Answer Options:
a. True
b. False
Answer: b. False
Question: The text identifies three methods for estimating the cost of common stock from retained earnings: the CAPM method, the DCF method, and the bond-yield-plus-risk-premium method. Since we cannot be sure that the estimate obtained with any of these methods is correct, it is often appropriate to use all three methods, then consider all three estimates, and end up using a judgmental estimate when calculating the WACC.
Answer Options:
a. True
b. False
Answer: a. True
Question: The lower the firm’s tax rate, the lower will be its after-tax cost of debt and also its WACC, other things held constant.
Answer Options:
a. True
b. False
Answer: b. False
Question: If the tax laws were changed so that $0.50 out of every $1.00 of interest paid by a corporation was allowed as a tax-deductible expense, this would probably encourage companies to use more debt financing than they presently do, other things held constant.
Answer Options:
a. True
b. False
Answer: a. True
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 Options:
a. True
b. False
Answer: a. True
Question: The longer its customers normally hold inventory, the longer the credit period supplier firms normally offer. Still, suppliers have some flexibility in the credit terms they offer. If a supplier lengthens the credit period offered, this will shorten the customer’s cash conversion cycle but lengthen the supplier firm’s own CCC.
Answer Options:
a. True
b. False
Answer: b. False
Question: The cash budget and the capital budget are handled separately, and although they are both important, they are developed completely independently of one another.
Answer Options:
a. True
b. False
Answer: b. False
Question: In finance, we are generally more interested in cash flows than in accounting profits. Free cash flow (FCF) is calculated as after-tax operating income plus depreciation less the sum of capital expenditures and changes in net operating working capital.
Answer Options:
a. True
b. False
Answer: a. True
Question: If you plotted the returns of a company against those of the market and found that the slope of your line was negative, the CAPM would indicate that the required rate of return on the stock should be less than the risk-free rate for a well-diversified investor, assuming that the observed relationship is expected to continue in the future.
Answer Options:
a. True
b. False
Answer: b. False
Question: The firm’s cost of external equity raised by issuing new stock is the same as the required rate of return on the firm’s outstanding common stock.
Answer Options:
a. True
b. False
Answer: b. False
Question: On average, a firm collects checks totaling $250,000 per day. It takes the firm approximately 4 days from the day the checks were mailed until they result in usable cash for the firm. Assume that (1) a lockbox system could be employed which would reduce the cash conversion procedure to 2 1/2 days and (2) the firm could invest any additional cash generated at 6% after taxes. The lockbox system would be a good buy if it costs $25,000 annually.
Answer Options:
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 Options:
a. True
b. False
Answer: b. False
Question: The retained earnings account on the balance sheet does not represent cash. Rather, it represents part of the stockholders’ claims against the firm’s existing assets. Put another way retained earnings are stockholders’ reinvested earnings.
Answer Options:
a. True
b. False
Answer: a. True
Question: When estimating the cost of equity by use of the DCF method, the single biggest potential problem is to determine the growth rate that investors use when they estimate a stock’s expected future rate of return. This problem leaves us unsure of the true value of rs.
Answer Options:
a. True
b. False
Answer: a. True
Question: Funds acquired by the firm through retaining earnings have no cost because there are no dividend or interest payments associated with them, and no flotation costs are required to raise them, but capital raised by selling new stock or bonds does have a cost.
Answer Options:
a. True
b. False
Answer: b. False
Question: To estimate the cash flow from operations, depreciation must be added back to net income because it is a non-cash charge that has been deducted from revenue in the net income calculation.
Answer Options:
a. True
b. False
Answer: a. True
Question: The cash conversion cycle (CCC) combines three factors: The inventory conversion period, the receivables collection period, and the payables deferral period, and its purpose is to show how long a firm must finance its working capital. Other things held constant, the shorter the CCC, the more effective the firm’s working capital management.
Answer Options:
a. True
b. False
Answer: a. True
Question: A firm’s collection policy, i.e., the procedures it follows to collect accounts receivable, plays an important role in keeping its average collection period short, although too strict a collection policy can reduce profits due to lost sales.
Answer Options:
a. True
b. False
Answer: a. True
Question: A firm constructing a new manufacturing plant and financing it with short-term loans, which are scheduled to be converted to first mortgage bonds when the plant is completed, would want to separate the construction loan from its current liabilities associated with working capital when calculating net working capital.
Answer Options:
a. True
b. False
Answer: a. True
Question: One of the effects of ceasing to take trade credit discounts is that the firm’s accounts payable will rise, other things held constant.
Answer Options:
a. True
b. False
Answer: a. True
Question: If a firm has set up a revolving credit agreement with a bank, the risk to the firm of being unable to obtain funds when needed is lower than if it had an informal line of credit.
Answer Options:
a. True
b. False
Answer: a. True
Question: Since depreciation is a non-cash charge, it neither appears on nor has any effect on the cash budget. Thus, if the depreciation charge for the coming year doubled or halved, this would have no effect on the cash budget.
Answer Options:
a. True
b. False
Answer: b. False