1a. The mixture of long-term funding sources that a firm uses to finance its assets is:
A) capital structure
B) financial leverage
C) operating leverage
D) debt operations
2. Which of the following factors affect the optimal (best) capital structure for a firm?:
A) the firm’s cost of debt, cost of common equity, and cost of preferred stock (if any)
B) market conditions
C) investor perceptions
D) all of the above
3. When forecasting changes in Net Working Capital, which of the following could likely
happen spontaneously as sales increase?
A) decrease in common stock on the balance sheet
B) increases in gross fixed equipment
C) increase in long-term debt
D) increase in accounts receivables
4. Your firm is in the 30% tax bracket with a before-tax required rate of return on its
equity of 13% and on its debt of 10%. If the firm uses 60% equity and 40% debt
financing, calculate its after-tax WACC.
5. The following net cash flows are projected for two separate projects. Your required
rate of return is 12%.
a. Calculate the payback period for each project.
b. Calculate the NPV of each project.
c. Calculate the IRR of each project.
d. Which project(s) would you accept and why?
6.The relevant cash flows in capital budgeting can best be described as:
A) incremental after-tax net income
B) incremental cash flows
C) externality cash flows
D) changes in fixed asset cash flows
Use the following to answer questions 7-8:
You have been asked to render an opinion to your boss as to whether your employer should enter into the short-term capital project described below.
The project requires the purchase of a new piece of equipment for a price of $25,000.
The firm has paid a consultant $1,000 to estimate the revenues expected from the project. The firm that ships the equipment and installs it in our plant will charge $500.
The project’s incremental operating cash flows before taxes will be $12,000 per year for three years. At the end of three years the equipment will be sold for $5000. The equipment has a three-year useful life and will be depreciated using the three-year MACRS (Modified Accelerated Cost Recovery System – current U.S. accounting rules) schedule that specifies the percentage of equipment costs to be depreciated per year as follows: 33.3%, 44.5%, 14.8%,7.4%). The tax rate is 34% and the firm’s required rate of return is 17%.
7. a. What is the Acquisition Cost (the tax basis) for the equipment?
b. What are the depreciation deductions for years 1, 2, and 3?
c. If the asset is sold for more than its depreciated value, the difference is viewed as
taxable income and taxes must be paid on that gain. What will be the after tax net cash
flow from the sale of the asset at the end of year three?
d. Given the Acquisition Cost, the incremental operating cashflows, the depreciation,
the EBIT, and the taxes owed, calculate the total operating cash flow for each of the
8. Based on the net cash flows that you calculated in the question above, what is the:
a. payback period
b. net present value
c. internal rate of return
9.What is the relevant initial cash outflow for the following project?
Equipment cost $ 50,000
Installation $ 5,000
Cash increase needed $ 2,000
Inventory increase needed $ 3,000
Increase in Accounts payable $ 2,000
10. Your firm is considering an acquisition with incremental net cash flows projected to be $152,500 in Year 10, the last year of the analysis that you have done to evaluate the
A) What is the present value of the “Terminal Value” of this opportunity if you
assume a long-term growth rate of 3% and your firm’s WACC is 9.0%?
B) If the seller insists he will accept no less than $2 million and the total present value
of the incremental cash flows for years 0-10 of your forecast = $1 million, should
you proceed with the Acquisition? Why or why not?
11. The sales break-even point is defined as:
A) the level of sales that a firm must reach to cover fixed costs
B) the level of income that a firm must reach to cover variable costs
C) the level of sales that a firm must reach to cover all operating costs
D) the point where operating income equals fixed costs
12. Given fixed costs of $200,000, variable costs of $6.20 per unit, and a sales price per unit of $7.00, calculate the break-even point in units.
13. Operating leverage has the effect of triggering:
A) a smaller percentage change in EBIT when a given percentage change in sales
B) a smaller given percentage change in EBIT when a larger percentage change in
C) a smaller given percentage change in EBIT when a smaller percentage change in
D) a larger percentage change in EBIT when a given percentage change in sales
14. If variable costs = $10.00 per unit; and the selling price = $13.00 per unit, and the
break-even point in units = 100,000, calculate the fixed costs.
B) $ 4,348
15. Firms with high fixed operating costs:
A) tend to have low variable costs
B) tend to have high variable costs
C) tend to have low operating leverage
D) tend to have low sales levels
16. As a firm moves to a capital structure with higher debt:
A) financial risk of the firm increases
B) financial risk of the firm decreases if interest payments are tax deductible
C) financial risk of the firm is unaffected if interest payments are tax deductible
D) DOL increases
17. Which of the following are investment grade bonds?
A) AAA U.S. Treasury Bonds
B) A- corporate mortgage bonds
C) BBB corporate debentures
D) All of the above are investment grade bonds.
18. For investors, an important characteristic of a secured bond is that it has:
A) a plan for paying off the bond at maturity
B) no restrictive covenants
C) a claim on specific assets in the event of default
D) an independent trustee
19. Which statement is FALSE regarding preferred stock?
A) Preferred stock is issued by a limited number of corporations.
B) Preferred shareholders have priority over the creditors of the corporation.
C) Preferred shareholders do not have voting rights.
D) All of the above are false.
20. Which of the following statements about residual income – i.e., net income after taxes -is not accurate?
A) it is income left over after other claimants of the firm have been paid
B) it is almost always paid out in the form of a cash dividend to both common and
C) it can be reinvested in the firm
D) it can be reinvested in the firm and can be paid in the form of dividends to common
21. The board of directors of a publicly traded company:
A) is elected by, and represents the interests of the common stockholders
B) is part of the professional management team
C) is appointed by the CEO
D) is a figurehead position only
22. Why might a firm issue new stock?
A) to send a signal
B) for dilution–too few shares outstanding makes the share price too high for some
C) to increase its debt/equity ratio
D) to raise capital and therefore lower the firm’s financial risk
23. Investors are likely to view a new issuance of common stock as a signal that:
A) prospects of the firm are better than generally believed
B) prospects of the firm are worse than generally believed
C) the firm is preparing for a new debt issue
D) new management or directors of the board are being put in place