Final exam/2

Multiple Choice
Identify the choice that best completes the statement or answers the question.

____ 1. An analyst has collected the following information regarding Christopher Co.:

• The company's capital structure is 70 percent equity, 30 percent debt.

• The yield to maturity on the company's bonds is 9 percent.
• The company's year-end dividend is forecasted to be $0.80 a share.
• The company expects that its dividend will grow at a constant rate of 9 percent a year.
• The company's stock price is $25.
• The company's tax rate is 40 percent.
• The company anticipates that it will need to raise new common stock this year. Its investment
bankers anticipate that the total flotation cost will equal 10 percent of the amount issued.

Assume the company accounts for flotation costs by adjusting the cost of capital. Given this information,
calculate the company's WACC. (3 points)

a. 10.41%
b. 12.56%
c. 10.78%
d. 13.55%
e. 9.29%
____ 2. McCarver Inc. is considering the following mutually exclusive projects:

Project A Project B
Year Cash Flow Cash Flow
0 -$5,000 -$5,000
1       200    3,000
2       800    3,000
3    3,000       800
4    5,000       200

At what cost of capital will the net present value of the two projects be the same? (That is, what is the
"crossover" rate?) (3 points)

a. 15.68%
b. 16.15%
c. 16.25%
d. 17.72%
e. 17.80%
____ 3. Which of the following statements is false? As a firm increases its operating leverage for a given quantity of
output, this
a. changes its operating cost structure.
b. increases its business risk.
c. increases the standard deviation of its EBIT.
d. increases the variability in earnings per share.
e. decreases its financial leverage.(2 points)
____ 4. Company A and Company B have the same total assets, operating income (EBIT), tax rate, and business risk.
Company A, however, has a much higher debt ratio than Company B. Company A's basic earning power
(BEP) exceeds its cost of debt financing (rd). Which of the following statements is most correct? (2 points)
a. Company A has a higher return on assets (ROA) than Company B.
b. Company A has a higher times interest earned (TIE) ratio than Company B.
c. Company A has a higher return on equity (ROE) than Company B, and its risk, as
measured by the standard deviation of ROE, is also higher than Company B's.
d. Statements b and c are correct.
e. All of the statements above are correct.
____ 5. Elephant Books sells paperback books for $7 each. The variable cost per book is $5. At current annual sales
of 200,000 books, the publisher is just breaking even. It is estimated that if the authors' royalties are reduced,
the variable cost per book will drop by $1. Assume authors' royalties are reduced and sales remain constant;
how much more money can the publisher put into advertising (a fixed cost) and still break even? (2 points)
a. $600,000
b. $466,667
c. $333,333
d. $200,000
e. None of the above
____ 6. While the portfolio return is a weighted average of realized security returns, portfolio risk is not necessarily a
weighted average of the standard deviations of the securities in the portfolio. It is this aspect of portfolios that
allows investors to combine stocks and actually reduce the riskiness of a portfolio. (2 points)
a. True
b. False
____ 7. You have been scouring The Wall Street Journal looking for stocks that are "good values" and have
calculated the expected returns for five stocks. Assume the risk-free rate (r RF) is 7 percent and the market risk
premium (rM - rRF) is 2 percent. Which security would be the best investment? (Assume you must choose just
one.) (3 points)

Expected Return Beta

a.   9.01%          1.70
b.   7.06%          0.00
c.   5.04%         -0.67
d.   8.74%          0.87
e. 11.50%          2.50
____ 8. Acheson Aluminum is considering a project with the following cash flows. Cash flows in parentheses denote
negative cash flows.

Year Cash Flow

0 ($200,000)  
1 125,000
2 140,000
3   (50,000)
4 100,000

Acheson's WACC is 10 percent. What is the project's modified internal rate of return (MIRR)? (3 points)

a. 17.95%
b. 16.38%
c. 14.90%
 d. 15.23%
e. 12.86%
____ 9. Projects S and L are equally risky, mutually exclusive, and have normal cash flows. Project S has an IRR of
15%, while Project L’s IRR is 12%. The two projects have the same NPV when the WACC is 7%. Which of
the following statements is CORRECT? (3 points)
a. If the WACC is 10%, both projects will have positive NPVs.
b. If the WACC is 6%, Project S will have the higher NPV.
c. If the WACC is 13%, Project S will have the lower NPV.
d. If the WACC is 10%, both projects will have a negative NPV.
e. Project S’s NPV is more sensitive to changes in WACC than Project L's.
____ 10. Your company, CSUS Inc., is considering a new project whose data are shown below. The required
equipment has a 3-year tax life, and the accelerated rates for such property are 33%, 45%, 15%, and 7% for
Years 1 through 4. Revenues and other operating costs are expected to be constant over the project's 10-year
expected operating life. What is the project's Year 4 cash flow? (3 points)

Equipment cost (depreciable basis) $70,000

Sales revenues, each year $35,500
Operating costs (excl. depr.) $25,000
Tax rate 35.0%

a. $9,223
b. $10,163
c. $8,540
d. $8,882
e. $6,747
____ 11. The Target Copy Company is contemplating the replacement of its old printing machine with a new model
costing $60,000. The old machine, which originally cost $40,000, has 6 years of expected life remaining and a
current book value of $30,000 versus a current market value of $24,000. Target's corporate tax rate is 40
percent. If Target sells the old machine at market value, what is the initial after-tax outlay for the new printing
machine? (3 points)

a. -$22,180
b. -$30,000
c. -$33,600
d. -$36,000
e. -$40,000

Special-Purpose Truck

You have been asked by the president of your company to evaluate the proposed acquisition of a new special-
purpose truck. The truck's basic price is $50,000, and it will cost another $10,000 to modify it for special use
by your firm. The truck falls into the MACRS three-year class, and it will be sold after three years for
$20,000. Use of the truck will require an increase in net operating working capital (spare parts inventory) of
$2,000. The truck will have no effect on revenues, but it is expected to save the firm $20,000 per year in
before-tax operating costs, mainly labor. The firm's marginal tax rate is 40 percent.

[Note: MACRS table required.]

____ 12. Refer to Special-Purpose Truck. What is the operating cash flow in Year 1? (3 points)
 a. $17,820
b. $18,254
c. $19,920
d. $20,121
e. $21,737
____ 13. Nachman Industries just paid a dividend of D0 = $1.75. Analysts expect the company's dividend to grow by
30% this year, by 10% in Year 2, and at a constant rate of 5% in Year 3 and thereafter. The required return
on this low-risk stock is 9.00%. What is the best estimate of the stock’s current market value? (3 points)

a. $55.91
b. $48.18
c. $59.48
d. $72.57
e. $50.56
____ 14. Bumpas Enterprises purchases $4,562,500 in goods per year from its sole supplier on terms of 2/15, net 115.
If the firm chooses to pay on time but does not take the discount, what is the effective annual percentage cost
of its non-free trade credit? (Assume a 365-day year.)(2 points)
a. 7.12%
b. 7.65%
c. 6.58%
d. 9.41%
e. 6.66%
____ 15.
Klose O Klose outfitters Inc. believes that its optimal capital structure consists of 60 %common equity and 40% debt,
and its tax rate is 40%. Klose must raise additional capital to fund its upcoming expansion. the firm will have
$2 million of retained earnings with a cost of 12%. New common stock in an amount up to $6 million would
have a cost of 15%. Furthermore, Klose can raise up to $3 million debt at an interest rate of 10% and an
additional $4 million of debt at 12%. The CFO estimates that a proposed expansion would require an
investment of $5.9 million. What is the WACC for the last dollar raised to complete the expansion?(3 points)

a. 11.4%
b. 10.6%
c. 13%
d. 7.2%