.

13) JW Enterprises is considering a new marketing campaign that will require the addition

of a new computer programmer and new software. The programmer will occupy an

office in JW’s current building and will be paid $8,000 per month. The software

license costs $1,000 per month. The rent for the building is $4,000 per month. JW’s

computer system is always on, so running the new software will not change the

current monthly electric bill of $900. The incremental expenses for the new market-

ing campaign are:

a. $8,000 per month.

b. $13,000 per month.

c. $13,900 per month.

d. $9,000 per month.

14) Increased depreciation expenses affect tax-related cash flows by

a. increasing taxable income, thus increasing taxes.

b. decreasing taxable income, thus reducing taxes.

c. pushing a corporation into a higher tax bracket.

d. decreasing taxable income, with no effect on cash flow since depreciation is a non-

cash expense.

15) When terminating a project for capital budgeting purposes, the working capital outlay

required at the initiation of the project will

a. not affect the cash flow.

b. decrease the cash flow because it is an outlay.

c. increase the cash flow because it is recaptured.

d. decrease the cash flow because it is a historical cost.

16) If depreciation expense in year one of a project increases for a highly profitable

company, ________.

a. net income decreases and incremental free cash flow decreases

b. net income increases and incremental free cash flow increases

c. the book value of the depreciating asset increases at the end of year one

d. net income decreases and incremental free cash flow increases

17) Which of the following is NOT considered in the calculation of incremental cash

flows?

a. tax saving due to increased depreciation expense

b. interest payments if new debt is issued

c. increased dividend payments if additional preferred stock is issued

d. both b and c

18) If bankruptcy costs and/or shareholder under diversification are an issue, what mea-

sure of risk is relevant when evaluating project risk in capital budgeting?

a. Total project risk

b. Beta risk

c. Capital rationing risk

d. Contribution-to-firm risk

19) The average cost associated with each additional dollar of financing for investment

projects is ________.

a. the incremental return

b. the marginal cost of capital

c. CAPM required return

d. the component cost of capital

20) A firm with positive MVA is ________.

a. controlling operating expenses extremely well

b. using investments to produce what investors perceive to be positive net present

values

c. experiencing monetary volatility acceleration

d. likely to have an unhappy group of common stockholders

21) Two factors that cause the investor’s required rate of return to differ from the

company’s cost of capital are ________.

a. taxes and risk

b. taxes and transactions costs

c. transactions costs and risk

d. risk and opportunity cost differences

22) Royal Mediterranean Cruise Line’s common stock is selling for $22 per share. The

last dividend was $1.20, and dividends are expected to grow at a 6% annual rate.

Flotation costs on new stock sales are 5% of the selling price. What is the cost of

Royal’s retained earnings?

a. 12.09%

b. 11.45%

c. 11.78%

d. 5.73%

23) Cost of capital is

a. the average cost of the firm’s assets.

b. a hurdle rate set by the board of directors.

c. the coupon rate of debt.

d. the rate of return that must be earned on additional investment if firm value is to

remain unchanged.

24) Acme Conglomerate Corporation operates three divisions. One division involves sig-

nificant research and development, and thus has a high-risk cost of capital of 15%.

The second division operates in business segments related to Acme’s core business,

and this division has a cost of capital of 10% based upon its risk. Acme’s core busi-

ness is the least risky segment, with a cost of capital of 8%. The firm’s overall weight

ed average cost of capital of 11% has been used to evaluate capital budgeting proj-

ects for all three divisions. This approach will

a. favor projects in the core business division because that division is the least risky.

b. favor projects in the research and development division because the higher risk proj-

ects look more favorable if a lower cost of capital is used to evaluate them.

c. not favor any division over the other because they all use the same company-wide

weighted average cost of capital.

d. favor projects in the related businesses division because the cost of capital for this

division is the closest to the firm’s weighted average cost of capital.

25) Market value added is equal to

a. the current stock price per share minus the par value per share of stock.

b. the total market value of the company minus total invested capital.

c. the total market value of the company less retained earnings.

Unit 4 Examination

1) Which of the following is a fixed cost?

a. packaging

b. administrative salaries

c. direct labor

d. freight costs on products

2) Break-even analysis is used to study the effect on EBIT of changes in all of the fol-

lowing except:

a. corporate taxes

b. cost structure

c. volume

d. prices

3) Based on the data contained in Table A, what is the break-even point in units pro-

duced and sold?

TABLE A

Average selling price per unit $15.00

Variable cost per unit $10.00

Units sold 200,000

Fixed costs $450,000

Interest expense $ 40,000

a. 98,000

b. 30,000

c. 75,000

d. 90,000

4) The break-even point in sales dollars is convenient if

a. the firm sells a large amount of one product.

b. the price per unit is very low.

c. the firm deals with more than one product.

d. depreciation expense is high.

5) Which of the following would be considered a variable cost in a manufacturing

setting?

a. Direct labor

b. Administrative salaries

c. Rent

d. Insurance

6) The primary purpose of a cash budget is to ________.

a. determine the level of investment in current and fixed assets

b. determine financing needs

c. provide a detailed plan of future cash flows

d. determine the estimated income tax for the year

7) Which of the following statements about financial leverage is true?

a. Financial leverage reduces a firm’s risk.

b. Financial leverage involves the incurrence of fixed operating costs in the firm’s income

stream.

c. Financial leverage is the responsiveness of the firm’s EBIT to fluctuations in sales.

d. Financial leverage is the responsiveness of the firm’s EPS to fluctuations in EBIT.

8) The optimal capital structure is the funds mix that will

a. maximize total leverage.

b. minimize the firm’s composite cost of capital.

c. minimize the use of debt.

d. achieve an equal proportion of debt, preferred stock, and common equity.

9) Current assets would usually not include:

a. plant and equipment

b. marketable securities

c. accounts receivable

d. inventories

10) Dividend changes may be used by management as a credible communication tool to

signal investors about future earnings under which of the following dividend policy

theories?

a. The information effect

b. The residual dividend theory

c. The expectations theory

d. The clientele effect

11) All of the following factors support the proposition that dividend policy matters

except:

a. perfect capital markets

b. investors desire to minimize and defer taxes, and capital gains get preferential tax

treatment over dividend income

c. flotation costs significantly increase the cost of new common stock compared to re-

tained earnings

d. information asymmetry exists between shareholders and managers

12) According to the clientele effect,

a. companies should change their dividend policies to please their target group of inves-

tors.

b. companies should have dividend payout ratios of either 100% or 0%.

c. even if capital markets are perfect, dividend policy still matters.

d. companies should avoid making capricious changes in their dividend policies.

13) Which of the following is true if dividend policy is irrelevant?

a. The information effect exists.

b. The clientele effect exists.

c. Tax deferral on capital gains exists.

d. Perfect capital markets exist.

14) Which of the following dividend policies will cause dividends per share to fluctuate

the most?

a. small, low, regular dividend plus a year-end extra

b. constant dividend payout ratio

c. stable dollar dividend

d. no difference between the various dividend policies

15) All of the following are potential benefits of stock repurchases except

a. an approach for maintaining the existing capital structure while still making a distri-

bution to shareholders.

b. a favorable impact on earnings per share.

c. the elimination of a minority ownership group of stockholders.

d. a means for providing an internal investment opportunity.

16) The first step involved in predicting financing needs is

a. estimating the levels of investment in current and fixed assets that are necessary to

support the projected sales.

b. determining the firm’s financing needs throughout the planning period.

c. estimating the cost of debt.

d. project the firm’s sales revenues and expenses over the planning period.

17) Which of the following is the initial and most important step in the preparation of pro

forma financial statements?

a. Estimate the levels of investment in current and fixed assets.

b. Determine the rate of interest that will be required for borrowed funds.

c. Approximate the cost of raw materials.

d. Project the firm’s sales revenues for the planning period.

18) A firm’s cash position would most likely be hurt by

a. retiring outstanding debt.

b. establishing stricter (shorter) credit terms.

c. increasing the net profit margin.

d. decreasing excess inventory.

19) Fielding Wilderness Outfitters had projected its sales for the first six months of 2008

to be as follows:

Jan. $ 50,000 April $180,000

Feb. $ 60,000 May $240,000

Mar. $100,000 June $240,000

Cost of goods sold is 60% of sales. Purchases are made and paid for two months prior to the sale. 40% of sales are collected in the month of the sale, 40% are collected in the month following the sale, and the remaining 20% in the second month following the sale. Total other cash expenses are $40,000/month. The company’s cash balance as of March 1st, 2008 is projected to be $40,000, and the company wants to maintain a minimum cash balance of $15,000. Excess cash will be used to retire short-term borrowing (if any exists). Fielding has no short-term borrowing as of March 1st, 2008. Assume that the interest rate on short-term borrowing is 1% per month. What was Fielding’s projected loss for March?

a. $84,000

b. $110,000

c. $184,000

d. none of the above

20) Which of the following items does not belong in a cash budget?

a. Rent

b. Depreciation

c. Taxes

d. Wages and salaries

21) Current assets would usually not include

a. marketable securities.

b. plant and equipment.

c. accounts receivable.

d. inventories.

22) A company that increases its liquidity by holding more cash and marketable securities

is

a. likely to achieve a higher return on equity because of higher interest income.

b. going to maximize firm value because risk is decreased.

c. going to have to sell common stock to raise the cash to become more liquid.

d. likely to achieve a lower return on equity because of the smaller rates of return earned

on cash and marketable securities compared to the firm’s other investments.

23) Which of the following is not a source of unsecured short-term credit?

a. trade credit

b. floating lien

c. a line of credit

d. commercial paper

24) The effective annual cost of not taking advantage of the 2/10, net 50 terms offered

by a supplier is

a. 18.37%.

b. 14.69%.

c. 20.45%.

d. 2.27%.

25) The terminal warehouse agreement differs from the field warehouse agreement in

that

a. the warehouse procedure differs for both agreements.

b. the borrower of the field warehouse agreement can sell the collateral without the con-

sent of the lender.

c. the terminal agreement transports the collateral to a public warehouse.

d. the cost of the terminal warehouse agreement is lower due to the lower degree of risk.