1. A beta greater than 1 is indicative of an above-average level of diversifiable (unsystematic) risk.   False
2. 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
3. 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
4. Acquisitions create shareholder value, on average.   True
5. All else equal, a terminal value based on a no-growth perpetuity would be higher than a terminal value based on a perpetuity with 2 percent growth.   False
6. 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
7. An acquirer should be willing to pay a higher control premium for a poorly managed company than for a well-managed company.   True
8. An acquirer should never consider a target that would reduce the acquirer’s earnings per share.   False
9. 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
10. Asset betas measure financial risk and business risk.  False
11. Debt financing results in lower after-tax earnings relative to equity financing. True
12. Failing to include real options in a project valuation could cause the NPV of the project to be overestimated.   False
13. Ginormous Oil entered into an agreement to purchase all of the outstanding shares of Slick Company for $60 per share. The number of outstanding shares at the time of the announcement was 82 million. The book value of liabilities on the balance sheet of Slick Co. was $1.46 billion. What was the cost of this acquisition to the shareholders of Ginormous Oil?   $6.38
14. Homemade leverage is:  the borrowing or lending of money by individual shareholders as a means of adjusting their level of financial leverage.
15. If the maturity of a company’s liabilities is less than that of its assets, the company incurs a refinancing risk.   True
16. In business valuation, a typical discount for lack of marketability is about 10 percent.  False
17. In general, the capital structures used by non-financial U.S. firms:   vary significantly across industries.
18. 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
19.  In some instances, additional debt financing can encourage managers to act more in the interests of owners.   True
20.  In venture capital valuation, the post-money valuation is equal to the pre-money valuation plus the amount of the venture capitalist’s investment.   True
21. 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
22. 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
23. The after-tax cost of debt generally increases when:   II and III only
24. 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.
25. The best financing choice is the one that:  maximizes expected cash flows.
26. 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.
27. The cost of equity for a firm:   can be estimated from the capital asset pricing model or the dividend growth model.
28. 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.
29. 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
30. The evidence indicates that, on average, a company’s stock price declines when it announces a new issue of equity.   True
31. 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.
32. The following table presents forecasted financial and other information for Havasham Industries:  None of the options are correct.
33. 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
34. The pre-tax cost of debt:   is based on the current yield to maturity of the firm’s outstanding bonds.
35. 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.
36. Total risk is measured by _____ and systematic risk is measured by ___   standard deviation; beta
37. Under the simplifying assumptions of Modigliani and Miller, an increase in a firm’s financial leverage will:  increase the variability in earnings per share.
38. 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.
39. Unsystematic risk:   can be effectively eliminated by portfolio diversification.
40. When a company is in financial distress, its shareholders may have an incentive to undertake excessively risky investments.   True
41. When an acquirer purchases all of a target firm’s equity, it must assume the target’s liabilities.  True
42.  When an acquirer values a potential target, it should discount the target’s cash flows at the target’s cost of capital.  True
43. 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.
44. 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.
45. When projected cash flows are in nominal dollars, they should be discounted with a nominal discount rate.   True
46. Which of the following are examples of diversifiable risk?   I and IV only
47. 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.
48. 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
49. Which of the following statements are correct concerning diversifiable, or unsystematic, risks?    I, II, and III only
50. Which of the following statements concerning risk are correct?  I and III only
51. 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.
52. Which of the following would not be considered a cost of financial distress?  Lack of interest tax shields
53. Which one of the following is an example of systematic risk?    The Federal Reserve unexpectedly announces an increase in target interest rates.

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