Part 2: Multiple choice: Theory.

(20 points)
1. The _________ is the rate of return a firm must earn on its investments in projects in order to
maintain the market value of its stock.

• net resent value

• cost of capital
• internal rate of return
• gross profit margin

2. The cost of capital reflects the cost of funds

• Over a short-run time period.

• at a given point in time.
• Over a long-run time period.
• at current book values.

3. The cost to a corporation of each type of capital is dependent upon

• the risk-free rate of bonds plus the business risk of the firm.
• the risk-free rate of each type of capital plus the business risk of the firm.
• the risk-free rate of each type of capital plus the financial risk of the firm.
• the risk-free rate of each type of capital plus the business risk and the financial risk of
the firm.

4. The specific cost of each source of long-term financing is based on _________ and
_________ costs.

• before-tax; historical
• after-tax; historical
• before-tax; book value
• after-tax; current

5. The _________ from the sale of a security are the funds actually received from the sale after
________, or the total costs of issuing and selling the security, which have been subtracted
from the total proceeds.

• gross proceeds; the after-tax costs

• gross proceeds; the flotation costs
• net proceeds; the flotation costs
• net proceeds; the after-tax costs

6. When determining the after-tax cost of a bond, the face value of the issue must be adjusted to
the net proceeds amounts by considering

• the risk.
• the flotation costs.
• the approximate returns.
• the taxes.

7. Debt is generally the least expensive source of capital. This is primarily due to

• fixed interest payments.

• its position in the priority of claims on assets and earnings in the event of liquidation.
• the tax deductibility of interest payments.
• the secured nature of a debt obligation.

8. The cost of common stock equity is

 • the cost of the guaranteed stated dividend.
• the rate at which investors discount the expected dividends of the firm.
• the after-tax cost of the interest obligations.
• the historical cost of floating the stock issue.

9. The cost of new common stock financing is higher than the cost of retained earnings due to

• flotation costs and underpricing.

• flotation costs and overpricing.
• flotation costs and commission costs.
• commission costs and overpricing.

10. When discussing weighing schemes for calculating the weighted average cost of capital, the
preferences can be stated as

• market value weights are preferred over book value weights and target weights are
preferred over historic weights.
• book value weights are preferred over market value weights and target weights are
preferred over historic weights.
• book value weights are preferred over market value weights and historic weights are
preferred over target weights.
• market value weights are preferred over book value weights and historic weights are
preferred over target weights.

11. _________ is the process of evaluating and selecting long-term investments consistent with
the firm’s goal of owner wealth maximization.

• Recapitalizing assets
• Capital budgeting
• Ratio analysis
• Restructuring debt

12. A capital expenditure is all of the following except

• an outlay made for the earning assets of the firm.

• expected to produce benefits over a period of time greater than one year.
• an outlay for current asset expansion.
• commonly used to expand the level of operations.

13. _________ projects do not compete with each other; the acceptance of one _________ the
others from consideration.

• Capital; eliminates
• Independent; does not eliminate
• Mutually exclusive; eliminates
• Replacement; does not eliminate

14. _________ projects have the same function; the acceptance of one _________ the others
from consideration.

• Capital; eliminates
• Independent; does not eliminate
• Mutually exclusive; eliminates
• Replacement; does not eliminate

15. The cash flows of any project having a conventional pattern include all of the basic
components except
 • initial investment.
• operating cash outflows.
• operating cash inflows.
• terminal cash flow.

16. A firm would accept a project with a net present value of zero because

• the project would maintain the wealth of the firm’s owners.

• the project would enhance the wealth of the firm’s owners.
• the return on the project would be positive.
• the return on the project would be zero.

17. The _________ is the discount rate that equates the present value of the cash inflows with
the initial investment.

• payback period
• average rate of return
• cost of capital
• internal rate of return

18. In comparing the internal rate of return and net present value methods of evaluation,

• internal rate of return is theoretically superior, but financial managers prefer net
present value.
• net present value is theoretically superior, but financial managers prefer to use
internal rate of return.
• financial managers prefer net present value, because it is presented as a rate of
return.
• financial managers prefer net present value, because it measures benefits relative to
the amount invested.

19. Unlike the net present value criteria, the internal rate of return approach assumes an interest
rate equal to

• the relevant cost of capital.

• the project’s internal rate of return.
• the project’s opportunity cost.
• the market’s interest rate.

20. Assume a project has normal cash flows (that is, the initial cash flow is negative, and all other
cash flows are positive). Which of the following statements is most correct?

• All else equal, a project’s IRR increases as the cost of capital declines.
• All else equal, a project’s NPV increases as the cost of capital declines.
• All else equal, a project’s MIRR is unaffected by changes in the cost of capital.
• Statements a and b are correct.