A-150

1. M&M Model. Gail's Dance Studio is currently an all equity firm that has 80,000 shares of
stock outstanding with a market price of $42 a share. The current cost of equity is 12% and the
tax rate is 34%. Gail is considering adding $1 million of debt with a coupon rate of 8% to her
capital structure. The debt will be sold at par value. What is the levered value of the equity?
A.$3.3 million B.$2.7 million C.$2.4 million
D.$3.7 million E.$3.9 million

2. Spring Time, Inc., is considering a new three-year expansion project that requires an initial
fixed asset investment of $3.9 million. The fixed asset will be depreciated straight-line to zero
over its three-year tax life, after which time it will be worthless. The project is estimated to
generate $2,650,000 in annual sales, with costs of $840,000. The inventories at initial require to
increase by $500,000; the account receivable and trade payable are reduced by $400,000 by the
end of year one. Tax rate is 35%. What is the net cash flow at the end of year 1?
A.$2,431,500 B.$1,931,500 C.$1,531,500 D.$1,631,500

3. The ---------- requires us to give up a benefit.

A.opportunity cost B.sunk cost C.initial cost
D.incremental cost E.marginal cost

4. In calculating the NPV using the free cash flow to equity approach the discount rate is the:
A.all equity cost of capital minus the weighted average cost of debt.
B.weighted average cost of capital.
C.all equity cost of capital.
D.cost of equity for the levered firm.
E.all equity cost of capital plus the weighted average cost of debt.

5. The process of planning and managing a firm's long-term investments is called:

A.capital structure. B.working capital management.
C.financial depreciation. D.capital budgeting.
E.agency cost analysis.

6. A situation in which a firm has positive NPV projects but cannot find the necessary financing
is known as:
A.reliance on financial leverage B.hard rationing
C.capital rationing D.soft rationing
E.none of the above

7. The pecking order states how financing should be raised. In order to avoid asymmetric
information problems and misinterpretation of whether management is sending a signal on
security overvaluation, the firm's first rule is to:
A.always issue debt then the market won't know when management thinks the security is
overvalued.
B.issue debt first.
C.issue new equity first.
D.finance with internally generated funds.
E.None of these.

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8. Net working capital:
A.requirements generally, but not always, create a cash inflow at the beginning of a project.
B.can be ignored in project analysis because any expenditure is normally recouped by the
end of the project.
C.is frequently affected by the additional sales generated by a new project.
D.is the only expenditure where at least a partial recovery can be made at the end of a
project.
E.expenditures commonly occur at the end of a project.

9. The free cash flow to equity approach to capital budgeting is a three step process of:
A.calculating the unlevered cash flow, the cost of equity capital for a levered firm, and then
discounting the unlevered cash flows.
B.calculating the levered cash flow after interest expense and taxes, the cost of equity capital
for a levered firm, and then discounting the levered cash flows by the cost of equity capital.
C.calculating the levered cash flow, the cost of equity capital for a levered firm, then adding
the interest expense when the cash flows are discounted.
D.calculating the levered cash flow after interest expense and taxes, the cost of equity capital
for a levered firm, and then discounting the levered cash flows at the risk free rate.
E.None of these.

10. If the risk of an investment project is different than the firm's risk then:
A.you must exercise risk aversion and use the market rate.
B.you must adjust the discount rate for the project based on the project risk.
C.one must have the actual data to determine any differences in the calculations.
D.you must adjust the discount rate for the project based on the firm's risk.
E.an average rate across prior projects is acceptable because estimates contain errors.

11. M&M Model. The Winter Wear Company has expected earnings before interest and taxes of
$2,100, an unlevered cost of capital of 14% and a tax rate of 34%. The company also has $2,800
of debt that carries a 7% coupon. The debt is selling at par value. What is the value of this firm?
A.$11,748 B.$9,900 C.$10,852
D.$12,054 E.$12,700

12. The Felix Corp. projects to pay a dividend of $.75 next year and then have it grow at 12%
for the following 3 years before growing at 8% indefinitely thereafter. The equity has a required
return of 10% in the market. The price of the stock should be _______.
A.$62.38 B.$41.67 C.$17.05
D.$9.38 E.$59.80

13. A project has a required return of 15%, conventional cash flows and a five-year life. Of the
following that have been computed, which choice is inconsistent with the other four?
A.The PI = 0
B.NPV = $0
C.IRR = 15%
D.The discounted payback is exactly five years
E.The present value of the future cash flows equals the initial outlay
14. Including the option to expand in your project analysis will tend to:
A.increase the net present value of a project.
B.extend the duration of a project but not affect the project's net present value.
C.have no effect on either a project's cash flows or its net present value.
D.increase the cash flows of a project but decrease the project's net present value.
E.decrease the net present value of a project.
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15. What is the effective annual rate of 14.9% compounded continuously?
A.15.96% B.16.01% C.16.17%
D.16.05% E.16.07%

16. A five-year project has an initial fixed asset investment of $270,000, an initial NWC
investment of $25,000, and an annual operating CF of $42,000. The fix asset is fully depreciated
over the life of the project and has no salvage value. It the required return is 11%, what is this
project's AEV - Annual equivalent value?
A.33,803.983 B.37,818.24 C.40,512.22
D.27,039.73 E.35,273.84

17. In order to compare different investment opportunities (each with the

same risk) with interest rates reported in different manners you should*
A.convert each interest rate to an APR
B.compare them by using the published annual rates
C.convert each interest rate to an annual nominal rate
D.convert each interest rate to an effective annual rate
E.convert each interest rate to a monthly nominal rate

18. M&M Model. A firm has zero debt in its capital structure. Its overall cost of capital is 10%.
The firm is considering a new capital structure with 60% debt. The interest rate on the debt
would be 8%. Assuming there are no taxes or other imperfections, its cost of equity capital with
the new capital structure would be _____.
A.10% B.13% C.9%
D.14% E.None of these.

19. You are considering a project with an initial cost of $4,300. What is the payback period for
this project if the cash inflows are $550, $970, $2,600, and $500 a year over the next four years?
A.2.36 years B.2.04 years C.2.89 years
D.3.04 years E.3.36 years

20. You are choosing between investments offered by two different banks. One promises a
return of 10% for three years in simple interest while the other offers a return of 10% for three
years in compound interest. You should choose the
A.compound interest option only if the compounding is for monthly periods
B.simple interest option because both have the same basic interest rate
C.compound interest option only if you are investing less than $5,000
D.simple interest option only if compounding occurs more than once a year
E.none of the above

21. Last month you introduced a new product to the market. Consumer demand has been
overwhelming and it appears that strong demand will exist over the long-term. Given this
situation, management should consider the option to:
A.suspend. B.wait. C.abandon.
D.expand. E.withdraw.

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 22. Paddington, Inc. is looking at setting up a new manufacturing plant in West Park to produce
garden tools. The company bought some land six years ago for $6 million in anticipation of
using it as a warehouse and distribution site. If the land were sold today, the company would net
$6.4 million (ignore the capital gain tax). The company wants to build its new manufacturing
plant on this land; the plant will cost $14.2 million to build, and the site requires $890,000 worth
of grading before it is suitable for construction. What is the proper cash flow amount to use as
the initial investment?
A.$15.09 million B.$14.2 million C.$21.49 million D.$6.91 million

23. You are the beneficiary of a life insurance policy. The insurance company informs you that
you have two options for receiving the insurance proceeds. You can receive a lump sum of
$50,000 today or receive payments of $641 a month for ten years. You can earn 6.5% on your
money. Which option should you take and why?
A.You should accept the payments because they are worth $56,451.91 today.
B.You should accept the $50,000 because the payments are only worth $47,808.17 today)
C.You should accept the $50,000 because the payments are only worth $47,757.69 today.
D.You should accept the payments because they are worth $56,523.74 today.
E.You should accept the payments because they are worth $56,737.08 today.

24. Which capital investment evaluation technique is described by the attributes below?
1. Closely related to NPV
2. Easy to understand and communicate
3. May lead to incorrect decisions in comparing mutually exclusive invests
4. May be useful when the available investment funds are limited
A.Payback period B.NPV C.Discounted payback period
D.IRR E.PI

25. Disco Inc. needs to maintain 15% of its sales in net working capital. Lottie's is considering a
3-year project which will increase sales from their current level of $110,000 to $135,000 the first
year and $145,000 a year for the following two years. What amount should be included in the
project analysis for the last year of the project in regards to the net working capital?
A.$5,250 B.-$5,250 C.$0
D.-$35,000 E.$35,000