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FINANCE BAM 313 – Unit 3 & Unit 4 Exams

Unit
3 Exam
1.
The DEF Company is planning a $64
million expansion. The expansion is to be financed by selling $25.6 million in
new debt and $38.4 million in new common stock. The before-tax required rate of
return on debt is 9% and the required rate of return on equity is 14%. If the
company is in the 35% tax bracket, what is the firm’s cost of capital?
a. 8.92%
b. 10.74%
c. 11.50%
d. 9.89%

2.
Which of the above projects should the
company take on?
a. Project
3 only
b. Projects
1, 2 and 3
c. Projects
1 and 3
d. Projects
1 and 2

3.
PrimaCare has a capital structure that
consists of $7 million of debt, $2 million of preferred stock, and $11 million
of common equity, based upon current market values. The firm’s yield to
maturity on its bonds is 7.4%, and investors require an 8% return on the firm’s
preferred stock and a 14% return on PrimaCare’s common stock. If the tax rate
is 35%, what is PrimaCare’s WACC?
a. 7.21%
b. 10.18%
c. 12.25%
d. 8.12%

4.
JPR Company is financed 75% by equity
and 25% by debt. If the firm expects to earn $30 million in net income next
year and retain 40% of it, how large can the capital budget be before common
stock must be sold?
a. $15.5
million
b. $7.5
million
c. $16.0
million
d. $12.0
million

5.
All else equal, an increase in beta
results in:
a. An
increase in the cost of retained earnings
b. An
increase in the cost of common equity, whether or not the funds come from
retained earnings or newly issued common stock
c. An
increase in the cost of newly issued common stock
d. An
increase in the after-tax cost of debt

6.
Haroldson Inc. common stock is selling
for $22 per share. The last dividend was $1.20, and dividends are expected to
grow at 6% annually. Flotation costs on new stock sales are 5% of the selling
price. What is the cost of Haroldson’s retained earnings?
a. 12.09%
b. 11.78%
c. 11.45%
d. 5.73%

7.
A company has preferred stock that can
be sold for $21 per share. The preferred stock pays an annual dividend of 3.5%
based on a par value of $100. Flotation costs associated with the sale of
preferred stock is equal to $1.25 per share. The company’s marginal tax rate is
35%. Therefore, the cost of preferred stock is:
a. 14.26%
b. 12.94%
c. 18.87%
d. 17.72%

8.
Which of the following should NOT be
considered when calculating a firm’s WACC?
a. After-tax
YTM on a firm’s bonds
b. Cost
of newly issued preferred stock
c. After-tax
cost of accounts payable
d. Cost
of newly issued common stock

9.
Your firm is considering an investment
that will cost $920,000 today. The investment will produce cash flows of
$450,000 in year 1, $270,000 in years 2 through 4, and $200,000 in year 5. The
discount rate that your firm uses for projects of this type is 11.25%. What is
the investment’s profitability index?
a. 1.26
b. 1.69
c. 1.21
d. 1.43

10.
Your firm is considering investing in
one of two mutually exclusive projects. Project A requires an initial outlay of
$3,500 with expected future cash flows of $2,000 per year for the next three
years. Project B requires an initial outlay of $2,500 with expected future cash
flows of $1,500 per year for the next two years. The appropriate discount rate
for your firm is 12% and it is not subject to capital rationing. Assuming both
projects can be replaced with a similar investment at the end of their
respective lives, compute the NPV of the two chain cycle for Project A and
three chain cycle for Project B.
a. $2,865
and $94
b. $3,528
and $136
c. $5,000
and $1,500
d. $2,232
and $85

11.
The capital budgeting manager for XYZ
Corporation, a very profitable high technology company, completed her analysis
of Project A assuming 5-year depreciation. Her accountant reviews the analysis
and changes the depreciation method to 3-year depreciation. This change will:
a. Increase
the present value of the NCFs
b. Have
no effect on the NCFs because depreciation is a non-cash expense
c. Only
change the NCFs if the useful life of the depreciable asset is greater than 5
years
d. Decrease
the present value of the NCFs

12.
Lithium, Inc. is considering two
mutually exclusive projects, A and B. Project A costs $95,000 and is expected
to generate $65,000 in year one and $75,000 in year two. Project B costs
$120,000 and is expected to generate $64,000 in year one, $67,000 in year two,
$56,000 in year three, and $45,000 in year four. Lithium, Inc.’s required rate
of return for these projects is 10%. The modified internal rate of return for
Project B is:
a. 18.52%
b. 22.80%
c. 19.75%
d. 17.84%

13.
A capital budgeting project has a net
present value of $30,000 and a modified internal rate of return of 15%. The
project’s required rate of return is 13%. The internal rate of return is:
a. Greater
than $30,000
b. Greater
than 15%
c. Between
13% and 15%
d. Less
than 13%

14.
A new project is expected to generate
$800,000 in revenues, $250,000 in cash operating expenses, and depreciation
expense of $150,000 in each year of its 10-year life. The corporation’s tax
rate is 35%. The project will require an increase in net working capital of
$85,000 in year one and a decrease in net working capital of $75,000 in year
ten. What is the free cash flow from the project in year one?
a. $410,000
b. $375,000
c. $380,000
d. $298,000

15.
A local restaurant owner is considering
expanding into another rural area. The expansion project will be financed
through a line of credit with City Bank. The administrative costs of obtaining
the line of credit are $500, and the interest payments are expected to be
$1,000 per month. The new restaurant will occupy and existing building that can
be rented for $2,500 per month. The incremental cash flows for the new
restaurant include:
a. $2,500
per month rent
b. $500
administrative costs, $1,000 per month interest costs, $2,500 per month rent
c. $1,000
per month interest payments, $2,500 per month rent
d. $500
administrative costs, $2,500 per month rent

16.
Which of the following should be
included in the initial outlay?
a. Increased
investment in inventory and accounts receivable
b. Preexisting
firm overhead reallocated to the new project
c. First
year depreciation expense on any new equipment purchased
d. Taxable
gain on the sale of old equipment being replaced

17.
QRW Corp. needs to replace an old lathe
with a new, more efficient model. The old lathe was purchased for $50,000 nine
years ago and has a current book value of $5,000. (The old machine is being
depreciated on a straight-line basis over a ten-year useful life.) The new
machine costs $100,000. It will cost the company $10,000 to get the new lathe
to the factory and get it installed. The old machine will be sold as scrap
metal for $2,000. The new machine is also being depreciated on a straight-line
basis over ten years. Sales are expected to increase by $8,000 per year while
operating expenses are expected to decrease by $12,000 per year. QRW’s marginal
tax rate is 40%. Additional working capital of $3,000 is required to maintain
the new machine and higher sales level. The new lathe is expected to be sold
for $5,000 at the end of the project’s ten-year life. What is the incremental
free cash flow during year 1 of the project?
a. $11,400
b. $15,200
c. $12,800
d. $14,400

18.
The cost of retained earnings is less
than the cost of new common stock because:
a. Dividends
are not tax deductible
b. Flotation
costs are incurred when new stock is issued
c. Accounting
rules allow a deduction when using retained earnings
d. Marginal
tax brackets increase

19.
Beauty Inc. plans to maintain its
optimal capital structure of 40% debt, 10% preferred stock, and 50% common
equity indefinitely. The required return on each component source of capital is
as follow: debt—8%; preferred stock—12%; common equity—16%. Assuming a 40%
marginal tax rate what after-tax rate of return must the firm earn on its
investments if the value of the firm is to remain unchanged?
a. 12.00%
b. 11.12%
c. 12.40%
d. 10.64%

20.
Your firm is considering an investment
that will cost $920,000 today. The investment will produce cash flows of
$450,000 in year 1, $270,000 in years 2 through 4, and $200,000 in year 5. The
discount rate that your firm uses for projects of this type is 11.25%. What is
the investment’s internal rate of return?
a. 15.98%
b. 27.28%
c. 20.53%
d. 21.26%

21.
The advantages of NPV are all of the
following EXCEPT:
a. It
provides the amount by which positive NPV projects will increase the value of
the firm
b. It
allows the comparison of benefits and costs in a logical manner through the use
of time value of money principles
c. It
recognized the timing of the benefits resulting from the project
d. It
can be used as a rough screening device to eliminate those projects whose
returns do not materialize until later years

22.
Which of the following are included in
the terminal cash flow?
a. Recapture
of any working capital increase included in the initial outlay
b. The
expected salvage value of the asset
c. Any
tax payments or receipts associated with the salvage value of the asset
d. All
of the above

23.
Which of the following differentiates
the cost of retained earnings from the cost of newly issued common stock?
a. The
larger dividends paid to the new common stockholders
b. The
flotation costs incurred when issuing new securities
c. The
cost of the pre-emptive rights held by existing shareholders
d. The
greater marginal tax rate faced by the now-larger firm

24.
Lithium, Inc. is considering two
mutually exclusive projects, A and B. Project A costs $95,000 and is expected
to generate $65,000 in year one and $75,000 in year two. Project B costs
$120,000 and is expected to generate $64,000 in year one, $67,000 in year two,
$56,000 in year three, and $45,000 in year four. Lithium, Inc.’s required rate
of return for these projects is 10%. The profitability index for Project B is:
a. 1.55
b. 1.39
c. 1.33
d. 1.48

25.
When terminating a project for capital
budgeting purposes, the working capital outlay required at the initiation of
the project will:
a. Increase
the cash flow because it is recaptured
b. Decrease
the cash flow because it is an outlay
c. Not
affect the cash flow
d. Decrease
the cash flow because it is a historical costUnit 4 Exam1. A
high degree risk of variability in a firm’s earnings before interest and taxes
refers to:a. A
business riskb. Financial
leveragec. Operating
leveraged. Financial
risk2. If
a firm has no operating leverage and no financial leverage, then a 10% increase
in sales will have what effect on EPS?a. EPS
will increase by 10%b. EPS
will remain the samec. EPS
will increase by less than 10%d. EPS
will decrease by 10%3. According
to the moderate view of capital costs and financial leverage, as the use of
debt financing increases:a. The
cost of capital continuously increasesb. There
is an optimal level of debt financingc. The
cost of capital remains constantd. The
cost of capital continuously decreases4. The
primary weakness of EBIT-EPS analysis is that:a. It
double counts the cost of debt financingb. It
applies only to firms with large amounts of debt in their capital structurec. It
may only be used by firms that are profitable this yeard. It
ignores the implicit cost of debt financing5. Potential
applications of the break-even model include:a. Optimizing
he cash-marketable securities position of a firmb. Replacement
for time-adjusted capital budgeting techniquesc. Pricing
policyd. All
of the above6. The
Modigliani and Miller hypothesis does NOT work in the “real world” because:a. Interest
expense is tax deductible, providing an advantage to debt financingb. Higher
levels of debt increase the likelihood of bankruptcy, and bankruptcy has real
costs for any corporationc. Both
A and Bd. Dividend
payments are fixed and tax deductible for the corporation7. A
corporation with very high growth prospects and many positive NPV projects to
fund may want to increase its dividend based on the:a. Very
low agency costs of the corporationb. Information
effectc. Tax
bias against capital gainsd. Residual
dividend theory8. Which
of the following strategies may be used to alter a firm’s capital structure
toward a higher percentage of debt compared to equity?a. Stock
splitb. Stock
repurchasec. Stock
dividendd. Maintain
a low dividend payout ratio9. AFB,
Inc.’s dividend policy is to maintain a constant payout ratio. This year AFB,
Inc. paid out a total of $2 million in dividends. Next year, AFB, Inc.’s sales
and earnings per share are expected to increase. Dividend payments are expected
to:a. Increase
above $2 million only if the company issues additional shares of common stockb. Decrease
below $2 millionc. Increase
above $2 milliond. Remain
at $2 million10. Which
of the following is true?a. In
industries with volatile earnings, the residual dividend policy results in the
most consistent dividend streamb. If
the clientele effect is correct, firms should follow a constant dividend payout
ratio policyc. In
general, the higher the number of positive NPV investment opportunities for a
firm, the lower the dividend payout ratiod. According
to the informational content of dividends, an increase in dividends is always a
positive signal11. Which
of the following is always a non-cash expense?a. Salariesb. Depreciationc. Income
taxesd. None
of the above12. Which
of the following is a limitation of the “percent of sales method” of preparing
pro forma financial statements?a. Inventory
levels are seldom affected by changes in sales volumeb. A
firm’s investment in accounts receivable is seldom related to sales volumec. Not
all assets and liabilities increase or decrease as a constant percent of salesd. The
dividend payout ratio may change from one year to the next13. Spontaneous
sources of funds refer to all of the below EXCEPT:a. Accounts
payableb. Accrualsc. Common
stockd. A
bank loan14. Selection
of a source of short-term financing should include all of the following EXCEPT:a. The
effect of the use of credit from a particular source on the cost and
availability of other sources of creditb. The
flotation costs for debenturesc. The
effective cost of creditd. The
availability of financing in the amount and for the time needed15. The
terminal warehouse agreement differs from the field warehouse agreement in
that:a. The
cost of the terminal warehouse agreement is lower due to the lower degree of
riskb. The
warehouse procedure differs for both agreementsc. The
terminal agreement transport the collateral to a public warehoused. The
borrower of the field warehouse agreement can sell the collateral without the
consent of the lender16. Your
company buys supplies on credit terms of 2/10 net 45. Suppose the company makes
a purchase of $20,000 today. Which of the following payment options makes the
most sense as a general rule?a. Pay
the bill as soon as possible to keep the supplier happyb. Pay
the bill on day 10 to get the discountc. Either
pay the bill on day 10 to get the discount, or wait until day 45d. Pay
the bill on day 45 due to the time value of money17. Which
of the following statements about financial leverage is true?a. Financial
leverage is the responsiveness of the firm’s EBIT to fluctuations in salesb. Financial
leverage is the responsiveness of the firm’s EPS to fluctuations in EBITc. Financial
leverage involves the occurrence of fixed operating costs in the firm’s income
streamd. Financial
leverage reduces a firm’s risk18. Which
of the following statements about combined (operating & financial) leverage
is true?a. Usage
of both operating and financial leverage reduces a firm’s riskb. If
a firm employs both operating and financial leverage, any percent change in
sales will produce a larger percent change in earnings per sharec. High
operating leverage and high financial leverage offset one another, meaning that
if sales increase by 10%, then EPS will also increase by 10%d. A
firm that is in a capital-intensive industry should use a higher level of
financial leverage than a firm that employs low levels of operating leverage19. The
“bird-in-the-hand-dividend theory” supports which view of the effect of
dividend policy on company value?a. Constant
dividends increase stock valuesb. High
dividends increase stock valuesc. A
firm’s dividend policy is irrelevantd. Low
dividends increase stock values20. All
of the following will increase the discretionary financing needed EXCEPT:a. Decrease
the dividend payout ratiob. Decrease
the spontaneous financingc. Decrease
the sales growth rated. Decrease
the net profit margin21. If
a firm relies on short-term debt or current liabilities in financing its asset
investments, and all other things remain the same, what can be said about the
firm’s liquidity?a. The
liquidity of the firm will be unchangedb. The
firm will be relatively more liquidc. The
firm will be relatively less liquidd. The
firm will be more liquid only if interest rates are below the company’s
weighted average cost of capital22. Dakota
Oil, Inc. reported that its sales and EBIT increased by 10%, but its EPS
increased by 30%. The much larger change in earnings per share could be the
result of:a. High
operating leverageb. High
financial leveragec. High
fixed costs of productiond. A
high percentage of credit sale collections from prior years23. Which
of the following statements would be consistent with the bird-in-the-hand
dividend theory?a. Dividends
are less certain than capital gainsb. Investors
are indifferent whether stock returns come from dividend income or capital
gains incomec. Wealthy
investors prefer corporations to defer dividend payments because capital gains
produce greater after-tax incomed. Dividends
are more certain than capital gains income24. The
term “lumpy asset” means:a. Assets
that have economies of scale but not economies of scopeb. Assets
that must be purchased in discrete quantitiesc. The
same thing as assets that exhibit scale economiesd. Assets
that can be purchased in incremental units25. All
of the following are potential advantages of commercial paper EXCEPT:a. Ability
to borrow very large amountsb. Flexible
repayment termsc. No
compensating balance requirementsd. Lower
interest rates than comparable sources of short-term financing

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