FINAL EXAM MGT 5002
MULTIPLE CHOICE CHAPTER 9
(9-5) Required return
1). If in the
opinion of a given investor a stock’s expected return exceeds its
required return, this suggests that the investor thinks
a. the stock is
experiencing supernormal growth.
b. the stock should be
sold.
c. the stock is a good buy.
d. management is probably
not trying to maximize the price per share.
e. dividends are not likely
to be declared.
(9-1) Preemptive right
2). The preemptive
right is important to shareholders
because it
a. allows managers to buy additional shares below the current market
price.
b. will result in higher
dividends per share.
c. is included in every
corporate charter.
d. protects the current
shareholders against a dilution of their ownership interests.
e. protects bondholders,
and thus enables the firm to issue debt with a relatively low interest rate.
(9-2) Classified stock
3). Companies can
issue different classes of common stock.
Which of the following statements concerning stock classes is CORRECT?
a. All common stocks fall into one
of three classes: A, B, and C.
b. All common stocks, regardless of class, must have the same voting
rights.
c. All firms have several classes
of common stock.
d. All common stock, regardless of class, must pay the same dividend.
e. Some class or classes of common
stock are entitled to more votes per share than other classes.
(9-5) Constant growth
model
4). If a stock’s
dividend is expected to grow at a
constant rate of 5% a year, which of the following statements is CORRECT? The
stock is in equilibrium.
a. The expected return on the stock is 5% a year.
b. The stock’s dividend yield
is 5%.
c. The price of the stock is expected to decline in the future.
d. The stock’s required return
must be equal to or less than 5%.
e. The stock’s price one year
from now is expected to be 5% above the current price.
(9-7) Corporate valuation
model
5). Which of the
following statements is CORRECT?
a. To implement the corporate valuation model, we discount projected
free cash flows at the weighted
average cost of capital.
b. To implement the corporate valuation model, we discount net
operating profit after taxes (NOPAT) at the weighted average cost of capital.
c. To implement the corporate valuation model, we discount projected
net income at the weighted average cost of capital.
d. To implement the corporate valuation model, we discount projected
free cash flows at the cost of equity capital.
e. The corporate valuation
model requires the assumption of a constant growth rate in all years.
(9-8) Preferred stock
concepts
6). Which of the
following statements is CORRECT?
a. A major disadvantage of financing with preferred stock is that
preferred stockholders typically have supernormal voting rights.
b. Preferred stock is normally expected to provide steadier, more
reliable income to investors than the
same firm’s common stock, and, as a result, the expected after-tax yield on the
preferred is lower than the after-tax expected return on the common stock.
c. The preemptive right is
a provision in all corporate charters that gives preferred stockholders the
right to purchase (on a pro rata basis) new issues of preferred stock.
d. One of the disadvantages to a corporation of owning preferred
stock is that 70% of the dividends received represent taxable income to the
corporate recipient, whereas interest income earned on bonds would be tax free.
e. One of the advantages to financing with preferred stock is that
70% of the dividends paid out are tax deductible to the issuer.
(9-5) Expected total return
7). If D1
= $1.25, g (which is constant) =
5.5%, and P0 = $44, what is the stock’s expected total return for
the coming year?
a. 7.54%
b. 7.73%
c. 7.93%
d. 8.13%
e. 8.34%
Chapter 10 – Multiple Choice
(10-6) Internal vs.
external common
8). Bankston
Corporation forecasts that if all of its existing financial policies are
followed, its proposed capital budget would be so large that it would have to
issue new common stock. Since new stock
has a higher cost than retained earnings, Bankston would like to avoid issuing new stock. Which of the following actions would REDUCE its need to issue new
common stock?
a. Increase the dividend payout
ratio for the upcoming year.
b. Increase the percentage of
debt in the target capital structure.
c. Increase the proposed capital
budget.
d. Reduce the amount of short-term
bank debt in order to increase the current ratio.
e. Reduce the percentage of debt in the target capital structure.
(10-5) Cost of equity:
CAPM
9). When working
with the CAPM, which of the following
factors can be determined with the most precision?
a. The market risk premium
(RPM).
b. The beta coefficient, bi,
of a relatively safe stock.
c. The most appropriate
risk-free rate, rRF.
d. The expected rate of
return on the market, rM.
e. The beta coefficient of “the
market,” which is the same as the beta of an average stock.
(10-9) Risk and projects
10). LaPango Inc.
estimates that its average-risk projects have a WACC of 10%, its below-average
risk projects have a WACC of 8%, and its above-average risk projects have a
WACC of 12%. Which of the following
projects (A, B, and C) should the company accept?
a. Project B, which is of below-average risk and has a return of
8.5%.
b. Project C, which is of above-average risk and has a return of 11%.
c. Project A, which is of average risk and has a return of 9%.
d. None of the projects
should be accepted.
e. All of the projects
should be accepted.
(10-5) Cost of RE: CAPM
11). O’Brien Inc. has
the following data: rRF =
5.00%; RPM = 6.00%; and b = 1.05.
What is the firm’s cost of equity from retained earnings based on the
CAPM?
a. 11.30%
b. 11.64%
c. 11.99%
d. 12.35%
e. 12.72%
(10-5) Cost of RE: CAPM
12). Scanlon Inc.’s
CFO hired you as a consultant to help her estimate the cost of capital. You have been provided with the following data: rRF = 4.10%; RPM =
5.25%; and b = 1.30. Based on the CAPM
approach, what is the cost of equity from retained earnings?
a. 9.67%
b. 9.97%
c. 10.28%
d. 10.60%
e. 10.93%
(10-5)
Bond-yield-plus-risk premium
13). A. Butcher Timber
Company hired your consulting firm to help them estimate the cost of
equity. The yield on the firm’s bonds is
8.75%, and your firm’s economists believe that the cost of equity can be
estimated using a risk premium of 3.85% over a firm’s own cost of debt. What is an estimate of the firm’s cost of
equity from retained earnings?
a. 12.60%
b. 13.10%
c. 13.63%
d. 14.17%
e. 14.74%
(10-7) WACC
14). You were hired as
a consultant to Giambono Company, whose target capital structure is 40% debt,
15% preferred, and 45% common equity.
The after-tax cost of debt is
6.00%, the cost of preferred is 7.50%, and the cost of retained earnings is
12.75%. The firm will not be issuing any
new stock. What is its WACC?
a. 8.98%
b. 9.26%
c. 9.54%
d. 9.83%
e. 10.12%
(Comp.) Cost of capital concepts
15). Which of the
following statements is CORRECT?
a. Since debt capital can cause a company to go bankrupt but equity
capital cannot, debt is riskier than equity, and thus the after-tax cost of
debt is always greater than the cost of equity.
b. The tax-adjusted cost of debt is always greater than the interest
rate on debt, provided the company does in fact pay taxes.
c. If a company assigns the same cost of capital to all of its
projects regardless of each project’s
risk, then the company is likely to reject some safe projects that it actually
should accept and to accept some risky projects that it should reject.
d. Because no flotation
costs are required to obtain capital as retained earnings, the cost of retained
earnings is generally lower than the after-tax cost of debt.
e. Higher flotation costs tend to reduce the cost of
equity capital.
(Comp.) Capital
components
16). Which of the
following statements is CORRECT?
a. The component cost of preferred
stock is expressed as rp(1 – T).
This follows because preferred stock dividends are treated as fixed charges,
and as such they can be deducted by the issuer for tax purposes.
b. A cost should be assigned to retained
earnings due to the opportunity cost principle, which refers to the fact that
the firm’s stockholders would themselves expect to earn a return on earnings
that were paid out rather than retained and reinvested.
c. No cost should be assigned to retained
earnings because the firm does not have to pay anything to raise them. They are generated as cash flows by operating
assets that were raised in the past, hence they are “free.”
d. Suppose a firm has been losing money and thus is not paying taxes,
and this situation is expected to persist into the foreseeable future. In this case, the firm’s before-tax and
after-tax costs of debt for purposes of calculating the WACC will both be equal
to the interest rate on the firm’s currently outstanding debt, provided that
debt was issued during the past 5 years.
e. If a firm has enough retained earnings
to fund its capital budget for the coming year, then there is no need to
estimate either a cost of equity or a WACC.
Chapter 11 – Multiple Choice
(11-2) NPV
17). Which of the
following statements is CORRECT? Assume
that the project being considered has normal cash flows, with one outflow
followed by a series of inflows.
a. A project’s NPV is found by compounding the cash inflows at the
IRR to find the terminal value (TV), then discounting the TV at the WACC.
b. The lower the WACC used to calculate it, the lower the calculated
NPV will be.
c. If a project’s NPV is less than zero, then its IRR must be less
than the WACC.
d. If a project’s NPV is greater than zero, then its IRR must be less
than zero.
e. The NPV of a relatively low-risk project should be found using a
relatively high WACC.
(11-3) IRR
18). Which of the
following statements is CORRECT?
a. One defect of the IRR method is that it does not take account of
cash flows over a project’s full life.
b. One defect of the IRR method is that it does not take account of
the time value of money.
c. One defect of the IRR method is that it does not take account of
the cost of capital.
d. One defect of the IRR method is that it values a dollar received
today the same as a dollar that will not be received until sometime in the
future.
e. One defect of the IRR method is that it assumes that the cash
flows to be received from a project can be reinvested at the IRR itself, and
that assumption is often not valid.
(11-8) Payback
19). Which of the
following statements is CORRECT? Assume
that the project being considered has normal cash flows, with one outflow
followed by a series of inflows.
a. The longer a project’s payback period, the more desirable the
project is normally considered to be by this criterion.
b. One drawback of the payback criterion for evaluating projects is
that this method does not properly account for the time value of money.
c. If a project’s payback is positive, then the project should be
rejected because it must have a negative NPV.
d. The regular payback ignores cash flows beyond the payback period,
but the discounted payback method overcomes this problem.
e. If a company uses the same payback requirement to evaluate
all projects, say it requires a
payback of 4 years or less, then the
company will tend to reject projects
(11-5) NPV and IRR
20). Which of the
following statements is CORRECT?
a. The NPV method assumes that cash flows will be reinvested at the
WACC, while the IRR method assumes reinvestment at the IRR.
b. The NPV method assumes that cash flows will be reinvested at the
risk-free rate, while the IRR method assumes reinvestment at the IRR.
c. The NPV method assumes that cash flows will be reinvested at the
WACC, while the IRR method assumes reinvestment at the risk-free rate.
d. The NPV method does not consider all relevant cash flows,
particularly cash flows beyond the payback period.
e. The IRR method does not consider all relevant cash flows,
particularly cash flows beyond the payback period.
(Comp.) Miscellaneous
concepts
21). Which of the
following statements is CORRECT?
a. The IRR method appeals to some managers because it gives an
estimate of the rate of return on projects rather than a dollar amount, which
the NPV method provides.
b. The discounted payback method eliminates all of the problems
associated with the payback method.
c. When evaluating independent projects, the NPV and IRR methods
often yield conflicting results regarding a project’s acceptability.
d. To find the MIRR, we discount the TV at the IRR.
e. A project’s NPV profile must intersect the X-axis at the project’s
WACC.
(11-7) NPV profiles
22). Which of the following
statements is CORRECT? Assume that all
projects being considered have normal cash flows and are equally risky.
a. If a project’s IRR is equal to its WACC, then, under all
reasonable conditions, the project’s NPV must be negative.
b. If a project’s IRR is equal to its WACC, then under all reasonable
conditions, the project’s IRR must be negative.
c. If a project’s IRR is equal to its WACC, then under all reasonable
conditions the project’s NPV must be zero.
d. There is no necessary relationship between a project’s IRR, its
WACC, and its NPV.
e. When evaluating mutually exclusive projects, those projects with
relatively long lives will tend to have relatively high NPVs when the cost of
capital is relatively high.
Chapter 12 Multiple
choice
(12-1) Sunk costs
23). Which of the
following statements is CORRECT?
a. A sunk cost is any cost that must be expended in order to complete
a project and bring it into operation.
b. A sunk cost is any cost that was expended in the past but can be
recovered if the firm decides not to go forward with the project.
c. A sunk cost is a cost that was incurred and expensed in the past
and cannot be recovered if the firm decides not to go forward with the project.
d. Sunk costs were formerly hard to deal with, but once the NPV
method came into wide use, it became possible to simply include sunk costs in
the cash flows and then calculate the project’s NPV.
e. A good example of a sunk cost is a situation where Home Depot
opens a new store, and that leads to a decline in sales of one of the firm’s
existing stores.
(12-1) Relevant cash
flows
24). Which of the
following factors should be included in the cash flows used to estimate
a project’s NPV?
a. All costs associated with the project that have been incurred
prior to the time the analysis is being conducted.
b. Interest on funds borrowed to help finance the project.
c. The end-of-project recovery of any additional net operating working
capital required to operate the project.
d. Cannibalization effects, but only if those effects increase the
project’s projected cash flows.
e. Expenditures to date on research and development related to the
project, provided those costs have already been expensed for tax purposes.
(12-1) Incremental cash
flows
25). Which one of the
following would NOT
result in incremental cash flows and thus should NOT be included in the capital budgeting analysis for a new
product?
a. A firm has a parcel of land that can be used for a new plant site
or be sold, rented, or used for agricultural purposes.
b. A new product will generate new sales, but some of those new sales
will be from customers who switch from one of the firm’s current products.
c. A firm must obtain new equipment for the project, and $1 million
is required for shipping and installing the new machinery.
d. A firm has spent $2 million on research and development associated
with a new product. These costs have
been expensed for tax purposes, and they cannot be recovered regardless of
whether the new project is accepted or rejected.
e. A firm can produce a new product, and the existence of that
product will stimulate sales of some of the firm’s other products.
(12-4) Risk analysis
26). Taussig
Technologies is considering two potential projects, X and Y. In assessing the projects’ risks, the company
estimated the beta of each project versus both the company’s other assets and
the stock market, and it also conducted thorough scenario and simulation
analyses. This research produced the
following data:
|
Project X |
Project Y |
|
|
Expected NPV |
$350,000 |
$350,000 |
|
Standard deviation (?NPV) |
$100,000 |
$150,000 |
|
Project beta (vs. market) |
|
|
|
Correlation of the |
Cash flows are not |
Cash flows are highly |
Which of the following
statements is CORRECT?
a. Project X has more stand-alone risk than Project Y.
b. Project X has more corporate (or within-firm) risk than
Project Y.
c. Project X has more market risk than Project Y.
d. Project X has the same level of corporate risk as Project Y.
e. Project X has the same market risk as Project Y since its cash
flows are not correlated with the cash flows of existing projects.
(12-4) Project’s effect
on firm risk
27). A firm is
considering a new project whose risk is greater than the risk of the firm’s
average project, based on all methods for assessing risk. In evaluating this project, it would be
reasonable for management to do which of the following?
a. Increase the estimated IRR of the project to reflect its greater
risk.
b. Increase the estimated NPV of the project to reflect its greater
risk.
c. Reject the project, since its acceptance would increase the firm’s
risk.
d. Ignore the risk differential if the project would amount to only a
small fraction of the firm’s total assets.
e. Increase the cost of
capital used to evaluate the project to reflect its higher-than-average risk.
(12-2) Annual CF
28). As assistant to
the CFO of Boulder Inc., you must estimate the Year 1 cash flow for a project
with the following data. What is the
Year 1 cash flow?
Sales revenues $13,000
Depreciation $4,000
Other operating costs $6,000
Tax rate 35.0%
a. $5,950
b. $6,099
c. $6,251
d. $6,407
e. $6,568
Chapter 13 – Multiple Choice
(13-5) Flexibility option
29). Which one of the
following is an example of a “flexibility” option?
a. A company has an option to invest in a project today or to wait
for a year before making the commitment.
b. A company has an option to close down an operation if it turns out
to be unprofitable.
c. A company agrees to pay more to build a plant in order to be able
to change the plant’s inputs and/or outputs at a later date if conditions
change.
d. A company invests in a project today to gain knowledge that may
enable it to expand into different markets at a later date.
e. A company invests in a jet aircraft so that its CEO, who must
travel frequently, can arrive for distant meetings feeling less tired than if
he had to fly a commercial airline.
(13-6) Risk and project
selection
30). Langston Labs has
an overall (composite) WACC of 10%, which reflects the cost of capital for its
average asset. Its assets vary widely in
risk, and Langston evaluates low-risk projects with a WACC of 8%, average-risk
projects at 10%, and high-risk projects at 12%.
The company is considering the following projects:
Project Risk Expected Return
A High 15%
B Average 12%
C High 11%
D Low 9%
E Low 6%
Which set of projects
would maximize shareholder wealth?
a. A and B.
b. A, B, and C.
c. A, B, and D.
d. A, B, C, and D.
e. A, B, C, D, and E.
(Comp.) Real options
31). Which one
of the following will NOT
increase the value of a real option?
a. Lengthening the time during which a real option must be exercised.
b. An increase in the volatility of the underlying source of risk.
c. An increase in the risk-free rate.
d. An increase in the cost of obtaining the real option.
e. A decrease in the probability that a competitor will enter the
market of the project in question.
(Comp.) Real options
32). Gleason Research
regularly takes real options into account when evaluating its proposed
projects. Specifically, it considers the
option to abandon a project whenever it turns out to be unsuccessful (the
abandonment option), and it evaluates whether it is better to invest in a
project today or to wait and collect more information (the investment timing
option). Assume the proposed projects
can be abandoned at any time without penalty.
Which of the following statements is CORRECT?
a. The abandonment option tends to reduce a project’s NPV.
b. The abandonment option tends to reduce a project’s risk.
c. If there are important first-mover advantages, this tends to
increase the value of waiting a year to collect more information before
proceeding with a proposed project.
d. A project can either have an abandonment option or an investment
timing option, but never both.
e. Investment timing options always increase the value of a project.
(13-2) Growth option: NPV
33). Tutor.com is
considering a plan to develop an online finance tutoring package that has the
cost and revenue projections shown below.
One of Tutor’s larger competitors, Online Professor (OP), is expected to
do one of two things in Year 5: (1)
develop its own competing program, which will put Tutor’s program out of
business, or (2) offer to buy Tutor’s program if it decides that this would be
less expensive than developing its own program.
Tutor thinks there is a 35% probability that its program will be
purchased for $6 million and a 65% probability that it won’t be bought, and
thus the program will simply be closed down with no salvage value. What is the estimated net present value of
the project (in thousands) at a WACC = 10%, giving consideration to the
potential future purchase?
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