Multiple Choice Answers

1. How does the net present value (NPV) decision rule relate to the primary goal of financial management, which is creating wealth for shareholders? (Points : 4)
2. An investment project provides cash flows of $1,190 per year for 10 years. If the initial cost is $8,000, what is the payback period? (Points : 4)
3. A project has an initial cost of $6,500. The cash inflows are $900, $2,200, $3,600, and $4,100 over the next four years, respectively. What is the payback period? (Points : 4)
1.73 years
2.51 years
2.94 years
3.51 years
3.94 years
4. Which of the following statements related to the internal rate of return (IRR) are correct?
I. The IRR method of analysis can be adapted to handle non-conventional cash flows.
II. The IRR that causes the net present value of the differences between two project’s cash flows to equal zero is called the crossover rate.
III. The IRR tends to be used more than net present value simply because its results are easier to comprehend.
IV. Both the timing and the amount of a project’s cash flows affect the value of the project’s IRR.
(Points : 4)
I and II only
III and IV only
I, II, and III only
II, III, and IV only
I, II, III, and IV
5. Phone Home, Inc. is considering a new 6-year expansion project that requires an initial fixed asset investment of $5.994 million. The fixed asset will be depreciated straight-line to zero over its 6-year tax life, after which time it will be worthless. The project is estimated to generate $5,328,000 in annual sales, with costs of $2,131,200. The tax rate is 31 percent. What is the operating cash flow for this project? (Points : 4)

6. The difference between a firm’s future cash flows if it accepts a project and the firm’s future cash flows if it does not accept the project is referred to as the project’s: (Points : 4)
incremental cash flows.
internal cash flows.
external cash flows.
erosion effects.
financing cash flows.
7. In a single sentence, explain how you can determine which cash flows should be included in the analysis of a project. (Points : 4)
8. A project has a unit price of $5,000, a variable cost per unit of $4,000, fixed costs of $17,000,000, and depreciation expense of $6,970,000. What is the accounting break-even quantity? (Points : 4)
9. Variable costs are constant over the short-run regardless of the quantity of output produced. (Points : 4)
10. Brubaker & Goss has received requests for capital investment funds for next year from each of its five divisions. All requests represent positive net present value projects. All projects are independent. Senior management has decided to allocate the available funds based on the profitability index of each project since the company has insufficient funds to fulfill all of the requests. Management is following a practice known as: (Points : 4)
scenario analysis.
sensitivity analysis.
hard rationing.
soft rationing.
11. A stock has an expected return of 11 percent, the risk-free rate is 6.1 percent, and the market risk premium is 4 percent.
Calculate the stock’s beta. (Points : 4)
12. Explain the difference between systematic and unsystematic risk. (Points : 4)
13. Which one of the following should earn the most risk premium based on CAPM? (Points : 4)
diversified portfolio with returns similar to the overall market
stock with a beta of 1.38
stock with a beta of 0.74
U.S. Treasury bill
portfolio with a beta of 1.01
14. A group of individuals got together and purchased all of the outstanding shares of common stock of DL Smith, Inc. What is the return that these individuals require on this investment called? (Points : 4)
dividend yield
cost of equity
capital gains yield
cost of capital
income return
15. Jungle, Inc. has a target debt-equity ratio of 0.72. Its WACC is 11.5 percent and the tax rate is 34 percent. What is the cost of equity if the aftertax cost of debt is 5.5 percent? (Points : 4)
16. Textile Mills borrows money at a rate of 13.5 percent. This interest rate is referred to as the: (Points : 4)
compound rate.
current yield.
cost of debt.
capital gains yield.
cost of capital.
17. It can be argued that the decision to accept venture capital is one of the most critical decisions an entrepreneur must make. Explain why. (Points : 4)
18. A prospectus is a letter issued by the SEC authorizing a new issue of securities.
(Points : 4)
19. Outdoor Living needs $7.5 million to finance modifications to its production equipment because the design of its all-season tents has changed dramatically. The underwriters estimate that the firm could sell additional shares of stock at $14.50 a share with a 7.5 percent underwriting spread. This would be a firm commitment underwriting. The estimated issue costs are $121,000. How many shares of stock will Outdoor Living need to sell to finance this project? (Points : 4)
20. Explain how a firm loses value during the bankruptcy process from both a creditors and a shareholders perspective. (Points : 4)
21. Which one of the following states that the value of a firm is unrelated to the firm’s capital structure?
(Points : 4)
Capital Asset Pricing Model
M&M Proposition I
M&M Proposition II
Law of One Price
Efficient Markets Hypothesis

22. Which of the following statements are correct in relation to M&M Proposition II with no taxes?
I. The required return on assets is equal to the weighted average cost of capital.
II. Financial risk is determined by the debt-equity ratio.
III. Financial risk determines the return on assets.
IV. The cost of equity declines when the amount of leverage used by a firm rises.
(Points : 4)

I and III only
II and IV only
I and II only
III and IV only
I and IV only
23. The Turtle Cave currently has 160,000 shares of stock outstanding that sell for $60 per share. Assume no market imperfections or tax effects exist. What will the new share price be if the firm declares a 15 percent stock dividend? (Points : 4)

24. HJ Corporation has excess cash and has opted to buy some of its shares of outstanding common stock. What is this process of buying called?
(Points : 4)

stock dividend
stock split
stock repurchase
stock recap
stock repeal
25. Green Roof Motels has more cash on hand than its operations require. Thus, the firm has decided to pay out some of its earnings in the form of cash to its shareholders. What are these payments to shareholders called?
(Points : 4)
stock payments
stock splits