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- Chapter 11 - Fundamentals of Corporate Finance 9th Edition - Test Bank
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Question 1-10 are True & False Questions which carry 1 point weight each.

1. An investment's average net income divided by its average book value is the Payback period.

A. True

B. False

2. The method of financing a project affects the determination of its cash flows.

A. True

B. False

3. Sunk costs do not influence capital budgeting decisions unless they are larger than future

Cash inflows

A. True

B. False

C. True

D. False

5. If a project permits a reduction in the level of working capital, this reduction is assumed to increase

cash flows

C. True

D. False

6. Accurate capital budgeting analysis depends on total cash flows as opposed to incremental

cash flows.

C. True

D. False

7. For mutually exclusive projects, the project with the higher NPV is always the correct

Selection, regardless of IRR.

A. True

B. False

8. When calculating IRR with a trial and error process, discount rates should be lowered if

NPV is still positive.

A. True

B. False

9. When using a profitability index to select projects, a value of 0.63 is preferred over a value

of 0.21.

A. True

B. False

10. A project's payback period is the length of time necessary to generate an NPV of zero

A. True

B. False

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Aditya

Question 11-20 are multiple choice Questions which carry 2 points weight each.

11. All other things being equal, the sensitivity of the price of an annual coupon bond with a

Fixed maturity to a change in interest rates can best be described as:

A) The shorter the time to maturity, the greater the sensitivity of bond price to a change in

interest rates.

B) Bond price is sensitive to maturity and the coupon level, but not to interest rates.

C) The longer the time to maturity, the greater the sensitivity of bond price to a

change in interest rates.

D) None of the above.

12. According to the valuation approaches we have covered so far, and all other things being

Equal, an increase in interest rates would

B) Reduce the price of preferred stock.

C) Reduce the price of common stock.

D) all of the above

A) The plowback ratio times the return on equity

B) The return on equity divided by the plowback ratio

C) The return on assets times the plowback ratio

D) The plowback ratio times the return on equity times the ratio of equity to assets

14. You are considering an investment with the following cash flows. Your required return is 10%; you

require a payback of three years and a discounted payback of four years. If your objective is to

maximize your wealth, should you take this investment?

Year 0 1 2 3 4 5

Cash Flow -$100,000 $40,000 $40,000 $40,000 $40,000 -$50,000

B) Yes, because the discounted payback is four years.

C) Yes, because both the payback and the discounted payback are less than two years.

D) No, because the NPV is negative.

E) No, because the project has a large negative cash flow at the end of its life.

15. Randy's Manufacturing is considering two mutually exclusive projects. The company has a

required rate of return of 13.5% on projects of this nature. Project A costs $100,000 and has an

IRR of 14.5%. Project B costs $150,000 and has an IRR of 14%. Which project should be accepted

and why?

A) Project A because it costs less and has a higher IRR than Project B

B) Project A because it has the highest IRR of two projects and exceeds the required return

C) Project B because it has the largest net present value

D) Project B because it has the lower IRR of the two projects

E) Both projects because both project IRRs are greater than the required return

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16. Ginny is considering two independent projects. Each project costs $10,000. Project A produces

cash inflows of $3,000 a year for four years. Project B produces no cash flows for the first two

years and $6,000 a year for the following two years. Ginny wants to recoup her money within

3 years. Should Ginny accept these projects?

B) Ginny should accept Project A and reject Project B.

C) Ginny should reject Project A and accept Project B.

D) Ginny should reject both projects.

E) Ginny cannot make that decision based on the information provided.

17. All other things being equal, if the inflation rate goes up, the observed risk less interest rate

A) is unaffected.

B) Goes down.

C) Goes up.

D) Need more information

A) Value of the dividends received from the project since its inception.

B) Present value of the cash flows you expect to receive from the project over its

remaining life.

C) Value of past dividends and price increases for the project.

D) Future value of the cash flows you expect to receive from the project over its remaining life.

19. The return measure that an investor demands for giving up current use of funds, without

Adjusting for risk or purchasing power changes, is the

A) Risk premium.

B) Inflation premium.

C) Real rate of return.

D) Discount rate.

20. The cost of capital for a new project should be determined with reference to

A) The cost of the specific kind of financing used to implement the project.

B) The weighted average cost of capital of firms facing similar risks to this project.

C) The prime bank rate.

D) None of the above.

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Aditya

21. When doing financial discounting problems that involve payments, annuities and valuations at

various points in time, it is frequently useful to describe the business situation we are facing

using a:

Equations.

Written description.

Time line.

None of the above.

22. If in searching for the yield to maturity on a bond with a stated coupon rate and a known

Market price you get a value below the current market price, then in the next calculation

To correctly determine the bond’s yield to maturity you should try

B) A lower interest rate.

C) A longer maturity.

D) A higher coupon payment.

A. Taxable income resulting from a deductible expense.

B. Cash flow from an expense.

C. Net income.

D. Tax liability resulting from a deductible expense.

24. Firms that make investment decisions based upon the payback rule may be biased

Toward rejecting projects:

A. With short lives.

B. With long lives.

C. With undiscounted cash flows.

D. That are mutually exclusive.

25. A project has an initial cash outlay of $29,500. Cash inflows are estimated at $1,200, $6,900,

$7,800, $9,500, and $4,800 for years 1 through 5, respectively. What is the net present value of

this project given a 7% discount rate?

A) -$5,677.15

B) -$5,314.82

C) -$2,618.03

D) $700.00

E) $1,806.33

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Aditya

Question 21-40 are MC questions with workings which carry 3 points weight each. Any answer in

this section without working WILL NOT BE EVALUATED.

Support your answers for the following questions with adequate workings in the space provided

here. Answers without workings will not be evaluated.

26. If a project is expected to increase inventory by $20,000, increase accounts payable by $12,000,

and increase accounts receivable by $6,000, what effect does working capital have during the

life of the project? Give illustration for your answer here.

B. Increases investment by $20,000.

C. Increases investment by $12,000.

D. Working capital has no effect during the life of the project.

27. Which of the following statements is most likely correct for a project costing $50,000 and

returning $14,000 per year for five years? Demonstrate.

A. NPV = $36,274.

B. NPV = $20,000.

C. IRR = 1.4%.

D. IRR is greater than 10%.

28. What is the approximate IRR for a project that costs $4,356 and provides cash inflows

Of $1,000 in the 1st year, $ 2000 in the 2nd year and $3,000 in the 3rd year. Show.

A. 20.0%

B. 22.0%

C. 15.0%

D. none of the above

29. L& T has undertaken two mutually exclusive projects. Which one of them should be selected if

both are priced at $1,000 and the discount rate is 15%; Project A with three annual cash flows of

$1,000, or Project B, with three years of zero cash flow followed by three years of $1,500

annually?

A. Project A.

B. Project B.

C. The IRRs are equal, hence you are indifferent.

D. The NPVs are equal, hence you are indifferent.

30. A ten-year bond pays 11% interest on a $1000 face value annually. If it currently sells for

$1,195, what is its approximate yield to maturity? Show.

A) 11.50%

B) 12.95 %

C) 11.00 %

D) 8.08 %

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31. What is the NPV of a project that costs $100,000, provides $23,000 in cash flows annually for six

years, requires a $5,000 increase in net working capital, and depreciates the asset straight line

over six years while ignoring the half-year convention? The discount rate is 14%. Prove your

answer.

A. -$15,561

B. $-13,283

C. $13,283

D. $15,561

31. What is the amount of the cash flow for a firm with $50,000 profit before tax, $20,000

depreciation expense, and a 35% marginal tax rate? Demonstrate.

A. $50,000

B. $30,000

C. $39,500

D. $70,000

32. For a profitable firm in the 30% marginal tax bracket with $20,000 of annual depreciation

expense, the depreciation tax shield will be: (Demonstrate)

A. $ 9,000.00

B. $ 3,000.00

C. $20.000.00

D. $ 6,000.00

33. A 15-year bond pays 11% on a face value of $1,000. If similar bonds are currently yielding 8%,

what is the market value of the bond? Prove.

A. $1,000

B. $ 909

C. $1,350

D. $1,375

34. Find out the Duration of a bond at the discounting rate of 15%. This bond carries coupon rate of

10%, has a face value of $100 per bond and maturity of three years. PV at 15% for the 1st year =

0.870, 2nd year= 0.757 and the 3rd year is 0.658.

A. 3 years

B. 10 years

C. 15 years

D. 2.72 years

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Aditya

35. Last year Simon Inc. reported total assets of $200, equity of $70, net income of $50, dividends of

$15 and retained earnings of $35. What is Simon Inc's sustainable growth rate?

a) 25%

b) 57.1%

c) 50.0%

d) 71.4%

Common Stock: 1 million shares outstanding, $40 per share, $1 par value, beta = 1.3

Bonds: 10,000 bonds outstanding, $1,000 face value each, 8% annual coupon, 22 years to maturity,

market price = $1,101.23 per bond

Market risk premium = 8. 6%, risk-free rate = 4. 5%, marginal tax rate = 34%

A) 7.89%

B) 9.90%

C) 12.19%

D) 13.30%

E) 15.78%

37. RMB, Inc. sold a 20-year bond at par 12 years ago. The bond pays an 8% annual coupon, has a

$1,000 face value, and currently sells for $893.30. What is the firm's cost of debt?

A) 8.0%

B) 9.2%

C) 9.5%

D) 10.0%

E) 10.5%

38. Anthony's Antiques, Inc. has preferred stock outstanding which pays a dividend of $4 per share a

year. The current stock price is $32 per share. What is the cost of preferred stock?

A) 8.0%

B) 9.0%

C) 10.0%

D) 11.0%

E) 12.5%

39. Suppose a firm has 10.4 million shares of common stock outstanding with a par value of $1 per

share. The current market price per share is $12. The firm has outstanding debt with a par

value of $56 million selling at 102% of par. What capital structure weight would you use for

debt when calculating the firm's WACC?

A) 0.157

B) 0.314

C) 0.686

D) 0.739

E) 0.843

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Aditya

40. A firm has 2,000,000 shares of common stock outstanding with a market price of $2 per share.

It has 2,000 bonds outstanding, each selling for $1,200. The bonds mature in 15 years, have a

coupon rate of 10%, and pay coupons annually. The firm's beta is 1.2, the risk free rate is 5%,

and the market risk premium is 7%. The tax rate is 34%. Calculate the WACC.

A) 5.42%

B) 6.53%

C) 9.36%

D) 10.28%

E) 11.57%

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