Answer Choices:
a. True
b. False
Answer: a. True
Question: The cost of equity raised by retaining earnings can be less than, equal to, or greater than the cost of external equity raised by selling new issues of common stock, depending on tax rates, flotation costs, the attitude of investors, and other factors.
Answer Choices:
a. True
b. False
Answer: a. True
Question: One advantage of the payback method for evaluating potential investments is that it provides information about a project’s liquidity and risk.
Answer Choices:
a. True
b. False
Answer: a. True
Question: A firm should never accept a project if its acceptance would lead to an increase in the firm’s cost of capital (its WACC).
Answer Choices:
a. True
b. False
Answer: b. False
Question: If expectations for long-term inflation rose, but the slope of the SML remained constant, this would have a greater impact on the required rate of return on equity, rs, than on the interest rate on long-term debt, rd, for most firms. Therefore, the percentage point increase in the cost of equity would be greater than the increase in the interest rate on long-term debt.
Answer Choices:
a. True
b. False
Answer: b. False
Question: Assuming that their NPVs based on the firm’s cost of capital are equal, the NPV of a project whose cash flows accrue relatively rapidly will be more sensitive to changes in the discount rate than the NPV of a project whose cash flows come in later in its life.
Answer Choices:
a. True
b. False
Answer: b. False
Question: For capital budgeting and cost of capital purposes, the firm should always consider retained earnings as the first source of capital (i.e., use these funds first) because retained earnings have no cost to the firm.
Answer Choices:
a. True
b. False
Answer: b. False
Question: Other things held constant, an increase in the cost of capital will result in a decrease in a project’s IRR.
Answer Choices:
a. True
b. False
Answer: b. False
Question: If a typical U.S. company correctly estimates its WACC at a given point in time and then uses that same cost of capital to evaluate all projects for the next 10 years, then the firm will most likely
Answer Choices:
a. become riskier over time, but its intrinsic value will be maximized.
b. become less risky over time, and this will maximize its intrinsic value.
c. accept too many low-risk projects and too few high-risk projects.
d. become more risky and also have an increasing WACC. Its intrinsic value will not be maximized.
e. continue as before, because there is no reason to expect its risk position or value to change over time as a result of its use of a single cost of capital.
Answer: c. accept too many low-risk projects and too few high-risk projects.
Question: If markets are in equilibrium, which of the following conditions will exist?
Answer Choices:
a. Each stock’s expected return should equal its realized return as seen by the marginal investor.
b. Each stock’s expected return should equal its required return as seen by the marginal investor.
c. All stocks should have the same expected return as seen by the marginal investor.
d. The expected and required returns on stocks and bonds should be equal.
e. All stocks should have the same realized return during the coming year.
Answer: b. Each stock’s expected return should equal its required return as seen by the marginal investor.
Question: The cost of common equity obtained by retaining earnings is the rate of return the marginal stockholder requires on the firm’s common stock.
Answer Choices:
a. True
b. False
Answer: a. True
Question: Which of the following statements is CORRECT?
Answer Choices:
a. The WACC is calculated using before-tax costs for all components.
b. The after-tax cost of debt usually exceeds the after-tax cost of equity.
c. For a given firm, the after-tax cost of debt is always more expensive than the after-tax cost of non-convertible preferred stock.
d. Retained earnings that were generated in the past and are reported on the firm’s balance sheet are available to finance the firm’s capital budget during the coming year.
e. The WACC that should be used in capital budgeting is the firm’s marginal, after-tax cost of capital.
Answer: e. The WACC that should be used in capital budgeting is the firm’s marginal, after-tax cost of capital.
Question: If investors’ aversion to risk rose, causing the slope of the SML to increase, this would have a greater impact on the required rate of return on equity, rs, than on the interest rate on long-term debt, rd, for most firms. Other things held constant.
Answer Choices:
a. True
b. False
Answer: a. True
Question: Which of the following statements is CORRECT?
Answer Choices:
a. The internal rate of return method (IRR) is generally regarded by academics as being the best single method for evaluating capital budgeting projects.
b. The payback method is generally regarded by academics as being the best single method for evaluating capital budgeting projects.
c. The discounted payback method is generally regarded by academics as being the best single method for evaluating capital budgeting projects.
d. The net present value method (NPV) is generally regarded by academics as being the best single method for evaluating capital budgeting projects.
e. The modified internal rate of return method (MIRR) is generally regarded by academics as being the best single method for evaluating capital budgeting projects.
Answer: d. The net present value method (NPV) is generally regarded by academics as being the best single method for evaluating capital budgeting projects.
Question: Which of the following statements is CORRECT? Assume that the project being considered has normal cash flows, with one outflow followed by a series of inflows.
Answer Choices:
a. A project’s regular IRR is found by compounding the cash inflows at the WACC to find the terminal value (TV), then discounting this TV at the WACC.
b. A project’s regular IRR is found by discounting the cash inflows at the WACC to find the present value (PV), then compounding this PV to find the IRR.
c. If a project’s IRR is greater than the WACC, then its NPV must be negative.
d. To find a project’s IRR, we must solve for the discount rate that causes the PV of the inflows to equal the PV of the project’s costs.
e. To find a project’s IRR, we must find a discount rate that is equal to the WACC.
Answer: d. To find a project’s IRR, we must solve for the discount rate that causes the PV of the inflows to equal the PV of the project’s costs.