1. Which of the following statements is most accurate regarding a firm's cost of preferred shares? A firm's cost of preferred stock is:
A.the market price of the preferred shares as a percentage of its issuance price.
B.the dividend yield on the firm's newly-issued preferred stock.
C.approximately equal to the market price of the firm's debt as a percentage of the market price of its common shares.
A B C
B
The newly-issued preferred shares of most companies generally sell at par. As such, the dividend yield on a firm's newly-issued preferred shares is the market's required rate of return. The yield on a BBB corporate bond reflects a pre-tax cost of debt. The other choices make no sense.
2. Helmut Humm, manager at a large U. S. firm, has just been assigned to the capital budgeting area to replace a person who left suddenly. One of Humm's first tasks is to calculate the company's weighted average cost of capital (WACC). Humm finds clear notes on the target capital component weights. Unfortunately, all he can find for the cost of capital components is some handwritten notes. He can make out the numbers, but not the corresponding capital component. So, he has to guess. Here is what Humm deciphered: Target weights : wd = 30% , wps = 20% , wce= 50% , where wd, wps, and wce are the weights used for debt, preferred stock, and common equity. Cost of components (in no particular order) : 6.0% , 15.0% , and 8.5%. The cost of debt is the after-tax cost. If Humm guesses correctly, the WACC is:
A.9.2%.
B.11.0%.
C.9.0%.
A B C
B
If Humm remembers to order the capital components from cheapest to most expensive, he can calculate WACC. The order from cheapest to most expensive is: debt, preferred stock (which acts like a hybrid of debt and equity) , and common equity. Then, using the formula for WACC = ( wd ) ( kd ) + ( wps ) ( kps) + ( wce ) ( kce ) where wd, wps, and we are the weights used for debt, preferred stock, and common equity. WACC= (0.30 ×6.0%) + (0.20 ×8.5%) +(0.50 ×15.00%) =11.0%.
3. If the calculated net present value (NPV) is negative, which of the following must be TRUE? The discount rate used is:
A.equal to the internal rate of return (IRR).
B.greater than the internal rate of return (IRR).
C.less than the internal rate of return (IRR).
A B C
B
When the NPV = 0, this means the discount rate used is equal to the IRR. If a discount rate is used that is higher than the IRR, the NPV will be negative. Conversely, if a discount rate is used that is lower than the IRR, the NPV will be positive.
4. Projected net capital expenditures and financing decisions are most important as a component of a firm's:
A.pro-forma income statement.
B.expected operating cash flows.
C.long-term cash flow forecast.
A B C
C
Long-term cash flow forecasts are derived from projected income statements and balance sheets for future years that are based on statistical models of sales, credit collections, and input costs, as well as planned capital expenditures, asset sales, and financings. Pro-forma income statements can be affected by projected capital expenditures (through expected depreciation expense) and financing ( through interest expense) but long-term cash flow forecasts are more directly affected by expected capital expenditures and financing activities. Operating cash flows are not directly affected by financing and capital spending decisions (only indirectly through interest and taxes), which are classified as financing and investing activities, not operating activities.
5. Jamal Winfield is an analyst with Stolzenbach Technologies, a major computer services company based in the U.S. Stolzenbach's management team is considering opening new stores in Mexico, and wants to estimate the cost of equity capital for Stolzenbach's investment in Mexico. Winfield has researched bond yields in Mexico and found that the yield on a Mexican government 10-year bond is 7.7 percent. A similar maturity U.S. Treasury bond has a yield of 4.6 percent. In the most recent year, the standard deviation of Mexico's All Share Index stock index and the S&P 500 index was 38 percent and 20 percent respectively. The annualized standard deviation of the Mexican dollar-denominated 10-year government bond over the last year was 26 percent. Winfield has also determined that the appropriate beta to use for the project is 1.25, and the market risk premium is 6 percent. The risk free interest rate is 4.2 percent. What is the appropriate country risk premium for Mexico and what is the cost of equity that Winfield should use in his analysis? Country Risk Premium for Mexico Cost of Equity for Project ①A. 4.53% 19.06% ②B. 5.89% 17.36% ③C. 4.53% 17.36%
6. Randox Industries has the following investment policy statement: "In order to achieve the safety and liquidity necessary in the investment of excess cash balances, the CFO or his designee may invest excess cash balances in 30 - day U. S. Treasury bills, or in bankers acceptances with maturities of less than 31 days or 30 - day certificates of deposit, where the credit rating of the issuing bank is A + or higher. " This policy statement is.
A.appropriate because these are all safe, liquid securities.
B.inappropriate because it is too restrictive.
C.inappropriate because both banker's acceptances and certificates of deposit are illiquid.
A B C
B
The policy statement is inappropriate because it is too restrictive. A policy statement should focus on meeting the specific safety and liquidity needs of the firm but should also allow the flexibility to increase yield within these constraints. There are many other securities potentially suitable for cash management that would provide equivalent or better liquidity and safety of principal at least equivalent to that of the securities issued by A + rated banks.
7. Project sequencing is best described as:
A.prioritizing funds to achieve the maximum value for shareholders, given capital limitations.
B.selecting the first project from a set of mutually exclusive projects.
C.an investment in a project today that creates the opportunity to invest in other projects in the future.
A B C
C
Projects are often sequenced through time so that investing in a project today may create the opportunity to invest in other projects in the future. Note that funding from the first project is not a requirement for project sequencing.
8. Which of the following strategies is most likely to be considered good payables management?
A.Paying trade invoices on the day they arrive.
B.Paying invoices on the last possible day to still get the supplier's discount for early payment.
C.Taking trade discounts only if the firm's annual return on short-term investments is less than the discount percentage.
A B C
B
Paying invoices on the last day to get a discount (for early payment) ifs often the most advantageous strategy for a firm. If the annualized percentage cost of not taking advantage of the discount is less than the firm's short-term cost of funds, it would be advantageous to pay on the due date. Paying prior to the discount cut-off date or prior to the due date sacrifices interest income for no advantage.
9. Enamel Manufacturing (EM) is considering investing in a new vehicle. EM finances new projects using retained earnings and bank loans. This new vehicle is expected to have the same level of risk as the typical investment made by EM. Which one of the following should the firm use in making its decision?
A.After-tax cost of debt.
B.Marginal cost of capital.
C.Cost of preferred stock.
A B C
B
The marginal cost of capital represents the cost of raising an additional dollar of capital. Preferred stock is not a method of financing for the company. The cost of retained earnings would only be appropriate if the company avoided creditor-supplied financing or the issuance of new common or preferred stock (and preferred stock financing). The after-tax cost of debt is never sufficient, because a business, regardless of their size, always has a residual owner, and hence a cost of equity.
10. An analyst is forecasting a company's financial performance for the next year and prepares the following pro forma financial statements.
Actual
Estimated
20X1
20X2
Sales
1000000
1010000
Cost of goods sold
600000
606000
SG&A expenses
300000
303000
Interest expense
72000
72000
Earnigs before tax
20000
29000
Income tax
7000
7250
Net income
21000
21750
Dividends
8400
8700
Retained earnings
12600
13050
Pro Forma Balance Sheet
Actual
Estimated
20X1
20X2
Current assets
600000
606000
PP&E,net
1300000
1313000
Total assets
1900000
1919000
Current liabilities
200000
202000
Long-term debt
900000
900000
Common stock
300000
300000
Retained earnings
500000
513050
Total liabilities and equity
1900000
1915050
The analyst is most likely to reconcile these pro forma financial statements by assuming the company:
A.pays out the financial surplus as additional dividends.
B.uses the financial surplus to pay down long-term debt.
C.resolves the financial deficit by issuing long-term debt.
A B C
C
On the pro forma balance sheet, total liabilities and equity are less than total assets, holding the amounts of debt and stock outstanding constant. This means projected retained earnings, although positive, are not enough to keep the accounting equation in balance. To resolve this financial deficit (reconcile the pro forma financial statements) , the analyst can assume the company issues new debt or stock or reduces its dividend payout ratio.
11. The expected dividend one year from today is $2.50 for a share of stock priced at $22.50. The long-term growth in dividends is projected at 8 percent. The cost of common equity is closest to :
12. An analyst computes the following ratios for Iridescent Carpeting Inc. and compares the results to the industry averages:
Financial Ratio
Iridescent Carpeting
Industry Average
Current Ratio
2.3x
1.8x
Net Profit Margin
22%
24%
Return on Equity
17%
20%
Total Debt / Total Capital
35%
56%
Times Interest Earned
4.7x
4.1x
Based on the above data, which of the following can the analyst conclude?
A.Iridescent Carpeting has better short-term liquidity than its competitors.
B.Iridescent Carpeting has stronger profitability than its competitors.
C.Iridescent Carpeting has more financial risk than its competitors.
A B C
A
Based on the data provided, the analyst can conclude that Iridescent Carpeting has weaker profitability than its competitors based on the net profit margin and return on equity. The analyst can also conclude that the company has less financial leverage (risk) than the, industry average based on the total debt / total capital and the times interest earned ratios. The analyst can conclude that the company has better short-term liquidity than the industry average ( i. e. , its competitors ) based on the current ratio.
13. Which of the following statements regarding long-term forecasts of cash flows is most accurate? Long-term cash flow forecasts are:
A.constructed from recent daily and weekly cash flows.
B.are usually more accurate than short term cash flow forecasts.
C.based on pro-forma balance sheet projections for future years.
A B C
C
Long-term forecasts are derived from projected income statements and balance sheets for future years that are based on statistical models of sales, credit collections, and input costs as well as planned capital expenditures, asset sales, and financings.
14. The company has a target capital structure of 40 percent debt and 60 percent equity. Bonds pay 10 percent 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 percent, and market risk premium is 5 percent. 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 percent. The company's marginal tax rate is 40 percent. The after-tax cost of debt is:
A.8.0%.
B.9.1%.
C.7.2%.
A B C
C
n =40, PMT=50, FV= 1000, PV=849.54, CPT I =6% , double = 12% , now 12 × (1 - 0.4) =7.2%.
15. Which of the following statements regarding corporate governance practices is FALSE?
A.Corporate governance is the system of internal controls/procedures by which firms are managed.
B.Corporate governance provides a framework that defines rights of management and the board.
C.Corporate governance is not as important for firms with largely dispersed minority shareholders.
A B C
C
Good corporate governance practices are extremely important in the case of firms with largely dispersed minority shareholders. The other statements are correct.
16. A board of directors is most likely to protect the shareholders' interests when:
A.the board requires that management attend all meetings.
B.the board includes representatives from the firm's key customers and suppliers.
C.one individual can be identified as the leading board member from outside the firm.
A B C
C
Especially in cases where the chairman of the board is closely aligned with the firm, independent board members are more able to protect shareholders' interests when they have a leading or primary independent member. The board should meet regularly outside the presence of management. Board members who represent the firm's customers and suppliers may have interests that conflict with those of shareholders. A board is unlikely to be independent if the firm's management comprises a majority.
17. A company has the following data associated with it: A target capital structure of 10% preferred stock, 50% common equity and 40% debt. Outstanding 20-year annual pay 6% coupon bonds selling for $894. Common stock selling for $45 per share that is expected to grow at 8% and expected to pay a $2 dividend one year from today. Their $100 par preferred stock currently sells for $90 and is earning 5%. The company's tax rate is 40%. What is the after tax cost of debt capital and after tax cost of preferred stock capital? Debt Capital Preferred Stock Capital ①A. 4.2% 6.3% ②B. 4.5% 5.6% ③C. 4.2% 5.6%
18. When calculating the weighted average cost of capital (WACC) an adjustment is made for taxes because :
A.equity is risky.
B.preferred stock is used.
C.the interest on debt is tax deductible.
A B C
C
Equity and preferred stock are not adjusted for taxes because dividends are not deductible for corporate taxes. Only interest expense is deductible for corporate taxes.
19. Which of the following statements about the discounted payback period is FALSE? The discounted payback :
A.period is generally shorter than the regular payback.
B.frequently ignores terminal values.
C.period is the time it takes for the present value of the project cash inflows to equal the cost of the investment.
A B C
A
The discounted payback period calculates the present value of the future cash flows. Because these present values will be less than the actual cash flows it will take a longer time period to recover the original investment amount.
20. Which of the following projects would have multiple internal rates of return (IRRs)? The cost of capital for all projects is 9.75 percent.
Cash Flows
Blackjack
Roulette
Keno
T0
-10000
-12000
-8000
T1
10000
7000
4000
T2
15000
2000
0
T3
-10000
2000
6000
A.Projects Roulette and Keno.
B.Project Blackjack only.
C.Project Keno only.
A B C
B
The multiple IRR problem occurs if a project has non-normal cash flows, that is, the sign of the net cash flows changes from negative to positive to negative, or vice versa. For the exam, a shortcut to look for is the project cash flows changing signs more than once. Only Project Blackjack has this cash flow pattern. The net cash flow in T2 for Project Keno and likely negative net present value (NPV) for Project Roulette would not necessarily result in multiple IRRs.
21. Jeffery Marian, an analyst with Arlington Machinery, is estimating a country risk premium to include in his estimate of the cost of equity for a project Arlington is starting in India. Marian has compiled the following information for his analysis: Indian 10-year government bond yield=7.20%. 10-year U. S. Treasury bond yield =4.60%. Annualized standard deviation of the Bombay Sen stock index =40%. Annualized standard deviation of Indian dollar denominated 10-year government bond=24%. Annualized standard deviation of the S&P 500 Index = 18%. The estimated country risk premium for India based on Marian's research is closest to:
A.5.8%.
B.2.6%.
C.4.3%.
A B C
C
072 - 0.046 ) × (0.40/0.24) = 0.043, or 4.3 %.
22. Stolzenbach Technologies has a target capital structure of 60 percent equity and 40 percent debt. The schedule of financing costs for the Stolzenbach is shown in the table below:
Amount of New Debt (in millions)
After-tax Cost of Debt
Amount of New Equity (in millions)
Cost of Equity
$0 to $199
4.5 percent
$0 to $299
7.5 percent
$200 to $399
5.0 percent
$300 to $699
8.5 percent
$400 to $599
5.5 percent
$700 to $999
9.5 percent
Stolzenbach Technologies has breakpoints for raising additional financing at both:
A.$500 million and $1000 million.
B.$400 million and $700 million.
C.$500 million and $700 million.
A B C
A
Stolzenbach will have a break point each time a component cost of capital changes, for a total of three marginal cost of capital schedule breakpoints.
23. A large, creditworthy manufacturing firm would most likely get short-term financing by:
A.factoring its receivables.
B.issuing commercial paper.
C.entering into an agreement for a committed line of credit.
A B C
B
Large, creditworthy firms can get the lowest cost of financing by issuing commercial paper. Selling receivables to a factor is a higher cost source of funds used by firms with poor credit quality. A committed line of credit requires payment of a fee and represents bank borrowing, which would be attractive to a firm that did not have the size or creditworthiness to issue commercial paper. Banker's acceptances are issued by banks for the benefit of a customer who imports goods.
24. Cullen Casket Company is considering a project that requires a $175000 cash outlay and is expected to produce cash flows of $65000 per year for the next four years. Cullen's tax rate is 40 percent and the before-tax cost of debt is 9 percent. The current share price for Cullen stock is $32 per share and the expected dividend next year is $1.50 per share. Cullen's expected growth rate is 5 percent. Cullen finances the project with 70 percent newly issued equity and 30 percent debt, and the flotation costs for equity are 4.5 percent. What is the dollar amount of the flotation costs attributable to the project, and that is the NPV for the project, assuming that flotation costs are accounted for correctly? Dollar amount of floatation costs NPV of project ①A. $5513 $30510 ②B. $5513 $32872 ③C. $7875 $32872
A.①
B.②
C.③
A B C
B
In order to determine the discount rate, we need to calculate the WACC. After-tax cost of debt =9.0% × (1 -0.40) =5.40% Cost of equity=( $1.50/ $32.00) +0.05=0.0469+0.05=0.0969, or 9.69% WACC =0.70 ×9.69% +0.30 ×5.40% =8.40% Since the project is financed with 70% newly issued equity, the amount of equity capital raised is 0.70 × $175000 = $122500 Flotation costs are 4.5 percent, which equates to a dollar flotation cost of $122500 × 0.045 = $5512.50.
25. A firm is choosing among three short-term investment securities: Security 1 - A 30 - day U. S. Treasury bill with a discount yield of 3.6%. Security 2 - A 30 - day banker's acceptance selling at 99.65% of face value. Security 3 - A 30 - day time deposit with a bond equivalent yield of 3.65%. Based only on these securities' yields, the firm would:
A.prefer the banker's acceptance.
B.prefer the time deposit.
C.prefer the U. S. Treasury bill.
A B C
A
We can compare the yields of these securities on any single basis. The preferred basis is the bond equivalent yield. Security 1 = discount is 3.6% × (30/360) =0.3% BEY of Security 2 = (0.35/99.65) × (365/30) = 4.273% BEY of Security 3 =3.65%
26.
Ratio
2003
2004
Net profit margin
0.15
0.18
Total asset turnover
1.60
1.75
Financial leverage multiplier
1.00
1.50
The return on equity (ROE) for 2003 and 2004 respectively is :
A.8% and 24%.
B.24% and 47%.
C.24% and 8%.
A B C
B
ROE for 2003 : 0.15 ×1.6 × 1.0 =24%. Similarly, for 2004, ROE will be 47%.
27. A critical corporate governance issue is ensuring that the board and its members have the requisite experienced needed to properly govern the firm for the shareholders' benefit. When considering board member qualifications, investors and shareholders should consider whether board members can act with care and competence as a result of their experience with all of the following EXCEPT :
A.technologies, products, services which the firm offers.
B.the competitive landscape the firm faces.
C.strategies and planning.
A B C
A
Knowledge of the firm's competitive landscape is likely beyond what a board member should have intimate knowledge about. The other items are all issues a board member should be knowledgeable about. Other issues board members should have experience with include financial operations, accounting and auditing topics, and business risks the firm faces.
28. Which of the following statements about NPV and IRR is FALSE?
A.The NPV method assumes that all cash flows are reinvested at the cost of capital.
B.For independent projects if the IRR is > the cost of capital accept the project.
C.For mutually exclusive projects you should use the IRR to rank and select projects.
A B C
C
For mutually exclusive projects you should use NPV to rank and select projects.
29. Which of the following ratios is NOT part of the original DuPont system?
A.Debt to total capital.
B.Asset turnover.
C.Equity multiplier.
A B C
A
The debt to total capital ratio is not part of the original DuPont system. The firm's leverage is accounted for through the equity multiplier.
30. Which of the following statements about the cost of capital is TRUE?
A.Ideally, historical measures of the component costs from prior financing should be used in estimating the appropriate weighted average cost of capital.
B.The cost of issuing new equity could possibly be lower than the cost of retained earnings if the market risk premium and risk-free rate decline by a substantial amount.
C.In the weighted average cost of capital calculation, the cost of preferred stock must be adjusted for the cost to issue new preferred stock.
A B C
C
The marginal cost of capital will increase or stay the same as more capital is raised. Marginal costs of capital, not historical costs, should be used in estimating the weighted average cost of capital.
31. In preparing a cash flow forecast, a firm is likely to employ a minimum acceptable cash balance:
A.of zero.
B.that includes a component for opportunities that may arise.
C.equal to the amount necessary to pay projected payables, interest, taxes, and day-to-day expenses.
A B C
B
Firms typically establish some minimum level of cash balances that they feel are necessary for their business. Cash may be needed for unforeseen costs as well as to take advantage of opportunities that arise, such as discount prices on important inputs.
32. The NPV profile is a graphical representation of the change in net present value relative to a change in the:
A.prime rate.
B.payback period.
C.discount rate.
A B C
C
As discount rates change the net present values change. The NPV profile is a graphic illustration of how sensitive net present values are to different discount rates. By comparison, every project has a single internal rate of return and payback period because the values are determined solely by the investment's expected cash flows.
33. The least appropriate security for investing short-term excess cash balances would be:
A.bank certificates of deposit.
B.preferred stock.
C.time deposits.
A B C
B
While adjustable-rate preferred is an appropriate security for short-term investment of excess cash balances, other preferred shares are not. Bank certificates of deposit and time deposits can be for appropriately short periods.
34. When using net present value (NPV) profiles:
A.the NPV profile's intersection with the horizontal x-axis identifies the amount of profit the project will make.
B.the NPV profile's intersection with the vertical y-axis identifies the project's internal rate of return.
C.one should accept all independent projects with positive NPVs.
A B C
C
Where the NPV intersects the vertical y-axis you have the value of the cash inflows less the cash outflows, assuming an absence of money having a time value ( i. e. , the discount rate is zero). Where the NPV intersects the horizontal x-axis you have the project's internal rate of return. At this cost of financing, the cash inflows and cash outflows offset each other. The NPV profile is a tool that graphically plots the project's NPV as calculated using different discount rates. Assuming an appropriate discount rate, one should accept all projects with positive net present values, if the projects are independent. If projects are mutually exclusive select the one with the higher NPV at any given level of the cost of capital.
35. A company has the following capital structure: Target weightings: 30% debt, 20% preferred stock, 50% common equity. Tax Rate: 35%. The firm can issue $1000 face value, 7.00% semi-annual coupon debt with a 15-year maturity for a price of $1047.46. An 8.0% dividend preferred stock issue has a value of $35 per share. The company's growth rate is estimated at 6.0%. The company's common shares have a value of $40 and a dividend in year 0 of DO = $3.00. The company's weighted average cost of capital is closest to:
A.9.84%.
B.9.28%.
C.9.21%.
A B C
A
Step 1 : Determine the after-tax cost of debt: The after-tax cost of debt [ kd ( 1 - t) ] is used to compute the weighted average cost of capital. It is the interest rate on new debt (kd) less the tax savings due to the deductibility of interest (kdt). Here, we are given the inputs needed to calculate kd: n = 15 × 2 = 30, PMT = (1000 × 0.07)/2 = 35, FV = 1000, PV = - 1047.46, CPT I = 3.25, multiply by 2 = 6.50%. Thus, kd(1 -t) =6.50% × (1 -0.35) =4.22% Step 2: Determine the cost of preferred stock: Preferred stock is a perpetuity that pays a fixed dividend (Dps) forever. The cost of preferred stock (kps) = Dps/P where Dps = preferred dividends. P = price. Here, Dps =0.08 × $35.00 = $2.80, so kps =Dps/ P = $2.80/$35 =0.08, or 8.0%. Step 3: Determine the cost of common equity: kce = (D1/ P0) +g where D1 = Dividend in next year P0 = Current stock price g = Dividend growth rate Here, D1 =D0×(1 +g) = $3.00×( 1 +0.06) = $3.18. k = (3.18 / 40) +0.06 =0.1395 or 13.95%. Step 4 : Calculate WACC : WACC = (wd) × (kd) + (wps) × (kps) + (wce) × (kce) where wd, wps, and wce are the weights used for debt, preferred stock, and common equity. Here, WACC = (0.30 ×4.22%) + (0.20 ×8.0%) + (0.50 ×13.95%) =9.84%. Note: Your calculation may differ slightly, depending on whether you carry all calculations in your calculator, or round to two decimals and then calculate.
36. Which of the following characteristics is least likely required to ensure that a company's Board of Directors Audit Committee is adequately representing shareowner interests?
A.Any conflicts between the external auditor and the firm are resolved in a manner that favors shareholders.
B.The shareholders vote on whether to approve of the board's selection of the external auditor.
C.The committee regularly reviews the performance, independence, skills, and experience of existing board members.
A B C
C
Regularly reviewing performance, independence, skills, and experience of existing board members is a characteristic of the Remunerations/Compensation Committee, not the Audit Committee . All other choices are positive characteristics of the Audit Committee.
37. A company is planning a $50 million expansion. The expansion is to be financed by selling $20 million in new debt and $30 million in new common stock. The before-tax required return on debt is 9 percent and 14 percent for equity. If the company is in the 40 percent tax bracket, what is the marginal weighted average cost of capital?
A.10.6%.
B.9.0%.
C.10.0%.
A B C
A
4 ×9 × (1 -0.4) +0.6 ×16 =0.106.
38. A firm has $3 million in outstanding 10-year bonds, with a fixed rate of 8 percent ( assume annual payments). The bonds trade at a price of $92 per $100 par in the open market. The firm's marginal tax rate is 35 percent. What is the after-tax component cost of debt to be used in the weighted average cost of capital (WACC) calculations?
A.9.89%.
B.6.02%.
C.9.26%.
A B C
B
If the bonds are trading at $92 per $100 par, the required yield is 9.26 percent, and the market value of the issue is $2.76 million. The equivalent after-tax cost of this financing is : 9.26% × (1 -0.35) =6.02%.
39. Which of the following types of capital budgeting projects are most likely to generate little to no revenue ?
A.Regulatory projects.
B.New product or market development.
C.Replacement projects to maintain the business.
A B C
A
Mandatory regulatory or environmental projects may be required by a governmental agency or insurance company and typically involve safety-related or environmental concerns. The projects typically generate little to no revenue, but they accompany other new revenue producing projects and are accepted by the company in order to continue operating.
40. An investment policy statement for a firm's short-term cash management function would least appropriately include :
A.a list of permissible securities.
B.procedures to follow if the investment guidelines are violated.
C.limits on the proportion of the portfolio which can be invested in each permitted security type.
A B C
A
An investment policy statement typically begins with a statement of the purpose and objective of the investment portfolio, some general guidelines about the strategy to be employed to achieve those objectives, and the types of securities that will be used. A list of permitted securities for investment would be limited and likely too restrictive. A list of permitted security types is appropriate and can provide the necessary flexibility to increase yield within the safety and liquidity constraints appropriate for the firm.
41. Which one of the following statements about the marginal cost of capital (MCC) is TRUE?
A.The MCC is the cost of the last dollar obtained from bondholders.
B.The MCC is the cost of the last dollar obtained from shareholders.
C.The breakpoint on the marginal cost curve is calculated by dividing retained earnings by the equity weight in the capital structure.
A B C
C
The marginal cost of capital (MCC) is defined as the weighted average cost of the last dollar raised by the company. Typically, the marginal cost of capital will increase as more capital is raised by the firm. The marginal cost of capital is the weighted average rate across all sources of long-term financings - bonds, preferred stock, and common stock - when the final dollar was obtained, regardless of its specific source.
42. An analyst has gathered the following data about a company with a 12 percent cost of capital:
Project A
Project B
Cost
$15000
$25000
Life
5 years
5 years
Cash inflows
$5000/year
$7500/year
If the projects are independent, what should the company do?
A.Reject A, Reject B. B. Accept A, Reject B.
C.Accept A, Accept
B.
A B C
C
Project A: N =5, PMT=5000, FV=0, I/Y=12, CPT PV =18024; NPV for Project A = 18024 - 15000 = 3024. Project B: N =5, PMT =7, 500, FV =0, I/Y = 12, CPT PV =27036; NPV for Project B = 27036 - 25000 = 2036. For independent projects the NPV decision rule is to accept all projects with a positive NPV. Therefore, accept both projects.
43. A firm is considering a $200000 project that will last 3 years and has the following financial data : Annual after-tax cash flows are expected to be $90000. Target debt/equity ratio is 0. 4. Cost of equity is 14 percent. Cost of debt is 7 percent. Tax rate is 34 percent. Determine the project's payback period and net present value(NPV). Payback Period NPV ①A. 2.43 years $18716 ②B. 2.22 years $18716 ③C. 2.43 years $21872
A.①
B.②
C.③
A B C
B
Payback Period $200000/$90000 = 2.22 years NPV Method First, calculate the weights for debt and equity wd+we=1 we=1-wd wd/we=0.40 wd=0.40×(1-wd) wd=0.40-0.40wd 1.40wd=0.40 wd=0.286, we=0.714 Second, calculate WACC WACC=(wd×kd)×(1-t)+(we×ke) =(0.286×0.07×0.66)+(0.714×0.14)= 0.0132+0.100 =0.1132 Third, calculate the PV of the project cash flows 90/(1+0.1132)1+90/(1+0.1132)2+90/(1+0.1132)3=$218716 And finally, calculate the project NPV by subtracting out the initial cash flow NPV=$218716-$200000=$18716
44. A banker's acceptance that is priced at $99145 and matures in 72 days at $100000 has a (n):
A.money market yield greater than its discount yield.
B.discount yield greater than its bond equivalent yield.
C.money market yield greater than its bond equivalent yield.
A B C
A
The money market yield is the holding period yield times 360/72 and is always greater than the discount yield which is the actual discount from face value times 360/72, since the holding period yield is always greater than the percentage discount from face value. A security's discount yield and its money market yield are always less than its bond equivalent yield, and its effective annual yield is always greater than its bond equivalent yield.