Multiple Choice Answers

1. Company insiders cannot earn excess profits based on the knowledge they have related to their employer if the financial markets are: (Points : 4)
weak form efficient.
strong form efficient.
semistrong form efficient.
efficient at any level.
aware that the trader is an insider.

2. Royal Petroleum Co. can buy a piece of equipment that can be financed with debt at a cost of 6 percent (after-tax) and common equity at a cost of 18 percent. Assume debt and common equity each represent 50 percent of the firm’s capital structure. What is the weighted average cost of capital? (Points : 4)
between 3 and 9%
exactly 12%
more than 14%
exactly 11%
none of the above

3. An issue of common stock is expected to pay a dividend of $4.80 at the end of the year. Its growth rate is equal to eight percent. If the required rate of return is 13 percent, what is its current price? (Points : 4)
none of these

4. Which of the following is true regarding the cost of debt? (Points : 4)
It is the return that the firm’s creditors demand on new borrowing.
It is always equal to the weighted cost of capital.
An appropriate method to compute the cost of debt is using the coupon rate of current bonds outstanding.
All of the above are true.

5. Which of the following is true regarding the cost of retained earnings? (Points : 4)
it is irrelevant to the WACC
requires new funds to be raised
need to be adjusted for the flotation costs
have a cost, which is the opportunity cost associated with stockholder funds

6. A project has the following cash flows. What is the internal rate of return?

Year 0 1 2 3
Cash flow -$195,600 $99,800 $87,600 $75,300
(Points : 4)
less than 5%
between 5 and 15%
between 15 and 18%
more than 21%

7. Which one of the following is a correct statement? (Points : 4)
Current tax laws favor debt financing.
A decrease in the dividend growth rate increases the cost of equity.
An increase in the systematic risk of a firm will decrease the firm’s cost of capital.
A decrease in a firm’s debt-equity ratio will usually decrease the firm’s cost of capital.
The cost of preferred stock decreases when the tax rate increases.

8. The six percent preferred stock of FKH Manufacturing is selling for $62 a share. What is the firm’s cost of preferred stock, if the tax rate is 34 percent and the par value per share is $100? (Points : 4) 


9. Which one of the following occurs if a firm files for Chapter 7 bankruptcy, but does not generally occur if the firm files for Chapter 11 bankruptcy? (Points : 4)
a petition is filed in federal court
administrative fees are incurred
a list of creditors is compiled
pre-bankruptcy shareholders tend to lose part, if not all, of their investment in the firm
a trustee-in-bankruptcy is elected by the creditors

10. Which of the following statements is true regarding the cost of capital? (Points : 4)
The cost of capital should not consider any flotation costs.
All other being equal, it is preferable to use book value weights than market value weights.
The WACC is the most appropriate discount rate for all projects.
Depends primarily on the use of the funds, not the source.

11. Which of the following increases the cash account? (Points : 4)
Goods are sold on credit
An interest payment on a notes payable is made
A payment due is received from a client
Raw materials are purchased and paid for with credit

12. Which of the following statements is true? (Points : 4)
The optimal credit policy minimizes the total cost of granting credit.
Firms should avoid offering credit at all cost.
An increase in a firm’s average collection period generally indicates that an increased number of customers are taking advantage of the cash discount.
Character, refers to the ability of a firm to meet its credit obligations out its operating cash flows.
The optimal credit policy, is the policy that produces the largest amount of sales for a firm.

13. Which one of the following industries is most apt to have the shortest cash cycle? (Points : 4)
electric utility company
airplane manufacturer
fast-food restaurant
furniture store
clothing manufacturer