FINN analysis exam2
All else equal, a firm's business risk is higher when: a) fixed costs are the highest portion of its expense. b) the firm has low operating leverage. c) variable costs are the highest portion of its expense.
A
An analyst has gathered the following expenditure information for three different firms, each of which has a sales level of $4 million. Which firm has the highest degree of operating leverage (DOL)? a) Firm B b) Firm A c)Firm C.
A
As financial leverage increases, what will be the impact on the expected rate of return and financial risk? a) Both will rise. b) Both will fall. c) One will rise while the other falls.
A
If a 10% increase in sales causes EPS to increase from $1.00 to $1.50 (DTL), and if the firm uses no debt, then what is its degree of operating leverage (DOL)? a) 5.0. b) 4.7. c) 4.2.
A
Jayco, Inc., sells 10,000 units at a price of $5 per unit. Jayco's fixed costs are $8,000, interest expense is $2,000, variable costs are $3 per unit, and EBIT is $12,000. Jayco's degree of total leverage (DTL) is closest to: a) 2.00 b) 1.75 c) 1.50
A
The debt of Savanna Equipment, Inc. has an average maturity of ten years and a BBB rating. A market yield to maturity is not available because the debt is not publicly traded, but the market yield on debt with similar characteristics is 8.33%. Savanna is planning to issue new ten-year notes that would be subordinate to the firm's existing debt. The company's marginal tax rate is 40%. The most appropriate estimate of the after-tax cost of this new debt is: a) More than 5.0%. b) 5.0%. c) Between 3.3% and 5.0%.
A
The following data is regarding the Link Company:A target debt/equity ratio of 0.5Bonds are currently yielding 10%Link is a constant growth firm that just paid a dividend of $3.00Stock sells for $31.50 per share, and has a growth rate of 5%Marginal tax rate is 40%What is Link's after-tax cost of capital? a) 12.0%. b) 10.5%. c) 12.5%.
A
Which of the following best describes a firm with low operating leverage? A large change in: a) the number of units a firm produces and sells result in a similar change in the firm's earnings before interest and taxes. b) earnings before interest and taxes result in a small change in net income. c) sales result in a small change in net income.
A
A preferred stock's dividend is $5 and the firm's bonds currently yield 6.25%. The preferred shares are priced to yield 75 basis points below the bond yield. The price of the preferred is closest to: a) $5.00. b) $90.91. c) $80.00.
B
A properly qualified board member is of vital importance to proper corporate governance within a firm. Board members who lack the requisite skills, knowledge and expertise to conduct a thorough review of the firm's activities are: a) less likely to participate fully in decision-making matters during board meetings. b) more likely to defer to management when making decisions. c) more likely to consult with outside interests to assist in decision-making.
B
At a recent Haggerty Semiconductors Board of Directors meeting, Merle Haggerty was asked to discuss the topic of the company's weighted average cost of capital (WACC).At the meeting Haggerty made the following statements about the company's WACC:Statement 1: A company creates value by producing a higher return on its assets than the cost of financing those assets. As such, the WACC is the cost of financing a firm's assets and can be viewed as the firm's opportunity cost of financing its assets.Statement 2: Since a firm's WACC reflects the average risk of the projects that make up the firm, it is not appropriate for evaluating all new projects. It should be adjusted upward for projects with greater-than-average risk and downward for projects with less-than-average risk.Are Statement 1 and Statement 2, as made by Haggerty CORRECT? a) Statement 1- Correct; Statement 2- Incorrect b) Statement 1- Correct; Statement 2- Correct c) Statement 1- Incorrect; Statement 2- Correct
B
BPM Ltd. has the following capital structure: 40% debt and 60% equity. The cost of retained earnings is 13%, and the cost of new common stock is 16%. BPM will not have any retained earnings available in the upcoming year. Its before tax cost of debt is 8%, and its corporate tax rate is 40%. BPM is considering between two mutually exclusive projects that have the following cash flows:Which project should BPM choose? a) Project A since its NPV is $16 million. b) Project A since its net present value (NPV) is +$5.01 million. c) Project B since its NPV is $22 million.
B
Rochelle Dixon is delivering a presentation on best practices for corporate governance. One of her recommendations is: "The more members a Board of Directors has, the more likely it is to represent shareholders' interests fairly."Is Dixon's statement CORRECT? a) Yes b) No
B
The company has a target capital structure of 40% debt and 60% equity.Bonds pay 10% coupon (semi-annual payout), mature in 20 years, and sell for $849.54.The company stock beta is 1.2.Risk-free rate is 10%, and market risk premium is 5%.The company is a constant growth firm that just paid a dividend of $2.00, sells for $27.00 per share, and has a growth rate of 8%.The company's marginal tax rate is 40%.The after-tax cost of debt is: a) 8.0%. b) 7.2%. c) 9.1%.
B
Which of the following activities would least likely be an example of good corporate governance? a) The board has decided to eliminate finders' fees for its members for any potential acquisitions that are brought to management's attention. b) Management is allowed to act independently of board of directors. c) The board of directors has decided to conduct a self-assessment.
B
Which of the following statements about NPV and IRR is least accurate? a) The IRR is the discount rate that equates the present value of the cash inflows with the present value of outflows. b) For mutually exclusive projects, if the NPV method and the IRR method give conflicting rankings, the analyst should use the IRRs to select the project. c) The NPV method assumes that cash flows will be reinvested at the cost of capital, while IRR rankings implicitly assume that cash flows are reinvested at the IRR.
B
Which of the following statements about the payback period method is least accurate? The payback period: a) provides a rough measure of a project's liquidity. b) considers all cash flows throughout the entire life of a project. c) is the number of years it takes to recover the original cost of the investment.
B
Which of the following statements regarding leverage is most accurate? a) A firm with high business risk is more likely to increase its use of financial leverage than a firm with low business risk. b) A firm with low operating leverage has a small proportion of its total costs in fixed costs. c) High levels of financial leverage increase business risk while high levels of operating leverage will decrease business risk.
B
A company is considering a $10,000 project that will last 5 years.Annual after tax cash flows are expected to be $3,000Target debt/equity ratio is 0.4Cost of equity is 12%Cost of debt is 6%Tax rate 34%What is the project's net present value (NPV)? a) -$1,460. b) $1,245 c) $1,460.
C
A firm has $100 in equity and $300 in debt. The firm recently issued bonds at the market required rate of 9%. The firm's beta is 1.125, the risk-free rate is 6%, and the expected return in the market is 14%. Assume the firm is at their optimal capital structure and the firm's tax rate is 40%. What is the firm's weighted average cost of capital (WACC)? a) 8.6%. b) 5.4%. c) 7.8%.
C
As the director of capital budgeting for Denver Corporation, you are evaluating two mutually exclusive projects with the following net cash flows: Year Project X Project Z 0 -$100,000 -$100,000 1 $50,000 $10,000 2 $40,000 $30,000 3 $30,000 $40,000 4 $10,000 $60,000 If Denver's cost of capital is 15%, which project should be chosen? a) Project X, since it has the higher IRR. b) Project X, since it has the higher net present value (NPV). c) Neither project.
C
Investors have a duty to determine whether the board has properly established committees of independent board members to help carry out various board functions. Which of the following statements about the "audit committee" is least accurate? a) The audit committee should ensure that the audit is conducted consistent with generally accepted auditing standards (GAAS). b) The audit committee should ensure that the independent auditors have authority over the audit of the entire corporate group, which includes foreign subs and affiliates. a) Firm management is responsible for hiring and supervising the independent external auditors, but the audit committee has strict oversight responsibilities.
C
Justin Lopez, CFA, is the Chief Financial Officer of Waterbury Corporation. Lopez has just been informed that the U.S. Internal Revenue Code may be revised such that the maximum marginal corporate tax rate will be increased. Since Waterbury's taxable income is routinely in the highest marginal tax bracket, Lopez is concerned about the potential impact of the proposed change. Assuming that Waterbury maintains its target capital structure, which of the following is least likely to be affected by the proposed tax change? a) Waterbury's return on equity (ROE). b) Waterbury's after-tax cost of corporate debt. c) Waterbury's after-tax cost of preferred stock.
C
The NPV profiles of two projects will intersect: a) at their internal rates of return. b) if they have different discount rates. c) at the discount rate that makes their net present values equal.
C
The company has a target capital structure of 40% debt and 60% equity. Bonds pay 10% coupon (semi-annual payout), mature in 20 years, and sell for $849.54. The company stock beta is 1.2. Risk-free rate is 10%, and market risk premium is 5%. The company is a constant growth firm that just paid a dividend of $2.00, sells for $27.00 per share, and has a growth rate of 8%. The company marginal tax rate is 40%. The cost of equity using the capital asset pricing model (CAPM) approach and the dividend discount model (DDM) approach is: a) CAPM: 16.0%; DDM: 15.4% b) CAPM: 16.6%; DDM: 15.4% c) CAPM: 16.0%; DDM: 16.0%
C
