Practice exam_part 3

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

__B__ 1. The optimal capital budget is indicated by the point at which the __________ and the __________
intersect.
a. depreciation schedule; investment opportunity schedule
b. investment opportunity curve; marginal cost of capital curve
c. investment opportunity curve; average cost of capital curve
d. efficient portfolio curve; marginal cost of capital curve
__A__ 2. Which of the following items is not considered as a part of the net investment calculation?
a. the first year's net cash flow
b. increase in net working capital
c. salvage of an old piece of equipment that is being replaced
d. installation and shipping charges
__A__ 3. Determining the net investment (NINV) of a project includes explicit consideration of all of the following
except:
a. estimated net cash flow
b. project cost plus installation and shipping costs
c. increases in net working capital
d. taxes associated with the sale of an existing asset and/or the purchase of a new one
__B__ 4. Raider Productions has to decide whether to build its warehouse in Dallas or Houston. This decision falls
into the class of:
a. independent projects
b. mutually exclusive projects
c. contingent projects
d. marginal projects
__D__ 5. Which of the following are (is) generally considered problems associated with cash flow estimation?
a. uncertainty about the future cash flows
b. the introduction of bias into the estimation of cash flows
c. uncertainty about the magnitude of fixed cost financing charges
d. uncertainty about the future cash flows and the introduction of bias into the estimation of
cash flows
__A__ 6. In estimating the net investment, an outlay that has already been made is known as a (n) _________.
a. sunk cost
b. cash outflow
c. opportunity cost
d. expansion cost
__B__ 7. In Step Video is considering expanding its video rental library to 8,000 tapes. The purchase price of the
additional videos will be $80,000 and the shipping cost is another $4,000. To house the tapes, the owner
will have to spend another $10,000 for display shelves, increase net working capital by $5,000, and
interest expenses will add another $8,000 to the operating cost. What is the net investment to In Step
Video for this project?
a. $95,000
b. $99,000
c. $84,000
d. $107,000
__A__ 8. Anderson Clayton will purchase a new pellet mill that replace an older, less efficient, mill. The new mill
costs $360,000 and shipping costs are $10,000. Improving the steam lines to the new mill will cost an
additional $22,000. The old mill has a book value of $25,000 and can be sold for $12,000. The installation
of the new mill will cause inventories to increase by $8,000, accounts receivable will go up $20,000, and
accounts payable will increase $10,000. If Anderson Clayton has a marginal tax rate of 40%, what is the
NINV for the new mill?
a. $392,800
b. $412,800
c. $374,800
d. $398,000
__D__ 9. The disadvantages of the payback approach include:
a. cash flows after the payback period are ignored in the calculation
b. payback ignores the time value of money
c. payback fails to provide an objective decision-making criterion
d. all of the above
__D__ 10. One weakness of the internal rate of return approach is that:
a. it does not directly consider the timing of the cash flows from a project
b. it fails to provide a straightforward decision-making criterion
c. it implicitly assumes that the firm is able to reinvest the interim cash flows from a project
at the firm's cost of capital.
d. none of the above
__A__ 11. If a net present value analysis for a normal project gives an NPV greater than zero, an internal rate of
return calculation on the same project would yield an internal rate of return ___________ the required
rate of return for the firm.
a. greater than
b. less than
c. equal to
d. cannot be determined from the information given
D 12. The net present value method assumes that the cash flows over the life of the project are reinvested at
a. the computed internal rate of return
b. the risk-free rate
c. the market capitalization rate
d. the firm's cost of capital
__C__ 13. The internal rate of return method assumes that the cash flows over the life of the project are reinvested
at:
a. the risk-free rate
b. the firm's cost of capital
c. the computed internal rate of return
d. the market capitalization rate
_A___ 14. The profitability index would be __________ if the present value of the net cash flows (NCF) over the
life of a project were __________.
a. negative; less than zero
b. negative; less than the net investment
c. zero; equal to the net investment
d. none of the above
__C__ 15. Would you invest in a project that has a net investment of $14,600 and a single net cash flow of $24,900
in 5 years, if your required rate of return was 12 percent?
a. Yes - the NPV is $862.90
b. No - the NPV is -$1,975.70
 c. No - the NPV is -$481.70
d. Yes - the NPV is $165.70
__A__ 16. Using the profitability index, which of the following mutually exclusive projects should be accepted?
Project A: NPV = $6,000; NINV = $50,000
Project B: NPV = $10,000; NINV = $120,000
Project C: NPV = $8,000; NINV = $80,000
a. A
b. B
c. C
d. all projects should be accepted
__B__ 17. Break points can be determined by dividing the amount of funds available from each financing source at a
fixed cost by the _____ proportion for that financing source.
a. weighted capital structure
b. target capital structure
c. economic capital structure
d. divisional capital structure
__D__ 18. Retained earnings are a cheaper source of funds than the sale of new equity because
a. retention defers the payment of taxable dividends to shareholders
b. there are no flotation costs
c. new shares are usually priced below current market price
d. all the above
_A___ 19. Historic average capital costs are _______ new (marginal) resource allocation decisions.
a. not relevant for making
b. very useful when making
c. necessary for making
d. the relevant costs for making
__D__ 20. Calculate the after-tax cost of preferred stock for Ohio Valley Power Company, which is planning to sell
$100 million of $3.25 cumulative preferred stock to the public at a price of $25 per share. Flotation costs
are $1.00 per share. Ohio Valley has a marginal income tax rate of 40%.
a. 13.0%
b. 7.8%
c. 8.12%
d. 13.54%
__B__ 21. The following financial information is available on Fortis Inc.:

Current per share market price $48.00

Beta 1.1
Expected rate of return on market 12.0%
Risk-free rate 6.0%

Fortis can issue new common stock to net the company $44 per share. Determine the cost of internal
equity capital using the capital asset pricing model approach. (Compute answer to the nearest 0.1%).
a. 12.9%
b. 12.6%
c. 13.0%
d. 11.8%
__B__ 22. Crickentree has a target capital structure of 30 percent debt and 70 percent equity. If the firm expects to
have a net income of $1.7 million and a dividend payout ratio of 40 percent, what will be its equity break
point?
 a. $2,428,571
b. $1,457,143
c. $3,400,000
d. $ 971,429
__D__ 23. Easy Rider Inc. sold a 15 year $1,000 face value bond with a 10 percent coupon rate. Interest is paid
annually. After flotation costs, Easy Rider received $928 per bond. Compute the after-tax cost of debt for
these bonds if the firm's marginal tax rate is 40 percent.
a. 6.0%
b. 7.2%
c. 7.8%
d. 6.6%
_A___ 24. Wellington Gas has a target capital structure of 50 percent common equity, 40 percent debt, and 10
percent preferred stock. The cost of retained earnings is 16 percent, and the cost of new equity (external)
is 16.7 percent. Wellington can sell debentures that will have an after-tax cost of 8.3 percent and the after-
tax cost of preferred stock will be 11.9 percent. What is the marginal cost of capital before and after the
break point?
a. 12.51% and 12.86%
b. 11.18% and 11.53%
c. 14.23% and 14.68%
d. 12.51% and 11.53%
__A__ 25. Whipple Industries, Inc. is in the process of determining its optimal capital budget for next year. The
following investment projects are under consideration:

Required Expected Rate

Project Investment of Return
A $2 million 20.0%
B 3 million 15.0
C 1 million 13.5
D 4 million 13.0
E 1 million 12.5
F 3 million 12.0
G 5 million 11.5

The firm's marginal cost of capital schedule is as follows:

Amount of
Funds Raised Cost
$0 - $6 million 12.0%
$6 million - $12 million 12.5%
$12 million - $18 million 13.5%
Over $18 million 15.0%

Determine Whipple's optimal capital budget (in dollars) for the coming year.
a. $11 million
b. $10 million
c. $5 million
d. $14 million