Multiple Choice Answers

1. Bob’s Baked Goods Company reported the following income statement for 2009: Sales $2,500,000 Variable Costs 900,000 Fixed Operating Costs 700,000 EBIT 900,000 Interest Expense 200,000 EBT 700,000 Taxes (30%) 210,000 Net Income $490,000 Earnings Per Share $4.90 If Bob’s sales next year increase by 20%, Bob’s EBIT will increase: (Points : 1) 20%, showing no operating leverage. 20%, showing no financial leverage. over 35%, due to operating leverage. over 35%, due to operating leverage and financial leverage.
2. The break-even point is equal to (Points : 1)
fixed costs divided by (sales price per unit — variable cost per unit).
fixed costs divided by unit variable costs.
fixed costs divided by selling price per unit.
(sales price per unit — variable cost per unit) times the fixed costs.
3. Moline Manufacturing Corporation reported the following items: Sales = $6,000,000; Variable Costs of Production = $1,500,000; Variable Selling and Administrative Expenses = $550,000; Fixed Costs = $1,350,000; EBIT = $2,600,000; and the Marginal Tax Rate =35%. Moline’s break-even point in sales dollars is (Points : 1) $2,050,633. $2,197,500. $2,438,750. $2,785,000.
4. Amish Enterprises makes wooden play sets. The company pays annual rent of $400,000 per year and pays administrative salaries totaling $150,000 per year. Each play set requires $400 of wood, ten hours of labor at $70 per hour, and variable overhead costs of $100. Fixed advertising expenses equal $100,000 per year. Each play set sells for $3,200. What is Amish Enterprises’ break-even output level? (Points : 1) 340 play sets 325 play sets 297 play sets 258 play sets
5. The break-even model enables the manager of the firm to (Points : 1)
calculate the minimum price of common stock for certain situations.
set appropriate equilibrium thresholds.
determine the quantity of output that must be sold to cover all operating costs.
determine the optimal amount of debt financing to use.
6. Assume that the tax on dividends and the tax on capital gains is the same. All else equal, what would a prudent investor prefer? (Points : 1)
The prudent investor would be indifferent between receiving dividends or capital gains.
The prudent investor would prefer dividendsa dollar today is always worth more than a dollar to be received in the future.
The prudent investor would prefer capital gainsthe capital gain tax liability can be deferred until gains are realized.
More information is needed.
7. Based on the data contained in Table A, what is the break-even point in units produced and sold? TABLE A Average selling price per unit $18.00 Variable cost per unit $13.00 Units sold 400,000 Fixed costs $650,000 Interest expense $ 50,000 (Points : 1) 130,000 140,000 150,000 180,000
8. Sweet Tooth Bakery bakes and sells pies. Sweet Tooth has annual fixed costs of $880,000 and a variable cost per pie of $7.50. Each pie sells for $15.50 each. The firm expects to sell 500,000 pies annually. What is the break-even point in sales dollars? (Points : 1) $3,100,000 $2,875,000 $1,705,000 $1,625,000
9. If a firm has no operating leverage and no financial leverage, then a 10% increase in sales will have what effect on EPS? (Points : 1)
EPS will remain the same
EPS will increase by 10%
EPS will decrease by 10%
EPS will increase by less than 10%
10. The Modigliani and Miller hypothesis does not work in the “real world” because (Points : 1)
interest expense is tax deductible, providing an advantage to debt financing.
higher levels of debt increase the likelihood of bankruptcy, and bankruptcy has real costs for any corporation.
both A and B.
dividend payments are fixed and tax deductible

1. J.B. Enterprises purchased a new molding machine for $85,000. The company paid $8,000 for shipping and another $7,000 to get the machine integrated with the company’s existing assets. J.B. must maintain a supply of special lubricating oil just in case the machine breaks down. The company purchased a supply of oil for $4,000. The machine is to be depreciated on a straight-line basis over its expected useful life of 8 years. J.B. is replacing an old machine that was purchased 6 years ago for $50,000. The old machine was being depreciated on a straight-line basis over a ten year expected useful life. The machine was sold for $15,000. J.B.’s marginal tax rate is 40%. What is the amount of the initial outlay? (Points : 1)
2. Five Rivers Casino is undergoing a major expansion. The expansion will be financed by issuing new 15-year, $1,000 par, 9% annual coupon bonds. The market price of the bonds is $1,070 each. Gamblers flotation expense on the new bonds will be $50 per bond. Gamblers marginal tax rate is 35%. What is the pre-tax cost of debt for the newly-issued bonds? (Points : 1)

3. Nickel Industries is considering the purchase of a new machine that will cost $178,000, plus an additional $12,000 to ship and install. The new machine will have a 5-year useful life and will be depreciated using the straight-line method. The machine is expected to generate new sales of $85,000 per year and is expected to increase operating costs by $10,000 annually. Nickel’s income tax rate is 40%. What is the projected incremental cash flow of the machine for year 1? (Points : 1)

4. Rent-to-Own Equipment Co. is considering a new inventory system that will cost $750,000. The system is expected to generate positive cash flows over the next four years in the amounts of $350,000 in year one, $325,000 in year two, $150,000 in year three, and $180,000 in year four. Rent-to-Own’s required rate of return is 8%. What is the net present value of this project? (Points : 1)

5. A project for Jevon and Aaron, Inc. results in additional accounts receivable of $400,000, additional inventory of $180,000, and additional accounts payable of $70,000. What is the additional investment in net working capital? (Points : 1)

6. Porky Pine Co. is issuing a $1,000 par value bond that pays 8.5% interest annually. Investors are expected to pay $1,100 for the 12-year bond. Porky will pay $50 per bond in flotation costs. What is the after-tax cost of new debt if the firm is in the 35% tax bracket? (Points : 1)
(Note the correct value would be 5.10% but that is not listed as option)

7. Zellars, 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. Zellars, Inc.’s required rate of return for these projects is 10%. The internal rate of return for Project B is (Points : 1)

8. PDF 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 lathe 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. PDF’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 project’s terminal cash flow? (Points : 1)

9. Given the following information on S & G Inc.’s capital structure, compute the company’s weighted average cost of capital.

Type of                                           Percent of                          Before-Tax
Capital                                      Capital Structure             Component Cost
Bonds                                                40%                                    7.5%
Preferred Stock                                  5%                                    11%
Common Stock (Internal Only)      55%                                   15%

The company’s marginal tax rate is 40%. (Points : 1)

10. Which of the following cash flows are not considered in the calculation of the initial outlay for a capital investment proposal? (Points : 1)
increase in accounts receivable
cost of issuing new bonds if the project is financed by a new bond issue
installation costs
none of the above – all are considered