test 4 fina 3332 john lopez uh

The weighted average cost of capital of a firm represents the _____.

a. minimum rate of return a firm must earn on average-risk investments to maintain its current valueb. maximum rate of return a firm can expect to earn on its investmentsc. maximum interest rate a firm should pay on the debt it usesd. minimum dividend yield a firm must pay to its preferred stockholderse. required rate of return that should be used to evaluate capital budgeting projects that have above-averagerisk

a

2. A firm's weighted average cost of capital (WACC) is _____.

a. set by the board of directors of the firm, because it is the benchmark they use to evaluate members of the senior management team

b. regulated by the Internal Revenue Service (IRS), because tax-deductible debt is included in the computation

c. determined by participants in the financial markets, because investors set the minimum return they require (demand) to provide the funds the firm invests in capital budgeting projects

d. the same as the average internal rate of return (IRR) the firm earns on its assets

e. the combined net present value (NPV) of all the capital budgeting projects in which the firm invests

c

When determining a project's true profitability, it is normally better to compute the project's modified internal rate of return (MIRR) rather than its internal rate of return (IRR) because the MIRR technique _____.

a.

considers only the cash flows after the project's payback period

b.

has a decision rule that is easier to apply than the IRR decision rule

c.

assumes that the project's cash flows are reinvested at the firm's required rate of return, whereas IRR assumes the cash flows are reinvested at the project's IRR

d.

assumes that the project's cash flows are reinvested at the risk-free rate

e.

assumes that the project's cash flows are discounted at its IRR

c

. A graph of the capital budgeting projects a firm is evaluating ranked in the order of their internal rates of return is called a(n) _____.

a.

marginal cost of capital graph

b.

investment opportunity schedule (IOS)

c.

modified internal rate of return (MIRR) graph

d.

internal project classification schedule

e.

optimal capital budget (OCB) schedule

b

. Beige Inc. is evaluating three capital budgeting projects whose internal rates of return (IRRs) are greater than the firm's marginal cost of capital (MCC). Beige should choose _____.

a.

the projects that minimize its marginal cost of capital

b.

all of the projects whose internal rates of return (IRRs) are greater than the firm's weighted average cost of capital WACC)

c.

the projects that maximize its dividend payout

d.

the projects that generate the greatest combination of cash inflows

e.

the one (single) project that has the highest net present value (NPV)

b

Which of the following is a correct statement about the discounted payback period (DPB) technique that is used to evaluate capital budgeting projects?

a.

To compute a project's DPB, simply add up the unadjusted expected cash flows for each year until the cumulative value equals the amount that is initially invested.

b.

According to DPB, a project should be accepted when its discounted payback period is greater than its useful life.

c.

The DPB does not provide information about the liquidity of a project.

d.

The DPB method considers the time value of money.

e.

To compute a project's DPB, its internal rate of return (IRR) must be known.

d

Which of the following statements about the internal rate of return (IRR) capital budgeting technique is correct?

a.

It is the same as the firm's required rate of return.

b.

It is the discount rate that equates the present value of a project's expected future cash flows to the initial amount invested.

c.

It is the discount rate at which the net present value of a project is negative.

d.

It is the rate of return at which a project's payback period is shortest.

e.

It is the discount rate that should be used to evaluate a project with multiple cash outflows.

b

If a project's _____ exceeds the firm's weighted average cost of capital (WACC), its net present value (NPV) will be positive.

a.

marginal cost of capital

b.

incremental operating cash flows

c.

inflation premium

d.

internal rate of return (IRR)

e.

initial investment outlay

d

The component costs of capital are market-determined variables in as much as they are based on investors' required returns.

a.

True

b.

False

a

The net present value (NPV) method implicitly assumes that the rate at which cash flows can be reinvested is the required rate of return, whereas the internal rate of return (IRR) method implies that the firm has the opportunity to reinvest at the project's IRR.

a.

True

b.

False

a

Which of the following capital budgeting evaluation techniques is based on the concept that it is better to recover the cost of (investment in) a project sooner rather than later?

a.

Internal rate of return (IRR)

b.

Traditional payback period (PB)

c.

Modified internal rate of return (MIRR)

d.

Net present value (NPV)

e.

Present value (PV) of cash flows

b

The value of any asset—real or financial—is based on the _____ and the _____.

a.

weighted average cost of the investment; rate of return achieved by the firm

b.

cash flow expected to be generated by the asset; rate of return required by investors

c.

marginal return an investor expects to earn from the investment; additional cash flow generated by the asset

d.

rate of return achieved by the investment firm; investors' weighted average cost of investing their money

e.

rate of return earned by the firm; cash flow expected to be generated by the asset

b

In capital budgeting analyses, the primary difference between the traditional payback period (PB) technique and the discounted payback period (DPB) technique is that the DPB _____.

a.

considers cash flows that occur after the discounted payback period

b.

is always shorter than the traditional payback period

c.

considers the time value of money

d.

ensures a shorter payback period for a project, because projects with longer payback periods generally are accepted using the DPB technique

e.

ensures the amount of the original investment is recovered more quickly from the project's cash flows

c

Everything else equal, a project that has a long traditional payback period (PB) _____.

a.

has greater implied risk than a project that has a shorter PB

b.

generally ensures the firm has enough liquidity to survive for a fairly long period of time

c.

must have a positive net present value (NPV)

d.

has an expected rate of return that is greater its internal rate of return

e.

results in a terminal value that is greater than the present value of its cash outflows

a

. Suppose a firm evaluates four independent investments using only capital budgeting techniques that consider the time value of money. Which of the following statements is correct?

a.

The company should purchase the one project that has the highest internal rate of return (IRR).

b.

All of the capital budgeting techniques the company uses should provide the same accept/reject decisions.

c.

The company should purchase the project that has the shortest traditional payback period (PB).

d.

The company should purchase the one project that has the highest net present value (NPV); the other projects should not be purchased, even if their NPVs are positive.

e.

The capital budgeting techniques used by the company will always agree on which project should be ranked as the best one to purchase.

b

Suppose a firm has evaluated four capital budgeting projects and, using one of the time value of money capital budgeting techniques, has determined that all of the projects are acceptable. If the projects are mutually exclusive, which of the following capital budgeting techniques should be used to make the purchasing decision to ensure the firm's value is maximized?

a.

traditional payback period (PB)

b.

internal rate of return (IRR)

c.

modified internal rate of return (MIRR)

d.

net present value (NPV)

e.

discounted payback period (DPB)

d

To determine the actual cost of using debt, a firm must adjust its bonds' average yield to maturity for the fact that _____.

a.

interest payments on debt represent taxable income to the firm

b.

interest payments on debt represent a tax deductible expense to the firm

c.

the average yield to maturity on its debt is a positive return that the firm receives (earns)

d.

the average yield to maturity on the firm's debt determines the tax rate that it pays on its operating income

e.

the firm's bondholders do not have to pay taxes on the interest they receive from the firm

b

Which of the following statements is correct?

a.

The internal rate of return (IRR) does not allow you to determine whether mutually exclusive projects are acceptable.

b.

The net present value (NPV) is the only capital budgeting technique that allows you to determine which independent projects are acceptable.

c.

The net present value (NPV) technique provides an indication of the dollar benefit (on a present value basis) to the firm's shareholders of purchasing a capital budgeting project.

d.

A project's internal rate of return (IRR) depends on the firm's required rate of return, which means that a project's IRR is different for each firm that has a different required rate of return.

e.

The net present value (NPV) technique contains information about a project's safety margin, which is not inherent in the internal rate of return (IRR).

c

Seattle Inc. identified an investment opportunity that requires an initial cash outflow of $150,000. Seattle's required rate of return is 10 percent. The investment will yield cash flows of $30,000 per year in Years 1 through 4, $35,000 per year in Years 5 through 9, and $40,000 in Year 10. Assume the cash flows occur evenly during the year. What is the traditional payback period for this investment?

a.

5.23 years

b.

4.86 years

c.

4.51 years

d.

6.12 years

e.

4.35 years

b

Bouchard Company's stock sells for $20 per share, its last dividend (D0) was $1.00, its growth rate is a constant 6 percent, and the company must pay flotation cost equal to 20 percent when it issues new common stock. What is Bouchard's cost of issuing new common stock?

a.

11.00%

b.

12.25%

c.

12.63%

d.

11.30%

e.

11.56%

c

Suppose a firm is evaluating a capital budgeting project using the internal rate of return (IRR) technique. If the firm's required rate of return increases, the project's IRR will decrease.

a.

True

b.

False

b

An investment firm is selling a new product that will pay $100 at the end of each of the next 20 years. If the new investment costs $1,246 to purchase, what is its internal rate of return (IRR)?

a.

9%

b.

7%

c.

5%

d.

3%

e.

11%

c

Rollins Corporation is constructing its marginal cost of capital (MCC) schedule. Its target capital structure is 30 percent debt, 20 percent preferred stock, and 50 percent common equity. Its bonds have a 12 percent coupon rate of interest, semiannual interest payments, a current maturity of 20 years, and a market value equal to their par value of $1,000. The firm's marginal tax rate is 40 percent. What is Rollins' after-tax cost of debt?

a.

8.4%

b.

7.2%

c.

4.8%

d.

12.0%

e.

3.6%

b

Diggin Tools plans to issue new preferred stock, which has a market value of $85 per share. Holders of the stock will receive an annual dividend equal to $9.35. The flotation costs associated with the new issue were 6 percent and Diggin's marginal tax rate is 30 percent. What Diggin's component cost of preferred stock, rps?

a.

17.00%

b.

11.66%

c.

10.38%

d.

11.70%

e.

11.00%

d

Super Solutions Inc. just paid a dividend equal to $3.00 per share which are expected to grow at 6%. Its stock sells for $33.00 per share. What is Super's cost of retained earnings?

a.

9.09%

b.

15.64%

c.

15.09%

d.

9.64%

e.

14.58%

b

. J. Ross and Sons Inc. has a target capital structure that calls for 40 percent debt, 10 percent preferred stock, and 50 percent common equity. Ross' common stock currently sells for $40 per share. The firm recently paid a dividend equal to $2 per share on its common stock, and investors expect the dividend to grow indefinitely at a constant rate of 10 percent per year. If it issues new common stock, the firm will incur flotation costs equal to 7 percent. What is the firm's cost of retained earnings?

a.

15.00%

b.

15.91%

c.

15.50%

d.

14.54%

e.

16.50%

c

Oval Inc. just paid a dividend equal to $1.50 per share on its common stock, and it expects this dividend to grow by 4 percent per year indefinitely. The firm plans to issue common stock, which has a $16 per share market price, to raise funds to support operations. Oval's investment bankers estimate that the flotation costs for new issues of common stock will be equal to 8 percent of the issue (market) price. What is Oval's cost of new common equity, re?

a.

14.60%

b.

13.38%

c.

10.60%

d.

8.76%

e.

18.55%

a

Coral Inc.'s preferred stock currently sells for $90 a share and pays a dividend of $10 per share. However, the firm will net only $80 per share if it issues new preferred stock. What is Coral's cost of preferred stock? Coral's marginal tax rate is 35 percent.

a.

8.13%

b.

12.50%

c.

11.11%

d.

7.22%

e.

11.76%

b

In capital budgeting analyses, the net present value (NPV) method and the internal rate of return (IRR) method both assume that the reinvestment of the project's cash flows occurs at the same rate.

a.

True

b.

False

a

The main reason that the net present value (NPV) method is regarded as being conceptually superior to the internal rate of return (IRR) method for the purpose of evaluating mutually exclusive investments, is that mutually exclusive projects have multiple internal rates of return (IRRs).

a.

True

b.

False

b

There exists an internal rate of return (IRR) solution for each time the direction of cash flows associated with a project is interrupted, that is, each time outflows change to inflows.

a.

True

b.

False

a

Which of the following statements is true about capital budgeting analysis?

a.

A project should be purchased if its net present value (NPV) is positive.

b.

A project with only cash outflows and no cash inflows would have two internal rates of return (IRRs).

c.

The traditional payback period method should be used for capital budgeting decisions when there is a conflict in the project rankings using the NPV method and the internal rate of return (IRR) method.

d.

The net present value (NPV) method should be used to evaluate independent projects, but the internal rate of return (IRR) method should be used to evaluate mutually exclusive projects.

e.

The payback period method should be used to evaluate capital budgeting projects that have multiple cash outflows.

a

The Jackson Company just paid a dividend equal to $3.00 per share on its common stock, and it expects this dividend to grow by 7 percent per year indefinitely. The firm has a beta coefficient equal to 1.50, the risk-free rate is 10 percent, and the expected return on the market is 14 percent. According to the capital asset pricing model, what is Jackson's cost of retained earnings, rs?

a.

23%

b.

11%

c.

7%

d.

16%

e.

21%

d

Which of the following statements is correct?

a.

A project's discounted payback period (DBP) is normally shorter than its traditional payback period (PB) because DPB accounts for the time value of money, whereas PB does not.

b.

To compute the NPV for a project, the firm's required rate of return must be known. To compute a project's internal rate of return (IRR), the firm's required rate of return is not used because the IRR is the discount rate where the project's NPV equals zero.

c.

Two firms could compute different internal rate of return (IRR) for a project if their required rates of return differ.

d.

If a project's net present value (NPV) is equal to its internal rate of return (IRR), the project's value is in equilibrium.

e.

Everything else equal, firms with higher required rates of return generally are able to purchase more capital budgeting projects than firms will lower required rates of return.

b

With the improvement in the technology and understanding of discounting techniques, both the net present value (NPV) technique and internal rate of return (IRR) technique used in capital budgeting analyses have become more popular because these techniques provide decisions that help the firm to _____.

a.

minimize its overall payback period

b.

maximize it required rate of return

c.

maximize its value

d.

minimize the number of multiple IRRs computed for every project

e.

maximize the initial capital investment

c

Suppose a capital budgeting project generates its largest cash flows in the early years of its life(i.e., up front) rather than near the end of its life. In this situation. Which of the following statements about the project must be correct?

a.

The project's traditional payback period will be greater than the years expected to recover the original investment.

b.

The net present value of the project is not as sensitive to changes in the firm's required rate of return as the net present value of a project that generates large cash flows later in its life.

c.

The required rate of return of the project must be revised throughout its life.

d.

The net present value of the project must be negative.

e.

The project will have multiple internal rates of return.

b