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Question
Assume that the economy is enjoying a strong boom, and as a result interest rates and money costs generally are relatively high. The WACC for two mutually exclusive projects that are being considered is 12%. Project S has an IRR of 20% while Project L's IRR is 15%. The projects have the same NPV at the 12% current WACC. However, you believe that the economy will soon fall into a mild recession, and money costs and thus your WACC will soon decline. You also think that the projects will not be funded until the WACC has decreased, and their cash flows will not be affected by the change in economic conditions. Under these conditions, which of the following statements is CORRECT?
a. You should reject both projects because they will both have negative NPVs under the new conditions.
b. You should delay a decision until you have more information on the projects, even if this means that a competitor might come in and capture this market.
c. You should recommend Project L, because at the new WACC it will have the higher NPV.
d. You should recommend Project S, because at the new WACC it will have the higher NPV.
e. You should recommend Project L because it will have both a higher IRR and a higher NPV under the new conditions.
Answer
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Related questions
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Master Card and other credit card issuers must by law print the Annual Percentage Rate (APR) on their monthly statements. If the APR is stated to be 19.25%, with interest paid monthly, what is the card's EFF%?
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d. 17.68%
e. 23.15%
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a. 9.96%
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e. 10.86%
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You sold a car and accepted a note with the following cash flow stream as your payment. What was the effective price you received for the car assuming an interest rate of 13.0%?
0 1 2 3 4
CFs: $0 $1,000 $2,000 $2,000 $2,000
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Q:
Some of these questions are just definitions, but others require real thought about the make-up of the ratios and relationships among the ratios. We tell our students that to answer some of these questions it is useful (1) to write out the relevant ratio or ratios, (2) then to think about how the ratios would change if the accounting data changed, and (3) occasionally to make up illustrative data to test their conclusions.
Q:
Refer to Exhibit 4.1. What is the firm's market-to-book ratio? Do not round your intermediate calculations.
a. 1.82
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Q:
Refer to Exhibit 4.1. What is the firm's total debt to total capital ratio? Do not round your intermediate calculations.
a. 43.14%
b. 47.76%
c. 58.04%
d. 53.93%
e. 51.36%
Q:
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a. True
b. False
Q:
Modigliani and Miller (MM), in their second article, took account of taxes, bankruptcy, and other factors that were assumed away in their original article. Once they took account of all these assumptions, they concluded that every firm has a unique optimal capital structure. Moreover, a manager can use the second MM model to determine his or her firm's optimal debt ratio.
a. True
b. False
Q:
The Miller model begins with the Modigliani and Miller (MM) model without corporate taxes and then adds personal taxes.
a. True
b. False
Q:
As the text indicates, a firm's financial risk can and should be divided into separate market and diversifiable risk components.
a. True
b. False
Q:
It is possible for Firms A and B to have identical financial and operating leverage, yet for Firm A to have more risk as measured by the variability of EPS. This would occur if Firm A has more business risk than Firm B.
a. True
b. False
Q:
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WACC 10.0%
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u200b u200b
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Annual operating costs $30,000
Expected pre-tax salvage value $5,000
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a. $5,650
b. $378
c. $344
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Q:
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b. The interest rate today on a 2-year bond should be approximately 6%.
c. The interest rate today on a 2-year bond should be approximately 7%.
d. The interest rate today on a 3-year bond should be approximately 7%.
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Q:
Assuming that the term structure of interest rates is determined as posited by the pure expectations theory, which of the following statements is CORRECT?
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Q:
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Q:
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Q:
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Q:
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a. 1, 3, 4, 6
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c. 1, 2, 3, 4, 6
d. 1, 2, 3, 4, 5, 6
e. 1, 3, 4, 5, 6
Q:
Which of the following statements is CORRECT?
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c. A 10-year coupon bond would have more reinvestment risk than a 5-year coupon bond, but all 10-year coupon bonds have the same amount of reinvestment risk.
d. A 10-year coupon bond would have more price risk than a 5-year coupon bond, but all 10-year coupon bonds have the same amount of price risk.
e. If their maturities and other characteristics were the same, a 5% coupon bond would have less price risk than a 10% coupon bond.
Q:
Last year Jandik Corp. had $270,000 of assets (which is equal to its total invested capital), $18,750 of net income, and a debt-to-total-capital ratio of 37%. Now suppose the new CFO convinces the president to increase the debt-to-total-capital ratio to 48%. Sales, total assets and total invested capital will not be affected, but interest expenses would increase. However, the CFO believes that better cost controls would be sufficient to offset the higher interest expense and thus keep net income unchanged. By how much would the change in the capital structure improve the ROE? Do not round your intermediate calculations.
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c. $268,392
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Q:
Song Corp's stock price at the end of last year was $28.50 and its earnings per share for the year were $1.30. What was its P/E ratio?
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c. 21.48
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e. 20.39
Q:
Herring Corporation has operating income of $275,000 and a 25% tax rate. The firm has short-term debt of $143,000, long-term debt of $323,000, and common equity of $466,000. What is its return on invested capital?
a. 20.88%
b. 21.46%
c. 22.13%
d. 23.38%
e. 24.23%
Q:
X-1 Corp's total assets at the end of last year were $365,000 and its EBIT was $52,500. What was its basic earning power (BEP) ratio?
a. 14.10%
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Q:
Which of the following statements is CORRECT?
a. A time line is not meaningful unless all cash flows occur annually.
b. Time lines are not useful for visualizing complex problems prior to doing actual calculations.
c. Time lines can be constructed to deal with situations where some of the cash flows occur annually but others occur quarterly.
d. Time lines can only be constructed for annuities where the payments occur at the end of the periods, i.e., for ordinary annuities.
e. Time lines cannot be constructed where some of the payments constitute an annuity but others are unequal and thus are not part of the annuity.
Q:
Which of the following statements is CORRECT?
a. A time line is not meaningful unless all cash flows occur annually.
b. Time lines are not useful for visualizing complex problems prior to doing actual calculations.
c. Time lines cannot be constructed in situations where some of the cash flows occur annually but others occur quarterly.
d. Time lines can be constructed for annuities where the payments occur at either the beginning or the end of the periods.
e. Some of the cash flows shown on a time line can be in the form of annuity payments, but none can be uneven amounts.
Q:
Which of the following statements is CORRECT?
a. A time line is not meaningful unless all cash flows occur annually.
b. Time lines are useful for visualizing complex problems prior to doing actual calculations.
c. Time lines cannot be constructed in situations where some of the cash flows occur annually but others occur quarterly.
d. Time lines cannot be constructed for annuities where the payments occur at the beginning of the periods.
e. Some of the cash flows shown on a time line can be in the form of annuity payments, but none can be uneven amounts.
Q:
When a loan is amortized, a relatively high percentage of the payment goes to reduce the outstanding principal in the early years, and the principal repayment's percentage declines in the loan's later years.
a. True
b. False
Q:
As a result of compounding, the effective annual rate on a bank deposit (or a loan) is always equal to or less than the nominal rate on the deposit (or loan).
a. True
b. False