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##### Fin 221 Exam 4

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Question;Multiple Choice;Identify the choice that best completes the statement or answers the;question.;1) Several years ago the Haverford Company sold;a $1,000 par value bond that now has 25 years to maturity and an 8.00% annual;coupon that is paid quarterly. The bond currently sells for $900.90, and the;company's tax rate is 40%. What is the component cost of debt for use in the;WACC calculation?;A.;5.40%;B.;5.73%;C.;5.98%;D.;6.09%;E.;6.24%;2) Assume that Mary Brown Inc. hired you as a;consultant to help it estimate the cost of capital. You have been provided with;the following data: D0= $1.20, P0= $40.00, and g= 7% (constant). Based on the DCF approach, what is Brown's cost of;equity from retained earnings?;A.;10.06%;B.;10.21%;C.;10.37%;D.;10.54%;E.;10.68%;3) Crum International's target capital structure;calls for 80% debt and 20% equity. The company expects to have $3 million of;net income this year, and 60% of the net income will be paid out in dividends.;How large can the firm's capital budget be this year before it will have to;issue new common stock?;A.;$5.5 million;B.;$6.0 million;C.;$6.3 million;D.;$6.8 million;E.;$7.1 million;4) Assume that you are on the financial staff of;Christopher Inc., and you have collected the following data: (1) The yield;on the company's outstanding bonds is 7.0%, and its tax rate is 40%.;(2) The expected year-end dividend is $0.80 a share, the dividend is;expected to grow at a constant rate of 6% a year, the price of Christopher's;stock is $25 per share, and the flotation cost for selling new shares is 10%.;(3) The target capital structure is 40% debt and 60% equity. What is;Christopher's WACC assuming that it must issue new stock to finance its capital;budget?;A.;7.11%;B.;7.26%;C.;7.41%;D.;7.67%;E.;7.89%;5) Moussawi Enterprises, which finances only;with equity from retained earnings, is considering two large capital budgeting;projects, and its CFO hired you to assist in deciding whether one, both, or;neither of the projects should be accepted. You have the following information;(1) rRF= 5.5%, RPM= 6%, and b= 0.8. (2) The company adds 3% to the corporate WACC when it;evaluates relatively risky projects, and it deducts 1% from the WACC when;evaluating relatively safe projects. (3) Project S is relatively safe, it;costs $10,000, and its expected rate of return is 8%, while Project R is relatively;risky, it costs $15,000, and its expected rate of return is 12%. If these are;the only two projects under consideration, how large should the capital budget;be?;A.;$ 5,000;B.;$10,000;C.;$15,000;D.;$20,000;E.;$25,000;6) Which of the following statements is CORRECT?;A.;If a company's tax rate increases but the YTM of its noncallable bonds;remains the same, the after-tax cost of its debt will fall.;B.;All else equal, an increase in a company's stock price will increase;its marginal cost of retained earnings, rs.;C.;All else equal, an increase in a company's stock price will increase;its marginal cost of new common equity, re.;D.;Since the money is readily available, the after-tax cost of retained;earnings is usually much lower than the after-tax cost of debt.;E.;When calculating the cost of preferred stock, a company needs to;adjust for taxes, because preferred stock dividends are tax deductible.;7) Maese Sisters Inc has been paying out all of;its earnings as dividends, and hence has no retained earnings. This same;situation is expected to persist in the future. The company uses the CAPM to;calculate its cost of equity. Its target capital structure consists of common;stock, preferred stock, and debt. Which of the following events would reduce;the WACC?;A.;The flotation costs associated with issuing new common stock increase.;B.;The market risk premium declines.;C.;The company's beta increases.;D.;Expected inflation increases.;E.;The flotation costs associated with issuing preferred stock increase.;8) The Nunnally Company has equal amounts of;low-risk, average-risk, and high-risk projects. Nunnally estimates that its;overall WACC is 12%. The CFO believes that this is the correct WACC for the;company's average-risk projects, but that a lower rate should be used for lower;risk projects and a higher rate for higher risk projects. However, the CEO;argues that, even though the company's projects have different risks, the WACC;used to evaluate each project should be the same because the company obtains;capital for all projects from the same sources. If the CEO's opinion is;followed, what is likely to happen over time?;A.;The company will take on too many low-risk projects and reject too;many high-risk projects.;B.;The company will take on too many high-risk projects and reject too;many low-risk projects.;C.;Things will generally even out over time, and, therefore, the firm's;risk should remain constant over time.;D.;The company's overall WACC should decrease over time because its stock;price should be increasing.;E.;The CEO's recommendation would maximize the firm's intrinsic value.;9) Given the following information, what is the;required cash outflow associated with the acquisition of a new machine, that;is, in a project analysis, what is the cash outflow at t= 0?;Purchase price of new machine;$8,000;Installation charge;2,000;Market value of old machine;2,000;Book value of old machine;1,000;Inventory decrease if new machine;is installed;1,000;Accounts payable increase if new;machine is installed;500;Tax rate;35%;Cost of capital;15%;A.;-$ 8,980;B.;-$ 6,460;C.;-$ 5,200;D.;-$ 6,850;E.;-$12,020;10) Blanchford Enterprises is considering a;project that has the following cash flow and WACC data. What is the project's;discounted payback?;Year;0;1;2;3;Cash flows;-$1,000;$500;$500;$500;A.;2.01 years;B.;2.26 years;C.;2.65 years;D.;2.84 years;E.;3.17 years;11) Rockmont Recreation Inc. is considering a;project that has the following cash flow and WACC data. What is the project's;MIRR? Note that a project's projected MIRR can be less than the WACC (and even;negative), in which case it will be rejected.;WACC= 10%;Year;0;1;2;3;4;Cash flows;-$900;$300;$320;$340;$360;A.;13.33%;B.;14.01%;C.;15.69%;D.;16.35%;E.;17.18%;12) Pettway Inc. is considering Projects S and L;whose cash flows are shown below. These projects are mutually exclusive;equally risky, and not repeatable. If the decision is made by choosing the;project with the higher IRR, how much value will be foregone? Note that under;some conditions choosing projects on the basis of the IRR will cause $0.00;value to be lost.;WACC= 12%;Year;0;1;2;3;4;CFS;-$1,025;$375;$380;$385;$390;CFL;-$2,153;$750;$759;$768;$777;A.;$15.57;B.;$21.49;C.;$28.02;D.;$33.69;E.;$37.39;13) You must find the payback for a project, and;you have misplaced some of the information that you were given. You know that;the project will generate positive cash flows of $60,000 per year at the end of;each of the next 5 years, that its NPV is $75,000, and that the company's WACC;is 10%. What is the project's regular payback? Hint: You must first find the;project's cost, then use it to find the payback.;A.;2.11 years;B.;2.27 years;C.;2.38 years;D.;2.45 years;E.;2.54 years;14) Assume a project has normal cash flows. All;else equal, which of the following statements is CORRECT?;A.;The project's IRR increases as the WACC declines.;B.;The project's NPV increases as the WACC declines.;C.;The project's MIRR is unaffected by changes in the WACC.;D.;The project's regular payback increases as the WACC declines.;E.;The project's discounted payback increases as the WACC declines.;15) 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.;16) Which of the following statements is CORRECT?;A.;One advantage of the NPV over the IRR method is that NPV takes account;of cash flows over a project's full life whereas IRR does not.;B.;One advantage of the NPV over the IRR is that NPV assumes that cash;flows will be reinvested at the WACC whereas IRR assumes that cash flows are;reinvested at the IRR, and the NPV's assumption is generally more likely to;be appropriate.;C.;One advantage of the NPV over the MIRR method is that NPV takes;account of cash flows over a project's full life whereas MIRR does not.;D.;One advantage of the NPV over the MIRR method is that NPV discounts;cash flows whereas the MIRR is based on undiscounted cash flows.;E.;Since cash flows under the IRR and MIRR are both discounted at the;same rate (the WACC), these two methods always rank mutually exclusive;projects in the same order.;17) Projects C and D are mutually exclusive and;have normal cash flows. Project C has a higher NPV if the WACC is less than;12%, whereas Project D has a higher NPV if the WACC exceeds 12%. Which of the;following statements is CORRECT?;A.;Project D has a higher IRR.;B.;Project D is probably larger in scale than Project C.;C.;Project C probably has a faster payback.;D.;Project C has a higher IRR.;E.;The crossover rate between the two projects is below 12%.;18) Sacramento Paper is considering two equally;risky, mutually exclusive projects, and both projects have normal cash flows.;Project A has an IRR of 11%, while Project B has an IRR of 14%. When the WACC;is 8%, the projects have the same NPV. Given this information, which of the;following statements is CORRECT?;A.;If the WACC is 13%, Project A's NPV will be higher than Project B's.;B.;If the WACC is 9%, Project A's NPV will be higher than Project B's.;C.;If the WACC is 6%, Project B's NPV will be higher than Project A's.;D.;If the WACC goes over 14%, Project A's IRR will exceed Project B's.;E.;If the WACC is 9%, Project B's NPV will be higher than Project A's.;19) As a member of Gamma Corporation's financial;staff, you must estimate the Year 1 operating net cash flow for a proposed;project with the following data. What is the Year 1 operating cash flow?;Sales;$33,000;Depreciation;$10,000;Other operating costs;$17,000;Interest expense;$ 4,000;Tax rate;35%;A.;$ 9,500;B.;$10,600;C.;$11,700;D.;$12,800;E.;$13,900;20) Big Air Services is now in the final year of;a project. The equipment originally cost $20 million, of which 75% has been;depreciated. Big Air can sell the used equipment today for $6 million, and its;tax rate is 40%. What is the equipment's after-tax net salvage value?;A.;$500,000;B.;$600,000;C.;$700,000;D.;$800,000;E.;$900,000;21) The Movie Place is considering a new;investment whose data are shown below. The required equipment has a 3-year tax;life and would be fully depreciated by the straight line method over the 3;years, but it would have a positive salvage value at the end of Year 3, when;the project would be closed down. Also, some new working capital would be;required, but it would be recovered at the end of the project's life. Revenues;and other operating costs are expected to be constant over the project's 3-year;life. What is the project's NPV?;WACC;10%;Net equipment cost (depreciable basis);$65,000;Required new working capital;$10,000;Straight line depr'n rate;33.33%;Sales revenues;$70,000;Operating costs excl. depr'n;$25,000;Expected pretax salvage value;$ 5,000;Tax rate;35%;A.;$24,971.86;B.;$25,538.17;C.;$26,553.97;D.;$27,356.82;E.;$28,879.81;22) 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 PV.;E.;A good example of a sunk cost is a situation where a retailer opens a;new store, and that leads to a decline in sales of some of the firm's;existing stores.;23) 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 to date.;B.;Interest on funds borrowed to help finance the project.;C.;The end-of-project recovery of any 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 that have already been expensed for tax purposes.;24) Berry Beverage Company spent $3 million two;years ago to build a plant for a project. It then decided not to go forward;with the project, so the building is available for sale or for a new project.;It owns the building free and clear---there is no mortgage on it. Which of the;following statements is CORRECT?;A.;Since the building has been paid for, it can be used by another;project with no additional cost. Therefore, it should not be reflected in the;cash flows for any new project or projects.;B.;If the building could be sold, then the after-tax proceeds that would;be generated by any such sale should be charged as a cost to any new project;that would use it.;C.;This is an example of an externality, because the very existence of;the building affects the cash flows for any new project the Berry might;consider.;D.;Since the building was built in the past, its cost is a sunk cost and;thus need not be considered when new projects are being evaluated, even if it;would be used by those new projects.;E.;If there was a mortgage loan on the building, then the interest on;that loan would have to be charged to the new project.;25) Merlin 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 Merlin evaluates low-risk projects with a WACC of 8%;average 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.

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