ACF103 2014 – Week 3 Quiz

Chapter 12
1. The Pink Pussycat Lounge is considering replacing its lighting system. The
new lights will cost $16,000 and can be installed for $2,500. The old light
fixtures were depreciated to zero but can be sold to Secondhand Sam for
$1,000. If the Pink Pussycat has a 35% tax rate, the initial cash outflow for the
new lighting system is ________.
A. $16,000
B. $17,500
C. $17,850
D. $18,500

2. Project EXPAND will require $350,000 to replace some existing machinery.

Capitalized expenditures total $40,000. The after-tax salvage value of the 'old'
machinery will provide $90,000 to the firm. The new machine will require that
the firm purchase some additional inventory which will result in an increase in
net working capital of $50,000. What is the initial cash outflow?
A. $350,000
B. $300,000
C. $270,000
D. none of the above

3. Project GROW will result in the following expected changes in the balance
sheet: (1) an increase in accounts receivable of $20,000, (2) an increase in
inventory of $20,000, and finally (3) an increase in accounts payable of
$15,000. What is the change in net working capital (NWC)?
A. -$25,000
B. -$15,000
C. +$15,000
D. +$25,000

4. In analyzing a long-term investment proposal, ________.

A. include sunk costs
B. include after-tax interest payments
C. include before-tax interest payments
D. include opportunity costs

5. The basic characteristics of relevant project flows include all of the following
except ________.
A. after-tax flows
B. cash flows
C. financing flows
D. incremental flows
Chapter 13.
1. The payback period method is inferior to the net present value method because
it ________.
A. deals with accounting income rather than cash flows
B. fails to consider cash flows beyond the payback period
C. assumes that cash flows are uniform over the life of the investment
D. is difficult to compute

2. The initial cost of a conventional project is $14,000. The present value of the
project's cash inflows, discounted at 12%, is $12,500. The internal rate of
return is ________.
A. greater than 12%
B. equal to 12%
C. less than 12%
D. cannot tell without additional information

3. In capital budgeting, the hurdle rate is ________.

A. the minimum rate of return acceptable to the firm
B. the internal rate of return on a project
C. essentially the same as the prime rate
D. the present value of the expected future cash flows divided by the
initial cash outflow

4. An investment proposal has an initial cash outlay of $100,000 and a net

present value of $50,000. The project's profitability index is ________.
A. 0.50
B. 2.00
C. 1.00
D. 1.50

5. The internal rate of return method of capital budgeting implicitly assumes that
the cash flows from a project can be reinvested at the ________.
A. required rate of return
B. Treasury bill rate
C. project's internal rate of return
D. risk-free rate

6. The profitability index is the

A. difference between the project's initial cash outflow and the present
value of the expected future cash flows.
B. sum of the project's initial cash outflow and the present value of the
future expected cash flows.
C. project's initial cash outflow divided by the present value of the
expected future cash flows.
D. present value of the expected future cash flows divided by the project's
initial cash outflow.
Chapter 15
1. The use of an overall cost of capital as the acceptance criterion for investment
decisions is appropriate only if the current projects of the firm are of similar
risk and investment proposals under consideration are of the same character.
True?
False?

2. According to the capital asset pricing model, the cost of equity is equal to a
risk-free rate plus the market risk premium adjusted by the appropriate beta.
True?
False?

3. Generally, a firm should try to maximize its overall cost of capital.

True?
False?

4. When calculating the overall cost of capital, component costs should be based
on the ________ costs of various sources of financing.
A. historical
B. marginal
C. imbedded
D. residual

5. XXX's common stock currently sells for $60 a share. If a dividend of $3 a

share is expected in the coming year, the firm's marginal tax rate is 34%, and
if dividends are expected to grow at a 10% rate, the cost of equity is closest to
________.
A. 5%
B. 10%
C. 15%
D. 18%

6. YYY's common stock is currently selling for $45 a share. Last year's dividend
was $2, the firm's marginal tax rate is 34%, and dividends are expected to
grow 5% annually. The cost of equity is ________.
A. 9.7%
B. 2.2%
C. 9.4%
D. 8.7%

7. The beta coefficient for Field Flowers, Inc. (FFI) is 1.90. If the risk-free rate is
3.5% and the market risk premium is 6.0%, the required return for FFI
common stock is closest to ________.
A. 8.25%
B. 9.50%
C. 11.4%
D. 14.9%
Chapter 16
1. Any time a company has fixed operating costs, a change in the volume of sales can
result in a more than proportional change in operating profit or loss.
True?
False?

2. A break-even chart shows the relationship among total revenues, total operating
costs, and profits for various levels of production and sales.
True?
False?

3. "DOL at 2,500 units = 4" means that if sales decrease 3 percent to 2,425 units, EBIT
will decrease by 7 percent.
True?
False?

4. A company has fixed costs of $50,000 and variable costs per unit of output of $8. If its
sole product sells for $18, what is the break-even quantity of output?
A. 1,500
B. 2,500
C. 5,000
D. 7,500

5. A firm's degree of total leverage (DTL) is equal to its degree of operating leverage
(DOL) ________.
A. plus its degree of financial leverage (DFL)
B. minus its DFL
C. divided by its DFL
D. multiplied by its DFL

6. Solar Wind Manufacturing has fixed costs of $600,000 directly attributable to producing
a particular product. The product sells for $2,000 a unit and variable costs are $1,200.
Solar is financed with $8 million of common equity financing and $2 million of long-
term debt at 6% before taxes. Solar sold 1,000 units last year and expects volume to
increase by 100%, what is the Degree of Operating Leverage (DOL) at 1,000 units?

A. 1.67
B. 4.00
C. 2.50
D. 10.00

7. Solar Wind Manufacturing has fixed costs of $600,000 directly attributable to producing
a particular product. The product sells for $2,000 a unit and variable costs are $1,200.
 Solar is financed with $8 million of common equity financing and $2 million of long-
term debt at 6% before taxes. Solar sold 1,000 units last year and expects volume to
increase by 100%, what is the Degree of Financial Leverage (DFL) at 1,000 units?

A. 1.67
B. 4.00
C. 2.50
D. 10.00

8. Solar Wind Manufacturing has fixed costs of $600,000 directly attributable to producing
a particular product. The product sells for $2,000 a unit and variable costs are $1,200.
Solar is financed with $8 million of common equity financing and $2 million of long-
term debt at 6% before taxes. Solar sold 1,000 units last year and expects volume to
increase by 100%, what is the Degree of Total Leverage (DTL) at 1,000 units?

A. 1.67
B. 4.00
C. 2.50
D. 10.00

Chapter 17
1. The lower a firm's cost of capital, the lower the total valuation of the firm.
True?
False?
2. Under the traditional approach to valuation and capital structure, the weighted
average cost of capital at first declines with moderate use of leverage, then increases.
True?
False?

3. The traditional approach to capital structure theory implies that the value of the firm
is independent of its capital structure.
True?
False?

4. Agency costs are defined as the costs of monitoring management so that it and the
firm behave in ways consistent with contractual agreements with stockholders and
lenders.
True?
False?

5. A firm has net operating income of $1 million, an overall capitalization rate of 15%,
and $1 million of 10% debt. The total market value of the stock, using the net
operating income method approach, is ________.
A. $6,667,000
B. $7,667,000
C. $5,667,000
D. $4,667,000

6. Two firms are virtually identical except for their capital structure, but they are selling
at different values. According to M&M's original position ________.
A. one will be at greater risk of bankruptcy
B. the firm with greater financial leverage will have the higher value
C. this proves that markets cannot be efficient
D. this will not continue because arbitrage will eventually cause the firms to sell
at the same value.