Answer:
a. True
Question: Firms raise capital at the total corporate level by retaining earnings and by obtaining funds in the capital markets. They then provide funds to their different divisions for investment in capital projects. The divisions may vary in risk, and the projects within the divisions may also vary in risk. Therefore, it is conceptually correct to use different risk-adjusted costs of capital for different capital budgeting projects. a. True b. False
Answer:
a. True
Question: The IRR method is based on the assumption that projects’ cash flows are reinvested at the project’s risk-adjusted cost of capital.
Answer Options:
a. True
b. False
Answer:
False
Question: Under certain conditions, a project may have more than one IRR. One such condition is when, in addition to the initial investment at time = 0, a negative cash flow (or cost) occurs at the end of the project’s life.
Answer Options:
a. True
b. False
Answer:
True
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.
Answer Options:
a. True
b. False
Answer:
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. a. True b. False
Answer:
a. True
Question: The amount shown on the December 31, 2015, balance sheet as “retained earnings” is equal to the firm’s net income for 2015 minus any dividends it paid.
Answer Options:
a. True
b. False
Answer:
b. False
Question: Which of the following statements is CORRECT? A) Free cash flow (FCF) is, essentially, the cash flow that is available for interest and dividends after the company has made the investments in current and fixed assets that are necessary to sustain ongoing operations. B) After-tax operating income is calculated as EBIT(1 – T) + Depreciation. C) Two firms with identical sales and operating costs but with different amounts of debt and tax rates will have different operating incomes by definition. D) If a firm is reporting its income in accordance with generally accepted accounting principles, then its net income as reported on the income statement should be equal to its free cash flow. E) Retained earnings as reported on the balance sheet represent cash and, therefore, are available to distribute to stockholders as dividends or any other required cash payments to creditors and suppliers.
Answer:
A
Question: If the information content, or signaling, hypothesis is correct, then a change in a firm’s dividend policy can have an important effect on its stock price and cost of equity.
Answer Options:
a. True
b. False
Answer:
a. True
Question: An increase in the firm’s WACC will decrease projects’ NPVs, which could change the accept/reject decision for any potential project. However, such a change would have no impact on projects’ IRRs. Therefore, the accept/reject decision under the IRR method is independent of the cost of capital.
Answer Options:
a. True
b. False
Answer:
True
Question: In general, firms should use their weighted average cost of capital (WACC) to evaluate capital budgeting projects because most projects are funded with general corporate funds, which come from a variety of sources. However, if the firm plans to use only debt or only equity to fund a particular project, it should use the after-tax cost of that specific type of capital to evaluate that project. a. True b. False
Answer:
b. False
Question: The NPV and IRR methods, when used to evaluate two equally risky but mutually exclusive projects, will lead to different accept/reject decisions and thus capital budgets if the cost of capital at which the projects’ NPV profiles cross is greater than the crossover rate.
Answer Options:
a. True
b. False
Answer:
False
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.
Answer Options:
a. True
b. False
Answer:
True
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: Both the regular and the modified IRR (MIRR) methods have wide appeal to professors, but most business executives prefer the NPV method to either of the IRR methods.
Answer Options:
a. True
b. False
Answer:
False
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. 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. a. True b. 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.
Answer Options:
a. True
b. False
Answer:
False
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.
Answer Options:
a. True
b. False
Answer:
True
Question: The NPV method is based on the assumption that projects’ cash flows are reinvested at the project’s risk-adjusted cost of capital.
Answer Options:
a. True
b. False
Answer:
True
Question: If a firm’s marginal tax rate is increased, this would, other things held constant, lower the cost of debt used to calculate its WACC. a. True b. False
Answer:
a. True
Question: The regular payback method is deficient in that it does not take account of cash flows beyond the payback period. The discounted payback method corrects this fault.
Answer Options:
a. True
b. False
Answer:
False