Answer Choices:
a. The MIRR and NPV decision criteria can never conflict.
b. The IRR method can never be subject to the multiple IRR problem, while the MIRR method can be.
c. One reason some people prefer the MIRR to the regular IRR is that the MIRR is based on a generally more reasonable reinvestment rate assumption.
d. The higher the WACC, the shorter the discounted payback period.
e. The MIRR method assumes that cash flows are reinvested at the crossover rate.
Answer:
c) One reason some people prefer the MIRR to the regular IRR is that the MIRR is based on a generally more reasonable reinvestment rate assumption.
Question: Which of the following statements is CORRECT?
Answer Choices:
a. Since debt capital can cause a company to go bankrupt but equity capital cannot, debt is riskier than equity, and thus the after-tax cost of debt is always greater than the cost of equity.
b. The tax-adjusted cost of debt is always greater than the interest rate on debt, provided the company does in fact pay taxes.
c. If a company assigns the same cost of capital to all of its projects regardless of each project’s risk, then the company is likely to reject some safe projects that it actually should accept and to accept some risky projects that it should reject.
d. Because no flotation costs are required to obtain capital as retained earnings, the cost of retained earnings is generally lower than the after-tax cost of debt.
e. Higher flotation costs tend to reduce the cost of equity capital.
Answer:
Options:
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: Which of the following statements is CORRECT?
Answer Choices:
a. For a project with normal cash flows, any change in the WACC will change both the NPV and the IRR.
b. To find the MIRR, we first compound cash flows at the regular IRR to find the TV, and then we discount the TV at the WACC to find the PV.
Answer:
a) For a project with normal cash flows, any change in the WACC will change both the NPV and the IRR.
Question: Which of the following statements is CORRECT?
Answer Choices:
a. MVA stands for market value added, and it is defined as follows:
MVA = (Shares outstanding)(Stock price) + Book value of common equity.
b. The primary difference between EVA and accounting net income is that when net income is calculated, a deduction is made to account for the cost of common equity, whereas EVA represents net income before deducting the cost of the equity capital the firm uses.
c. MVA gives us an idea about how much value a firm’s management has added
during the last year.
d. EVA gives us an idea about how much value a firm’s management has added over the firm’s life.
e. EVA stands for economic value added, and it is defined as follows:
EVA = NOPAT – (Total invested capital)(AT cost of capital %)
Answer:
e. EVA stands for economic value added, and it is defined as follows:
EVA = NOPAT – (Total invested capital)(AT cost of capital %)
Question: Which of the following statements is CORRECT?
Answer Choices:
a. One defect of the IRR method versus the NPV is that the IRR does not take account of cash flows over a project’s full life.
b. One defect of the IRR method versus the NPV is that the IRR does not take account of the time value of money.
c. One defect of the IRR method versus the NPV is that the IRR does not take account of the cost of capital.
d. One defect of the IRR method versus the NPV is that the IRR values a dollar received today the same as a dollar that will not be received until sometime in the future.
e. One defect of the IRR method versus the NPV is that the IRR does not take proper account of differences in the sizes of projects.
Answer:
e) One defect of the IRR method versus the NPV is that the IRR does not take proper account of differences in the sizes of projects.
Question: Which of the following statements is CORRECT? The capital structure that maximizes the stock price is also the capital structure that minimizes the cost of equity from retained earnings (rs). The capital structure that maximizes the stock price is also the capital structure that maximizes earnings per share. The capital structure that maximizes the stock price is also the capital structure that maximizes the firm’s times interest earned (TIE) ratio. If a company increases its debt ratio, this will typically increase the marginal costs of both debt and equity, but it still may reduce the company’s WACC. If Congress were to pass legislation that increases the personal tax rate but decreases the corporate tax rate, this would encourage companies to increase their debt ratios.
Answer:
Options:
Question: Projects C and D are mutually exclusive and have normal cash flows. Project C has a higher NPV if the WACC is less than 12%, whereas Project D has a higher NPV if the WACC exceeds 12%. Which of the following statements is CORRECT?
Answer Choices:
a. Project D probably has a higher IRR.
b. Project D is probably larger in scale than Project C.
c. Project C probably has a faster payback.
d. Project C probably has a higher IRR.
e. The crossover rate between the two projects is below 12%.
Answer:
a) Project D probably has a higher IRR.
Question: Project S has a pattern of high cash flows in its early life, while Project L has a longer life, with large cash flows late in its life. Neither has negative cash flows after Year 0, and at the current cost of capital, the two projects have identical NPVs. Now suppose interest rates and money costs decline. Other things held constant, this change will cause L to become preferred to S. True False
Answer:
a) True
Question: Which of the following statements is CORRECT?
Answer Choices:
a. For a project to have more than one IRR, then both IRRs must be greater than the WACC.
b. If two projects are mutually exclusive, then they are likely to have multiple IRRs.
c. If a project is independent, then it cannot have multiple IRRs.
d. Multiple IRRs can only occur if the signs of the cash flows change more than once.
e. If a project has two IRRs, then the smaller one is the one that is most relevant, and it should be accepted and relied upon.
Answer:
d) Multiple IRRs can only occur if the signs of the cash flows change more than once.
Question: Which of the following statements is CORRECT?
Answer Choices:
a. The NPV method assumes that cash flows will be reinvested at the WACC, while the IRR method assumes reinvestment at the IRR.
b. The NPV method assumes that cash flows will be reinvested at the risk-free rate, while the IRR method assumes reinvestment at the IRR.
c. The NPV method assumes that cash flows will be reinvested at the WACC, while the IRR method assumes reinvestment at the risk-free rate.
d. The NPV method does not consider all relevant cash flows, particularly cash flows beyond the payback period.
e. The IRR method does not consider all relevant cash flows, particularly cash flows beyond the payback period.
Answer:
a) The NPV method assumes that cash flows will be reinvested at the WACC, while the IRR method assumes reinvestment at the IRR.
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:
Options:
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. If Project A has a higher IRR than Project B, then Project A must have the lower NPV.
b. If Project A has a higher IRR than Project B, then Project A must also have a higher NPV.
c. The IRR calculation implicitly assumes that all cash flows are reinvested at the WACC.
d. The IRR calculation implicitly assumes that cash flows are withdrawn from the business rather than being reinvested in the business.
e. If a project has normal cash flows and its IRR exceeds its WACC, then the project’s NPV must be positive.
Answer:
e) If a project has normal cash flows and its IRR exceeds its WACC, then the project’s NPV must be positive.
Question: “Capital” is sometimes defined as funds supplied to a firm by investors.
Answer Choices:
a. True
b. False
Answer:
a. True
Question: The NPV method’s assumption that cash inflows are reinvested at the cost of capital is generally more reasonable than the IRR’s assumption that cash flows are reinvested at the IRR. This is an important reason why the NPV method is generally preferred over the IRR method. True False
Answer:
a) True
Question: Other things held constant, an increase in the cost of capital will result in a decrease in a project’s IRR. True False
Answer:
b) False
Question: The before-tax cost of debt, which is lower than the after-tax cost, is used as the component cost of debt for purposes of developing the firm’s WACC.
Answer Choices:
a. True
b. False
Answer:
b. False
Question: Which of the following statements is CORRECT? Since debt financing raises the firm’s financial risk, increasing the target debt ratio will always increase the WACC. Since debt financing is cheaper than equity financing, raising a company’s debt ratio will always reduce its WACC. Increasing a company’s debt ratio will typically reduce the marginal costs of both debt and equity financing. However, this action still may raise the company’s WACC. Increasing a company’s debt ratio will typically increase the marginal costs of both debt and equity financing. However, this action still may lower the company’s WACC. Since a firm’s beta coefficient is not affected by its use of financial leverage, leverage does not affect the cost of equity.
Answer:
Options:
Question: In theory, capital budgeting decisions should depend solely on forecasted cash flows and the opportunity cost of capital. The decision criterion should not be affected by managers’ tastes, choice of accounting method, or the profitability of other independent projects. True False
Answer:
a) True
Question: Which of the following statements is CORRECT?
Answer Choices:
a. One defect of the IRR method is that it does not take account of cash flows over a project’s full life.
b. One defect of the IRR method is that it does not take account of the time value of money.
c. One defect of the IRR method is that it does not take account of the cost of capital.
d. One defect of the IRR method is that it values a dollar received today the same as a dollar that will not be received until sometime in the future.
e. One defect of the IRR method is that it assumes that the cash flows to be received from a project can be reinvested at the IRR itself, and that assumption is often not valid.
Answer:
e) One defect of the IRR method is that it assumes that the cash flows to be received from a project can be reinvested at the IRR itself, and that assumption is often not valid.
Question: The cost of debt is equal to one minus the marginal tax rate multiplied by the interest rate on new debt.
Answer Choices:
a. True
b. False
Answer:
a. True
Question: Which of the following statements is CORRECT? If Congress lowered corporate tax rates while other things were held constant, and if the Modigliani-Miller tax-adjusted theory of capital structure were correct, this would tend to cause corporations to decrease their use of debt. A change in the personal tax rate should not affect firms’ capital structure decisions. “Business risk” is differentiated from “financial risk” by the fact that financial risk reflects only the use of debt, while business risk reflects both the use of debt and such factors as sales variability, cost variability, and operating leverage. The optimal capital structure is the one that simultaneously (1) maximizes the price of the firm’s stock, (2) minimizes its WACC, and (3) maximizes its EPS. If changes in the bankruptcy code made bankruptcy less costly to corporations, this would likely reduce the average corporation’s debt ratio.
Answer:
Options:
Question: Suppose you are the president of a small, publicly-traded corporation. Since you believe that your firm’s stock price is temporarily depressed, all additional capital funds required during the current year will be raised using debt. In this case, the appropriate marginal cost of capital for use in capital budgeting during the current year is the after-tax cost of debt.
Answer Choices:
a. True
b. False
Answer:
b. False