1. A beta greater than 1 is indicative of an above-average level of diversifiable (unsystematic) risk.  False
2. A divisional manager submitted a project proposal to the chief financial officer, complete with a calculated NPV for the project. The chief financial officer studied the proposal and pointed out that the divisional manager had failed to account for a one-time increase in net working capital of $60,000 that will be required over the life of the seven-year project. Assuming the full value of net working capital will be recovered at the end of the project, how will the project’s NPV change after making the chief financial officer’s adjustment? Assume a discount rate of 9%.   None of the above.
3. A firm is considering an average-risk project with an IRR of 6%. The firm’s cost of debt (KD) is 5%, its cost of equity (KE) is 12%, and its tax rate (t) is 20%. The target debt ratio (D/(D+E)) for the project, in market values, is 0.5. The firm should:   reject the project regardless of the financing method
4. A project will produce after-tax operating cash inflows of $3,200 a year for 5 years. The after-tax salvage value of the project is expected to be $2,500 in year 5. The project’s initial cost is $9,500. What is the net present value of this project if the required rate of return is 16 percent?   $2,168.02
5. According to the pecking order theory of capital structure, why do firms avoid issuing equity?  Because equity issuance signals that managers believe their stock is overvalued, which causes the price of the stock to fall
6. According to the pecking order theory proposed by Stewart Myers of MIT, which of the following are correct?  I, II, and IV only
7. All else equal, if two competing firms in industry X are valuing the same plant in industry Y for a potential acquisition, the firm with the more volatile stock should arrive at a lower valuation for the plant.   False
8. An average-risk project that has an NPV of zero when its cash flows are discounted at the weighted-average cost of capital will provide sufficient returns to satisfy both stockholders and bondholders   True
9. As a noncash expense, depreciation is irrelevant in the determination of a project’s cash flows   False
10. Asset betas measure financial risk and business risk.   False
11. Company X has 2 million shares of common stock outstanding at a book value of $2 per share. The stock trades for $3.00 per share. It also has $2 million in face value of debt that trades at 90% of par. What is the appropriate debt ratio (D/(D+E)) to use for calculating Company X’s weighted-average cost of capital?   23.1%
12. Debt financing results in lower after-tax earnings relative to equity financing.  True
13. EAC Nutrition offers a 9.5 percent coupon bond with annual payments, maturing 11 years from today. Your required return is 11.2 percent. What price are you willing to pay for this bond if the face (or par) value is $1,000?    $895.43
14. Failing to include real options in a project valuation could cause the NPV of the project to be overestimated.   False
15. Financial leverage:   II, III, and IV only
16. Florida Corp. is calculating the appropriate rate for discounting cash flows on a project valued using the APV method. Florida’s target debt ratio (D/(D+E)) in market value terms is 50%, and the yield-to-maturity on its outstanding debt is 6%. A comparable firm has an equity beta of 1.4 and a debt ratio (D/(D+E)) of 40%. Assume a risk-free rate of 5% and a market risk premium of 8%. Florida’s tax rate is 40%. What discount rate should Florida use?   11.72%
17. Giant Corp. is considering a project that requires a $1,500 initial cost for a new machine that will be depreciated straight line to a salvage value of 0 on a 5-year schedule. The project will require a one-time increase in the level of net working capital of $300. The project will generate an additional $1,600 in revenues and $700 in operating expenses each year. The project will end at the end of year 2, at which time the machinery is expected to be sold for $800. Giant’s tax rate is 50%. In a discounted cash flow analysis of this project, what would be the projected Year 0 free cash flow?   -$1,800
18. Homemade leverage is:  the borrowing or lending of money by individual shareholders as a means of adjusting their level of financial leverage.
19. Honest Abe’s is a chain of furniture retail stores. Integral Designs is a furniture maker and a supplier to Honest Abe’s. Honest Abe’s has a beta of 1.38 as compared to Integral Designs’ beta of 1.12. Both firms carry no debt, i.e., are 100% equity-financed. The risk-free rate of return is 3.5 percent and the market risk premium is 8 percent. What discount rate should Honest Abe’s use if it considers a project that involves the manufacturing of furniture?   12.46%
20. Ian is going to receive $20,000 six years from now. Sunny is going to receive $20,000 nine years from now. Which one of the following statements is correct if both Ian and Sunny apply a 7 percent discount rate to these amounts?    In today’s dollars, Ian’s money is worth more than Sunny’s.
21. If the maturity of a company’s liabilities is less than that of its assets, the company incurs a refinancing risk.  True
22. In a discounted cash flow analysis of Giant Corp.’s project described in the problem above, what would be the projected Year 1 free cash flow?    $600
23. In a discounted cash flow analysis of Giant Corp.’s project described in the problem above, what would be the projected Year 2 free cash flow?   $1,750
24. In general, the capital structures used by non-financial U.S. firms:   vary significantly across industries
25. In reality, the cost of equity is always less than the cost of debt because firms are not obligated to pay out cash to shareholders.   False
26. In some instances, additional debt financing can encourage managers to act more in the interests of owners   true
27. JKL Corporation, a company devoted primarily to paper products, is estimating the cost of equity appropriate for a vegetable processing plant it is planning to build. JKL Corp. has an equity beta of 1.0 and a debt ratio (D/(D+E)) of 0.3. A comparable (vegetable processing) firm has an equity beta of 0.8 and a debt ratio of 0.2. Assume a risk-free rate of 5% and a market risk premium of 8%. What cost of equity should JKL use in this situation?   12.3%
28. Naomi plans on saving $3,000 a year and expects to earn an annual rate of 10.25 percent. How much will she have in her account at the end of 45 years?    $2,333,572
29. Please refer to the information for FM Foods above. Estimate FM’s after-tax cost of equity capital.   12.20%
30. Please refer to the information for FM Foods above. Estimate FM’s after-tax cost of debt capital.    4.10%
31. Please refer to the information for FM Foods above. Estimate FM’s weighted-average cost of capital.   11.27%
32. Please refer to the information for FM Foods above. Estimate the appropriate weight of equity to be used when calculating FM’s weighted-average cost of capital.    88.5%
33. Please refer to the information for FM Foods above. Estimate the appropriate weight of debt to be used when calculating FM’s weighted-average cost of capital.  11.5%
34. Please refer to the information for FM Foods above. FM is contemplating an average-risk investment costing $100 million and promising an annual after-tax cash flow of $15 million in perpetuity. Which of the following statements is/are correct?   II and III only
35. Pro forma free cash flows for a proposed project should:  II and III only
36. Salinas Corporation has net income of $15 million per year on net sales of $90 million per year. It currently has no long-term debt, but is considering a debt issue of $20 million. The interest rate on the debt would be 7%. Salinas Corp. currently faces an effective tax rate of 40%. What would be the annual interest tax shield to Salinas Corp. if it goes through with the debt issuance?   $560,000
37. Sol’s Sporting Goods is expanding, and as a result expects additional operating cash flows of $26,000 a year for 4 years. This expansion requires $39,000 in new fixed assets. These assets will be worthless at the end of the project. In addition, the project requires an additional $3,000 of net working capital throughout the life of the project; Sol expects to recover this amount at the end of the project. What is the net present value of this expansion project at a 16 percent required rate of return?   $32,409.57
38. Taxable income is reduced by the amount of the interest on a firm’s debt.   Lack of interest tax shields
39. The accounting rate of return is deficient as a figure of merit because it is insensitive to the timing of cash flows  True
40. The adjusted present value (APV) method of valuation is superior to the standard WACC method of valuation because the WACC method makes no adjustment for interest tax shields   False
41. The after-tax cost of debt generally increases when:   II and III only
42. The basic lesson of the M&M theory is that the value of a firm is dependent upon:    the total cash flow of the firm.
43. The best financing choice is the one that:  maximizes expected cash flows.
44. The capital structure weights used in computing the weighted-average cost of capital:  are based on the market value of the firm’s debt and equity securities.
45. The cost of equity for a firm:   can be estimated from the capital asset pricing model or the dividend growth model.
46. The discount rate assigned to an individual project should be based on:   the risks associated with the use of the funds required by the project.
47. The dividend growth model can be used to compute the cost of equity for a firm in which of the following situations?   II and III only
48. The evidence indicates that, on average, a company’s stock price declines when it announces a new issue of equity.  True
49. The excess return earned by a risky asset, for example with a beta of 1.4, over that earned by a risk-free asset is referred to as a:   risk premium.
50. The IRR and NPV always yield the same investment recommendations   False
51. The IRR is the discount rate at which an investment’s NPV equals its initial cost.   False
52. The M&M irrelevance proposition assures financial managers that their choice between equity or debt financing will ultimately have no impact on firm value.   false
53. The pre-tax cost of debt:   is based on the current yield to maturity of the firm’s outstanding bonds
54. The term “financial distress costs” includes which of the following?   I, II, III, and IV
55. The weighted-average cost of capital for a firm is the:   rate of return a firm must earn on its existing assets to maintain the current value of its stock.
56. Total risk is measured by _____ and systematic risk is measured by ____   standard deviation; beta
57. Under the simplifying assumptions of Modigliani and Miller, an increase in a firm’s financial leverage will:    increase the variability in earnings per share.
58. Unitron Corp. is considering project Z, which costs $50 million and offers an annual after-tax cash flow of $7.5 million in perpetuity. The project is in an industry that has greater market risk than Unitron’s typical projects. Unitron’s company weighted-average cost of capital, based on its typical projects, is 15%. Should Unitron Corp. accept project Z?   No, because the NPV of the project is negative.
59. Unsystematic risk:   can be effectively eliminated by portfolio diversification.
60. What is the benefit-cost ratio for an investment with the following cash flows at a 14.5 percent required return?    1.02
61. What is the difference in the value of a $5,000 annual perpetuity and an annuity of $5,000 for 100 years? Assume that the discount rate is 8% and that cash flows are received at the end of the year.    $28
62. When a company is in financial distress, its shareholders may have an incentive to undertake excessively risky investments  true
63. When conducting a discounted cash flow analysis of a project, it is important to always include a careful estimate of financing costs in the project’s cash flows.  False
64. When considering the impact of distress costs on capital structure, which of the following facts should lead ABC Corporation to set a higher target debt ratio than XYZ Corporation (all else equal)?  ABC’s cash flows from operations are less volatile than XYZ’s.
65. When evaluating investments under capital rationing that are independent and can be acquired fractionally, ranking by the BCR is the appropriate technique.   True
66. When investment returns are less than perfectly positively correlated, the resulting diversification effect means that:   spreading an investment across many diverse assets will eliminate some of the total risk.
67. When making a capital budgeting decision, which of the following is/are NOT relevant?   III only
68. When projected cash flows are in nominal dollars, they should be discounted with a nominal discount rate.  True
69. Which  of the following statements related to the internal rate of return (IRR) are correct?                         I and III only
70. Which of the following are examples of diversifiable risk?   . I and IV only
71. Which of the following factors favor the issuance of debt in the financing decision?   I and III only
72. Which of the following factors favor the issuance of debt in the financing decision?   I and III only
73. Which of the following factors favor the issuance of equity in the financing decision?  II and IV only
74. Which of the following figures of merit does not directly take into consideration the time value of money?    I & IV only
75. Which of the following figures of merit might not use all possible cash flows in its calculations?     I only
76. Which of the following is NOT a likely financing policy for a rapidly growing business?  Borrow funds rather than limit growth, thereby limiting growth only as a last resort.
77. Which of the following is NOT a reason why a dollar today is worth more than a dollar in the future?   The value of a dollar in the future will be compounded more than the value of a dollar today.
78. Which of the following is NOT an implication of the pecking order theory of capital structure?   More-profitable firms (all else equal) should have higher debt ratios.
79. Which of the following is NOT an important step in the financial evaluation of an investment opportunity?   Estimate the accounting rate of return for the investment.
80. Which of the following is/are helpful for evaluating the effect of leverage on a company’s risk and potential returns?   I and III only
81. Which of the following should be included in the cash flow projections for a new product?           II and III only
82. Which of the following statements are correct concerning diversifiable, or unsystematic, risks?     I, II, and III only
83. Which of the following statements are correct?   I and IV only
84. Which of the following statements concerning risk are correct?    I and III only
85. Which of the following statements regarding interest tax shields is correct?   Taxable income is reduced by the amount of the interest on a firm’s debt.
86. Which one of the following is an example of systematic risk?  The Federal Reserve unexpectedly announces an increase in target interest rates.
87. You are the beneficiary of a life insurance policy. The insurance company informs you that you have two options for receiving the insurance proceeds. You can receive a lump sum of $200,000 today or receive payments of $1,400 a month for 20 years. You can earn a 6 percent annual rate on your money, compounded monthly. Which option should you take and why?   You should accept the $200,000 lump sum because the monthly payments are only worth $195,413 to you today.
88. You are to receive an annuity of $1,000 per year for 10 years. You will receive the first payment two years from today. At a discount rate of 10%, what is the present value of this annuity?   $5,585.97
89. You plan to buy a new Mercedes four years from now. Today, a comparable car costs $82,500. You expect the price of the car to increase by an average of 4.8 percent per year over the next four years. How much will your dream car cost by the time you are ready to buy it?   $99,517.41
90. You plan to pay $50 for a share of preferred stock that pays a $2.40 dividend per year forever. What annual rate of return will you realize?    4.80%
91. Your brother will borrow $17,800 to buy a car. The terms of the loan call for monthly payments for 5 years at an 8.6 percent annual interest rate, compounded monthly. What is the amount of each payment?   $366.05
92. Your grandmother invested a lump sum 26 years ago at 4.25 percent interest. Today, she gave you the proceeds of that investment which totaled $51,480.79. How much did she originally invest?    $17,444.86

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