Q&A Hero

Q: As long as a firm is near its target capital structure it will not have to concern itself with financial flexibility. a. True b. False

Q: The ability of a firm to raise sufficient capital on competitive terms under adverse conditions in order to sustain steady operations is referred to as financial flexibility. a. True b. False

Q: Business risk, which is the risk inherent in a firm's assets if it uses less than its optimal amount of debt, is one important influence in the capital structure decision. a. True b. False

Q: If a firm uses no debt, the uncertainty inherent in projections of future returns on equity can be described as business risk. a. True b. False

Q: Business risk will not affect a firm's beta, because beta is determined by the market and thus is outside the control of the firm. a. True b. False

Q: The optimal capital structure is that which results in the highest earnings per share because that will ensure maximum stock price. a. True b. False

Q: The optimal capital structure is that capital structure which strikes a balance between risk and return such that the firm's stock price is maximized. a. True b. False

Q: The mix of debt, preferred stock, and common equity with which the firm plans to support its asset structure is known as the target capital structure. a. True b. False

Q: Business risk depends on all of the following factors except ____. a. sales variability b. interest rates c. input price variability d. change in output prices

Q: What is the single most important determinant of capital structure for a company? a. Business risk b. Financial risk c. Exchange rate risk d. Interest rate risk

Q: Which of the following is not a factor that influences capital structure decisions for firms? a. financial flexibility b. rational investors c. business risk d. tax position

Q: If you own 100 shares in a company that announces a 2-for-1 stock split (with no other announcement), you should a. be happy because your investment has doubled. b. be happy because you will be receiving cash from your investment as a result of the split. c. be sad because the value of your investment will decline because of the split. d. be indifferent because the overall value of your investment has not changed.

Q: Once a target capital structure for a firm is determined the firm ____. a. does not allow the target to change. b. uses it as guide for raising capital. c. issues debt to lower leverage. d. none of the above.

Q: According to the signaling theory of capital structure, a firm with favorable prospects should raise new capital by issuing ____ and a firm with unfavorable prospects raise new capital by issuing ____. a. debt; equity b. equity; debt c. debt; debt d. equity; equity

Q: ____ information is the situation in which managers have better information about the firm's prospects. a. Asymmetric b. Symmetric c. Perfect d. Public

Q: It has been shown that a firm's beta ____ an increase in its degree of financial leverage. a. increases with b. decreases with c. remains constant with d. is not related to

Q: Which of the following factors do not have an impact on the business risk of a firm? a. Sales variability b. Input price variability c. Price elasticity d. Operating leverage e. All of the above impact a firm's business risk

Q: When a firm conducts a seasoned equity offering and uses the proceeds to purchase a portion of the firm's outstanding debt, then the firm's a. financial risk increases. b. financial risk decreases. c. business risk increases. d. business risk increases.

Q: Which of the following is not one of the four primary factors that influence capital structure? a. Geographic location of the firm. b. Managerial attitude of the firm. c. Financial flexibility of the firm. d. Tax position of the firm. e. Business risk of the firm.

Q: Using more debt in the firm's capital structure a. decreases the probability of filing for bankruptcy. b. raises the riskiness of the firm's earnings stream. c. generally leads to a lower expected rate of return. d. none of the above.

Q: Refer to Copybold Corporation. What is the coefficient of variation of expected EPS under the conservative capital structure plan? a. 0.58 b. 0.39 c. 0.15 d. 0.23 e. 1.00

Q: Refer to Copybold Corporation. What is the coefficient of variation of expected EPS under the aggressive capital structure plan? a. 1.00 b. 1.18 c. 2.45 d. 2.88 e. 3.76

Q: Refer to Copybold Corporation. What is the difference between the EPS forecasts for Feast and Famine under the conservative capital structure? a. $1.00 b. $0.80 c. $2.20 d. $0.44 e. $0

Q: Refer to Copybold Corporation. What is the difference between the EPS forecasts for Feast and Famine under the aggressive capital structure? a. $0 b. $1.48 c. $0.62 d. $0.98 e. $2.40

Q: Given the information below, calculate the expected growth rate (g) of dividends, using the constant growth model Beta = 1.75; rRF = 7 percent; rM = 11 percent; dividend payout ratio = 30 percent; rd = 10 percent (paid) on all long-term debt; P/E ratio = 10; sales = 5,000 units; sales price per unit = $5; variable cost per unit = $2; fixed cost = $1,000; common stock shares outstanding = 5,000; long-term debt outstanding = $10,000; tax rate = 40 percent. Assume equilibrium exists in the market. a. 11.34% b. 6.54% c. 11.0% d. 10.68% e. 10.19%

Q: Van Slyke Inc. has $5,000,000 in assets, and currently has no debtu23afit is financed entirely with 200,000 shares of common stock, each of which trades at $25 per share. The firm's EBIT is expected to be $1,250,000 at year end (i.e., at t = 1). The corporate tax rate is 40 percent. Van Slyke expects to pay out a dividend at year end which is 50 percent of its net income. The company estimates that its earnings and dividends grow at a constant rate of 3 percent a year. The company is considering a recapitalization where they would issue $1,000,000 of debt at a before-tax cost of 10 percent. The proceeds from the debt issued would be used to repurchase shares of the company's stock at $25 per share. The company's investment bankers estimate that the cost of equity capital would be 16 percent after the recapitalization. What would you expect the company's stock price to be immediately following the recapitalization? Assume that the dividend has not yet been paid. a. $12.15 b. $16.59 c. $20.98 d. $27.25 e. $33.17

Q: Calculate the current price per share (P0) for Olson Corporation, given the following information. The data all pertain to the year just ended. Sales = 10,000 units Sales price per unit = $10 Variable cost per unit = $5 Fixed cost = $10,000 Long-term debt outstanding = $15,000 rd on all long-term debt = 5% Tax rate = 30% Common stock shares outstanding = 10,000 shares Beta = 1.5 rRF= 5% rM= 9% Dividend payout ratio = 40% Growth rate in earnings and dividends = 7% a. $39.20 b. $57.84 c. $29.43 d. $61.90 e. None of the above.

Q: Driver Corporation faces an IOS schedule calling for a capital budget of $60 million. Its optimal capital structure is 60 percent equity and 40 percent debt. Its earnings before interest and taxes (EBIT) were $98 million for the year. The firm has $200 million in assets, pays an average of 10 percent on all its debt, and faces a marginal tax rate of 34 percent. If the firm maintains a residual dividend policy and will keep its optimal capital structure intact, what will be the amount of the dividends it pays out after financing its capital budget? a. $23.4 million b. $59.4 million c. $20.76 million d. $30.0 million e. $0

Q: Flavortech Inc. expects EBIT of $2,000,000 for the coming year. The firm's capital structure consists of 40 percent debt and 60 percent equity, and its marginal tax rate is 40 percent. The cost of equity is 14 percent, and the company pays a 10 percent rate on its $5,000,000 of long-term debt. One million shares of common stock are outstanding. In its next capital budgeting cycle, the firm expects to fund one large positive NPV project costing $1,200,000, and it will fund this project in accordance with its target capital structure. If the firm follows a residual dividend policy and has no other projects, what is its expected dividend payout ratio? a. 100% b. 60% c. 40% d. 20% e. 0%

Q: The following facts apply to your company: Target capital structure: 50% debt; 50% equity EBIT: $200 million Assets: $500 million Tax rate: 40% Cost of new and old debt: 8% Based on the residual dividend policy, the payout ratio is 60 percent. How large (in millions of dollars) will the capital budget be? a. $43.2 b. $50.0 c. $64.8 d. $86.4 e. $108.0

Q: Your company has decided that its capital budget during the coming year will be $20 million. Its optimal capital structure is 60 percent equity and 40 percent debt. Its earnings before interest and taxes (EBIT) are projected to be $34.667 million for the year. The company has $200 million of assets; its average interest rate on outstanding debt is 10 percent; and its tax rate is 40 percent. If the company follows the residual dividend policy and maintains the same capital structure, what will its dividend payout ratio be? a. 15% b. 20% c. 25% d. 30% e. 35%

Q: Strategic Systems Inc. expects to have net income of $800,000 during the next year. Its target, and current, capital structure is 40 percent debt and 60 percent common equity. The Director of Capital Budgeting has determined that the optimal capital budget for next year is $1.2 million. If Strategic uses the residual dividend model to determine next year's dividend payout, what is the expected payout ratio? a. 0% b. 10% c. 28% d. 42% e. 56%

Q: If the debt-to-assets ratio is 50 percent, the interest rate on all debt is 8 percent, the tax rate is 50 percent, and the return on equity is 10 percent, then the ratio of earnings before interest and taxes (EBIT) to total assets, or the basic earning power ratio, must be a. 10%. b. 14%. c. 12%. d. 8%. e. 16%.

Q: The Congress Company has identified two methods for producing playing cards. One method involves using a machine having a fixed cost of $10,000 and variable costs of $1.00 per deck of cards. The other method would use a less expensive machine (fixed cost = $5,000), but it would require greater variable costs ($1.50 per deck of cards). If the selling price per deck of cards will be the same under each method, at what level of output will the two methods produce the same net operating income? a. 5,000 decks b. 10,000 decks c. 15,000 decks d. 20,000 decks e. 25,000 decks

Q: Howell Enterprises is forecasting EPS of $4.00 per share for next year. The firm has 10,000 shares outstanding, it pays 12 percent interest on its debt, and it faces a 40 percent marginal tax rate. Its estimated fixed costs are $80,000 while its variable costs are estimated at 40 percent of revenue. The firm's target capital structure is 40 percent equity and 60 percent debt and it has total assets of $400,000. On what level of sales is Howell basing its EPS forecast? a. $1,000,000 b. $480,400 c. $316,722 d. $292,445 e. $105,280

Q: The Altman Company has a debt-to-assets ratio of 33 percent, and it needs to raise $100,000 to expand. Management feels that an optimal debt-to-assets ratio would be 16.67 percent. Sales are currently $750,000, and the total assets turnover is 7.5. How should the expansion be financed so as to produce the desired debt-to-assets ratio? a. Finance it all with equity. b. Finance it all with debt. c. Finance 20% debt, 80% equity. d. Finance 40% debt, 60% equity. e. Finance 50% debt, 50% equity.

Q: Stargell Industries follows a strict residual dividend policy. The company has a capital budget of $3,000,000. It has a target capital structure which consists of 30 percent debt and 70 percent equity. The company forecasts that its net income will be $3,500,000. What will be the company's payout ratio this year? a. 25% b. 30% c. 35% d. 40% e. 45%

Q: Which of the following is correct? a. Generally, debt to total assets ratios do not vary much among different industries although they do vary for firms within a particular industry. b. Utilities generally have very high common equity ratios due to their need for vast amounts of equity supported capital. c. The drug industry has a high debt to common equity ratio because their earnings are very stable and thus, can support the large interest costs associated with higher debt levels. d. Wide variations in capital structures exist between industries and also between individual firms within industries and are influenced by unique firm factors including managerial attitudes. e. Since most stocks sell at or around their book values, using accounting values provides an accurate picture of a firm's capital structure.

Q: Which of the following statements is correct? a. There have been no significant observed differences in the capital structures of U.S. corporations in comparison to their German and Japanese counterparts. b. Different countries use essentially the same international accounting conventions with respect to reporting assets on a historical versus replacement cost basis. c. An analysis of both bankruptcy and equity reporting costs leads to the conclusion that U.S. firms should have more equity and less debt than firms in Japan and Germany. d. Equity monitoring costs are higher in the United States than in Japan and Germany. e. Debt monitoring costs are probably lower in the United States than in Japan and Germany.

Q: Which of the following statements is correct? a. A key advantage of the residual dividend policy is that it usually results in a stable dividend policy which is attractive to investors. b. Investors should prefer that a corporation repurchase its common stock when the stock is overpriced. c. A reduction in the capital gains rate should work to discourage corporations from repurchasing their shares. d. The theory that investors prefer dividends rather than capital gains suggests that firms that increase their dividend payout should expect to realize a higher share price and a lower cost of equity capital. e. Answers c and d are both correct.

Q: Modigliani and Miller (MM) argued that dividend policy is irrelevant. On the other hand, others, such as Gordon and Lintner (GL), argued that dividend policy does matter. GL's argument rests on the contention that a. rs = /P0 + g is constant for any dividend policy. b. Because of perceived differences in risk, investors value a dollar of dividends more highly than a dollar of expected capital gains. c. Investors, because of tax differentials, value a dollar of expected capital gains more highly than a dollar of dividends. d. Most investors will reinvest rather than spend dividends, so it would save investors' money (taxes) if corporations simply reinvested earnings rather than paid them out as dividends. e. None of the above.

Q: Which of the following statement completions is correct? If investors prefer dividends to capital gains, then a. The equilibrium return, rs, will not be affected by a change in dividend policy because tax effects will offset these preferences. b. rs will decrease as dividends are reduced. c. rs will increase as dividends are reduced. d. rs will decrease as the retention rate increases. e. Dividend policy as determined by the residual dividend model is the only dividend policy which will maximize the price per share of common stock.

Q: If a firm adheres strictly to the residual dividend model, then if its optimal capital budget requires the use of all earnings for that year (along with new debt according to the optimal debt/total assets ratio), the firm should pay a. No dividends except out of past retained earnings. b. No dividends to common stockholders. c. Dividends, in effect, out of a new issue of common stock. d. Dividends by borrowing the money (debt). e. Either c or d above could be used.

Q: If a firm adheres strictly to the residual dividend model, a sale of new common stock by the company would suggest that a. The dividend payout ratio has remained constant. b. The dividend payout ratio is increasing. c. No dividends were paid for the year. d. The dividend payout ratio is decreasing. e. The dollar amount of investments has decreased.

Q: Which of the following statements is correct? a. If the dividend irrelevance theory (which is associated with the names Modigliani and Miller) were exactly correct, and if this theory could be tested with "clean" data, then we would find, in a regression of dividend yield and capital gains, a line with a slope of −1.0. b. The tax preference and bird-in-the-hand theories lead to identical conclusions as to the optimal dividend policy. c. If a company raises its dividend by an unexpectedly large amount, the announcement of this new and higher dividend is generally accompanied by an increase in the stock price. This is consistent with the bird-in-the-hand theory, and Modigliani and Miller used these findings to support their position on dividend theory. d. If it could be demonstrated that a clientele effect exists, this would suggest that firms could alter their dividend payment policies from year to year to take advantage of investment opportunities without having to worry about the effects of changing dividends on capital costs. e. Each of the above statements is false.

Q: If the Modigliani and Miller hypothesis about dividends is correct, and if one found a group of companies which differed only with respect to dividend policy, which of the following statements would be most correct? a. The residual dividend model should not be used, because it is inconsistent with the MM dividend hypothesis. b. The total expected return, which in equilibrium is also equal to the required return, would be higher for those companies with lower payout ratios because of the greater risk associated with capital gains versus dividends. c. If the expected total return of each of the sample companies were divided into a dividend yield and a growth rate, and then a scatter diagram (or regression) analysis were undertaken, then the slope of the regression line (or b in the equation D1/P0 = a + b(g)) would be equal to +1.0. d. None of the above statements is true. e. All of the above statements are true.

Q: If you were to argue that the firm's cost of equity, rs, increases as the dividend payout decreases, you would be making an argument ____ with MM's dividend irrelevance theory, and ____ with the theory that investors prefer dividends received in the current period rather than capital gains received in the future. a. consistent; consistent b. inconsistent; consistent c. consistent; inconsistent d. inconsistent; inconsistent e. The argument above does not make sense; neither theory involves the cost of equity capital.

Q: Which of the following statements is correct? a. "Business risk" is differentiated from "financial risk" by the fact that financial risk reflects only the use of debt, while business risk reflects both the use of debt and such factors as sales variability, cost variability, and operating leverage. b. If corporate tax rates were decreased while other things were held constant, and if the Modigliani-Miller tradeoff theory of capital structure were correct, then corporations should tend to increase their use of debt. c. If corporate tax rates were decreased while other things were held constant, and if the Modigliani-Miller tradeoff theory of capital structure were correct, then corporations should tend to decrease their use of debt. d. The optimal capital structure is the one which (1) maximizes the price of the firm's stock, (2) minimizes its WACC, and (3) maximizes its EPS. e. Statements b and d are both correct.

Q: Which of the following statements is correct? a. When financial leverage is used, the graphical probability distribution of net income would tend to be more peaked than a distribution where no leverage is present, other things held constant. b. From an operational standpoint the goal of maintaining financial flexibility translates into maintaining adequate reserve borrowing capacity. c. While business risk varies from one industry to another and can change over time, it affects all firms equally within a particular industry. d. The optimal capital structure is the one that maximizes EBIT, and this always calls for a debt-to-assets ratio which is lower than the one that maximizes expected EPS. e. The above statements are all false.

Q: If you know that your firm is facing relatively poor prospects but needs new capital, and you know that investors do not have this information, signaling theory would predict that you would a. Issue debt to maintain the returns of equity holders. b. Issue equity to share the burden of decreased equity returns between old and new shareholders. c. Be indifferent between issuing debt and equity. d. Postpone going into capital markets until your firm's prospects improve. e. Convey your inside information to investors using the media to eliminate the information asymmetry.

Q: The "Pure Modigliani and Miller Result" establishes, under restrictive assumptions, that the firm's stock price will be maximized if it uses virtually 100 percent debt. Which of the following real world conditions does the most to limit real world corporate debt-to-assets ratios to far less than 100 percent? a. There are brokerage costs. b. At high levels of debt revenues decline. c. Investors can't really borrow at the same rate as corporations. d. Interest rates increase as the debt-to-assets ratio rises. e. Dividends are relevant in the real world.

Q: Which of the following statements is correct? a. Suppose Company A's EPS is expected to experience a larger percentage change in response to a given percentage change in sales than Company B's EPS. Other things held constant, Company A would appear to have more business risk than Company B. b. Statement a would be correct if the term "EBIT" were substituted for "EPS." c. Statement a would be correct if the term "EBIT" were substituted for "sales." d. Statement a would be correct if the words "financial risk" were substituted for "business risk." e. The above statements are all false.

Q: If debt financing is used, which of the following is correct? a. The percentage change in net operating income is greater than a given percentage change in net income. b. The percentage change in net operating income is equal to a given percentage change in net income. c. The percentage change in net operating income depends on the interest rate charged on debt. d. The percentage change in net operating income is less than the percentage change in net income. e. The degree of operating leverage is greater than 1.

Q: Which of the following statements is most correct? a. The optimal capital structure minimizes the WACC. b. If the after-tax cost of equity financing exceeds the after-tax cost of debt financing, firms are always able to reduce their WACC by increasing the amount of debt in their capital structure. c. Increasing the amount of debt in a firm's capital structure is likely to increase the cost of both debt and equity financing. d. Answers a and c are both correct. e. Answers b and c are both correct.

Q: As a general rule, the capital structure that a. Maximizes expected EPS also maximizes the price per share of common stock. b. Minimizes the interest rate on debt also maximizes the expected EPS. c. Minimizes the required rate on equity also maximizes the stock price. d. Maximizes the price per share of common stock also minimizes the weighted average cost of capital. e. None of the above.

Q: Which of the following would not have an influence on the optimal dividend policy? a. The possibility of accelerating or delaying investment projects. b. A strong shareholders' preference for current income versus capital gains. c. Bond indenture constraints. d. The costs associated with selling new common stock. e. All of the above can have an effect on dividend policy.

Q: Which of the following types of dividends is (are) never paid out in the form of cash? a. Regular dividend. b. Stock dividend. c. Extra dividend. d. Liquidating dividend. e. All of the above are paid in the form of cash.

Q: A decrease in a firm's willingness to pay dividends might result from an increase in its a. Earnings stability. b. Access to capital markets. c. Profitable investment opportunities. d. Collection of accounts receivable. e. Stock price.

Q: In the real world, we find that dividends a. Usually exhibit greater stability than earnings. b. Fluctuate more widely than earnings. c. Tend to be a lower percentage of earnings for mature firms. d. Are usually changed every year to reflect earnings changes. e. Are usually set as a fixed percentage of earnings.

Q: Empirical testing has confirmed the validity of which of the following attitudes concerning dividends? a. Dividend irrelevance, or Modigliani-Miller, theory. b. Investors prefer dividends to capital gains because dividends are more certain. c. Investors prefer capital gains to dividends because capital gains are taxed at more favorable rates. d. Empirical testing has produced some evidence in support of each of the theories above. e. Empirical testing has not produced any definitive results.

Q: The most commonly held view of capital structure, according to the text, is that the weighted average cost of capital a. First falls with moderate levels of leverage and then increases. b. Does not change with leverage. c. Increases proportionately with increases in leverage. d. Increases with moderate amounts of leverage and then falls. e. None of the above.

Q: The firm's target capital structure is consistent with which of the following? a. Maximum earnings per share. b. Minimum cost of debt (rd). c. Minimum risk. d. Minimum cost of equity (rs). e. Minimum weighted average cost of capital.

Q: From the information below, select the optimal capital structure for Minnow Entertainment Company. a. Debt = 40%; Equity = 60%; EPS = $2.95; Stock price = $250. b. Debt = 50%; Equity = 50%; EPS = $3.05; Stock price = $28.90. c. Debt = 60%; Equity = 40%; EPS = $3.18; Stock price = $31.20. d. Debt = 80%; Equity = 20%; EPS = $3.42; Stock price = $30.40. e. Debt = 70%; Equity = 30%; EPS = $3.31; Stock price = $30.00.

Q: Which of the following statements is correct? a. As a rule, the optimal capital structure is found by determining the debt-equity mix that maximizes expected EPS. b. The optimal capital structure simultaneously maximizes EPS and minimizes the WACC. c. The optimal capital structure minimizes the cost of equity, which is a necessary condition for maximizing the stock price. d. The optimal capital structure simultaneously minimizes the cost of debt, the cost of equity, and the WACC. e. Each of the above statements is false.

Q: Which of the following factors does not affect a firm's business risk? a. Demand variability. b. Input price variability. c. Interest cost variability. d. Operating leverage. e. Sales price variability.

Q: Which of the following statements is correct? a. A firm's business risk is solely determined by the financial characteristics of its industry. b. The factors which affect a firm's business risk are determined partly by industry characteristics and partly by economic conditions. Unfortunately, these and other factors which affect a firm's business risk are not subject to any degree of managerial control. c. One of the benefits to a firm of being at or near its target capital structure is that financial flexibility becomes much less important. d. The firm's financial risk may have both market risk and diversifiable risk components. e. The above statements are all false.

Q: Business risk is concerned with the operations of the firm. Which of the following is not associated with (or not a part of) business risk? a. Demand variability. b. Sales price variability. c. The extent to which operating costs are fixed. d. Changes in required returns due to financing decisions. e. The ability to change prices as costs change.

Q: A decrease in the debt-to-assets ratio will generally have no effect on ____ risk. a. Financial b. Total c. Business d. Systematic, or market e. None of the above (it will affect each type of risk above).

Q: Which of the following statements is most correct? a. Sensitivity analysis is incomplete because it fails to consider the range of likely values of key variables as reflected in their probability distributions. b. In comparing two projects using sensitivity analysis, the one with the steeper lines would be considered less risky, because a small error in estimating a variable, such as unit sales, would produce only a small error in the project's NPV. c. The primary advantage of simulation is that it provides a very accurate point estimate of a project's NPV. d. One important benefit of simulation analysis as compared to scenario analysis, is that once the analysis is complete, it provides a clear accept/reject decision rule. e. Answers c and d are both correct.

Q: Which of the following statements is correct? a. Neither "stand-alone" nor "within-firm" risk takes account of diversification, either by stockholders or by the firm. b. If a project's expected returns are highly correlated with returns on the market, this will tend to reduce the project's market risk. c. Monte Carlo simulation analysis and sensitivity analysis are similar, but sensitivity analysis is generally harder to use because it requires knowledge of the probability distributions associated with the input variables. d. Sensitivity analysis requires a project's beta coefficient, which can be obtained by either the "pure play" or the "accounting beta" method. e. If we are choosing between two mutually exclusive projects which have only costs (no revenues), the riskier one should be evaluated with a lower required rate of return.

Q: In theory, the decision maker should view market risk as being of primary importance. However, within-firm, or corporate, risk is relevant to a firm's a. Well-diversified stockholders, because it may affect debt capacity and operating income. b. Management, because it affects job stability. c. Creditors, because it affects the firm's credit worthiness. d. All of the above are correct. e. Only answers a and c are correct.

Q: Suppose the firm's required rate of return is stated in nominal terms, but the project's expected cash flows are expressed in real dollars. In this situation, other things held constant, the calculated NPV would a. Be correct. b. Be biased downward. c. Be biased upward. d. Possibly have a bias, but it could be upward or downward. e. More information is needed; otherwise, we can make no reasonable statement.

Q: Which of the following is not considered a relevant concern in determining incremental cash flows for a new product? a. The use of factory floor space which is currently unused but available for production of any product. b. Revenues from the existing product that would be lost as a result of some customers switching to the new product. c. Shipping and installation costs associated with preparing the machine to be used to produce the new product. d. The cost of a product analysis completed in the previous tax year and specific to the new product. e. None of the above (All are relevant concerns in estimating relevant cash flows attributable to a new product project.)

Q: Which of the following statements is correct? a. In a capital budgeting analysis where part of the funds used to finance the project are raised as debt, failure to include interest expense as a cost when determining the project's supplemental operating cash flows will lead to an upward bias in the NPV. b. The preceding statement would be true if "upward" were replaced with "downward." c. The existence of "externalities" reduces the NPV to a level below the value that would exist in the absence of externalities. d. If one of the assets that would be used by a potential project is already owned by the firm, and if that asset could be leased to another firm if the project is not undertaken, then the net rent that could be obtained should be charged as a cost (initial investment outlay) to the project under consideration. e. The rent referred to in statement d is a sunk cost, and as such it should be ignored.

Q: Which of the following constitutes an example of a cost which is not incremental, and therefore not relevant in an accept/reject decision? a. A firm has a parcel of land that can be used for a new plant site or, alternatively, can be used to grow watermelons. b. A firm can produce a new cleaning product that will generate new sales, but some of the new sales will be from customers who switch from another product the company currently produces. c. A firm orders and receives a piece of new equipment which is shipped across the country and requires $25,000 in installation and set-up costs. d. All of the above are not examples of incremental cash flows. e. Answers a, b, and c are examples of incremental, and therefore relevant, cash flows.

Q: Regarding the net present value of a replacement decision, which of the following statements is false? a. The present value of the after-tax cost reduction benefits resulting from the new investment is treated as an inflow. b. The after-tax market value of the old equipment is treated as an inflow at t = 0 (initial investment outlay). c. The present value of depreciation expenses on the new equipment, multiplied by the tax rate, is treated as an inflow. d. Any loss on the sale of the old equipment is multiplied by the tax rate and is treated as an outflow at t = 0 (initial investment outlay). e. An increase in net working capital is treated as an outflow when the project begins (initial investment outlay) and as an inflow when the project ends (terminal cash flow).

Q: Which of the following statements is correct? a. An asset that is sold for less than book value at the end of a project's life will generate a loss for the firm and will cause an actual cash outflow attributable to the project. b. Only incremental cash flows are relevant in project analysis and the proper incremental cash flows are the reported accounting profits because they form the true basis for investor and managerial decisions. c. It is unrealistic to expect that increases in net working capital that are required at the start of an expansion project are simply recovered at the project's completion. Thus, these cash flows are included only at the start of a project. d. Equipment sold for more than its book value at the end of a project's life will increase income and, despite increasing taxes, will generate a greater cash flow than if the same asset is sold at book value. e. All of the above are false.

Q: Which of the following rules are essential to successful cash flow estimates, and ultimately, to successful capital budgeting? a. The return on invested capital is the only relevant cash flow. b. Only incremental cash flows are relevant to the accept/reject decision. c. Total cash flows are relevant to capital budgeting analysis and the accept/reject decision. d. All of the above are correct. e. Only answers a and b are correct.

Q: Two mutually exclusive projects each have a cost of $10,000. The total, undiscounted cash flows from Project L are $15,000, while the undiscounted cash flows from Project S total $13,000. Their NPV profiles cross at a discount rate of 10 percent. Which of the following statements best describes this situation? a. The NPV and IRR methods will select the same project if the required rate of return is greater than 10 percent; for example, 18 percent. b. The NPV and IRR methods will select the same project if the required rate of return is less than 10 percent; for example, 8 percent. c. To determine if a ranking conflict will occur between the two projects the required rate of return is needed as well as an additional piece of information. d. Project L should be selected at any required rate of return, because it has a higher IRR. e. Project S should be selected at any required rate of return, because it has a higher IRR.

Q: Projects L and S each have an initial cost of $10,000, followed by a series of positive cash inflows. Project L has total, undiscounted cash inflows of $16,000, while S has total undiscounted inflows of $15,000. Further, at a discount rate of 10 percent, the two projects have identical NPVs. Which project's NPV will be more sensitive to changes in the discount rate? (Hint: Projects with steeper NPV profiles are more sensitive to discount rate changes.) a. Project S. b. Project L. c. Both projects are equally sensitive to changes in the discount rate since their NPVs are equal at all required rates of return. d. Neither project is sensitive to changes in the discount rate, since both have NPV profiles which are horizontal. e. The solution cannot be determined unless the timing of the cash flows is known.