The cost of capital reflects the cost of funds

1. The cost of capital reflects the cost of funds
A) over a short-run time period.
B) at a given point in time.
C) over a long-run time period.
D) at current book values.

2. The ________ from the sale of a security are the funds actually received from the sale after ________, or the total costs of issuing and selling the security, which have been subtracted from the total proceeds.
A) gross proceeds; the after-tax costs
B) gross proceeds; the flotation costs
C) net proceeds; the flotation costs
D) net proceeds; the after-tax costs

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3. The cost of common stock equity may be estimated by using the
A) yield curve.
B) net present value method.
C) Gordon model.
D) DuPont analysis.

4. Generally, the order of cost, from the least expensive to the most expensive, for long-term capital of a corporation is
A) new common stock, retained earnings, preferred stock, long-term debt.
B) common stock, preferred stock, long-term debt, short-term debt.
C) preferred stock, retained earnings, common stock, new common stock.
D) long-term debt, preferred stock, retained earnings, new common stock.

5. As a source of financing, once retained earnings have been exhausted, the weighted average cost of capital will
A) increase.
B) remain the same.
C) decrease.
D) change in an undetermined direction.

6. A firm has determined its cost of each source of capital and optimal capital structure which is composed of the following sources and target market value proportions.

The firm is considering an investment opportunity, which has an internal rate of return of 10 percent. The project
A) should not be considered because its internal rate of return is less than the cost of long-term debt.
B) should be considered because its internal rate of return is greater than the cost of debt.
C) should not be considered because its internal rate of return is less than the weighted average cost of capital.
D) should be considered because its internal rate of return is greater than the weighted average cost of capital.

7. In the context of capital budgeting, risk generally refers to
A) the degree of variability of the cash inflows.
B) the degree of variability of the initial investment.
C) the chance that the net present value will be greater than zero.
D) the chance that the internal rate of return will exceed the cost of capital.

8. ________ measure(s) the risk of a capital budgeting project by estimating the NPVs associated with the optimistic, most likely, and pessimistic cash flow estimates.
A) Simulations
B) Risk-adjusted discount rates
C) Sensitivity analysis
D) Multiple regression analysis

Table 1

A firm is considering investment in a capital project which is described below. The firm’s cost of capital is 18 percent and the risk-free rate is 6 percent. The project has a risk index of 1.5. The firm uses the following equation to determine the risk adjusted discount rate, RADR, for each project: RADR = Rf + Risk Index (Cost of capital – Rf)

9. The net present value without adjusting the discount rate for risk is ________. (See Table 1.)
A) $336,000.
B) $250,000.
C) $179,400.
D) $87,000.

Table 2

Yong Importers, an Asian import company, is evaluating two mutually exclusive projects, A and B. The relevant cash flows for each project are given in the table below. The cost of capital for use in evaluating each of these equally risky projects is 10 percent.

10. The NPVs of projects A and B are ________. (See Table 2):
A) $95,066 and $56,386, respectively.
B) $56,386 and $95,066, respectively.
C) -$56,386 and -$95,066, respectively.
D) none of the above.

11. Major types of real options include all of the following except the
A) abandonment option.
B) timing option.
C) conversion option.
D) growth option.

12. Which of the following capital budgeting techniques ignores the time value of money?
A) Payback.
B) Net present value.
C) Internal rate of return.
D) Two of the above

13. All of the following are weaknesses of the payback period EXCEPT
A) a disregard for cash flows after the payback period.
B) only an implicit consideration of the timing of cash flows.
C) the difficulty of specifying the appropriate payback period.
D) it uses cash flows, not accounting profits.

14. A firm is evaluating three capital projects. The net present values for the projects are as follows:

The firm should
A) accept Projects 1 and 2 and reject Project 3.
B) accept Projects 1 and 3 and reject Project 2.
C) accept Project 1 and reject Projects 2 and 3.
D) reject all projects.

15. What is the IRR for the following project if its initial after tax cost is $5,000,000 and it is expected to provide after-tax operating cash inflows of $1,800,000 in year 1, $1,900,000 in year 2, $1,700,000 in year 3 and $1,300,000 in year 4?
A) 15.57%.
B) 0.00%.
C) 13.57%.
D) None of the above.

16. There is sometimes a ranking problem among NPV and IRR when selecting among mutually exclusive investments. This ranking problem only occurs when
A) the NPV is greater than the crossover point.
B) the NPV is less than the crossover point.
C) the cost of capital is to the right of the crossover point.
D) the cost of capital is to the left of the crossover point.

17. The ________ is the compound annual rate of return that the firm will earn if it invests in the project and receives the given cash inflows.
A) discount rate
B) internal rate of return
C) opportunity cost
D) cost of capital

18. Fixed assets that provide the basis for the firm’s profit and value are often called
A) tangible assets.
B) non-current assets.
C) earning assets.
D) book assets.

Table 3

19. The cash flow pattern depicted is associated with a capital investment and may be characterized as (See Table 3.)
A) an annuity and conventional cash flow.
B) a mixed stream and non-conventional cash flow.
C) an annuity and non-conventional cash flow.
D) a mixed stream and conventional cash flow.

20. When making replacement decisions, the development of relevant cash flows is complicated when compared to expansion decisions, due to the need to calculate ________ cash inflows.
A) conventional
B) non-conventional
C) incremental
D) initial

21. The book value of an asset is equal to the
A) fair market value minus the accounting value.
B) original purchase price minus annual depreciation expense.
C) original purchase price minus accumulated depreciation.
D) depreciated value plus recaptured depreciation.

Table 4
Computer Disk Duplicators, Inc. has been considering several capital investment proposals for the year beginning in 2004. For each investment proposal, the relevant cash flows and other relevant financial data are summarized in the table below. In the case of a replacement decision, the total installed cost of the equipment will be partially offset by the sale of existing equipment. The firm is subject to a 40 percent tax rate on ordinary income and on long-term capital gains. The firm’s cost of capital is 15 percent.

22. For Proposal 2, the tax effect on the sale of the existing asset results in ________. (See Table 4.)
A) $12,000 tax liability.
B) $14,560 tax liability.
C) $25,280 tax liability.
D) $16,600 tax liability.

23. A corporation is evaluating the relevant cash flows for a capital budgeting decision and must estimate the terminal cash flow. The proposed machine will be disposed of at the end of its usable life of five years at an estimated sale price of $2,000. The machine has an original purchase price of $80,000, installation cost of $20,000, and will be depreciated under the five-year MACRS. Net working capital is expected to decline by $5,000. The firm has a 40 percent tax rate on ordinary income and long-term capital gain. The terminal cash flow is
A) $5,800.
B) $7,800.
C) $8,200.
D) $6,200.

24. The Modified Accelerated Cost Recovery System (MACRS) is a depreciation method used for ________ purposes.
A) tax
B) financial reporting
C) managerial
D) cost accounting

25. All of the following are non-cash charges EXCEPT
A) depreciation.
B) accruals.
C) depletion.
D) amortization.

26. The key output(s) of the short-run financial planning process are a(n)
A) cash budget, pro forma income statement, and pro forma balance sheet.
B) cash budget, sales forecast, and income statement.
C) sales forecast and cash budget.
D) income statement, balance sheet, and source and use statement.

27. ________ forecast is based on the relationships between the firm’s sales and certain economic indicators.
A) An internal
B) An external
C) A sales
D) A pro forma

28. The strict application of the percent-of-sales method of preparing the pro forma income statement assumes all costs are
A) fixed.
B) constant.
C) independent.
D) variable.

29. A weakness of the percent-of-sales method to preparing a pro forma income statement is
A) the assumption that the values of certain accounts can be forced to take on desired levels.
B) the assumption that the firm faces linear total revenue and total operating cost functions.
C) the assumption that the firm’s past financial condition is an accurate predictor of its future.
D) ease of calculation and preparation.

30. Accounting practices and procedures used to prepare financial statements are called
A) SEC.
B) FASB.
C) GAAP.
D) IRB.

31. ________ analysis involves the comparison of different firms’ financial ratios at the same point in time.
A) Time-series
B) Cross-sectional
C) Marginal
D) Quantitative

32. ________ ratios are a measure of the speed with which various accounts are converted into sales or cash.
A) Activity
B) Liquidity
C) Debt
D) Profitability

33. The ________ ratio measures the firm’s ability to pay contractual interest payments.
A) times interest earned
B) fixed-payment coverage
C) debt
D) average payment period

34. The ________ indicates the percentage of each sales dollar remaining after the firm has paid for its goods.
A) net profit margin
B) operating profit margin
C) gross profit margin
D) earnings available to common shareholders

35. A decrease in total asset turnover will result in ________ in the return on equity.
A) an increase
B) a decrease
C) no change
D) an undetermined change

36. Which of the following legal forms of organization is most expensive to organize?
A) Sole proprietorships.
B) Partnerships.
C) Corporations.
D) Limited partnership.

37. Economic theories that the financial manager must be able to utilize for efficient business operations, include
A) supply-and-demand analysis.
B) marginal analysis.
C) profit-maximizing strategies.
D) price theory.
E) all of the above.

38. Making financing decisions includes all of the following EXCEPT
A) determining the appropriate mix of short-term and long-term financing.
B) deciding which individual short-term sources are best at a given point in time.
C) analyzing quarterly budget and performance reports.
D) deciding which individual long-term sources are best at a given point in time.

39. The primary goal of the financial manager is
A) minimizing risk.
B) maximizing profit.
C) maximizing wealth.
D) minimizing return.

40. The key participants in financial transactions are individuals, businesses, and governments. Individuals are net ________ of funds, and businesses are net ________ of funds.
A) demanders; suppliers
B) users; providers
C) suppliers; demanders
D) purchasers; sellers

41. If a corporation sells certain capital equipment for more than their initial purchase price, the difference between the sale price and the purchase price is called a(n)
A) ordinary gain.
B) capital loss.
C) capital gain.
D) ordinary loss.

42. Accruals and accounts payable are ________ sources of short-term financing.
A) negotiated, secured
B) negotiated, unsecured
C) spontaneous, secured
D) spontaneous, unsecured

43. 1/15 net 30 date of invoice translates as
A) a 1 percent cash discount may be taken if paid in 15 days; if no cash discount is taken, the balance is due in 30 days after the middle of the month.
B) a 1 percent cash discount may be taken if paid in 15 days; if no cash discount is taken, the balance is due 30 days after the invoice date.
C) a 1 percent cash discount may be taken if paid in 15 days; if no cash discount is taken, the balance is due 30 days after the end of the month.
D) a 1 percent discount may be taken on 15 percent of the purchase if the account is paid within 30 days after the end of the month.

44. The ________ is the lowest rate of interest charged on business loans to the best business borrowers by the nation’s leading banks.
A) prime rate
B) commercial paper rate
C) federal funds rate
D) treasury bill rate

45. ________ is a short-term, unsecured promissory note issued by firms with a high credit standing. These notes are primarily issued by commercial finance companies.
A) A line of credit
B) Commercial paper
C) A revolving line of credit
D) A self-liquidating loan

46. Collateral is typically required for a
A) secured short-term loan.
B) line of credit.
C) short-term self-liquidating loan.
D) single payment note.

47. A terminal warehouse is
A) a warehouse located at the airport.
B) a warehouse on the borrower’s premises.
C) a central warehouse storing the merchandise of several businesses.
D) a warehouse located near the lender.

48. Net working capital is defined as
A) a ratio measure of liquidity best used in cross-sectional analysis.
B) the portion of the firm’s assets financed with short-term funds.
C) current liabilities minus current assets.
D) current assets minus current liabilities.

49. Only the firm’s permanent financing requirement (and not the seasonal requirement) is financed with ________ in the aggressive financing strategy.
A) long-term sources
B) short-term sources
C) retained earnings
D) accounts payable

50. The ________ is a technique that divides inventory into three groups, according to dollar investment.
A) exponential smoothing technique
B) ABC system
C) EOQ model
D) LIFO model

51. A firm’s credit ________ provides guidelines for determining whether to extend credit to a customer and how much credit to extend.
A) scoring
B) terms
C) policy
D) standards

52. A technique that provides the analyst with the information concerning the proportion of each type of account that has been outstanding for a specified period of time is called
A) credit analysis.
B) credit scoring.
C) aging of receivables.
D) the economic order quantity model.

53. When managing accounts receivable, a good strategy to employ without losing future sales is to
A) send the accounts to a collection agency.
B) tighten the credit terms.
C) offer cash discount.
D) make frequent personal visits to the customer.

54. ________ leverage is concerned with the relationship between sales revenues and earnings before interest and taxes.
A) Financial
B) Operating
C) Variable
D) Total

Solution Summary
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