HMD 340 Final Exam
Jose's Diner has identified an investment project with the following cash flows. If the discount rate is 8 percent, what is the future value of these cash flows in Year 4? a) $6,884 b) $5,681 c) $4,234 d) $1,235
FV@8% = $1,250*(1.08) 3 + $1,450*(1.08) 2 +$1,600*(1.08) + $1,890 = $6,884
A firm's weighted average cost of capital is the average cost of the various short-term sources of financing employed by the firm.
False
An investment that pays $1,000 in a year, $1,500 in two years, and $2,000 in three years can properly be described as an annuity.
False
Everything else being the same, the higher the interest rate, the higher the present value.
False
If an interest rate is compounded monthly, the annual nominal rate is greater than the effective annual rate.
False
In capital budgeting, the cost of starting a project is called the annual net cash flow.
False
Issuance or flotation costs are the costs investors pay to brokers when they purchase common stock.
False
The cost of a firm's internal common equity is generally equal to the costs of a firm's external common equity.
False
The discounted payback period does not take into account the time value of money.
False
The length of time it takes for a company to recoup the money paid for the initial investment in a project is referred to as the internal rate of return.
False
The net present value is the ratio of a project's benefits to its costs.
False
When companies desire to fund a project with debt financing, they sell stock certificates to raise capital.
False
The cost of raising capital with debt is typically less costly for a firm than raising capital with preferred stock. Which one of the following is one of the reasons for this?
Interest is a tax-deductible cost, preferred dividends are not.
The cost of raising capital with debt is typically less costly for a firm than raising capital with preferred stock. Which one of the following is one of the reasons for this?
Interest on debt is a tax-deductible cost, preferred dividends are not
Shamas Famous Restaurants expects to pay a common stock dividend of $1.50 per share next year (d1). Dividends are expected to grow at a 4% rate for the foreseeable future. Shamas' common stock is selling for $18.50 per share and issuance costs are $3.50 per share. What is Shamas cost of external equity?
NOT 12.11%
A restaurant company evaluates all of its projects by applying the NPV decision rule. A project under consideration has the following cash flows: Year Cash Flow 0 -55,000 1 12,000 2 12,000 3 13,500 4 13,500 5 13,500 What is the NPV for the project if the required return is 11 percent? At a required return of 11 percent, should the firm accept this project?
NPV=-$7,674; reject the project
Which of the following methods properly ranks projects' contribution to firm value when the project shave scale differences?
Net present value
Which of the following is true for 5-year project with a 3-year payback period?
Not enough information to determine anything about the project's net present value
A capital budgeting project is expected to have the following cash flows: Year Cash Flows 0 -$340,000 1 $170,000 2 $220,000 What is the profitability index of the project if the required rate of return is 12%?
PV of FCs = 170,000/(1+0.12) + 220,000/(1+0.12)2 = 327,168 PI = 327,168 / 340,000 = 0.96
Which one of the following capital budgeting decision methods measures how long it takes for a project's benefits to recover the project's cost?
Payback period
Which one of the following statements related to the internal rate of return (IRR) is correct?
The IRR is equal to the required return when the net present value is equal to zero.
Which of the following properly describes the present value of an annuity due?
The first payment is on the same date as the present value.
The payback period investment method shows:
The number of years that it will take to recover the initial investment less eventual trade-in value
Which of the following is true for a project with an expected net present value of $200,000?
The project is expected to increase firm value by $200,000 in present value terms.
A major drawback of payback period method is that it does not take into account all cash flows from the project.
True
An infinite annuity is called a perpetuity.
True
Everything else being the same, the longer a lump sum is kept in an interest earning account, the larger the interest earnings on this investment will be.
True
Taxes are a relevant cost that should be accounted for in the firm's weighted average cost of capital.
True
The process of computing the present value of a future value is called discounting.
True
The weights in a firm's weighted average cost of capital should be a measure of the firm's target capital structure.
True
When making a capital budgeting decision, cash flows should be estimated on an incremental basis,not a total basis.
True
Joys Restaurants Inc., has a target capital structure of 60 percent common stock, 10 percent preferred stock, and 30 percent debt. Its cost of equity is 12 percent, the cost of preferred stock is 7 percent, and the pretax cost of debt is 5percent. The relevant tax rate is 21 percent. Given the information, what is the WACC of the company?
WACC = .60*(.12) + .1*(.07) + .30*[(.05)*(1 - .21)] WACC = .0909, or 9.09%
If the present value of the future cash inflows exceeds the initial cost of a given project, then the project should be:
accepted because the profitability index is greater than 1
Suppose you are borrowing money at a 10% annual nominal interest rate. To pay as little as possible, which one of the following compounding periods should you prefer?
annually
Keeping a project's future cash flows and the discount rate the same, increasing the project's initial cost at time zero would:
decrease the NPV of the project
Which model is typically used to estimate the cost of using external equity capital?
dividend valuation model
Truman Restaurants expects to pay a common stock dividend of $2.50 per share next year (d1 ). Dividends are expected to grow at a 5% rate for the foreseeable future. Truman's common stock is selling for $21.5 per share and issuance costs are $4.50 per share. What is Truman's cost of external equity?
ke = (d1 / Pnet ) + g ke = (2.5 / (21.5 - 4.5)) + 0.05 ke = 0.1471 + 0.05 = 0.1971 or 19.71%
Simons Tours Corp. is financed 100% with equity. Simons' common stock beta is 1.4, the expected market return is 12%, and the risk-free rate is 5%. What is the cost of equity for Simons?
ke = 0.05 + (0.12- 0.05)*1.4 = 0.148 or 14.8%
Jose's Cantinas Incorporated plans to issue preferred stock at a price of $48 per share. The annual dividend will be $5.10 per share and issuance costs are expected to be $3.00 per share. What is the cost of raising funds with preferred stock for Jose's?
kp = 5.10 / (48 - 3) = 0.1133 or 11.33%
A firm's weighted average cost of capital should not do which one of the following?
measure the cost of short-term sources of funds
The profitability index is most closely related to which one of the following?
net present value
The cost of external equity is greater than the cost of internal equity because
of the flotation or issuance costs.
Which one of the following capital budgeting decision methods measures how long it takes for a project's benefits to recover the project's cost?
payback period
Which of the following is typically not treated as one of the components of capital in cost of capital schedule calculations?
short-term debt
Which of the following should not be included in a firm's cost of capital estimation?
the cost of seasonal sources of short-term debt
The financial concept that suggests that money has different values in the future is called
time value of money
You plan to invest $2,000 at the end of each of the next 25 years. If the investment earns 7% annually, what is the investment worth at the end of 25 years?
$126,498.08
Dyson Hotels, Inc., has an unfunded pension liability of $400,000 that must be paid in 15 years. To assess the value of the firm's stock, financial analysts want to discount this liability back to the present. If the relevant discount rate is 6.6 percent, what is the present value of this liability? (Round to two decimals)
$153,356.41
If you deposit $12,550 at the end of each of the next 10 years into an account paying 7 percent interest, how much money will you have in the account in 10 years?
$173,396.42
Odarta can afford to pay $12,000 at the end of each of the next 30 years to repay a home loan. If the interest rate is 5.50%, what is the most Odarta can borrow?
$174,404.94
A capital budgeting project is expected to have the following cash flows: Year Cash Flows 0 -$740,000 1 $240,000 2 $550,000 3 $480,000 What is the project's net present value at an 16% required rate of return?
$183,151.83
A firm evaluates all of its projects by applying the NPV decision rule. A project under consideration has the following cash flows: Year Cash Flow 0 -27,700 1 11,700 2 14,700 3 10,700 What is the NPV for the project if the required return is 12 percent?
$2,081.23
Henry's Diner Inc. is planning a renovation project that will cost them $150,000 today. They will use a bank loan for this project that calls for monthly payments over the next 5 years. If the interest rate on the loan is 6%, what is the monthly payments?
$2,899.92
A capital budgeting project has a net investment of $450,000 and is expected to generate net cash flows of $150,000 annually for 5 years. What is the net present value at a 15% required rate of return?
$52,823.26
See the information below for an investment project. Year Cash Flow 0 -17,300 1 9,600 2 8,500 3 5,000 What is the profitability index for the set of cash flows if the relevant discount rate is 9 percent?
1.15
Spencers Magic Shows Incorporated is financed 100% with equity and intends to remain this way. Spencers' common stock beta is 0.85, the expected market return (average market return) is 14%, and the risk-free rate is 6%. If all of Spencers' equity is internal, what are the cost of equity and the weighted average cost of capital for Spencers?
12.80%
A capital budgeting project is expected to have the following cash flows: Year Cash Flows 0 -$900,000 1 $350,000 2 $400,000 3 $420,000 What is the project's internal rate of return?
13.89%
A firm evaluates all of its projects by applying the IRR rule. A project under consideration has the following cash flows: Year Cash Flow 0 -28,600 1 12,600 2 15,600 3 11,600 What is the IRR of this project? If the required return is 14 percent, should the firm accept the project?
18.75%, accept
Happy's Cafe is evaluating a project with the following cash flows: Year Cash Flow 0 -29,400 1 11,600 2 14,300 3 16,200 4 13,300 The company uses an interest rate of 8 percent on all of its projects. What is the IRR of the project?
30.03%
Tokyo Food Supplies Corporation sold an issue of 12-year bonds. The bonds sold at $980 each. After issuance costs, Tokyo Food Supplies received $975 each. The maturity value is $1,000 each and the coupon rate is 9% and paid annually. What is the after-tax cost of debt for these bonds if Tokyo Food Supplies' marginal tax rate is 40%?
5.61%
A money multiplier certificate is selling for $8,000 today and promises to be worth $10,000 in 3 years. What is the rate of return on this investment?
7.72%
Young's Specialized Cruises plans to issue preferred stock at a price of $25 per share. The annual dividend will be $2.18 per share and issuance costs are expected to be $2.00 per share. What is the cost of raising funds with preferred stock for Young?
9.48%
Why is external common equity capital more expensive then internal common equity capital?
Because the cost of external must take into account flotation costs, internal does not.
Discounting is defined as
Calculating the present value of projected cash flows using a proper interest rate.
__________ represents the long-term or permanent sources of the firm's financing.
Capital structure
