in the company's production process.
D. the level of fixed cost used in the company's production process.
Humongous Corporation is a multidivisional conglomerate. The Food Division is undergoing a capital budgeting analysis and must estimate the division's beta. This division has a different level of systematic risk than is typical for Humongous Corporation as a whole. The most appropriate method for estimating this beta is A. the regression coefficient from a time series regression of Humongous Corporation stock returns on a market index. B. the regression coefficient from a time series regression of Food Division's net income on the Humongous Corporation's return on assets. C. to multiply the company's beta by the ratio of the Food Division's total assets/Humongous Corporation total assets. D. the regression coefficient from a time series regression of Food Division's return on assets on a market index.
D. the regression coefficient from a time series regression of Food Division's return on assets on a market index.
The pure play method A. calculates beta using only project returns. B. selects one of the firm's existing projects that is similar to the project being analyzed and uses that project's required rate of return. C. selects a firm similar to the project being analyzed and uses its returns as the market return in estimating a project beta. D. uses the beta of a firm that is similar to the project being analyzed to determine the required rate of return for the project.
D. uses the beta of a firm that is similar to the project being analyzed to determine the required rate of return for the project.
A key tool for evaluating business risk is break−even analysis. True False
False
A weakness in the capital budgeting process is the funds for an investment proposal obtained by issuing bonds, and the respective interest payments, are not considered in the capital budgeting process. True False
False
Accounting profits are used to make capital budgeting decisions because generally accepted accounting principles ensure that profits are the best measure of a company's economic activity. Question content area bottom Part 1 True False
False
Any increase in interest payments caused by a project should be counted in the incremental cash flows. True False
False
A project's standing alone risk allows for diversification within a sole firm. True False
False
Hershey's expects to sell $2 million of its new candy bar, although $200,000 of this amount would have been spent on its existing candy bar. The $2 million is the appropriate cash inflow for the new candy bar project, while the $200,000 will be counted against the return on the old candy bar. Question content area bottom Part 1 True False
False
If a project uses an asset the corporation already owns, the cost of that asset for capital budgeting purposes is zero to reflect the advantage the project has over projects that require the purchase of new assets. Question content area bottom Part 1 True False
False
If a firm's production process requires high operating leverage (use of fixed costs), then the firm should finance its assets with debt, so that the cost of capital will be reduced and financing costs will remain fixed. True False
False
Interest payments on a loan obtained specifically to fund a new project should be considered an incremental cash flow for the new project when determining the accept/reject decision. Question content area bottom Part 1 True False
False
Sales of consumer durable goods, such as appliances, are more sensitive to swings in the business cycle, and therefore companies in these industries face a higher level of operating risk. True False
False
The independence hypothesis allows for bankruptcy and agency costs. True False
False
The less−risky investment is always the more desirable choice. True False
False
The optimal capital structure occurs when operating leverage equals financial leverage. True False
False
If Ford introduces a new auto line, might some of the cash flows from that new car line be diverted from existing product lines? Question content area bottom Part 1 (Select the best choice below.) A. If Ford introduces a new auto line that might compete with the firm's existing product lines, then new-product sales achieved at the cost of losing sales of existing product lines should also be considered as a benefit in capital-budgeting analysis. B. If Ford introduces a new auto line that might compete with the firm's existing product lines, this is called a synergistic effect. C. If Ford introduces a new auto line that might compete with the firm's existing product lines, then only the incremental sales the new line brings to the company should be considered in determining the free cash flows in capital-budgeting analysis. Your answer is correct. D. If Ford introduces a new auto line that might compete with the firm's existing product lines, then new-product sales achieved at the cost of losing sales of existing product lines are considered as sunk costs that should be excluded in capital-budgeting analysis.
If Ford introduces a new auto line that might compete with the firm's existing product lines, then only the incremental sales the new line brings to the company should be considered in determining the free cash flows in capital-budgeting analysis.
A grocery store decides to offer beer for sale and this decision results in more potato chip sales. This is an example of a synergistic effect. Question content area bottom Part 1 True Your answer is correct. False
True
According to the CAPM, systematic risk is the only relevant risk for capital budgeting purposes. True Your answer is correct. False
True
Additional investment in working capital, even if it may be recovered at the end of a project, must be included in capital budgeting analysis because of the time value of money. Question content area bottom Part 1 True Your answer is correct. False
True
An opportunity cost is a relevant incremental cost for capital budgeting decisions. True Your answer is correct. False
True
A project's contribution to firm risk is relevant for undiversified investors or when bankruptcy costs exist. True Your answer is correct. False
True
A small, family−owned corporation would be more likely to use the contribution−to−firm risk criteria rather than the systematic risk to evaluate capital budgeting projects. True Your answer is correct. False
True
Borrowing funds using short−term debt, such as commercial paper, and using the proceeds to invest in long−term investments, creates a refinancing risk that can force firms to sell assets at distressed prices if financing becomes unavailable. True Your answer is correct. False
True
Break−even analysis is a short−term concept because, in the long run, all costs are variable. True Your answer is correct. False
True
Capital structure is equal to financial structure minus current liabilities. True Your answer is correct. False
True
Financial risk applies to both the additional variability in earnings available to common shareholders and the additional chance of insolvency caused by the use of financial leverage. True Your answer is correct. False
True
Financial theory assumes that individuals are risk averse. True Your answer is correct. False
True
How do operating and financial leverage interact to affect the volatility of a firm's earnings per share? "Combining operating and financial leverage magnifies variations in earnings per share in response to changes in sales." Is the statement above true or false? True. (Select from the drop-down menu.)
True
If an old asset is sold for less than its book value, the resulting loss will save the company taxes, hence lowering the cost of the project. True Your answer is correct. False
True
If we ignore bankruptcy and agency costs then the optimal capital structure for a firm under the moderate view would be 100% debt. True Your answer is correct. False
True
Raising funds internally is effectively increasing the investment of the firm's existing common shareholders. True Your answer is correct. False
True
Sensitivity analysis involves changing one variable at a time. True Your answer is correct. False
True
Sunk costs are cash outflows that will occur regardless of the current accept/reject decision, and therefore should be excluded from the analysis. Question content area bottom Part 1 True Your answer is correct. False
True
The break−even quantity of output is that quantity of output, in units, that results in an EBIT equal to zero. True Your answer is correct. False
True
The more fixed−charge securities (such as bonds and preferred stock) the firm employs in its financial structure, the greater its financial leverage. True Your answer is correct. False
True
Three of the most common options that can add value to a capital budgeting project are the option to delay the project, the option to expand the project, and the option to abandon the project. True Your answer is correct. False
True
In terms of capital budgeting, a project's risk can be looked at on three levels. What are they? There are three types of capital-budgeting risk: (Select from the drop-down menus.) (1) The ___________________________, which is a project's risk ignoring the fact that much of this risk will be diversified away as the project is combined with the firm's other projects. (2) The project's _________________________, which is the amount of risk that the project contributes to the firm as a whole. (3) The project's _____________________, which is the risk of the project from the viewpoint of a well-diversified shareholder.
standing alone risk contribution-to-firm risk systematic risk
What are incremental cash flows? What are sunk costs? What are opportunity costs? Cash flows that have already taken place are often referred to as________________, cash flows that are lost because a given project consumes scarce resources that would have produced cash flows if that project had been rejected are often referred to as _______________________, and cash flows that a firm receives and is able to reinvest are often referred to as _________________________. (Select from the drop-down menus.)
sunk costs oppertunity costs incremental cash flows