FIN 325 (Copy)

Katie owns 100 shares of ABC stock. Which one of the following terms is used to refer to the return that Katie and the other shareholders require on their investment in ABC?

A. Weighted average cost of capital
B. Pure play cost
C. Cost of equity
D. Subjective cost
E. Cost of debt

C. Cost of equity

2. Lester lent money to The Corner Store by purchasing bonds issued by the store. The rate of return that he and the other lenders require is referred to as the:
A. pure play cost.
B. cost of debt.
C. weighted average cost of capital.
D. subjective cost.
E. cost of equity.

B. cost of debt

3. The weighted average cost of capital is defined as the weighted average of a firm's:
A. return on its investments.
B. cost of equity and its aftertax cost of debt.
C. pretax cost of debt and equity securities.
D. bond coupon rates.
E. dividend and capital gains yields.

B. cost of equity and its aftertax cost of debt.

4. Farmer's Supply, Inc. is considering opening a clothing store, which would be a new line of business for the firm. Management has decided to use the cost of capital of a similar clothing store as the discount rate that should be used to evaluate this proposed expansion. Which one of the following terms is used to describe the approach Farmer's Supply is taking to establish an appropriate discount rate for the project?
A. Equity approach
B. Aftertax approach
C. Subjective approach
D. Market play
E. Pure play approach

E. Pure play approach

5. Kate is the CFO of a major firm and has the job of assigning discount rates to each project that is under consideration. Kate's method of doing this is to assign an incrementally higher rate as the risk level of the project increases over that of the current firm. Likewise, she assigns lower rates as the risk level declines. Which one of the following approaches is Kate using to assign the discount rates?
A. Pure play approach
B. Divisional rating
C. Subjective approach
D. Straight WACC approach
E. Equity rating

C. Subjective approach

6. Ted is trying to decide what cost of capital he should assign to a project. Which one of the following should be his primary consideration in this decision?
A. Amount of debt used to finance the project
B. Use, or lack thereof, of preferred stock to finance the project
C. Mix of funds used to finance the project
D. Risk level of the project
E. Length of the project's life

D. Risk level of the project

7. Black Stone Furnaces wants to build a new facility. The cost of capital for this investment is primarily dependent upon which one of the following?
A. Firm's overall source of funds
B. Source of the funds used to build the facility
C. Current tax rate
D. The nature of the investment
E. Firm's historical average rate of return

D. The nature of the investment

8. Which one of the following statements is correct related to the dividend growth model approach to computing the cost of equity?
A. The rate of growth must exceed the required rate of return.
B. The rate of return must be adjusted for taxes.
C. The annual dividend used in the computation must be for year one if you are using today's stock price to compute the return.
D. The cost of equity is equal to the return on the stock plus the risk-free rate.
E. The cost of equity is equal to the return on the stock multiplied by the stock's beta

C. The annual dividend used in the computation must be for year one if you are using today's stock price to compute the return

9. A firm has a return on equity of 12.4 percent according to the dividend growth model and a return of 18.7 percent according to the capital asset pricing model. The market rate of return is 13.5 percent. What rate should the firm use as the cost of equity when computing the firm's WACC?
A. 12.4 percent because it is lower than 18.7 percent B. 18.7 percent because it is higher than 12.4 percent
C. The arithmetic average of 12.4 percent and 18.7 percent
D. The arithmetic average of 12.4 percent, 13.5 percent, and 18.7 percent E. 13.5 percent

C. The arithmetic average of 12.4 percent and 18.7 percent

10. Which of the following features are advantages of the dividend growth model? I. easy to understand II. model simplicity III. constant dividend growth rate IV. model's applicability to all common stocks
A. II only
B. I and III only
C. II and IV only
D. I and II only
E. I, II, and III only

D. I and II only

11. Which of the following are weaknesses of the dividend growth model? I. market risk premium fluctuations II. lack of dividends for some firms III. reliance on historical beta IV. sensitivity of model to dividend growth rate
A. II only
B. I and II only
C. I and III only
D. II and IV only
E. I, II, III, and IV

D. II and IV only

12. In an efficient market, the cost of equity for a risky firm does which one of the following according to the security market line?
A. Produces a return that will be less than the market rate but higher than the risk-free rate
B. Equals the market rate of return for all stocks
C. Has a maximum cost equal to the market rate of return
D. Decreases as the beta of the firm's stock increases
E. Increases in direct relation to the stock's systematic risk

E. Increases in direct relation to the stock's systematic risk

13. Which of the following will increase the cost of equity for a firm with a beta of 1.1? I. decrease in the security's beta II. decrease in the market risk premium III. decrease in the risk-free rate IV. increase in the risk-free rate
A. II only
B. III only
C. I and II only
D. II and III only
E. I and IV only

C. III only

14. Which one of the following will increase the cost of equity, all else held constant?
A. Increase in the dividend growth rate
B. Decrease in beta
C. Decrease in future dividends
D. Increase in stock price E. Decrease in market risk premium

A. Increase in the dividend growth rate

15. All else constant, which of the following will increase the aftertax cost of debt for a firm? I. increase in the yield to maturity of the firm's outstanding debt II. decrease in the yield to maturity of the firm's outstanding debt III. increase in the firm's tax rate IV. decrease in the firm's tax rate
A. I only
B. I and III only
C. I and IV only
D. II and III only
E. II and IV only

C. I and IV only

16. Which one of the following is the pre-tax cost of debt?
A. Average coupon rate on the firm's outstanding bonds
B. Coupon rate on the firm's latest bond issue
C. Weighted average yield-to-maturity on the firm's outstanding debt
D. Average current yield on the firm's outstanding debt
E. Annual interest divided by the market price per bond for the latest bond issue

C. Weighted average yield-to-maturity on the firm's outstanding debt

17. Which one of the following will decrease the aftertax cost of debt for a firm?
A. Decrease in the firm's beta
B. Increase in tax rates
C. Increase in the risk-free rate of return
D. Decrease in the market price of the debt
E. Decrease in a bond's yield-to-maturity

B. Increase in tax rates

18. All else constant, an increase in a firm's cost of debt:
A. could be caused by an increase in the firm's tax rate.
B. will result in an increase in the firm's cost of capital.
C. will lower the firm's weighted average cost of capital.
D. will lower the firm's cost of equity.
E. will increase the firm's capital structure weight of debt.

B. will result in an increase in the firm's cost of capital

19. The cost of preferred stock:
A. increases when a firm's tax rate decreases.
B. is constant over time.
C. is unaffected by changes in the market price.
D. is equal to the stock's dividend yield.
E. increases as the price of the stock increases

D. is equal to the stock's dividend yield.

20. Which one of the following statements is correct?
A. An increase in the market value of preferred stock will increase a firm's weighted average cost of capital.
B. The cost of preferred stock is unaffected by the issuer's tax rate.
C. Preferred stock is generally the cheapest source of capital for a firm.
D. The cost of preferred stock remains constant from year to year.
E. Preferred stock is valued using the capital asset pricing model.

B. The cost of preferred stock is unaffected by the issuer's tax rate.

21. Which one of the following will affect the capital structure weights used to compute a firm's weighted average cost of capital?
A. Decrease in the book value of a firm's equity
B. Decrease in a firm's tax rate
C. Increase in the market value of the firm's common stock
D. Increase in the market risk premium
E. Increase in the firm's beta

C. Increase in the market value of the firm's common stock

22. The aftertax cost of which of the following are affected by a change in a firm's tax rate? I. preferred stock II. debt III. equity IV. capital
A. I and III only
B. II and IV only
C. I, II, and IV only
D. II, III, and IV only
E. I, II, III, and IV

B. II and IV only

23. Which one of the following statements is correct concerning capital structure weights?
A. Target rates are less relevant to a project than are historical rates.
B. The weights are unaffected when a bond issue matures.
C. An increase in the debt-equity ratio will increase the weight of the common stock.
D. The repurchase of preferred stock will increase the weight of debt.
E. The issuance of additional shares of common stock will increase the weight of the preferred stock.

D. The repurchase of preferred stock will increase the weight of debt.

24. Which one of the following statements is correct? Assume the pre-tax cost of debt is less than the cost of equity.
A. A firm may change its capital structure if the government changes its tax policies.
B. A decrease in the dividend growth rate increases the cost of equity.
C. A decrease in the systematic risk of a firm will increase the firm's cost of capital.
D. A decrease in a firm's debt-equity ratio will decrease the firm's cost of capital.
E. The cost of preferred stock decreases when the tax rate increases.

A. A firm may change its capital structure if the government changes its tax policies.

25. Which one of the following represents the rate of return a firm must earn on its assets if it is to maintain the current value of its securities?
A. Cost of equity
B. Internal rate of return
C. Aftertax cost of debt
D. Weighted average cost of capital
E. Debt-equity ratio

D. Weighted average cost of capital

26. Which one of the following statements is accurate for a levered firm?
A. WACC should be used as the required return for all proposed investments. B. A firm's WACC will decrease whenever the firm's tax rate decreases. C. An increase in the market risk premium will decrease a firm's WACC.
D. The subjective approach totally ignores a firm's own WACC.
E. A reduction in the risk level of a firm will tend to decrease the firm's WACC.

E. A reduction in the risk level of a firm will tend to decrease the firm's WACC

27. Which one of the following statements is correct, all else held constant?
A. Beta is used to compute the return on equity and the standard deviation is used to compute the return on preferred.
B. A decrease in a firm's WACC will increase the attractiveness of the firm's investment options.
C. The aftertax cost of debt increases when the market price of a bond increases.
D. If you have both the dividend growth and the security market line's costs of equity, you should use the higher of the two estimates when computing WACC.
E. WACC is only applicable to firms that issue both common and preferred stock.

B. A decrease in a firm's WACC will increase the attractiveness of the firm's investment options

28. A firm has a cost of equity of 13 percent, a cost of preferred of 11 percent, and an aftertax cost of debt of 6 percent. Given this, which one of the following will increase the firm's weighted average cost of capital?
A. Increasing the firm's tax rate
B. Issuing new bonds at par
C. Redeeming shares of common stock
D. Increasing the firm's beta
E. Increasing the debt-equity ratio

D. Increasing the firm's beta

29. All else constant, the weighted average cost of capital for a risky, levered firm will decrease if:
A. the firm's bonds start selling at a premium rather than at a discount. B. the market risk premium increases.
C. the firm replaces some of its debt with preferred stock.
D. corporate taxes are eliminated.
E. the dividend yield on the common stock increases.

A. the firm's bonds start selling at a premium rather than at a discount.

30. A firm that uses its weighted average cost of capital as the required return for all of its investments will:
A. maintain a constant value for its shareholders.
B. increase the risk level of the firm over time.
C. make the best possible accept and reject decisions related to those investments.
D. find that its cost of capital declines over time. E. accept only the projects that add value to the firm's shareholders

B. increase the risk level of the firm over time

31. Old Town Industries has three divisions. Division X has been in existence the longest and has the most stable sales. Division Y has been in existence for five years and is slightly less risky than the overall firm. Division Z is the research and development side of the business. When allocating funds, the firm should probably:
A. require the highest rate of return from division X since it has been in existence the longest.
B. assign the highest cost of capital to division Z because it is most likely the riskiest of the three divisions.
C. use the firm's WACC as the cost of capital for division Z as it provides analysis for the entire firm.
D. use the firm's WACC as the cost of capital for divisions A and B because they are part of the revenue-producing operations of the firm.
E. allocate capital funds evenly amongst the divisions to maintain the current capital structure of the firm.

B. assign the highest cost of capital to division Z because it is most likely the riskiest of the three divisions.

32. A firm uses its weighted average cost of capital to evaluate the proposed projects for all of its varying divisions. By doing so, the firm:
A. automatically gives preferential treatment in the allocation of funds to its riskiest division.
B. encourages the division managers to only recommend their most conservative projects.
C. maintains the current risk level and capital structure of the firm.
D. automatically maximizes the total value created for its shareholders.
E. allocates capital funds evenly amongst its divisions.

A. automatically gives preferential treatment in the allocation of funds to its riskiest division

33. Kurt, who is a divisional manager, continually brags that his division's required return for its projects is one percent lower than the return required for any other division of the firm. Which one of the following most likely contributes the most to the lower rate requirement for Kurt's division?
A. Kurt tends to overestimate the projected cash inflows on his projects.
B. Kurt tends to underestimate the variable costs of his projects.
C. Kurt has the most efficiently managed division.
D. Kurt's division is less risky than the other divisions.
E. Kurt's projects are generally financed with debt while the other divisions' projects are financed with equity.

D. Kurt's division is less risky than the other divisions

34. Which one of the following is the primary determinant of an investment's cost of capital?
A. Life of investment
B. Initial cash outlay
C. Level of risk
D. Source of funds used for the investment
E. Investment's net present value

C. Level of risk

35. The cost of capital for a project depends primarily on which one of the following?
A. Source of funds used for the project
B. Division within the firm that undertakes the project
C. Project's modified internal rate of return
D. How the project uses its funds
E. Project's fixed costs

D. How the project used its funds

36. Marine Expeditors has three divisions. Division A is the core of the business and represents 80 percent of the firm's operations. Division B is involved only with contractual short-term projects and therefore has about 8 percent less risk than division A. Division C develops and markets new products and is about 12 percent riskier than division A and about equal in size to division B. The manager of division A has suggested that the operations of his division be increased by 10 percent next year. The proposed project should probably be assigned a required return that is equal to _____ percent of the firm's weighted average cost of capital.
A. 40
B. 60
C. 80
D. 100
E. 110

D. 100

37. Which one of the following is most apt to cause a wise manager to increase a project's cost of capital? Assume the firm is levered.
A. Management decides to issue new stock to finance the project.
B. The initial cash outlay requirement is reduced.
C. She learns the project is riskier than previously believed.
D. The aftertax cost of debt just decreased.
E. The project's life is shortened.

C. She learns the project is riskier than previously believed

38. Boone Brothers remodels homes and replaces windows. Ace Builders constructs new homes. If Boone Brothers considers expanding into new home construction, it should evaluate the expansion project using which one of the following as the required return for the project?
A. Boone Brothers' cost of capital
B. Ace Builders' cost of capital
C. Average of Boone Brothers' and Ace Builders' cost of capital
D. Lower of Boone Brothers' or Ace Builders' cost of capital
E. Higher of Boone Brothers' or Ace Builders' cost of capital

B. Ace Builders' cost of capital

39. You need to use the pure play approach to assign a cost of capital to a proposed investment. Which one of the following characteristics should you most concentrate on as you search for an appropriate pure play firm?
A. Firm size
B. Firm location
C. Firm experience
D. Firm operations
E. Firm management

D. Firm operations

40. When using the pure play approach for a proposed investment, a firm is primarily seeking a rate of return which:
A. is based on the actual source of funds that will be used to fund the project.
B. creates a positive net present value for the project.
C. reflects the size and life of the project.
D. most closely correlates with the proposed investment's internal rate of return.
E. best matches the risk level of the proposed investment

E. best matches the risk level of the proposed investment

41. Derek's is a brick-and-mortar toy store. The firm is considering expanding its operations to include Internet sales. Which one of the following would be the best firm to use in a pure play approach to analyzing this proposed expansion?
A. Another brick-and-mortar store that also sells online
B. A wholesale toy distributor
C. A toy store that only sells online
D. The oldest online retailer of any product
E. Derek's own store

C. A toy store that only sells online

42. Kelly's uses the firm's weighted average cost of capital (WACC) as the required return for some of its projects. For other projects, the firms uses a rate equal to WACC plus 1 percent, while another set of projects is assigned rates equal to WACC minus some amount. Which one of the following factors should be the key factor the firm uses to determine the amount of the adjustment it will make when assigning the project a discount rate?
A. Firm beta
B. Date for project commencement
C. Risk level of project
D. Division within the firm that will be assigned to manage the project
E. Current debt-equity ratio

C. Risk level of project

43. A firm has multiple divisions of similar nature, yet varying degrees of risk. Which one of the following would be the most appropriate, yet relatively easy, means of assigning discount rates to each of its proposed investments?
A. Assign every project a rate equal to the firm's cost of equity
B. Assign every firm a random rate that varies between the firm's cost of debt and its cost of equity
C. Assign every project a rate equal to the firm's WACC plus or minus a subjective adjustment
D. Determine the best pure play rate for each project
E. Assign every project a rate equal to the market rate of return at the time of the proposal

C. Assign every project a rate equal to the firm's WACC plus or minus a subjective adjustment

44. The computation of which one of the following requires assigning every proposed investment to a particular risk class?
A. Pure play cost of capital B. Cost of equity
C. Aftertax cost of debt
D. WACC
E. Subjective cost of capital

E. Subjective cost of capital

45. Judy's Boutique just paid an annual dividend of $1.65 on its common stock. The firm increases its dividend by 2.5 percent annually. What is the rate of return on this stock if the current stock price is $38.20 a share?
A. 6.93 percent
B. 7.37 percent
C. 7.54 percent
D. 8.19 percent
E. 8.33 percent

A. 6.93 percent

46. Farm Equipment, Inc. announced this morning that its next annual dividend will be decreased to $1.80 a share and that all future dividends will be decreased by an additional 1.5 percent annually. What is the current value per share of this stock if the required return is 16.5 percent?
A. $8
B. $10
C. $12
D. $14
E. $16

B. $10

47. The Green Balloon just paid its first annual dividend of $0.12 a share. The firm plans to increase the dividend by 3.5 percent per year indefinitely. What is the firm's cost of equity if the current stock price is $6.50 a share?
A. 5.35 percent
B. 5.41 percent
C. 14.42 percent
D. 18.79 percent
E. 19.98 percent

B. 5.41 percent

48. High Valley Antiques would like to issue new equity shares if its cost of equity declines to 10.5 percent. The company pays a constant annual dividend of $1.60 per share. What does the market price of the stock need to be for the firm to issue the new shares?
A. $14.48
B. $14.83
C. $15.24
D. $15.92
E. $16.80

C. $15.24

49. The common stock of Modern Interiors has a beta of 1.61 and a standard deviation of 27.4 percent. The market rate of return is 13.2 percent and the risk-free rate is 4.8 percent. What is the cost of equity for this firm?
A. 18.32 percent
B. 19.97 percent
C. 21.08 percent
D. 24.40 percent
E. 26.05 percent

A.18.32 percent

50. Jet Setters has a cost of equity of 17.8 percent. The market risk premium is 10.2 percent and the risk-free rate is 4.4 percent. The company is acquiring a competitor, which will increase the company's beta to 1.6. What effect, if any, will the acquisition have on the firm's cost of equity capital?
A. No effect
B. Decrease of 3.39 percent
C. Decrease of 0.84 percent
D. Increase of 2.92 percent
E. Increase of 4.13 percent

D. Increase of 2.92 percent

51. The common stock of Yanderloft and Sons has a beta that is 25 percent larger than the overall market beta. Currently, the market risk premium is 9.2 percent while the U.S. Treasury bill is yielding 4.7 percent. What is the cost of equity for this firm?
A. 13.76 percent
B. 14.96 percent
C. 15.80 percent
D. 16.20 percent
E. 17.85 percent

D. 16.20 Percent

52. Musical Charts just paid an annual dividend of $2.45 per share. This dividend is expected to increase by 3.3 percent annually. Currently, the firm has a beta of 1.09 and a stock price of $36 a share. The risk-free rate is 4.2 percent and the market rate of return is 12.6 percent. What is the cost of equity capital for this firm?
A. 10.28 percent
B. 11.84 percent
C. 12.29 percent
D. 12.95 percent
E. 13.42 percent

B. 11.84 percent

53. The Cracker Mill has a beta of 0.97, a dividend growth rate of 3.2 percent, a stock price of $33 a share, and an expected annual dividend of $1.06 per share next year. The market rate of return is 11.2 percent and the risk-free rate is 3.7 percent. What is the firm's cost of equity?
A. 7.74 percent
B. 8.69 percent
C. 9.30 percent
D. 9.72 percent
E. 10.01 percent

B. 8.69 percent

54. The market rate of return is 14.8 percent and the risk-free rate is 4.45 percent. Galaxy Co. has 54 percent more systematic risk than the overall market and has a dividend growth rate of 5.5 percent. The firm's stock is currently selling for $39 a share and has a dividend yield of 3.6 percent. What is the firm's cost of equity?
A. 14.73 percent
B. 15.31 percent
C. 15.82 percent
D. 16.28 percent
E. 16.73 percent

A. 14.73 percent

55. Appalachian Mountain Goods has paid increasing dividends of $.0.12, $0.18, $0.20, and $0.25 a share over the past four years, respectively. The firm estimates that future increases in its dividends will be equal to the arithmetic average growth rate over these past four years. The stock is currently selling for $12.60 a share. The risk-free rate is 3.2 percent and the market risk premium is 9.1 percent. What is the cost of equity for this firm if its beta is 1.26?
A. 14.34 percent
B. 16.91 percent
C. 19.78 percent
D. 22.96 percent
E. 24.03 percent

D. 22.96 percent

56. Winter Wear, Inc. has 6 percent bonds outstanding that mature in 13 years. The bonds pay interest semiannually and have a face value of $1,000. Currently, the bonds are selling for $993 each. What is the firm's pre-tax cost of debt?
A. 5.97 percent
B. 6.08 percent
C. 6.14 percent
D. 6.31 percent
E. 6.40 percent

B. 6.08 percent

57. Four years ago, the Moore Co. issued 15-year, 7.5 percent semiannual coupon bonds at par. Today, the bonds are quoted at 101.6. What is this firm's pre-tax cost of debt?
A. 6.97 percent
B. 7.08 percent
C. 7.29 percent
D. 7.33 percent
E. 7.39 percent

C. 7.29 percent

58. Birds and Yards has 10-year bonds outstanding that carry an annual coupon of 8 percent. The bonds mature in 7 years and are currently priced at 108.4 percent of face value. What is the firm's pre-tax cost of debt?
A. 6.47 percent
B. 6.82 percent
C. 7.34 percent
D. 7.70 percent
E. 8.23 percent

A. 6.47 percent

59. Catnip Stores has a $20 million bond issue outstanding that currently has a market value of $18.6 million. The bonds mature in 6.5 years and pay semiannual interest payments of $30 each. What is the firm's pre-tax cost of debt?
A. 6.99 percent
B. 7.37 percent
C. 7.58 percent
D. 7.74 percent
E. 7.80 percent

B. 7.37 percent

60. Hi Tech Products has 35,000 bonds outstanding that are currently quoted at 102.3. The bonds mature in 11 years and carry a 9 percent annual coupon. What is the firm's aftertax cost of debt if the applicable tax rate is 35 percent?
A. 4.47 percent
B. 4.79 percent
C. 5.63 percent
D. 5.98 percent
E. 6.31 percent

C. 5.63 percent

61. Major Manufacturing issued 30-year, 8.5 percent semiannual bonds 6 years ago. The bonds currently sell at 101 percent of face value. What is the firm's aftertax cost of debt if the tax rate is 35 percent?
A. 5.46 percent
B. 5.62 percent
C. 5.76 percent
D. 6.59 percent
E. 6.83 percent

A. 5.64 percent

62. Great Lakes Packing has two bond issues outstanding. The first issue has a coupon rate of 9 percent, matures in 3 years, has a total face value of $6 million, and is quoted at 108 percent of face value. The second issue has a 7.5 percent coupon, matures in 16 years, has a total face value of $18 million, and is quoted at 97 percent of face value. Both bonds pay interest semiannually. What is the firm's weighted average aftertax cost of debt if the tax rate is 35 percent?
A. 4.78 percent
B. 5.12 percent
C. 5.63 percent
D. 5.95 percent
E.6.08 percent

A. 4.78 percent

63. The 7.5 percent preferred stock of Home Town Brews is selling for $43 a share. What is the firm's cost of preferred stock if the tax rate is 34 percent and the par value per share is $100?
A. 14.47 percent
B. 15.92 percent
C. 16.17 percent
D. 16.52 percent
E. 17.44 percent

E. 17.44 percent

64. The 7.5 percent preferred stock of Tanners Floors is selling for $57 a share. What is the firm's cost of preferred stock if the tax rate is 35 percent and the par value per share is $100?
A. 11.69 percent
B. 12.81 percent
C. 13.16 percent
D. 13.79 percent
E. 14.14 percent

C. 13.16 percent

65. The preferred stock of Pollard's Pools pays an annual dividend of $5.50 a share and sells for $42 a share. The tax rate is 34 percent. What is the firm's cost of preferred stock?
A. 12.28 percent
B. 13.10 percent
C. 15.07 percent
D. 15.59 percent
E. 16.47 percent

B. 13.10 percent

66. Christie's Train Shoppe has 15,000 shares of common stock outstanding at a price of $11 a share. It also has 2,000 shares of preferred stock outstanding at a price of $34 a share. There are 50 bonds outstanding that have a 7.5 percent semiannual coupon. The bonds mature in 6 years, have a face value of $1,000, and sell at 96 percent of par. What is the capital structure weight of the preferred stock?
A. 20.50 percent
B. 21.68 percent
C. 23.15 percent
D. 24.20 percent
E. 26.23 percent

D. 24.20 percent

67. Chesterfield and Weston has 55,000 shares of common stock outstanding at a price of $31 a share. It also has 3,000 shares of preferred stock outstanding at a price of $62 a share. The firm has 8 percent, 12-year bonds outstanding with a total face value of $400,000. The bonds are currently quoted at 101.2 percent of face and pay interest semiannually. What is the capital structure weight of the firm's debt if the tax rate is 35 percent?
A. 14.49 percent
B. 15.20 percent
C. 15.67 percent
D. 16.84 percent
E. 17.63 percent

E. 17.63 percent

68. Claus Enterprises has 174,000 shares of common stock outstanding at a current price of $46 a share. The firm also has two bond issues outstanding. The first bond issue has a total face value of $250,000, pays 7.7 percent interest annually, and currently sells for 102.5 percent of face value. The second bond issue consists of 5,000 bonds that are selling for $993 each. These bonds pay 6.5 percent interest annually and mature in 8 years. The tax rate is 34 percent. What is the capital structure weight of the firm's common stock?
A. 47.78 percent
B. 51.39 percent
C. 55.50 percent
D. 60.52 percent
E. 71.86 percent

D. 60.52

69. Sunshine Cruises issues only common stock and coupon bonds. The firm has a debt-equity ratio of 0.55. The cost of equity is 16.3 percent and the pre-tax cost of debt is 9.9 percent. What is the capital structure weight of the firm's equity if the firm's tax rate is 34 percent?
A. 46.75 percent
B. 49.97 percent
C. 52.93 percent
D. 61.08 percent
E. 64.52 percent

E. 64.52 percent

70. The General Store has a cost of equity of 15.8 percent, a pre-tax cost of debt of 7.7 percent, and a tax rate of 32 percent. What is the firm's weighted average cost of capital if the debt-equity ratio is 0.40?
A. 10.18 percent
B. 11.72 percent
C. 12.78 percent
D. 13.30 percent
E. 14.93 percent

C. 12.78 percent

71. Fancee Restaurant's cost of equity is 15.3 percent and its aftertax cost of debt is 6.1 percent. What is the firm's weighted average cost of capital if its debt-equity ratio is 0.58 and the tax rate is 30 percent?
A. 8.94 percent
B. 10.36 percent
C. 11.92 percent
D. 12.28 percent
E. 13.01 percent

C. 11.92 percent

72. A firm wants to create a weighted average cost of capital (WACC) of 10.4 percent. The firm's cost of equity is 14.5 percent and its pre-tax cost of debt is 8.5 percent. The tax rate is 34 percent. What does the debt-equity ratio need to be for the firm to achieve its target WACC? A. 0.51
B. 0.57
C. 0.62
D. 0.70
E. 0.86

E. 0.86

73. The Color Box uses a combination of common stock, preferred stock, and debt financing. The company wants preferred stock to represent 8 percent of the total financing. It also wants to structure the firm in a manner that will produce a weighted average cost of capital of 10.25 percent. The aftertax cost of debt is 5.1 percent, the cost of preferred is 9.3 percent, and the cost of common stock is 15.6 percent. What percentage of the firm's capital funding should be debt financing?
A. 46.12 percent
B. 52.03 percent
C. 54.15 percent
D. 58.78 percent
E. 63.21 percent

A. 46.12 percent

74. Southwest Tours currently has a weighted average cost of capital of 11.3 percent based on a combination of debt and equity financing. The firm has no preferred stock. The current debt-equity ratio is 0.58 and the aftertax cost of debt is 6.4 percent. The company just hired a new president who is considering eliminating all debt financing. All else constant, what will the firm's cost of capital be if the firm switches to an all-equity firm?
A. 11.45 percent
B. 12.62 percent
C. 12.89 percent
D. 13.37 percent
E. 14.14 percent

E. 14.14 percent

75. Dallas Interiors has a cost of equity of 18.6 percent and a pre-tax cost of debt of 9.7 percent. The firm's target weighted average cost of capital is 10.8 percent and its tax rate is 35 percent. What is the firm's target debt-equity ratio?
A. 0.81
B. 0.87
C. 1.18
D. 1.32
E. 1.74

E. 1.74

76. Western Electric has 23,000 shares of common stock outstanding at a price per share of $57 and a rate of return of 14.2 percent. The firm has 6,000 shares of 7 percent preferred stock outstanding at a price of $48 a share. The preferred stock has a par value of $100. The outstanding debt has a total face value of $350,000 and currently sells for 102 percent of face. The yield-to-maturity on the debt is 8.49 percent. What is the firm's weighted average cost of capital if the tax rate is 34 percent?
A. 12.69 percent
B. 13.44 percent
C. 14.19 percent
D. 14.47 percent
E. 14.92 percent

A. 12.69 percent

77. Aaron's Rentals has 58,000 shares of common stock outstanding at a market price of $36 a share. The common stock just paid a $1.64 annual dividend and has a dividend growth rate of 2.8 percent. There are 12,000 shares of 6 percent preferred stock outstanding at a market price of $51 a share. The preferred stock has a par value of $100. The outstanding bonds mature in 17 years, have a total face value of $750,000, a face value per bond of $1,000, and a market price of $1,011 each. The bonds pay 8 percent interest, semiannually. The tax rate is 34 percent. What is the firm's weighted average cost of capital?
A. 7.74 percent
B. 8.68 percent
C. 9.29 percent
D. 9.97 percent
E.10.30 percent

A. 7.74 percent

78. Alpha Industries is considering a project with an initial cost of $7.4 million. The project will produce cash inflows of $1.54 million a year for 7 years. The firm uses the subjective approach to assign discount rates to projects. For this project, the subjective adjustment is +1.5 percent. The firm has a pre-tax cost of debt of 8.6 percent and a cost of equity of 13.7 percent. The debt-equity ratio is .0.65 and the tax rate is 35 percent. What is the net present value of the project?
A. -$372,951
B. -$187,016
C. $48,209
D. $133,333
E. $269,480

A. -$372,951

79. Orchard Farms has a pre-tax cost of debt of 7.68 percent and a cost of equity of 15.2 percent. The firm uses the subjective approach to determine project discount rates. Currently, the firm is considering a project to which it has assigned an adjustment factor of -0.5 percent. The firm's tax rate is 34 percent and its debt-equity ratio is 0.45. The project has an initial cost of $4.3 million and produces cash inflows of $1.27 million a year for 5 years. What is the net present value of the project?
A. $121,619
B. $328,895
C. $514,370
D. $561,027
E. $628,721

B. $328,895

80. Bruceton Hotels is an all-equity firm with 60,000 shares of stock outstanding. The stock has a beta of 1.27 and a standard deviation of 13.8 percent. The market risk premium is 9.1 percent and the risk-free rate of return is 4.2 percent. The company is considering a project that it considers riskier than its current operations so it wants to apply an adjustment of 1 percent to the project's discount rate. What should the firm set as the required rate of return for the project?
A. 12.54 percent
B. 13.92 percent
C. 15.39 percent
D. 16.76 percent
E. 17.03 percent

D. 16.76 percent

81. Brewster's is considering a project that is equally as risky as the firm's current operations. The firm has a cost of equity of 13.7 percent and a pre-tax cost of debt of 8.4 percent. The debt-equity ratio is .65 and the tax rate is 36 percent. What is the cost of capital for this project?
A. 9.97 percent
B. 10.42 percent
C. 11.38 percent
D. 11.62 percent
E. 13.30 percent

B. 10.42 percent

82. Global Exchange has three divisions: A, B, and C. Division A has the least risk and division C has the most risk. The firm has an aftertax cost of debt of 6.1 percent and a cost of equity of 14.3 percent. The firm is financed with 35 percent debt and 65 percent equity. Division A's projects are assigned a discount rate that is 2 percent less than the firm's weighted average cost of capital. What is the discount rate applicable to division A?
A. 7.98 percent
B. 8.27 percent
C. 9.43 percent
D. 11.48 percent
E. 13.43 percent

C. 9.43 percent

83. Swizer Industries has two separate divisions. Division X has less risk so its projects are assigned a discount rate equal to the firm's WACC minus 0.5 percent. Division Y has more risk and its projects are assigned a rate equal to the firm's WACC plus 1 percent. The company has a debt-equity ratio of .45 and a tax rate of 35 percent. The cost of equity is 14.7 percent and the aftertax cost of debt is 5.1 percent. Presently, each division is considering a new project. Division Y's project provides a 12.3 percent rate of return and division X's project provides an 11.64 percent return. Which projects, if any, should the company accept?
A. Accept both X and Y
B. Accept X and reject Y
C. Reject X and accept Y
D. Reject both X and Y
E. The answer cannot be determined based on the information provided.83.

B. Accept X and reject Y

84. Beverly's is a retail chain selling the latest fashions through its outlets located in various neighborhood malls. Clothing Galore is a wholesaler that buys from textile mills and sells to retail outlets. Beverly's has a cost of capital of 13.6 percent, while Clothing Galore's cost of capital is 17.8 percent. Both firms are considering opening a retail outlet in a gigantic new mall. Both proposals are quite similar in design and have basically the following financial features: an initial cash outlay of $2.7 million, a projected 5-year life with no salvage value, and cash inflows of $845,000 a year for the life of the project. Which firm or firms, if either, should open a retail outlet in the new mall?
A. Beverly's only
B. Clothing Galore only
C. Both Beverly's and Clothing Galore
D. Neither Beverly's nor Clothing Galore
E. The answer cannot be determined based on the information provided

C. Both Beverly's and Clothing Galore

85. Lester's is a globally diverse company with multiple divisions and a cost of capital of 15.8 percent. Med, Inc. is a specialty firm in the medical equipment field with a cost of capital of 13.7 percent. With the aging of America, both firms recognize the opportunities that exist in the medical field and are considering expansion in this area. At present, there is an opportunity for multiple firms to be involved in a new medical devices project. Each project will require an initial investment of $8.4 million with annual returns of $2.2 million per year for 7 years. Which firm or firms, if either, should become involved in the new projects?
A. Lester's only
B. Med, Inc. only
C. Both Lester's and Med, Inc.
D. Neither Lester's nor Med, Inc.
E. The answer cannot be determined based on the information provided

C. Both Lester's and Med, Inc.

86. Bob's is a retail chain of specialty hardware stores. The firm has 21,000 shares of stock outstanding that are currently valued at $68 a share and provide a 13.2 percent rate of return. The firm also has 500 bonds outstanding that have a face value of $1,000, a market price of $1,068, and a 7 percent coupon. These bonds mature in 6 years and pay interest semiannually. The tax rate is 35 percent. The firm is considering expanding by building a new superstore. The superstore will require an initial investment of $12.3 million and is expected to produce cash inflows of $1.1 million annually over its 10-year life. The risks associated with the superstore are comparable to the risks of the firm's current operations. The initial investment will be depreciated on a straight line basis over the life of the project. At the end of the 10 years, the firm expects to sell the superstore for $6.7 million. Should the firm accept or reject the superstore project and why?
A. Accept; The project's NPV is $1.27 million.
B. Accept; The NPV is $4.89 million.
C. Reject; The NPV is $1.06 million
D. Reject; The NPV -$3.27 million.
E. Reject; The NPV is -$5.71 million.

D. Reject; the NPV is -$3.27 million

87. Casper's is analyzing a proposed expansion project that is much riskier than the firm's current operations. Thus, the project will be assigned a discount rate equal to the firm's cost of capital plus 3 percent. The proposed project has an initial cost of $17.2 million dollars that will be depreciated on a straight-line basis over 20 years. The project also requires additional inventory of $687,000 over the project's life. Management estimates the facility will generate cash inflows of $2.78 million a year over its 20-year life. After 20 years, the company plans to sell the facility for an estimated $1.3 million. The company has 60,000 shares of common stock outstanding at a market price of $49 a share. This stock just paid an annual dividend of $1.84 a share. The dividend is expected to increase by 3.5 percent annually. The firm also has 10,000 shares of 12 percent preferred stock with a market value of $98 a share. The preferred stock has a par value of $100. The company has a 9 percent, semiannual coupon bond issue outstanding with a total face value of $1.1 million. The bonds are currently priced at 102 percent of face value and mature in 16 years. The tax rate is 33 percent. Should the firm pursue the expansion project at this point in time? Why or why not?
A. Accept; The NPV is $2.648 million.
B. Accept; The NPV is $4.507 million.
C. Reject; The NPV is -$3.241 million.
D. Reject; The NPV is -$3.027 million.
E. Reject; The NPV is -$1.040 million.

B. Accept; the NPV is $4.507million

92. Gray's Tools just issued a dividend of $1.60 per share on its common stock. The company is expected to maintain a constant 4 percent growth rate in its dividends indefinitely. If the stock sells for $31 a share, what is the company's cost of equity?
A. 8.81 percent
B. 9.37 percent
C. 9.94 percent
D. 10.32 percent
E. 11.46 percent

B. 9.37 percent

93. Stock in ABC Enterprises has a beta of 1.06. The market risk premium is 6.8 percent, and T-bills are currently yielding 3.2 percent. ABC's most recent dividend was $1.56 per share, and dividends are expected to grow at a 4 percent annual rate indefinitely. If the stock sells for $43 a share, what is your best estimate of ABC's cost of equity?
A. 7.78 percent
B. 8.82 percent
C. 9.09 percent
D. 9.41 percent
E. 9.69 percent

C. 9.09 percent

94. Upstate Bank has an issue of preferred stock with a $4.80 stated dividend that just sold for $86 a share. What is the bank's cost of preferred stock?
A. 4.91 percent
B. 5.58 percent
C. 6.23 percent
D. 6.47 percent
E. 7.32 percent

B. 5.58 percent

95. Raceway Motors issued a 20-year, 8 percent semiannual bond 3 years ago. The bond currently sells for 98.6 percent of its face value. The company's tax rate is 34 percent. What is the aftertax cost of debt?
A. 5.38 percent
B. 5.54 percent
C. 5.69 percent
D. 5.72 percent
E. 5.99 percent

A. 5.38 percent

96. Healthy Foods has a target capital structure of 55 percent common stock, 5 percent preferred stock, and 40 percent debt. Its cost of equity is 14.3 percent, the cost of preferred stock is 8.9 percent, and the pre-tax cost of debt is 8.1 percent. What is the company's WACC if the applicable tax rate is 34 percent?
A. 9.29 percent
B. 9.61 percent
C. 10.02 percent
D. 10.45 percent
E. 10.83 percent

D. 10.45 percent

97. Precision Engineering has a target debt-equity ratio of 0.55. Its cost of equity is 15.4 percent, and its pre-tax cost of debt is 7.8 percent. If the tax rate is 34 percent, what is the company's WACC?
A. 10.20 percent
B. 10.72 percent
C. 10.91 percent
D. 11.48 percent
E. 11.76 percent

E. 11.76 percent

98. Given the following information for Electric Transport, find the WACC. Assume the company's tax rate is 34 percent. Debt: 7,500, 8.4 percent coupon bonds outstanding. $1,000 par value, 22 years to maturity, selling for 103 percent of par, the bonds make semiannual payments. Common stock: 195,000 shares outstanding, selling for $78 per share, beta is 1.21 Preferred stock: 11,000 shares of 6.35 percent preferred stock outstanding, currently selling for $76 per share. Market: 8 percent market risk premium and 5.1 percent risk-free rate.
A. 11.49 percent
B. 12.07 percent
C. 12.42 percent
D. 13.33 percent
E. 13.80 percent

A. 11.49 percent

99. You are given the following information concerning Around Town Tours: Debt: 8,500, 7.1 percent coupon bonds outstanding, with 14 years to maturity and a quoted price of 102.6. These bonds pay interest semiannually. Common stock: 265,000 shares of common stock selling for $76 per share. The stock has a beta of 0.92 and will pay a dividend of $2.48 next year. The dividend is expected to grow by 4 percent per year indefinitely. Preferred stock: 7,500 shares of 6 percent preferred stock selling at $88 per share. Market: A 13.2 percent expected return, a 4.5 percent risk-free rate, and a 34 percent tax rate. Calculate the WACC for this firm.
A. 8.22 percent B. 8.67 percent C. 9.29 percent D. 9.57 percent E.

10.08 percent

A. 8.22 percent

100. Stewart's is considering a new project. The company has a debt-equity ratio of 0.72. The company's cost of equity is 15.1 percent, and the aftertax cost of debt is 7.2 percent. The firm feels that the project is riskier than the company as a whole and that it should use an adjustment factor of +2 percent. What is the WACC it should use for the project? A. 12.53 percent B. 12.98 percent
C. 13.79 percent D. 14.14 percent E. 14.68 percent

c. 13.79 percent

1. The use of borrowing by an individual to adjust his or her overall exposure to financial leverage is referred to as:
A. M&M Proposition I.
B. capital restructuring.
C. homemade leverage.
D. M&M Proposition II.
E. financial risk management.

C. Homemade leverage

2. Which one of the following statements matches M&M Proposition I?
A. The cost of equity capital has a positive linear relationship with a firm's capital structure.
B. The dividends paid by a firm determine the firm's value.
C. The cost of equity capital varies in response to changes in a firm's capital structure.
D. The value of a firm is independent of the firm's capital structure.
E. The value of a firm is dependent on the firm's capital structure.

D. The value of a firm is independent of the firm's capital structure

3. Which one of the following states that a firm's cost of equity capital is a positive linear function of the firm's capital structure?
A. Static theory of capital structure
B. M&M Proposition I
C. M&M Proposition II
D. Homemade leverage theory
E. WACC

C. M&M Proposition II

4. Which one of the following is the equity risk arising from the daily operations of a firm?
A. Strategic risk
B. Financial risk
C. Liquidity risk
D. Industry risk
E. Business risk

E. Business Risk

5. Which one of the following is the equity risk arising from the capital structure selected by a firm?
A. Strategic risk
B. Financial risk
C. Liquidity risk
D. Industry risk
E. Business risk

B. Financial Risk

6. Paying interest reduces the taxes owed by a firm. Which one of the following terms applies to this relationship?
A. Static theory of interest rates
B. M&M Proposition I
C. Financial risk
D. Interest tax shield
E. Homemade leverage

D. Interest tax shield

7. Which one of the following is a direct bankruptcy cost?
A. Loss of customer goodwill resulting from a bankruptcy filing
B. Legal and accounting fees related to a bankruptcy proceeding
C. Management time spent on a bankruptcy proceeding
D. Any financial distress cost
E. Costs a firm spends trying to avoid bankruptcy

B. Legal and accounting fees related to a bankruptcy proceeding

8. Which one of the following terms applies to the costs incurred by a firm which is trying to avoid filing for bankruptcy?
A. Indirect bankruptcy costs
B. Direct bankruptcy costs C. Static theory cost
D. Optimal capital structure cost
E. Reorganization costs

A. Indirect bankruptcy costs

9. Which one of the following terms is inclusive of both direct and indirect bankruptcy costs?
A. Financial distress costs B. Capital structure costs C. Financial leverage
D. Homemade leverage
E. Cost of capital

A. Financial distress costs

10. Which one of the following is the theory that a firm should borrow up to the point where the additional tax benefit from an extra dollar of debt equals the additional costs associated with financial distress from that additional debt?
A. M&M Proposition I, with taxes
B. M&M Proposition II, with taxes
C. M&M Proposition I, without taxes
D. Homemade leverage proposition
E. Static theory of capital structure

E. Static theory of capital structure

11. Which one of the following best defines legal bankruptcy?
A. Negotiating new payment terms with a firm's creditors
B. A temporary technical insolvency
C. A legal proceeding for liquidating or reorganizing a business
D. The internal process of revising the capital structure of a firm
E. The failure of a firm to meet its financial obligations in a timely manner

C. A legal proceeding for liquidating or reorganizing a business

12. Which one of the following terms refers to the termination of a firm as a going concern?
A. Insolvency
B. Reorganization
C. Chapter 11 bankruptcy D. Prepack
E. Liquidation

E. Liquidation

13. Greenwood Motels has filed a petition for bankruptcy but hopes to continue its operations both during and after the bankruptcy process. Which one of the following terms best applies to this situation?
A. Chapter 7 bankruptcy
B. Liquidation
C. Technical insolvency
D. Accounting insolvency
E. Reorganization

E. Reorganization

14. In the process of liquidation, some types of claims receive preference over other claims. Which one of the following determines which type of claim is paid first?
A. Technical insolvency definition
B. Absolute priority rule C. Accounting insolvency definition
D. Chapter 7 of the Federal Bankruptcy Reform Act of 1978
E. Securities and Exchange Commission

B. Absolute priority rule

15. Which one of the following is minimized when the value of a firm is maximized?
A. Return on equity
B. WACC
C. Debt
D. Taxes
E. Bankruptcy costs

B. WACC

16. Assume you are comparing two firms that are identical in every aspect, except one is levered and one is unlevered. Which one of the following statements is correct regarding these two firms?
A. The levered firm has higher EPS than the unlevered firm at the break-even point.
B. The levered firm will have higher EPS than the unlevered firm at all levels of EBIT.
C. The unlevered firm will have higher EPS than the levered firm at relatively high levels of EBIT.
D. The EPS for the unlevered firm will always exceed those of the levered firm.
E. The unlevered firm will have higher EPS at relatively low levels of EBIT.

E. The unleveled firm will have higher EPS at relatively low levels of EBIT

17. Which one of the following statements concerning financial leverage is correct?
A. Financial leverage increases profits and decreases losses.
B. Financial leverage has no effect on a firm's return on equity.
C. Financial leverage refers to the use of common stock.
D. Financial leverage magnifies both profits and losses.
E. Increasing financial leverage will always decrease the earnings per share.

D. Financial leverage magnifies both profits and losses

18. You are comparing two possible capital structures for a firm. The first option is an all-equity firm. The second option involves the use of $3.8 million of debt. The break-even point between these two financing options occurs when the earnings before interest and taxes (EBIT) are $428,000. Given this, you know that leverage is beneficial to the firm:
A. whenever EBIT is less than $428,000.
B. only when EBIT is $428,000.
C. whenever EBIT exceeds $428,000.
D. only if the debt is decreased by $428,000.
E. only if the debt is increased by $428,000.

C. whenever EBIT exceeds $428,000

19. Which one of the following statements concerning financial leverage is correct?
A. The benefits of leverage are unaffected by the amount of a firm's earnings.
B. The use of leverage will always increase a firm's earnings per share.
C. The shareholders of a firm are exposed to less risk anytime a firm uses financial leverage.
D. Changes in the capital structure of a firm will generally change the firm's earnings per share.
E. Financial leverage is beneficial to a firm only when the firm has negative earnings.

D. Changes in the capital structure of a firm will generally change the firm's earnings per share

20. T.L. C. Enterprises just revised its capital structure from a debt-equity ratio of 0.30 to a debt-equity ratio of 0.45. The firm's shareholders who prefer the old capital structure should:
A. sell some shares and hold the sale proceeds in cash.
B. sell all of their shares and loan out the entire sale proceeds.
C. do nothing.
D. sell some shares and loan out the sale proceeds. E. borrow funds and purchase more shares.

D. Sell some shares and loan out the sale proceeds

21. Which one of the following statements is the core principle of M&M Proposition I, without taxes?
A. A firm's cost of equity is directly related to the firm's debt-equity ratio.
B. A firm's WACC is directly related to the firm's debt-equity ratio.
C. The interest tax shield increases the value of a firm.
D. The capital structure of a firm is totally irrelevant. E. Levered firms have greater value than unlevered firms.

D. The capital structure of a firm is totally irrelevant

22. Which one of the following supports the theory that the value of a firm increases as the firm's level of debt increases? A. M&M Proposition I, without taxes
B. M&M Proposition II, without taxes
C. M&M Proposition I, with taxes
D. Static theory of capital structure
E. No theory suggests this.

C. M&M Proposition I, with taxes

23. Which one of the following is an implication of M&M Proposition II, without taxes?
A. A firm's optimal capital structure is 100 percent debt.
B. WACC is unaffected by the capital structure of a firm.
C. WACC decreases as the debt-equity ratio increases.
D. A firm's capital structure is irrelevant.
E. The risk of equity depends on both the degree of financial leverage and the riskiness of the firm's operations.

E. The risk of equity depends on both the degree of financial leverage and the riskiness of the firm's operations

24. M&M Proposition II, without taxes, states that the:
A. capital structure of a firm is highly relevant.
B. weighted average cost of capital decreases as the debt-equity ratio decreases.
C. cost of equity increases as a firm increases its debt-equity ratio.
D. return on equity is equal to the return on assets multiplied by the debt-equity ratio.
E. return on equity remains constant as the debt-equity ratio increases.

C. cost of equity increases as a firm increases its debt-equity ratio.

25. The level of financial risk to which a firm is exposed is dependent upon the firm's:
A. tax rate.
B. debt-equity ratio.
C. return on assets.
D. level of earnings before interest and taxes.
E. operational level of risk.

B. debt-equity ratio

26. Which one of the following represents the present value of the interest tax shield?
A. D x (1 - Tc)
B. D/(1 - Tc)
C. D/Tc
D. D - D(Tc)
E. TC x D

E. TC x D

27. Which of the following will increase the value of a levered firm according to M&M Proposition I, with taxes? I. decrease in the amount of the debt II. increase in the value of the unlevered firm III. decrease in the tax rate IV. increase in the interest rate on the debt
A. II only
B. I and IV only
C. II and III only
D. II and IV only
E. II, III, and IV only

A. II only

28. Which of the following statements correctly relate to M&M Proposition I, with taxes? I. Debt decreases the value of a firm. II. The levered value of a firm exceeds the firm's unlevered value. III. The weighted average cost of capital (WACC) is constant. IV. The optimal capital structure is zero debt.
A. I only
B. II only
C. II and III only
D. I and IV only
E. I, III, and IV only

B. II only

29. Which one of the following is an example of a direct bankruptcy cost? A. Operating at a debt-equity ratio that is less than the optimal ratio
B. Reducing the dividend payout ratio as a means of increasing a firm's equity C. Forgoing a positive net present value project to conserve current cash
D. Incurring legal fees for the preparation of bankruptcy filings
E. Losing a key customer due to concerns over a firm's financial viability

D. Incurring legal fees for the preparation of bankruptcy filings

30. The static theory of capital structure assumes a firm:
A. maintains a constant debt-equity ratio.
B. has an all-equity structure.
C. is fixed in terms of its assets.
D. pays no taxes.
E. is operating at the point where financial distress costs are eliminated

C. is fixed in terms of its assets

31. Which one of the following conditions exists at the point where a firm maximizes its value?
A. The tax benefit from an additional dollar of debt is zero.
B. Financial distress costs are equal to zero.
C. The debt-equity ratio is 1.0.
D. WACC is minimized.
E. The cost of equity is minimized

D. WACC is minimized

32. Which one of the following statements related to the static theory of capital structure is correct?
A. A firm begins to lose value as soon as the first dollar of debt is incurred. B. The actual value of a firm continually rises in direct proportion to the increased use of debt.
C. The linear function of a firm's value has a constant positive slope.
D. A firm's value is maximized when a firm operates at its optimal debt level.
E. The value of a firm will automatically decrease whenever the debt-equity ratio is decreased

D. A firm's value is maximized when a firm operates at its optimal debt level.

33. Which one of the following is correct based on the static theory of capital structure?
A. A firm receives the greatest benefit from debt financing when its tax rate is relatively low.
B. A debt-equity ratio of 1 is considered to be the optimal capital structure.
C. The costs of financial distress decrease the value of a firm.
D. The more debt a firm assumes, the greater the incentive to acquire even more debt until such time as the firm is financed with 100 percent debt.
E. At the optimal level of debt a firm also optimizes its tax shield on debt.

C. The costs of financial distress decrease the value of a firm

34. Assume both corporate taxes and financial distress costs apply to a firm. Given this, the static theory of capital structure illustrates that:
A. a firm's value and its weighted average cost of capital are inversely related.
B. a firm's value and its tax rate are inversely related. C. the maximum value of a firm is obtained when a firm is financed solely with debt.
D. the value of a firm rises as the interest rate on debt rises.
E. the value of a firm rises as both the interest rate on debt and the tax rate rise

A. a firm's value and its weighted average cost of capital are inversely related

35. When is a firm insolvent from an accounting perspective? A. When the firm is unable to meet its financial obligations in a timely manner
B. When the firm's debt exceeds the value of the firm's equity
C. When the firm has a negative net worth
D. When the firm's revenues cease
E. When the market value of the firm's equity equals zero

C. When the firm has a negative net worth

36. Peterboro recently defaulted on a bank loan. To avoid a bankruptcy proceeding, the bank agreed to a composition. This composition would do which one of the following?
A. Forgive the loan payment in its entirety
B. Extend the due date on the missed loan payment
C. Reduce the amount of the loan payments so Peterboro can pay timely D. Transfer some of Peterboro's assets to the bank in lieu of the loan payment
E. Transfer all the equity shares in Peterboro to the lending bank

C. Reduce the amount of the loan payments so Peterboro can pay timely

37. Which one of the following will generally receive the highest priority in a bankruptcy liquidation, assuming the absolute priority rule is followed?
A. Claims by unsecured creditors
B. Employee wages
C. Government tax claims D. Contributions to employee retirement plans
E. Bankruptcy administrative expenses

E. Bankruptcy administrative expenses

38. Which one of the following is a key provision of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005? A. Disallowance of bankruptcy prepacks
B. Right granted to creditors to file their own reorganization plan once a firm is in bankruptcy for 18 months
C. Disallowance of all management bonus payments while a firm is in bankruptcy
D. Requirement that only creditors can file reorganization plans for a bankrupt firm
E. Requirement for all Chapter 11 bankruptcies to be converted to Chapter 7 bankruptcies after 18 months

B. Right granted to creditors to file their own reorganization plan once a firm is in bankruptcy for 18 months

39. Which one of the following statements is correct?
A. A prepack is a plan of liquidation used to distribute a firm's assets.
B. Bankruptcy courts have "cram-down" powers.
C. The absolute priority rule must be strictly followed in all bankruptcy proceedings.
D. Creditors cannot force a firm into bankruptcy even though they might like to do so.
E. A reorganization plan can only be approved if the firm's creditors all agree with the plan.

B. Bankruptcy courts have "cram-down" powers

40. A prepack:
A. guarantees full payment to all creditors but lengthens the time span of the debt.
B. is the joint filing of both a bankruptcy filing and a creditor-approved reorganization plan.
C. protects the interests of both the current creditors and the existing shareholders.
D. applies only if a firm files under Chapter 7 of the bankruptcy code.
E. extends the time that a firm is protected by the bankruptcy process.

B. is the joint filing of both a bankruptcy filing and a creditor-approved reorganization plan

41. Which one of the following statements is correct?
A. All Chapter 7 bankruptcy filings must include a "workout" agreement.
B. Firms must remain in bankruptcy for at least 18 months.
C. Key employee retention plans (KERPS) are no longer legal.
D. Labor contracts cannot be modified through the bankruptcy process.
E. A firm can file for Chapter 11 bankruptcy even if the firm is solvent

E. A firm can file for Chapter 11 bankruptcy every if the firm is solvent

42. Glass Ornaments, Inc. is an all-equity firm with a total market value of $386,000 and 15,000 shares of stock outstanding. Management is considering issuing $75,000 of debt at an interest rate of 8 percent and using the proceeds on a stock repurchase. As an all-equity firm, management believes the earnings before interest and taxes (EBIT) will be $31,000 if the economy is normal, $11,000 if it is in a recession, and $37,000 if the economy booms. Ignore taxes. What will the earnings per share (EPS) be if the economy falls into a recession and the firm maintains its all-equity status?
A. $0.68
B. $0.73
C. $1.21
D. $1.67 E. $2.07

B. $0.73

43. The Green Briar is an all-equity firm with a total market value of $418,000 and 20,000 shares of stock outstanding. Management is considering issuing $120,000 of debt at an interest rate of 9 percent and using the proceeds on a stock repurchase. Ignore taxes. How many shares will the firm repurchase if it issues the debt securities?
A. 2,871 shares
B. 3,516 shares
C. 3,921 shares
D. 4,607 shares
E. 5,742 shares

E. 5,742 shares

44. Charleston Mills is an all-equity firm with a total market value of $221,000. The firm has 8,000 shares of stock outstanding. Management is considering issuing $50,000 of debt at an interest rate of 7 percent and using the proceeds on a stock repurchase. Ignore taxes. How many shares can the firm repurchase if it issues the debt securities?
A. 1,810 shares
B. 1,818 shares
C. 1,847 shares
D. 1,856 shares
E. 1,899 shares

A. 1,810 shares

45. Northern Wood Products is an all-equity firm with 16,000 shares of stock outstanding and a total market value of $352,000. Based on its current capital structure, the firm is expected to have earnings before interest and taxes of $26,000 if the economy is normal, $3,000 if the economy is in a recession, and $33,000 if the economy booms. Ignore taxes. Management is considering issuing $88,000 of debt with a 6 percent coupon rate. If the firm issues the debt, the proceeds will be used to repurchase stock. What will the earnings per share be if the debt is issued and the economy is in a recession?
A. -$0.27
B. -$0.19
C. $0.03
D. $0.26
E. $0.31

B. -$0.19

46. Cross Town Cookies is an all-equity firm with a total market value of $720,000. The firm has 150,000 shares of stock outstanding. Management is considering issuing $200,000 of debt at an interest rate of 7 percent and using the proceeds to repurchase shares. The projected earnings before interest and taxes are $58,600. What are the anticipated earnings per share if the debt is issued? Ignore taxes.
A. $0.25 B. $0.33 C. $0.38
D. $0.41 E. $0.47

D. $0.41

47. Ernst Electrical has 9,000 shares of stock outstanding and no debt. The new CFO is considering issuing $80,000 of debt and using the proceeds to retire 1,500 shares of stock. The coupon rate on the debt is 7.5 percent. What is the break-even level of earnings before interest and taxes between these two capital structure options?
A. $18,500 B. $21,000
C. $24,000 D. $32,500
E. $36,000

E. $36,000

48. Northwestern Lumber Products currently has 15,000 shares of stock outstanding. Patricia, the financial manager, is considering issuing $120,000 of debt at an interest rate of 6.75 percent. Given this, how many shares of stock will be outstanding once the debt is issued if the break-even level of EBIT between these two capital structure options is $60,000? Ignore taxes.
A. 12,975 shares
B. 13,650 shares
C. 14,025 shares
D. 14,550 shares
E.15,000 shares

A. 12,975 shares

49. Chick 'N Fish is considering two different capital structures. The first option consists of 25,000 shares of stock. The second option consists of 15,000 shares of stock plus $150,000 of debt at an interest rate of 7.5 percent. Ignore taxes. What is the break-even level of earnings before interest and taxes (EBIT) between these two options?
A. $2,813
B. $3,134
C. $16,410
D. $28,125
E. $31,338

D. $28,125

50. A firm is considering two different capital structures. The first option is an all-equity firm with 32,000 shares of stock. The second option is 20,000 shares of stock plus some debt. Ignoring taxes, the breakeven level of earnings before interest and taxes between these two options is $48,000. How much money is the firm considering borrowing if the interest rate is 8 percent?
A. $175,000
B. $225,000
C. $250,000
D. $275,000
E. $300,000

B. $225,000

51. Room and Board has determined that $36,000 is the breakeven level of earnings before interest and taxes for the two capital structures it is considering. The one structure consists of all equity with 14,000 shares of stock. The second structure consists of 10,000 shares of stock and $80,000 of debt. What is the interest rate on the debt?
A. 7.72 percent
B. 8.19 percent
C. 9.97 percent
D. 11.43 percent
E. 12.86 percent

E. 12.86 percent

52. Shoe Box Stores is currently an all-equity firm with 28,000 shares of stock outstanding. Management is considering changing the capital structure to 40 percent debt. The interest rate on the debt would be 9 percent. Ignore taxes. Jamie owns 300 shares of Shoe Box Stores stock that is priced at $17 a share. What should Jamie do if she prefers the all-equity structure but Shoe Box Stores adopts the new capital structure?
A. Borrow money and buy an additional 120 shares. B. Borrow money and buy an additional 180 shares. C. Keep her shares but loan out all of the dividend income at 9 percent.
D. Sell 120 shares and loan out the proceeds at 9 percent.
E. Sell 180 shares and loan out the proceeds at 9 percent

D. Sell 120 shares and loan out the proceeds at 9 percent

53. Katz is an all-equity development company that has 36,000 shares of stock outstanding at a market price of $25 a share. The firm's earnings before interest and taxes are $29,000. Katz has decided to issue $200,000 of debt at a rate of 6 percent and use the proceeds to repurchase shares. What should Faith do if she owns 500 shares of Katz stock and wants to use homemade leverage to offset the leverage being assumed by the firm?
A. Borrow money and buy an additional 22 shares
B. Borrow money and buy an additional 111 shares C. Sell 22 shares and loan out the proceeds
D. Sell 56 shares and loan out the proceeds
E. Sell 111 shares and loan out the proceeds

E. Sell 111 shares and loan out the proceeds

54. Gabella's is an all-equity firm that has 21,000 shares of stock outstanding at a market price of $40 a share. The firm has earnings before interest and taxes of $84,000 and has a 100 percent dividend payout ratio. Ignore taxes. Gabella's has decided to issue $160,000 of debt at a rate of 12 percent and use the proceeds to repurchase shares. Travis owns 500 shares of Gabella's stock and has decided to continue holding those shares. How will Gabella's debt issue affect Travis' annual dividend income?
A. Decrease from $2,400 to $1,840
B. Increase from $2,400 to $2,160
C. Decrease from $2,000 to $1,906
D. Increase from $2,000 to $2,094
E. No change

C. Decrease from $2,000 to $1,906

55. Henderson's is an all-equity firm that has 135,000 shares of stock outstanding. Neal, the financial vice-president, is considering borrowing $220,000 at 7.25 percent interest to repurchase 20,000 shares. Ignoring taxes, what is the value of the firm?
A. $1,260,000
B. $1,400,000
C. $1,485,000
D. $1,620,000
E. $1,750,000

C. $1,485,000

56. Tree Farms, Inc. currently has 45,000 shares of stock outstanding and no debt. The price per share is $17.50. The firm is considering borrowing funds at 7.5 percent interest and using the proceeds to repurchase 3,000 shares of stock. Ignore taxes. How much is the firm borrowing?
A. $52,500
B. $75,000
C. $110,500
D. $125,000
E. $135,000

A. $52,500

57. The Gable Inn is an all-equity firm with 16,000 shares outstanding at a value per share of $14.50. The firm is issuing $50,000 of debt and using the proceeds to reduce the number of outstanding shares. How many shares of stock will be outstanding once the debt is issued? Ignore taxes.
A. 11,970 shares
B. 12,552 shares
C. 12,846 shares
D. 13,030 shares
E. 13,561 shares

B. 12,552 shares

58. Western Shores is comparing two separate capital structures. The first structure consists of 260,000 shares of stock and no debt. The second structure consists of 210,000 shares of stock and $1.5 million of debt. What is the price per share of equity?
A. $18
B. $22
C. $27
D. $30
E. $33

D. $30

59. The Doll House has a pre-tax cost of debt of 7.9 percent and a return on assets of 11.7 percent. The debt-equity ratio 0.45. Ignore taxes. What is the cost of equity?
A. 11.87 percent
B. 12.03 percent
C. 12.47 percent
D. 12.98 percent
E. 13.41 percent

E. 13.41 percent

60. The Outlet has a cost of equity of 16.8 percent, a pre-tax cost of debt of 8.1 percent, and a return on assets of 14.5 percent. Ignore taxes. What is the debt-equity ratio?
A. 0.28
B. 0.36
C. 0.44
D. 0.52
E. 0.57

B. 0.36

61. Weston Mines has a cost of equity of 19.8 percent, a pre-tax cost of debt of 9.4 percent, and a return on assets of 17.1 percent. Ignore taxes. What is the debt-equity ratio?
A. 0.35
B. 0.41
C. 0.47
D. 0.56
E. 0.62

A. 0.35

62. Clark's Cookies has a return on assets of 15.3 percent and a cost of equity of 17.6 percent. What is the pre-tax cost of debt if the debt-equity ratio is 0.54? Ignore taxes. A. 8.87 percent
B. 9.29 percent
C. 9.64 percent
D. 10.31 percent
E. 11.04 percent

E. 11.04 percent

63. The Water Works has a return on assets of 13.7 percent, a cost of equity of 18.6 percent, and a pre-tax cost of debt of 7.1 percent. What is the debt-equity ratio? Ignore taxes. A. 0.44
B. 0.47
C. 0.61
D. 0.68
E. 0.74

E. 0.74 percent

64. An all-equity firm has a return on assets of 15.3 percent. The firm is considering converting to a debt-equity ratio of 0.30. The pre-tax cost of debt is 8.1 percent. Ignoring taxes, what will the cost of equity be if the firm switches to the levered capital structure? A. 15.57 percent
B. 16.28 percent
C. 16.67 percent
D. 17.46 percent
E. 18.19 percent

D. 17.46 percent

65. Stone House Cafe has a 30 percent tax rate and total taxes of $35,280. What is the value of the interest tax shield if the interest expense is $16,700?
A. $4,887
B. $5,010
C. $5,395
D. $5,708
E. $6,023

B. $5,010

66. Aaron's Tea House has a 32 percent tax rate and an interest tax shield valued at $6,728 for the year. How much did the firm pay in annual interest?
A. $2,153
B. $2,304
C. $2,468
D. $20,507
E. $21,025

E. $21,025

67. Kelner's Nursery has 8,000 bonds outstanding with a face value of $1,000 each. The coupon rate is 6.5 percent and the tax rate is 34 percent. What is the present value of the interest tax shield?
A. $2.72 million
B. $2.83 million
C. $3.09 million
D. $3.13 million
E. $3.26 million

A. $2.72 million

68. Southern Fried Foods has a $12 million bond issue outstanding with a coupon rate of 6.75 percent and a yield-to-maturity of 7.27 percent. What is the present value of the tax shield if the tax rate is 35 percent?
A. $283,500
B. $305,340
C. $3,053,400
D. $3,560,000
E. $4,200,000

E. $4,200,000

69. Liz's Home Remedy has a $24 million bond issue outstanding with a coupon rate of 7.75 percent and a current yield of 7.67 percent. What is the present value of the tax shield if the tax rate is 34 percent?
A. $632,400
B. $625,872
C. $6.28 million
D. $8.16 million
E. $8.68 million

$8.16 million

70. Tropical Fruit Extracts expects its earnings before interest and taxes to be $218,000 a year forever. Currently, the firm has no debt. The cost of equity is 16.3 percent and the tax rate is 35 percent. The company is in the process of issuing $2 million of bonds at par that carry a 6.5 percent annual coupon. What is the unlevered value of the firm?
A. $371,429
B. $431,971
C. $747,485
D. $869,325
E. $988,315

$869,325

71. Kline Construction is an all-equity firm that has projected perpetual earnings before interest and taxes of $879,000. The current cost of equity is 18.3 percent and the tax rate is 34 percent. The company is in the process of issuing $6.2 million of 8.5 percent annual coupon bonds at par. What is the levered value of the firm?
A. $5,278,164
B. $5,541,085
C. $6,422,225
D. $6,713,185
E. $7,385,695

A. $5,278,164

72. Stevenson's Bakery is an all-equity firm that has projected perpetual earnings before interest and taxes of $138,000 a year. The cost of equity is 13.7 percent and the tax rate is 32 percent. The firm can borrow money at 6.75 percent. Currently, the firm is considering converting to a debt-equity ratio of 0.45. What is the firm's levered value? A. $527,613
B. $689,919
C. $752,987
D. $829,507
E. $903,682

C. $752,987

73. Hot To Go is an all-equity firm specializing in hot ready-to-eat meals. Management has estimated the firm's earnings before interest and taxes will be $167,000 annually forever. The present cost of equity is 15.1 percent. Currently, the firm has no debt but is considering borrowing $750,000 at 9 percent interest. The tax rate is 34 percent. What is the value of the unlevered firm?
A. $623,017
B. $646,511
C. $704,141
D. $729,934
E. $755,200

D. $729,934

74. Great Lakes Shipping is an all-equity firm with anticipated earnings before interest and taxes of $439,000 annually forever. The present cost of equity is 16.4 percent. Currently, the firm has no debt but is considering borrowing $1.25 million at 8.5 percent interest. The tax rate is 36 percent. What is the value of the levered firm?
A. $2,163,171
B. $2,406,519
C. $2,588,547
D. $2,666,667
E. $2,818,181

A. $2,173,171

75. Jericho Snacks is an all-equity firm with estimated earnings before interest and taxes of $826,000 annually forever. Currently, the firm has no debt but is considering borrowing $650,000 at 6.75 percent interest. The tax rate is 34 percent and the current cost of equity is 17.2 percent. What is the value of the levered firm?
A. $3,187,271
B. $3,169,535
C. $3,307,271
D. $3,390,535
E. $3,506,418

D. $3,390,535

76. The Gift Mart is an all-equity firm with a current cost of equity of 19.6 percent. The estimated earnings before interest and taxes are $239,000 annually forever. Currently, the firm has no debt but is in the process of borrowing $400,000 at 9.5 percent interest. The tax rate is 30 percent. What is the value of the unlevered firm?
A. $849,207
B. $853,571
C. $856,411
D. $919,307
E. $926,667

B. $853,571

77. Coaster's has a cost of equity of 15.4 percent, a return on assets of 10.2 percent, and a cost of debt of 7.3 percent. There are no taxes. What is the firm's weighted average cost of capital?
A. 7.30 percent
B. 10.20 percent
C. 10.97 percent
D. 15.40 percent
E. Cannot be determined from the information provided

B. 10.20 percent

78. A firm has a cost of debt of 7.5 percent and a cost of equity of 16.2 percent. The debt-equity ratio is 0.45. There are no taxes. What is the firm's weighted average cost of capital?
A. 11.75 percent
B. 12.29 percent
C. 13.50 percent
D. 14.47 percent
E. 16.20 percent

C. 13.50 percent

79. A firm has a weighted average cost of capital of 11.68 percent and a cost of equity of 15.5 percent. The debt-equity ratio is 0.65. There are no taxes. What is the firm's cost of debt?
A. 5.80 percent
B. 6.27 percent
C. 6.44 percent
D. 7.23 percent
E. 7.81 percent

A. 5.80 percent

85. Jasper Industrial has no debt outstanding and a total market value of $110,000. Earnings before interest and taxes, EBIT, are projected to be $12,000 if economic conditions are normal. If there is strong expansion in the economy, then EBIT will be 15 percent higher. If there is a recession, then EBIT will be 20 percent lower. Jasper Industrial is considering a $35,000 debt issue with a 7 percent interest rate. The proceeds will be used to repurchase shares of stock. There are currently 7,500 shares outstanding. Ignore taxes for this problem. What is the percentage change in EPS when a normal economy slips into recession?
A. -33 percent
B. -25 percent
C. -20 percent
D. -16 percent
E. -10 percent

C. -20 percent

86. Gabe's Market is comparing two different capital structures. Plan I would result in 11,000 shares of stock and $225,000 in debt. Plan II would result in 14,000 shares of stock and $150,000 in debt. The interest rate on the debt is 8 percent. Ignoring taxes, compare both of these plans to an all-equity plan assuming that EBIT will be $45,000. The all-equity plan would result in 20,000 shares of stock outstanding. Of the three plans, the firm will have the highest EPS with _____ and the lowest EPS with _____.
A. Plan I; Plan II
B. Plan I; all-equity plan
C. Plan II; Plan I
D. Plan II; all-equity plan E. all-equity plan; Plan I

B. Plan I; all-equity plan

87. Uptown Construction is comparing two different capital structures. Plan I would result in 23,000 shares of stock and $320,000 in debt. Plan II would result in 17,000 shares of stock and $260,000 in debt. The interest rate on the debt is 10 percent. Ignoring taxes, EPS will be identical for Plans I and II when EBIT equals which one of the following?
A. $8,550
B. $9,000
C. $9,600
D. $10,400
E. $10,750

B. $9,000

88. Bruno's is considering a change from its current capital structure. Bruno's currently has an all-equity capital structure and is considering a capital structure with 30 percent debt. There are currently 6,500 shares outstanding at a price per share of $46. EBIT is expected to remain constant at $43,000. The interest rate on new debt is 8.5 percent and there are no taxes. Tracie owns $20,700 worth of stock in the company. The firm has a 100 percent payout. What would Tracie's cash flow be under the new capital structure assuming that she keeps all of her shares?
A. $1,998
B. $2,227
C. $2,815
D. $3,027
E. $3,499

E. $3,499

89. Delta Mowers has a debt-equity ratio of 1.2. Its WACC is 10.1 percent, and its cost of debt is 7.5 percent. There is no corporate tax. What is the firm's cost of equity capital?
A. 12.60 percent
B. 13.22 percent
C. 13.83 percent
D. 14.29 percent
E. 14.80 percent

B. 13.22 percent

90. Triangle Enterprises has no debt but can borrow at 9 percent. The firm's WACC is currently 14.7 percent, and there is no corporate tax. If the firm converts to 70 percent debt, what will its cost of equity be?
A. 20.67 percent
B. 22.95 percent
C. 24.47 percent
D. 26.39 percent
E. 28.00 percent

E. 28.00 percent

91. M.G. Movers can borrow at 7.5 percent. The firm currently has no debt, and the cost of equity is 16 percent. The current value of the firm is $540,000. What will the value be if the firm borrows $160,000 and uses the proceeds to repurchase shares? The corporate tax rate is 34 percent.
A. $528,000
B. $540,000
C. $552,000
D. $571,000
E. $594,400

E. $594,400

92. Snow Mountain Resort has a 33 percent tax rate. Its total interest payment for the year just ended was $6.8 million. What is the interest tax shield?
A. $2,006,500
B. $2,244,000
C. $2,410,600
D. $2,525,000
E. $2,618,000

B. $2,244,000

93. Marcos & Sons has no debt. Its current total value is $58 million. What will the company's value be if it sells $21 million in debt and has a tax rate of 34 percent? Assume debt proceeds are used to repurchase equity.
A. $58,220,000
B. $60,370,000
C. $62,330,000
D. $64,560,000
E. $65,140,000

E. $65,140,000

94. Glass Growers has no debt. Its cost of capital is 8.7 percent. Suppose the firm converts to a debt-equity ratio of 0.65. The interest rate on the debt is 6.9 percent. What is its new WACC?
A. 7.99 percent
B. 8.13 percent
C. 8.36 percent
D. 8.44 percent
E. 8.61 percent

A. 7.99 percent

95. One year ago, you purchased a 5 percent coupon bond with a face value of $1,000 when it was selling for 101.2 percent of par. Today, you sold this bond for 99.8 percent of par. What is your total dollar return on this investment? .
A. $36
B. $74
C. $82
D. $64
E. $60

A. $36

96. You own a portfolio that has $1,900 invested in Stock A and $2,700 invested in Stock B. If the expected returns on these stocks are 9 percent and 15 percent, respectively, what is the expected return on the portfolio? .
A. 11.96 percent
B. 12.52 percent
C. 11.14 percent
D. 13.07 percent
E. 10.57 percent

B. 12.52 percent

97. Which one of the following is the slope of the security market line? .
A. Market rate of return
B. Risk-free rate
C. Market risk premium
D. Risk premium on an individual asset
E. Beta coefficient

A. Market risk premium

98. Q: Based on the capital asset pricing model, investors are compensated based on which of the following?.I. Market risk premium.II. Portfolio standard deviation.III. Portfolio beta.IV. Risk-free rate .
A. II and IV only
B. I, III, and IV only
C. I, II, and III only
D. I, II, III, and IV
E. I and III only

B. I, III and IV only

99. Semistrong form market efficiency states that the value of a security is based on:.
A. historical information only
B. all public and private information
C. all publicly available information
D. all publicly available information plus any data that can be gathered from insider trading
E. random information with no clear distinction as to the source of that information

C. All publicly available information

100. The stock of Wiley United has a beta of 0.92. The market risk premium is 8.4 percent and the risk-free rate is 3.2 percent. What is the expected return on this stock? .
A. 10.93 percent
B. 11.52 percent
C. 12.01 percent
D. 8.87 percent
E. 10.69 percent

...

101. A stock has a beta of 1.56 and an expected return of 17.3 percent. A risk-free asset currently earns 5.1 percent. If a portfolio of the two assets has a beta of 1.06, what are the portfolio weights? .
A. Stock weight = 0.28; risk-free weight = 0.72
B. Stock weight = 0.72; risk-free weight = 0.28
C. Stock weight = 0.032;risk-free weight = 0.68
D. Stock weight = 0.68; risk-free weight = 0.32
E. Stock weight = 0.44; risk-free weight = 0.56

D. Stock weight = 0.68; risk-free weight = 0.32

102. Your portfolio has provided you with returns of 8.6 percent, 14.2 percent, -3.7 percent, and 12.0 percent over the past four years, respectively. What is the geometric average return for this period? .
A. 7.54 percent
B. 7.57 percent
C. 7.25 percent
D. 9.55 percent
E. 7.63 percent

A. 7.54 percent

103. You earned 26.3 percent on your investments for a time period when the risk-free rate was 3.8 percent and the inflation rate was 4.0 percent. What was your real rate of return for the period? .
A. 21.44 percent
B. 19.12 percent
C. 21.67 percent
D. 20.06 percent
E. 21.08 percent

A. 21.44 percent Website: http://www.calculatorpro.com/calculator/real-rate-of-return-calculator/

104. Which one of the following is the best example of systematic risk? .
A. Increase in agricultural exports.
B. Decrease in textile imports.
C. Decrease in gross domestic product.
D. Decrease in management bonuses for banking executives.
E. Discovery of a major gas field.

C. Decrease in gross domestic product

105. Which one of the following statements is correct?
A. A portfolio that contains at least 30 diverse individual securities that will have a beta of 1.0.
B. A risk-free security plots at the origin on a security market line graph.
C. An underpriced security will plot above the security market line.
D. A portfolio that has a beta of 1.12 will lie to the left of the market portfolio on a security market line graph
E. Any portfolio that is correctly valued will have a beta of 1.0.

...

106. The systematic risk principle states that the expected return on a risky asset depends only on which one of the following?
A. Diversifiable risk
B. Asset-specific risk
C. Unique risk
D. Market risk
E. Unsystematic risk

D. Market risk

107.You would like to create a portfolio that is equally invested in a risk-free asset and two stocks. One stock has a beta of 1.15. What does the beta of the second stock have to be if you want the portfolio to be equally as risky as the overall market? .
A. 1.23.
B. 1.85.
C. 1.55.
D. 0.97.
E. 0.78.

B. 1.85.

108. One year ago, Peyton purchased 3,600 shares of Broncos stock for $101,124. Today, he sold those shares for $26.60 a share. What is the total return on this investment if the dividend yield is 1.9 percent? .
A. -3.40 percent
B. -3.98 percent
C. 1.10 percent
D. 3.40 percent
E. -2.29 percent

A. -3.40 percent

109. What is the probability associated with a return that lies in the upper tail when the mean plus two standard deviations is graphed? .
A. 0.05 percent.
B. 1.0 percent.
C. 0.5 percent.
D. 2.5 percent.
E. 5.0 percent.

D. 2.5 percent.

110. A $36,000 portfolio is invested in a risk-free security and two stocks. The beta of Stock A is 1.29 while the beta of Stock B is 0.90. One-half of the portfolio is invested in the risk-free security. How much is invested in Stock A if the beta of the portfolio is 0.58?.
A. $6,000.
B. $18,000.
C. $15,000.
D. $9,000.
E. $12,000.

E. $12,000.

111. Investors require a 4 percent return on risk-free investments. On a particular risky investment, investors require an excess return of 7 percent in addition to the risk-free rate of 4 percent. What is this excess return called? .
A. Risk premium
B. Real return
C. Required return
D. Average return
E. Inflation premium

A. Risk Premium

112. Diversifying a portfolio across various sectors and industries might do more than one of the following. However, this diversification must do which one of the following? .
A. Increase the security's risk premium
B. Reduce the portfolio's systematic risk level
C. Increase the expected risk premium
D. Reduce the portfolio's unique risks
E. Reduce the beta of the portfolio to zero

D. Reduce the portfolio's unique risks

113. A stock has returns for five years of 23 percent, -17 percent, 8 percent, 22 percent, and 3 percent, respectively. The stock has an average return of ______ percent and a standard deviation of _____ percent.
A. 7.80; 14.63.
B. 7.80; 16.36.
C. 14.60; 14.63.
D. 14.60; 16.36.
E. 7.80; 13.54.

B. 7.80; 16.36.

114. You expect the inflation rate to be 3.8 percent and the U.S. Treasury bill yield to be 3.9 percent for the next year. The risk premium on small-company stocks is 12.6 percent. What nominal rate of return do you expect to earn on small-company stocks next year? .
A. 15.5 percent.
B. 9.2 percent.
C.16.8 percent.
D.16.5 percent.
E. 8.8 percent.

D. 16.5 percent.

115. Which one of the following statements is accurate for a levered firm? .
A. A firm's WACC will decrease whenever the firm's tax rate decreases.
B. The subjective approach totally ignores a firm's own WACC.
C. WACC should be used as the required return for all proposed investments.
D. An increase in the market risk premium will decrease a firm's WACC.
E. A reduction in the risk level of a firm will tend to decrease the firm's WACC.

E. A reduction in the risk level of a firm will tend to decrease the firm's WACC.

116. Aaron's Rentals has 58,000 shares of common stock outstanding at a market price of $36 a share. The common stock just paid a $1.64 annual dividend and has a dividend growth rate of 2.8 percent. There are 12,000 shares of 6 percent preferred stock outstanding at a market price of $51 a share. The preferred stock has a par value of $100. The outstanding bonds mature in 17 years, have a total face value of $750,000, a face value per bond of $1,000, and a market price of $1,011 each. The bonds pay 8 percent interest, semiannually. The tax rate is 34 percent. What is the firm's weighted average cost of capital? .
A. 9.97 percent.
B. 8.68 percent.
C. 10.30 percent.
D. 9.29 percent.
E. 7.74 percent.

E. 7.74 percent

117. A firm wants to create a WACC of 10.4 percent. The firm's cost of equity is 14.5 percent and its pretax cost of debt is 8.5 percent. The tax rate is 34 percent. What does the debt-equity ratio need to be for the firm to achieve its target WACC? .
A. 0.70.
B. 0.51.
C. 0.62.
D. 0.86.
E. 0.57.

D. 0.86.

118. All else constant, the weighted average cost of capital for a risky, levered firm will decrease if: .
A. the firm's bonds start selling at a premium rather than at a discount.
B. the market risk premium increases.
C. corporate taxes are eliminated.
D. the dividend yield on the common stock increases.
E. the firm replaces some of its debt with preferred stock.

A. the firm's bonds start selling at a premium rather than at a discount.

119. The Cracker Barrel has a beta of 0.98, a dividend growth rate of 3.2 percent, a stock price of $33 a share, and an expected annual dividend of $1.06 per share next year. The market rate of return is 11.2 percent and the risk-free rate is 3.7 percent. What is the firm's cost of equity? .
A. 7.74 percent.
B. 17.46 percent.
C. 9.72 percent.
D. 9.30 percent.
E. 8.73 percent.

E. 8.73 percent.

120. Stock in ABC Enterprises has a beta of 1.06. The market risk premium is 6.8 percent, and T-bills are currently yielding 3.2 percent. ABC's most recent dividend was $1.56 per share, and dividends are expected to grow at a 4 percent annual rate indefinitely. If the stock sells for $43 a share, what is your best estimate of ABC's cost of equity? .
A. 9.09 percent.
B. 8.82 percent.
C. 9.41 percent
D. 7.78 percent.
E. 9.69 percent.

A. 9.09 percent.

121. Healthy Snacks, Inc. has a target capital structure of 55 percent common stock, 5 percent preferred stock, and 40 percent debt. Its cost of equity is 14.3 percent, the cost of preferred stock is 8.9 percent, and the pretax cost of debt is 8.1 percent. What is the company's WACC if the applicable tax rate is 35 percent? .
A. 10.83 percent.
B. 10.34 percent.
C. 9.61 percent.
D. 9.29 percent.
E. 10.43 percent.

E. 10.43 percent.

122. USA Manufacturing issued 30-year, 8.5 percent semiannual bonds 6 years ago. The bonds currently sell at 101 percent of face value. What is the firm's aftertax cost of debt if the tax rate is 30 percent? .
A. 6.59 percent.
B. 5.76 percent.
C. 5.62 percent.
D. 8.40 percent.
E. 5.88 percent.

E. 5.88 percent.

123. A firm has a return on equity of 12.4 percent according to the dividend growth model and a return of 18.7 percent according to the capital asset pricing model. The market rate of return is 13.5 percent. What rate should the firm use as the cost of equity when computing the firm's weighted average cost of capital (WACC)? .
A. 13.5 percent.
B. The arithmetic average of 12.4 percent, 13.5 percent, and 18.7 percent.
C. 12.4 percent because it is lower than 18.7 percent.
D. The arithmetic average of 12.4 percent and 18.7 percent.
E. 18.7 percent because it is higher than 12.4 percent.

D. The arithmetic average of 12.4 percent and 18.7 percent.

124. Titans, Inc. has 6 percent bonds outstanding that mature in 14 years. The bonds pay interest semiannually and have a face value of $1,000. Currently, the bonds are selling for $993 each. What is the firm's pretax cost of debt? .
A. 6.08 percent.
B. 5.97 percent.
C. 6.40 percent.
D. 6.14 percent.
E. 6 31 percent.

A. 6.08 percent.

125. Madison Square Stores has a $20 million bond issue outstanding that currently has a market value of $18.6 million. The bonds mature in 6.5 years and pay semiannual interest payments of $35 each. What is the firm's pretax cost of debt? .
A. 7.58 percent.
B. 7.74 percent.
C. 8.42 percent.
D. 4.21 percent.
E. 7.80 percent.

C. 8.42 percent.

126. Ted is trying to decide what cost of capital he should assign to a project. Which one of the following should be his primary consideration in this decision? .
A. Use, or lack, or preferred stock to finance the project.
B. Mix of funds used to finance the project.
C. Amount of debt used to finance the project.
D. Risk level of the project.
E. Length of the project's life.

D. Risk level of the project.

127. The 7.5 percent preferred stock of Rock Bottom Floors is selling for $60 a share. What is the firm's cost of preferred stock if the tax rate is 35 percent and the par value per share is $100? .
A. 13.79 percent.
B. 14.14 percent.
C. 12.50 percent.
D. 8.13 percent.
E. 7.50 percent.

C. 12.50 percent.

128. Which one of the following statements is correct? Assume the pretax cost of debt is less than the cost of equity.
A. A firm may change its capital structure if the government changes its tax policies.
B. A decrease in the dividend growth rate increases the cost of equity.
C. A decrease in the systematic risk of a firm will increase the firm's cost of capital.
D. A decrease in a firm's debt-equity ratio will decrease the firm's cost of capital.
E. The cost of preferred stock decreases when the tax rate increases.

A. A firm may change its capital structure if the government changes its tax policies.

129. Tennessee Valley Antiques would like to issue new equity shares if its cost of equity declines to 10.5 percent. The company pays a constant annual dividend of $1.80 per share. What does the market price of the stock need to be for the firm to issue the new shares? .
A. $14.83.
B. $18.80.
C. $17.92.
D. $17.14.
E. $14.48.

D. $17.14.

130. Orchard Farms has a pretax cost of debt of 7.68 percent and a cost of equity of 15.2 percent. The firm uses the subjective approach to determine project discount rates. Currently, the firm is considering a project to which it has assigned an adjustment factor of -0.5 percent. The firm's tax rate is 34 percent and its debt-equity ratio is 0.45. The project has an initial cost of $4.3 million and produces cash inflows of $1.27 million a year for 5 years. What is the net present value of the project?.
A. $628,721
B. $514,370.
C. $328,895
D. $561,027
E. $121,619

C. $328,895

131. The 7.5 percent preferred stock of Home Town Brewers is selling for $45 a share. What is the firm's cost of preferred stock if the tax rate is 35 percent and the par value per share is $100? .
A. 16.52 percent.
B. 7.50 percent.
C. 16.17 percent.
D. 15.92 percent.
E. 16.67 percent.

E. 16.67 percent.

132. International Exchange has three divisions: A, B, and C. Division A has the least risk and Division C has the most risk. The firm has an aftertax cost of debt of 6.1 percent and a cost of equity of 14.3 percent. The firm is financed with 35 percent debt and 65 percent equity. Division A's projects are assigned a discount rate that is 3 percent less than the firm's weighted average cost of capital. What is the discount rate applicable to Division A? .
A. 9.48 percent.
B. 13.43 percent.
C. 8.27 percent.
D. 8.44 percent.
E. 7.98 percent.

D. 8.44 percent.

133. Farm Equipment, Inc. announced this morning that its next annual dividend will be decreased to $1.80 a share and that all future dividends will be decreased by an additional 1.5 percent annually. What is the current value per share of this stock if the required return is 16.5 percent? .
A. $8.
B. $16.
C. $12.
D. $10.
E. $14.

D. $10.

134. Kurt, who is a divisional manager, continually brags that his division's required return for its projects is 1 percent lower than the return required for any other division of the firm. Which one of the following most likely contributes the most to the lower rate requirement for Kurt's division? .
A. Kurt tends to underestimate the variable costs of his projects.
B. Kurt's division is less risky than the other divisions.
C. Kurt has the most efficiently managed division.
D. Kurt's projects are generally financed with debt while the other divisions' projects are financed with equity.
E. Kurt tends to overestimate the projected cash inflows on his projects.

B. Kurt's division is less risky than the other divisions.

135. Which one of the following is the equity risk arising from the daily operations of a firm? .
A. Strategic Risk
B. Financial Risk
C. Liquidity Risk
D. Industry Risk
E. Business Risk

E. Business Risk

136. Paying interest reduces the taxes owed by a firm. Which one of the following terms applies to this relationship? .
A. Static theory of interest rates.
B. M&M Proposition I.
C. Financial risk.
D. Interest tax shield.
E. Homemade leverage.

D. Interest tax shield.

137. Which one of the following is the theory that a firm should borrow up to the point where the additional tax benefit from an extra dollar of debt equals the additional costs associated with financial distress from that additional debt? .
A. M&M Proposition I, with taxes.
B. M&M Proposition II, with taxes.
C. M&M Proposition I, without taxes.
D. Homemade leverage proposition.
E. Static theory of capital structure

E. Static theory of capital structure

138. Which one of the following best defines legal bankruptcy? .
A. Negotiating new payment terms with a firm's creditors.
B. A temporary technical insolvency.
C. A legal proceeding for liquidating or reorganizing a business.
D. The internal process of revising the capital structure of a firm.
E. The failure of a firm to meet its financial obligations in a timely manner.

C. A legal proceeding for liquidating or reorganizing a business.

139. In the process of liquidation, some types of claims receive preference over other claims. Which one of the following determines which type of claim is paid first? .
A. Technical insolvency definition.
B. Absolute priority rule.
C. Accounting insolvency definition.
D. Chapter 7 of the Federal Bankruptcy Reform Act of 1978.
E. Securities and Exchange Commission

B. Absolute priority rule.

140. Assume you are comparing two firms that are identical in every aspect, except one is levered and one is unlevered. Which one of the following statements is correct regarding these two firms? .
A. The levered firm has higher EPS (earnings per share) than the unlevered firm at the break-even point.
B. The levered firm will have higher EPS than the unlevered firm at all levels of EBIT.
C. The unlevered firm will have higher EPS than the levered firm at relatively high levels of EBIT.
D. The EPS for the unlevered firm will always exceed those of the levered firm.
E. The unlevered firm will have higher EPS at relatively low levels of EBIT.

...

141. The level of financial risk to which a firm is exposed is dependent on the firm's:.
A. tax rate.
B. debt-equity ratio.
C. return on assets.
D. level of earnings before interest and taxes.
E. operation level of risk.

B. debt-equity ratio.

142. Which one of the following is an example of a direct bankruptcy cost?.
A. Operating at a debt-equity ratio that is less than the optimal ratio.
B. Reducing the dividend payout ratio as a means of increasing a firm's equity.
C. Forgoing a positive net present value project to conserve current cash.
D. Incurring legal fees for the preparation of bankruptcy filings.
E. Losing a key customer due to concerns over a firm's financial viability.

D. Incurring legal fees for the preparation of bankruptcy filings.

143. Christmas Ornaments, Inc. is an all-equity firm with a total market value of $386,000 and 15,000 shares of stock outstanding. Management is considering issuing $75,000 of debt at an interest rate of 8 percent and using the proceeds on a stock repurchase. As an all-equity firm, management believes the earnings before interest and taxes (EBIT) will be $31,000 if the economy is normal, $12,000 if it is in a recession, and $37,000 if the economy booms. Ignore taxes. What will the EPS be if the economy falls into a recession and the firm maintains its all-equity status? .
A. $0.78.
B. $0.80.
C. $1.21.
D. $1.67.
E. $2.07.

B. $0.80.

144. Northern Wood Products is an all-equity firm with 16,000 shares of stock outstanding and a total market value of $352,000. Based on its current capital structure, the firm is expected to have earnings before interest and taxes of $26,000 if the economy is normal, $3,000 if the economy is in a recession, and $33,000 if the economy booms. Ignore taxes. Management is considering issuing $88,000 of debt with a 6 percent coupon rate. If the firm issues the debt, the proceeds will be used to repurchase stock. What will the earnings per share be if the debt is issued and the economy is in a recession? .
A. -$0.27.
B. -$0.19.
C. $0.03
D. $0.26
E. $0.31.

B. -$0.19.

145. Ernst Electrical has 9,000 shares of stock outstanding and no debt. The new CFO is considering issuing $80,000 of debt and using the proceeds to retire 1,500 shares of stock. The coupon rate on the debt is 7.5 percent. What is the break-even level of earnings before interest and taxes between these two capital structure options? .
A. $18,500.
B. $21,000.
C. $24,000.
D. $32,500.
E. $36,000.

E. $36,000.

146. Weston Mines has a cost of equity of 20.8 percent, a pretax cost of debt of 9.4 percent, and a return on assets of 17.1 percent. Ignore taxes. What is the debt-equity ratio? .
A. 0.39.
B. 0.41.
C. 0.48.
D. 0.56.
E. 0.62.

C. 0.48.

147. Granny's Home Remedy has a $30 million bond issue outstanding with a coupon rate of 7.75 percent and a current yield of 7.67 percent. What is the present value of the tax shield if the tax rate is 34 percent? .
A. $632,400
B. $625,872
C. $1.20 million.
D. $8.16 million.
E. $10.2 million.

E. $10.2 million.

148. Forbidden Fruit Extracts expects its earnings before interest and taxes to be $325,000 a year forever. Currently, the firm has no debt. The cost of equity is 16.3 percent and the tax rate is 35 percent. The company is in the process of issuing $2 million of bonds at par that carry a 6.5 percent annual coupon. What is the unlevered value of the firm? .
A. $371,429
B. $431,971
C. $747,485
D. $949,325
E. $1,296.012

E. $1,296.012

149. Kline Construction is an all-equity firm that has projected perpetual earnings before interest and taxes of $879,000. The current cost of equity is 18.3 percent and the tax rate is 34 percent. The company is in the process of issuing $6.2 million of 8.5 percent annual coupon bonds at par. What is the levered value of the firm? .
A. $5,278,164.
B. $5,541,085.
C. $6,422,225.
D. $6,713,185.
E. $7,385,695.

A. $5,278,164.

150. Great Lakes Shipping is an all-equity firm with anticipated earnings before interest and taxes of $439,000 annually forever. The present cost of equity is 16.4 percent. Currently, the firm has no debt but is considering borrowing $1.25 million at 8.5 percent interest. The tax rate is 36 percent. What is the value of the levered firm? .
A. $2,163,171.
B. $2,406,519.
C. $2,588,547.
D. $2,666,667.
E. $2,818,181

A. $2,163,171.

151. Roller Coaster's has a cost of equity of 15.4 percent, a return on assets of 11.3 percent, and a cost of debt of 7.3 percent. There are no taxes. What is the firm's weighted average cost of capital? .
A. 7.30 percent.
B. 11.20 percent.
C. 12.97 percent.
D. 15.40 percent.
E. Cannot be determined from the information provided.

B. 11.20 percent.

152. A firm has a weighted average cost of capital of 11.68 percent and a cost of equity of 15.5 percent. The debt-equity ratio is 0.65. There are no taxes. What is the firm's cost of debt? .
A. 5.80 percent.
B. 6.27 percent.
C. 6.44 percent.
D. 7.23 percent.
E. 7.81 percent.

A. 5.80 percent.

153. Delta Mowers has a debt-equity ratio of 1.2. Its WACC is 10.1 percent, and its cost of debt is 7.5 percent. There is no corporate tax. What is the firm's cost of equity capital? .
A. 12.60 percent.
B. 13.22 percent.
C. 13.83 percent.
D. 14.29 percent.
E. 14.80 percent.

B. 13.22 percent.

154. The Piano Movers can borrow at 7.5 percent. The firm currently has no debt, and the cost of equity is 16 percent. The current value of the firm is $540,000. What will the value be if the firm borrows $160,000 and uses the proceeds to repurchase shares? The corporate tax rate is 40 percent.
A. $528,000
B. $540,000.
C. $552,000.
D. $571,000.
E. $604,000.

E. $604,000.

155. Kyle Electric has three positive net present value opportunities. Unfortunately, the firm has not been able to find financing for any of these projects. Which one of the following terms best describes the firm's situation? .
A. Contingency planning.
B. Sensitivity analysis.
C. Soft rationing.
D. Sunk cost.
E. Capital rationing.

E. Capital rationing.

156. Rock Haven has a proposed project that will generate sales of 1,680 units annually at a selling price of $22 each. The fixed costs are $12,700 and the variable costs per unit are $5.95. The project requires $28,000 of fixed assets that will be depreciated on a straight-line basis to a zero book value over the four-year life of the project. The salvage value of the fixed assets is $6,900 and the tax rate is 34 percent. What is the operating cash flow for year 4? .
A. $12,417.
B. $11,794.
C. $16,971.
D. $16,348.
E. $14,258.

B. $11,794.

157. The opportunities that a manager has to modify a project once it has started are called: .
A. scenario adjustments.
B. restructuring options.
C. managerial options.
D. erosion control measures.
E. sensitivity choices.

C. managerial options.

158. A cost that should be ignored when evaluating a project because that cost has already been incurred and cannot be recouped is referred to as which type of cost? .
A. Fixed.
B. Variable.
C. Forgotten.
D. Opportunity.
E. Sunk.

E. Sunk.

Hunter's Lodge purchased $578,000 of equipment four years ago. The equipment is seven-year MACRS property. The firm is selling this equipment today for $199,500. What is the aftertax cash flow from this sale if the tax rate is 35 percent? The MACRS allowance percentages are as follows, commencing with year 1: 14.29, 24.49, 17.49, 12.49, 8.93, 8.92, 8.93, and 4.46 percent.
A. $209,740.81.
B. $198,410.18.
C. $192,873.52
D. $216,610.81.
E. $153,869.81.

158,114.81?

A project has annual depreciation of $16,200, costs of $87,100, and sales of $123,000. The applicable tax rate is 40 percent. What is the operating cash flow according to the tax shield approach? .
A. $29,878.
B. $28,020.
C. $27,458.
D. $27,667.
E. $21,540.

B. $28,020.

Six years ago, China Exporters paid cash for a new packaging machine that cost $287,000. Three years ago, the firm spent $3,900 on repairs and modifications to the machine. The machine is now fully depreciated and has just sat idly in a back corner of the shop for the past seven months. The estimated value of the machine today is $125,500. The firm is considering using this machine in a new project. If it does so, what value should be assigned to this machine and included in the initial costs of the new project? .
A. $3,900
B. $143,500
C. $0
D. $125,500
E. $127,400

D. $125,500

A cost-cutting project will decrease costs by $58,500 a year. The annual depreciation on the project's fixed assets will be $10,300 and the tax rate is 34 percent. What is the amount of the change in the firm's operating cash flow resulting from this project? .
A. $25,805. NO
B. $24,552. NO
C. $42,112.
D. $29,791. NO
E. $38,610.

...

Any changes to a firm's projected future cash flows that are caused by adding a new project are referred to as which one of the following? .
A. Deviated projections.
B. Eroded cash flows.
C. Directly impacted flows.
D. Incremental cash flows.
E. Assumed flows.

D. Incremental cash flows.

Valley Forge and Metal purchased a truck five years ago for local deliveries. Which one of the following costs related to this truck is the best example of a sunk cost? Assume the truck has a usable life of eight years.
A. Money spent last month repairing a damaged front fender.
B. New tires that will be purchased this winter.
C. Cost for a truck driver for the remainder of the truck's useful life.
D. Engine tune-up that is scheduled for this afternoon.
E. Costs of repairs needed so the truck can pass inspection next month.

A. Money spent last month repairing a damaged front fender.

Assume a firm has positive net earnings. The operating cash flow of this firm: .
A. ignores both depreciation and taxes.
B. is equal to net income minus depreciation.
C. is unaffected by the depreciation expense.
D. increases when tax rates decrease.
E. must be negative.

D. increases when tax rates decrease.

Scenario analysis asks questions such as: .
A. How will the operating cash flow change if the depreciation method is changed?.
B. What is the best outcome that should reasonably be expected?.
C. How much will a $1 increase in the variable cost per unit change the net present value?.
D. How will changing the number of units sold affect the outcome of this project?.
E. Will the net present value increase or decrease if the quantity sold increases by 100 units?.

B. What is the best outcome that should reasonably be expected?.

A project has an initial requirement of $261,000 for fixed assets and $27,000 for net working capital. The fixed assets will be depreciated to a zero book value over the four-year life of the project and have an estimated salvage value of $78,000. All of the net working capital will be recouped at the end of the project. The annual operating cash flow is $96,200 and the discount rate is 13 percent. What is the project's net present value if the tax rate is 35 percent? .
A. $45,799.
B. $47,919.
C. $47,880.
D. $43,333.
E. $42,011.

A. $45,799.

Mike's Fish Market is implementing a project that will initially increase accounts payable by $4,600, increase inventory by $4,800, and decrease accounts receivable by $800. All net working capital will be recouped when the project terminates. What is the cash flow related to the net working capital for the last year of the project? .
A. -$2,000
B. $2,000
C. -$600
D. $200
E. -$400

C. -$600

One year ago, you purchased a 5 percent coupon bond with a face value of $1,000 when it was selling for 101.2 percent of par. Today, you sold this bond for 99.8 percent of par. What is your total dollar return on this investment? .
A. $36
B. $74
C. $82
D. $64
E. $60

A. $36

You own a portfolio that has $1,900 invested in Stock A and $2,700 invested in Stock B. If the expected returns on these stocks are 9 percent and 15 percent, respectively, what is the expected return on the portfolio? .
A. 11.96 percent
B. 12.52 percent
C. 11.14 percent
D. 13.07 percent
E. 10.57 percent

B. 12.52 percent $1,900 multiply by (1.09) = $2071 $2,700 multiply by 1.15 = $3105 Ending portfolio balance= 2071+3105 = $5176 Beginning balance= 1,900+$2,700 = $4600 Ending balance/ Beginning 5176/4600= 1.1252-1= .1252 = 12.52% is expected return on portfolio

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Katie owns 100 shares of ABC stock. Which one of the following terms is used to refer to the return that Katie and the other shareholders require on their investment in ABC?

A. Weighted average cost of capital
B. Pure play cost
C. Cost of equity
D. Subjective cost
E. Cost of debt

C. Cost of equity

2. Lester lent money to The Corner Store by purchasing bonds issued by the store. The rate of return that he and the other lenders require is referred to as the:
A. pure play cost.
B. cost of debt.
C. weighted average cost of capital.
D. subjective cost.
E. cost of equity.

B. cost of debt

3. The weighted average cost of capital is defined as the weighted average of a firm’s:
A. return on its investments.
B. cost of equity and its aftertax cost of debt.
C. pretax cost of debt and equity securities.
D. bond coupon rates.
E. dividend and capital gains yields.

B. cost of equity and its aftertax cost of debt.

4. Farmer’s Supply, Inc. is considering opening a clothing store, which would be a new line of business for the firm. Management has decided to use the cost of capital of a similar clothing store as the discount rate that should be used to evaluate this proposed expansion. Which one of the following terms is used to describe the approach Farmer’s Supply is taking to establish an appropriate discount rate for the project?
A. Equity approach
B. Aftertax approach
C. Subjective approach
D. Market play
E. Pure play approach

E. Pure play approach

5. Kate is the CFO of a major firm and has the job of assigning discount rates to each project that is under consideration. Kate’s method of doing this is to assign an incrementally higher rate as the risk level of the project increases over that of the current firm. Likewise, she assigns lower rates as the risk level declines. Which one of the following approaches is Kate using to assign the discount rates?
A. Pure play approach
B. Divisional rating
C. Subjective approach
D. Straight WACC approach
E. Equity rating

C. Subjective approach

6. Ted is trying to decide what cost of capital he should assign to a project. Which one of the following should be his primary consideration in this decision?
A. Amount of debt used to finance the project
B. Use, or lack thereof, of preferred stock to finance the project
C. Mix of funds used to finance the project
D. Risk level of the project
E. Length of the project’s life

D. Risk level of the project

7. Black Stone Furnaces wants to build a new facility. The cost of capital for this investment is primarily dependent upon which one of the following?
A. Firm’s overall source of funds
B. Source of the funds used to build the facility
C. Current tax rate
D. The nature of the investment
E. Firm’s historical average rate of return

D. The nature of the investment

8. Which one of the following statements is correct related to the dividend growth model approach to computing the cost of equity?
A. The rate of growth must exceed the required rate of return.
B. The rate of return must be adjusted for taxes.
C. The annual dividend used in the computation must be for year one if you are using today’s stock price to compute the return.
D. The cost of equity is equal to the return on the stock plus the risk-free rate.
E. The cost of equity is equal to the return on the stock multiplied by the stock’s beta

C. The annual dividend used in the computation must be for year one if you are using today’s stock price to compute the return

9. A firm has a return on equity of 12.4 percent according to the dividend growth model and a return of 18.7 percent according to the capital asset pricing model. The market rate of return is 13.5 percent. What rate should the firm use as the cost of equity when computing the firm’s WACC?
A. 12.4 percent because it is lower than 18.7 percent B. 18.7 percent because it is higher than 12.4 percent
C. The arithmetic average of 12.4 percent and 18.7 percent
D. The arithmetic average of 12.4 percent, 13.5 percent, and 18.7 percent E. 13.5 percent

C. The arithmetic average of 12.4 percent and 18.7 percent

10. Which of the following features are advantages of the dividend growth model? I. easy to understand II. model simplicity III. constant dividend growth rate IV. model’s applicability to all common stocks
A. II only
B. I and III only
C. II and IV only
D. I and II only
E. I, II, and III only

D. I and II only

11. Which of the following are weaknesses of the dividend growth model? I. market risk premium fluctuations II. lack of dividends for some firms III. reliance on historical beta IV. sensitivity of model to dividend growth rate
A. II only
B. I and II only
C. I and III only
D. II and IV only
E. I, II, III, and IV

D. II and IV only

12. In an efficient market, the cost of equity for a risky firm does which one of the following according to the security market line?
A. Produces a return that will be less than the market rate but higher than the risk-free rate
B. Equals the market rate of return for all stocks
C. Has a maximum cost equal to the market rate of return
D. Decreases as the beta of the firm’s stock increases
E. Increases in direct relation to the stock’s systematic risk

E. Increases in direct relation to the stock’s systematic risk

13. Which of the following will increase the cost of equity for a firm with a beta of 1.1? I. decrease in the security’s beta II. decrease in the market risk premium III. decrease in the risk-free rate IV. increase in the risk-free rate
A. II only
B. III only
C. I and II only
D. II and III only
E. I and IV only

C. III only

14. Which one of the following will increase the cost of equity, all else held constant?
A. Increase in the dividend growth rate
B. Decrease in beta
C. Decrease in future dividends
D. Increase in stock price E. Decrease in market risk premium

A. Increase in the dividend growth rate

15. All else constant, which of the following will increase the aftertax cost of debt for a firm? I. increase in the yield to maturity of the firm’s outstanding debt II. decrease in the yield to maturity of the firm’s outstanding debt III. increase in the firm’s tax rate IV. decrease in the firm’s tax rate
A. I only
B. I and III only
C. I and IV only
D. II and III only
E. II and IV only

C. I and IV only

16. Which one of the following is the pre-tax cost of debt?
A. Average coupon rate on the firm’s outstanding bonds
B. Coupon rate on the firm’s latest bond issue
C. Weighted average yield-to-maturity on the firm’s outstanding debt
D. Average current yield on the firm’s outstanding debt
E. Annual interest divided by the market price per bond for the latest bond issue

C. Weighted average yield-to-maturity on the firm’s outstanding debt

17. Which one of the following will decrease the aftertax cost of debt for a firm?
A. Decrease in the firm’s beta
B. Increase in tax rates
C. Increase in the risk-free rate of return
D. Decrease in the market price of the debt
E. Decrease in a bond’s yield-to-maturity

B. Increase in tax rates

18. All else constant, an increase in a firm’s cost of debt:
A. could be caused by an increase in the firm’s tax rate.
B. will result in an increase in the firm’s cost of capital.
C. will lower the firm’s weighted average cost of capital.
D. will lower the firm’s cost of equity.
E. will increase the firm’s capital structure weight of debt.

B. will result in an increase in the firm’s cost of capital

19. The cost of preferred stock:
A. increases when a firm’s tax rate decreases.
B. is constant over time.
C. is unaffected by changes in the market price.
D. is equal to the stock’s dividend yield.
E. increases as the price of the stock increases

D. is equal to the stock’s dividend yield.

20. Which one of the following statements is correct?
A. An increase in the market value of preferred stock will increase a firm’s weighted average cost of capital.
B. The cost of preferred stock is unaffected by the issuer’s tax rate.
C. Preferred stock is generally the cheapest source of capital for a firm.
D. The cost of preferred stock remains constant from year to year.
E. Preferred stock is valued using the capital asset pricing model.

B. The cost of preferred stock is unaffected by the issuer’s tax rate.

21. Which one of the following will affect the capital structure weights used to compute a firm’s weighted average cost of capital?
A. Decrease in the book value of a firm’s equity
B. Decrease in a firm’s tax rate
C. Increase in the market value of the firm’s common stock
D. Increase in the market risk premium
E. Increase in the firm’s beta

C. Increase in the market value of the firm’s common stock

22. The aftertax cost of which of the following are affected by a change in a firm’s tax rate? I. preferred stock II. debt III. equity IV. capital
A. I and III only
B. II and IV only
C. I, II, and IV only
D. II, III, and IV only
E. I, II, III, and IV

B. II and IV only

23. Which one of the following statements is correct concerning capital structure weights?
A. Target rates are less relevant to a project than are historical rates.
B. The weights are unaffected when a bond issue matures.
C. An increase in the debt-equity ratio will increase the weight of the common stock.
D. The repurchase of preferred stock will increase the weight of debt.
E. The issuance of additional shares of common stock will increase the weight of the preferred stock.

D. The repurchase of preferred stock will increase the weight of debt.

24. Which one of the following statements is correct? Assume the pre-tax cost of debt is less than the cost of equity.
A. A firm may change its capital structure if the government changes its tax policies.
B. A decrease in the dividend growth rate increases the cost of equity.
C. A decrease in the systematic risk of a firm will increase the firm’s cost of capital.
D. A decrease in a firm’s debt-equity ratio will decrease the firm’s cost of capital.
E. The cost of preferred stock decreases when the tax rate increases.

A. A firm may change its capital structure if the government changes its tax policies.

25. Which one of the following represents the rate of return a firm must earn on its assets if it is to maintain the current value of its securities?
A. Cost of equity
B. Internal rate of return
C. Aftertax cost of debt
D. Weighted average cost of capital
E. Debt-equity ratio

D. Weighted average cost of capital

26. Which one of the following statements is accurate for a levered firm?
A. WACC should be used as the required return for all proposed investments. B. A firm’s WACC will decrease whenever the firm’s tax rate decreases. C. An increase in the market risk premium will decrease a firm’s WACC.
D. The subjective approach totally ignores a firm’s own WACC.
E. A reduction in the risk level of a firm will tend to decrease the firm’s WACC.

E. A reduction in the risk level of a firm will tend to decrease the firm’s WACC

27. Which one of the following statements is correct, all else held constant?
A. Beta is used to compute the return on equity and the standard deviation is used to compute the return on preferred.
B. A decrease in a firm’s WACC will increase the attractiveness of the firm’s investment options.
C. The aftertax cost of debt increases when the market price of a bond increases.
D. If you have both the dividend growth and the security market line’s costs of equity, you should use the higher of the two estimates when computing WACC.
E. WACC is only applicable to firms that issue both common and preferred stock.

B. A decrease in a firm’s WACC will increase the attractiveness of the firm’s investment options

28. A firm has a cost of equity of 13 percent, a cost of preferred of 11 percent, and an aftertax cost of debt of 6 percent. Given this, which one of the following will increase the firm’s weighted average cost of capital?
A. Increasing the firm’s tax rate
B. Issuing new bonds at par
C. Redeeming shares of common stock
D. Increasing the firm’s beta
E. Increasing the debt-equity ratio

D. Increasing the firm’s beta

29. All else constant, the weighted average cost of capital for a risky, levered firm will decrease if:
A. the firm’s bonds start selling at a premium rather than at a discount. B. the market risk premium increases.
C. the firm replaces some of its debt with preferred stock.
D. corporate taxes are eliminated.
E. the dividend yield on the common stock increases.

A. the firm’s bonds start selling at a premium rather than at a discount.

30. A firm that uses its weighted average cost of capital as the required return for all of its investments will:
A. maintain a constant value for its shareholders.
B. increase the risk level of the firm over time.
C. make the best possible accept and reject decisions related to those investments.
D. find that its cost of capital declines over time. E. accept only the projects that add value to the firm’s shareholders

B. increase the risk level of the firm over time

31. Old Town Industries has three divisions. Division X has been in existence the longest and has the most stable sales. Division Y has been in existence for five years and is slightly less risky than the overall firm. Division Z is the research and development side of the business. When allocating funds, the firm should probably:
A. require the highest rate of return from division X since it has been in existence the longest.
B. assign the highest cost of capital to division Z because it is most likely the riskiest of the three divisions.
C. use the firm’s WACC as the cost of capital for division Z as it provides analysis for the entire firm.
D. use the firm’s WACC as the cost of capital for divisions A and B because they are part of the revenue-producing operations of the firm.
E. allocate capital funds evenly amongst the divisions to maintain the current capital structure of the firm.

B. assign the highest cost of capital to division Z because it is most likely the riskiest of the three divisions.

32. A firm uses its weighted average cost of capital to evaluate the proposed projects for all of its varying divisions. By doing so, the firm:
A. automatically gives preferential treatment in the allocation of funds to its riskiest division.
B. encourages the division managers to only recommend their most conservative projects.
C. maintains the current risk level and capital structure of the firm.
D. automatically maximizes the total value created for its shareholders.
E. allocates capital funds evenly amongst its divisions.

A. automatically gives preferential treatment in the allocation of funds to its riskiest division

33. Kurt, who is a divisional manager, continually brags that his division’s required return for its projects is one percent lower than the return required for any other division of the firm. Which one of the following most likely contributes the most to the lower rate requirement for Kurt’s division?
A. Kurt tends to overestimate the projected cash inflows on his projects.
B. Kurt tends to underestimate the variable costs of his projects.
C. Kurt has the most efficiently managed division.
D. Kurt’s division is less risky than the other divisions.
E. Kurt’s projects are generally financed with debt while the other divisions’ projects are financed with equity.

D. Kurt’s division is less risky than the other divisions

34. Which one of the following is the primary determinant of an investment’s cost of capital?
A. Life of investment
B. Initial cash outlay
C. Level of risk
D. Source of funds used for the investment
E. Investment’s net present value

C. Level of risk

35. The cost of capital for a project depends primarily on which one of the following?
A. Source of funds used for the project
B. Division within the firm that undertakes the project
C. Project’s modified internal rate of return
D. How the project uses its funds
E. Project’s fixed costs

D. How the project used its funds

36. Marine Expeditors has three divisions. Division A is the core of the business and represents 80 percent of the firm’s operations. Division B is involved only with contractual short-term projects and therefore has about 8 percent less risk than division A. Division C develops and markets new products and is about 12 percent riskier than division A and about equal in size to division B. The manager of division A has suggested that the operations of his division be increased by 10 percent next year. The proposed project should probably be assigned a required return that is equal to _____ percent of the firm’s weighted average cost of capital.
A. 40
B. 60
C. 80
D. 100
E. 110

D. 100

37. Which one of the following is most apt to cause a wise manager to increase a project’s cost of capital? Assume the firm is levered.
A. Management decides to issue new stock to finance the project.
B. The initial cash outlay requirement is reduced.
C. She learns the project is riskier than previously believed.
D. The aftertax cost of debt just decreased.
E. The project’s life is shortened.

C. She learns the project is riskier than previously believed

38. Boone Brothers remodels homes and replaces windows. Ace Builders constructs new homes. If Boone Brothers considers expanding into new home construction, it should evaluate the expansion project using which one of the following as the required return for the project?
A. Boone Brothers’ cost of capital
B. Ace Builders’ cost of capital
C. Average of Boone Brothers’ and Ace Builders’ cost of capital
D. Lower of Boone Brothers’ or Ace Builders’ cost of capital
E. Higher of Boone Brothers’ or Ace Builders’ cost of capital

B. Ace Builders’ cost of capital

39. You need to use the pure play approach to assign a cost of capital to a proposed investment. Which one of the following characteristics should you most concentrate on as you search for an appropriate pure play firm?
A. Firm size
B. Firm location
C. Firm experience
D. Firm operations
E. Firm management

D. Firm operations

40. When using the pure play approach for a proposed investment, a firm is primarily seeking a rate of return which:
A. is based on the actual source of funds that will be used to fund the project.
B. creates a positive net present value for the project.
C. reflects the size and life of the project.
D. most closely correlates with the proposed investment’s internal rate of return.
E. best matches the risk level of the proposed investment

E. best matches the risk level of the proposed investment

41. Derek’s is a brick-and-mortar toy store. The firm is considering expanding its operations to include Internet sales. Which one of the following would be the best firm to use in a pure play approach to analyzing this proposed expansion?
A. Another brick-and-mortar store that also sells online
B. A wholesale toy distributor
C. A toy store that only sells online
D. The oldest online retailer of any product
E. Derek’s own store

C. A toy store that only sells online

42. Kelly’s uses the firm’s weighted average cost of capital (WACC) as the required return for some of its projects. For other projects, the firms uses a rate equal to WACC plus 1 percent, while another set of projects is assigned rates equal to WACC minus some amount. Which one of the following factors should be the key factor the firm uses to determine the amount of the adjustment it will make when assigning the project a discount rate?
A. Firm beta
B. Date for project commencement
C. Risk level of project
D. Division within the firm that will be assigned to manage the project
E. Current debt-equity ratio

C. Risk level of project

43. A firm has multiple divisions of similar nature, yet varying degrees of risk. Which one of the following would be the most appropriate, yet relatively easy, means of assigning discount rates to each of its proposed investments?
A. Assign every project a rate equal to the firm’s cost of equity
B. Assign every firm a random rate that varies between the firm’s cost of debt and its cost of equity
C. Assign every project a rate equal to the firm’s WACC plus or minus a subjective adjustment
D. Determine the best pure play rate for each project
E. Assign every project a rate equal to the market rate of return at the time of the proposal

C. Assign every project a rate equal to the firm’s WACC plus or minus a subjective adjustment

44. The computation of which one of the following requires assigning every proposed investment to a particular risk class?
A. Pure play cost of capital B. Cost of equity
C. Aftertax cost of debt
D. WACC
E. Subjective cost of capital

E. Subjective cost of capital

45. Judy’s Boutique just paid an annual dividend of $1.65 on its common stock. The firm increases its dividend by 2.5 percent annually. What is the rate of return on this stock if the current stock price is $38.20 a share?
A. 6.93 percent
B. 7.37 percent
C. 7.54 percent
D. 8.19 percent
E. 8.33 percent

A. 6.93 percent

46. Farm Equipment, Inc. announced this morning that its next annual dividend will be decreased to $1.80 a share and that all future dividends will be decreased by an additional 1.5 percent annually. What is the current value per share of this stock if the required return is 16.5 percent?
A. $8
B. $10
C. $12
D. $14
E. $16

B. $10

47. The Green Balloon just paid its first annual dividend of $0.12 a share. The firm plans to increase the dividend by 3.5 percent per year indefinitely. What is the firm’s cost of equity if the current stock price is $6.50 a share?
A. 5.35 percent
B. 5.41 percent
C. 14.42 percent
D. 18.79 percent
E. 19.98 percent

B. 5.41 percent

48. High Valley Antiques would like to issue new equity shares if its cost of equity declines to 10.5 percent. The company pays a constant annual dividend of $1.60 per share. What does the market price of the stock need to be for the firm to issue the new shares?
A. $14.48
B. $14.83
C. $15.24
D. $15.92
E. $16.80

C. $15.24

49. The common stock of Modern Interiors has a beta of 1.61 and a standard deviation of 27.4 percent. The market rate of return is 13.2 percent and the risk-free rate is 4.8 percent. What is the cost of equity for this firm?
A. 18.32 percent
B. 19.97 percent
C. 21.08 percent
D. 24.40 percent
E. 26.05 percent

A.18.32 percent

50. Jet Setters has a cost of equity of 17.8 percent. The market risk premium is 10.2 percent and the risk-free rate is 4.4 percent. The company is acquiring a competitor, which will increase the company’s beta to 1.6. What effect, if any, will the acquisition have on the firm’s cost of equity capital?
A. No effect
B. Decrease of 3.39 percent
C. Decrease of 0.84 percent
D. Increase of 2.92 percent
E. Increase of 4.13 percent

D. Increase of 2.92 percent

51. The common stock of Yanderloft and Sons has a beta that is 25 percent larger than the overall market beta. Currently, the market risk premium is 9.2 percent while the U.S. Treasury bill is yielding 4.7 percent. What is the cost of equity for this firm?
A. 13.76 percent
B. 14.96 percent
C. 15.80 percent
D. 16.20 percent
E. 17.85 percent

D. 16.20 Percent

52. Musical Charts just paid an annual dividend of $2.45 per share. This dividend is expected to increase by 3.3 percent annually. Currently, the firm has a beta of 1.09 and a stock price of $36 a share. The risk-free rate is 4.2 percent and the market rate of return is 12.6 percent. What is the cost of equity capital for this firm?
A. 10.28 percent
B. 11.84 percent
C. 12.29 percent
D. 12.95 percent
E. 13.42 percent

B. 11.84 percent

53. The Cracker Mill has a beta of 0.97, a dividend growth rate of 3.2 percent, a stock price of $33 a share, and an expected annual dividend of $1.06 per share next year. The market rate of return is 11.2 percent and the risk-free rate is 3.7 percent. What is the firm’s cost of equity?
A. 7.74 percent
B. 8.69 percent
C. 9.30 percent
D. 9.72 percent
E. 10.01 percent

B. 8.69 percent

54. The market rate of return is 14.8 percent and the risk-free rate is 4.45 percent. Galaxy Co. has 54 percent more systematic risk than the overall market and has a dividend growth rate of 5.5 percent. The firm’s stock is currently selling for $39 a share and has a dividend yield of 3.6 percent. What is the firm’s cost of equity?
A. 14.73 percent
B. 15.31 percent
C. 15.82 percent
D. 16.28 percent
E. 16.73 percent

A. 14.73 percent

55. Appalachian Mountain Goods has paid increasing dividends of $.0.12, $0.18, $0.20, and $0.25 a share over the past four years, respectively. The firm estimates that future increases in its dividends will be equal to the arithmetic average growth rate over these past four years. The stock is currently selling for $12.60 a share. The risk-free rate is 3.2 percent and the market risk premium is 9.1 percent. What is the cost of equity for this firm if its beta is 1.26?
A. 14.34 percent
B. 16.91 percent
C. 19.78 percent
D. 22.96 percent
E. 24.03 percent

D. 22.96 percent

56. Winter Wear, Inc. has 6 percent bonds outstanding that mature in 13 years. The bonds pay interest semiannually and have a face value of $1,000. Currently, the bonds are selling for $993 each. What is the firm’s pre-tax cost of debt?
A. 5.97 percent
B. 6.08 percent
C. 6.14 percent
D. 6.31 percent
E. 6.40 percent

B. 6.08 percent

57. Four years ago, the Moore Co. issued 15-year, 7.5 percent semiannual coupon bonds at par. Today, the bonds are quoted at 101.6. What is this firm’s pre-tax cost of debt?
A. 6.97 percent
B. 7.08 percent
C. 7.29 percent
D. 7.33 percent
E. 7.39 percent

C. 7.29 percent

58. Birds and Yards has 10-year bonds outstanding that carry an annual coupon of 8 percent. The bonds mature in 7 years and are currently priced at 108.4 percent of face value. What is the firm’s pre-tax cost of debt?
A. 6.47 percent
B. 6.82 percent
C. 7.34 percent
D. 7.70 percent
E. 8.23 percent

A. 6.47 percent

59. Catnip Stores has a $20 million bond issue outstanding that currently has a market value of $18.6 million. The bonds mature in 6.5 years and pay semiannual interest payments of $30 each. What is the firm’s pre-tax cost of debt?
A. 6.99 percent
B. 7.37 percent
C. 7.58 percent
D. 7.74 percent
E. 7.80 percent

B. 7.37 percent

60. Hi Tech Products has 35,000 bonds outstanding that are currently quoted at 102.3. The bonds mature in 11 years and carry a 9 percent annual coupon. What is the firm’s aftertax cost of debt if the applicable tax rate is 35 percent?
A. 4.47 percent
B. 4.79 percent
C. 5.63 percent
D. 5.98 percent
E. 6.31 percent

C. 5.63 percent

61. Major Manufacturing issued 30-year, 8.5 percent semiannual bonds 6 years ago. The bonds currently sell at 101 percent of face value. What is the firm’s aftertax cost of debt if the tax rate is 35 percent?
A. 5.46 percent
B. 5.62 percent
C. 5.76 percent
D. 6.59 percent
E. 6.83 percent

A. 5.64 percent

62. Great Lakes Packing has two bond issues outstanding. The first issue has a coupon rate of 9 percent, matures in 3 years, has a total face value of $6 million, and is quoted at 108 percent of face value. The second issue has a 7.5 percent coupon, matures in 16 years, has a total face value of $18 million, and is quoted at 97 percent of face value. Both bonds pay interest semiannually. What is the firm’s weighted average aftertax cost of debt if the tax rate is 35 percent?
A. 4.78 percent
B. 5.12 percent
C. 5.63 percent
D. 5.95 percent
E.6.08 percent

A. 4.78 percent

63. The 7.5 percent preferred stock of Home Town Brews is selling for $43 a share. What is the firm’s cost of preferred stock if the tax rate is 34 percent and the par value per share is $100?
A. 14.47 percent
B. 15.92 percent
C. 16.17 percent
D. 16.52 percent
E. 17.44 percent

E. 17.44 percent

64. The 7.5 percent preferred stock of Tanners Floors is selling for $57 a share. What is the firm’s cost of preferred stock if the tax rate is 35 percent and the par value per share is $100?
A. 11.69 percent
B. 12.81 percent
C. 13.16 percent
D. 13.79 percent
E. 14.14 percent

C. 13.16 percent

65. The preferred stock of Pollard’s Pools pays an annual dividend of $5.50 a share and sells for $42 a share. The tax rate is 34 percent. What is the firm’s cost of preferred stock?
A. 12.28 percent
B. 13.10 percent
C. 15.07 percent
D. 15.59 percent
E. 16.47 percent

B. 13.10 percent

66. Christie’s Train Shoppe has 15,000 shares of common stock outstanding at a price of $11 a share. It also has 2,000 shares of preferred stock outstanding at a price of $34 a share. There are 50 bonds outstanding that have a 7.5 percent semiannual coupon. The bonds mature in 6 years, have a face value of $1,000, and sell at 96 percent of par. What is the capital structure weight of the preferred stock?
A. 20.50 percent
B. 21.68 percent
C. 23.15 percent
D. 24.20 percent
E. 26.23 percent

D. 24.20 percent

67. Chesterfield and Weston has 55,000 shares of common stock outstanding at a price of $31 a share. It also has 3,000 shares of preferred stock outstanding at a price of $62 a share. The firm has 8 percent, 12-year bonds outstanding with a total face value of $400,000. The bonds are currently quoted at 101.2 percent of face and pay interest semiannually. What is the capital structure weight of the firm’s debt if the tax rate is 35 percent?
A. 14.49 percent
B. 15.20 percent
C. 15.67 percent
D. 16.84 percent
E. 17.63 percent

E. 17.63 percent

68. Claus Enterprises has 174,000 shares of common stock outstanding at a current price of $46 a share. The firm also has two bond issues outstanding. The first bond issue has a total face value of $250,000, pays 7.7 percent interest annually, and currently sells for 102.5 percent of face value. The second bond issue consists of 5,000 bonds that are selling for $993 each. These bonds pay 6.5 percent interest annually and mature in 8 years. The tax rate is 34 percent. What is the capital structure weight of the firm’s common stock?
A. 47.78 percent
B. 51.39 percent
C. 55.50 percent
D. 60.52 percent
E. 71.86 percent

D. 60.52

69. Sunshine Cruises issues only common stock and coupon bonds. The firm has a debt-equity ratio of 0.55. The cost of equity is 16.3 percent and the pre-tax cost of debt is 9.9 percent. What is the capital structure weight of the firm’s equity if the firm’s tax rate is 34 percent?
A. 46.75 percent
B. 49.97 percent
C. 52.93 percent
D. 61.08 percent
E. 64.52 percent

E. 64.52 percent

70. The General Store has a cost of equity of 15.8 percent, a pre-tax cost of debt of 7.7 percent, and a tax rate of 32 percent. What is the firm’s weighted average cost of capital if the debt-equity ratio is 0.40?
A. 10.18 percent
B. 11.72 percent
C. 12.78 percent
D. 13.30 percent
E. 14.93 percent

C. 12.78 percent

71. Fancee Restaurant’s cost of equity is 15.3 percent and its aftertax cost of debt is 6.1 percent. What is the firm’s weighted average cost of capital if its debt-equity ratio is 0.58 and the tax rate is 30 percent?
A. 8.94 percent
B. 10.36 percent
C. 11.92 percent
D. 12.28 percent
E. 13.01 percent

C. 11.92 percent

72. A firm wants to create a weighted average cost of capital (WACC) of 10.4 percent. The firm’s cost of equity is 14.5 percent and its pre-tax cost of debt is 8.5 percent. The tax rate is 34 percent. What does the debt-equity ratio need to be for the firm to achieve its target WACC? A. 0.51
B. 0.57
C. 0.62
D. 0.70
E. 0.86

E. 0.86

73. The Color Box uses a combination of common stock, preferred stock, and debt financing. The company wants preferred stock to represent 8 percent of the total financing. It also wants to structure the firm in a manner that will produce a weighted average cost of capital of 10.25 percent. The aftertax cost of debt is 5.1 percent, the cost of preferred is 9.3 percent, and the cost of common stock is 15.6 percent. What percentage of the firm’s capital funding should be debt financing?
A. 46.12 percent
B. 52.03 percent
C. 54.15 percent
D. 58.78 percent
E. 63.21 percent

A. 46.12 percent

74. Southwest Tours currently has a weighted average cost of capital of 11.3 percent based on a combination of debt and equity financing. The firm has no preferred stock. The current debt-equity ratio is 0.58 and the aftertax cost of debt is 6.4 percent. The company just hired a new president who is considering eliminating all debt financing. All else constant, what will the firm’s cost of capital be if the firm switches to an all-equity firm?
A. 11.45 percent
B. 12.62 percent
C. 12.89 percent
D. 13.37 percent
E. 14.14 percent

E. 14.14 percent

75. Dallas Interiors has a cost of equity of 18.6 percent and a pre-tax cost of debt of 9.7 percent. The firm’s target weighted average cost of capital is 10.8 percent and its tax rate is 35 percent. What is the firm’s target debt-equity ratio?
A. 0.81
B. 0.87
C. 1.18
D. 1.32
E. 1.74

E. 1.74

76. Western Electric has 23,000 shares of common stock outstanding at a price per share of $57 and a rate of return of 14.2 percent. The firm has 6,000 shares of 7 percent preferred stock outstanding at a price of $48 a share. The preferred stock has a par value of $100. The outstanding debt has a total face value of $350,000 and currently sells for 102 percent of face. The yield-to-maturity on the debt is 8.49 percent. What is the firm’s weighted average cost of capital if the tax rate is 34 percent?
A. 12.69 percent
B. 13.44 percent
C. 14.19 percent
D. 14.47 percent
E. 14.92 percent

A. 12.69 percent

77. Aaron’s Rentals has 58,000 shares of common stock outstanding at a market price of $36 a share. The common stock just paid a $1.64 annual dividend and has a dividend growth rate of 2.8 percent. There are 12,000 shares of 6 percent preferred stock outstanding at a market price of $51 a share. The preferred stock has a par value of $100. The outstanding bonds mature in 17 years, have a total face value of $750,000, a face value per bond of $1,000, and a market price of $1,011 each. The bonds pay 8 percent interest, semiannually. The tax rate is 34 percent. What is the firm’s weighted average cost of capital?
A. 7.74 percent
B. 8.68 percent
C. 9.29 percent
D. 9.97 percent
E.10.30 percent

A. 7.74 percent

78. Alpha Industries is considering a project with an initial cost of $7.4 million. The project will produce cash inflows of $1.54 million a year for 7 years. The firm uses the subjective approach to assign discount rates to projects. For this project, the subjective adjustment is +1.5 percent. The firm has a pre-tax cost of debt of 8.6 percent and a cost of equity of 13.7 percent. The debt-equity ratio is .0.65 and the tax rate is 35 percent. What is the net present value of the project?
A. -$372,951
B. -$187,016
C. $48,209
D. $133,333
E. $269,480

A. -$372,951

79. Orchard Farms has a pre-tax cost of debt of 7.68 percent and a cost of equity of 15.2 percent. The firm uses the subjective approach to determine project discount rates. Currently, the firm is considering a project to which it has assigned an adjustment factor of -0.5 percent. The firm’s tax rate is 34 percent and its debt-equity ratio is 0.45. The project has an initial cost of $4.3 million and produces cash inflows of $1.27 million a year for 5 years. What is the net present value of the project?
A. $121,619
B. $328,895
C. $514,370
D. $561,027
E. $628,721

B. $328,895

80. Bruceton Hotels is an all-equity firm with 60,000 shares of stock outstanding. The stock has a beta of 1.27 and a standard deviation of 13.8 percent. The market risk premium is 9.1 percent and the risk-free rate of return is 4.2 percent. The company is considering a project that it considers riskier than its current operations so it wants to apply an adjustment of 1 percent to the project’s discount rate. What should the firm set as the required rate of return for the project?
A. 12.54 percent
B. 13.92 percent
C. 15.39 percent
D. 16.76 percent
E. 17.03 percent

D. 16.76 percent

81. Brewster’s is considering a project that is equally as risky as the firm’s current operations. The firm has a cost of equity of 13.7 percent and a pre-tax cost of debt of 8.4 percent. The debt-equity ratio is .65 and the tax rate is 36 percent. What is the cost of capital for this project?
A. 9.97 percent
B. 10.42 percent
C. 11.38 percent
D. 11.62 percent
E. 13.30 percent

B. 10.42 percent

82. Global Exchange has three divisions: A, B, and C. Division A has the least risk and division C has the most risk. The firm has an aftertax cost of debt of 6.1 percent and a cost of equity of 14.3 percent. The firm is financed with 35 percent debt and 65 percent equity. Division A’s projects are assigned a discount rate that is 2 percent less than the firm’s weighted average cost of capital. What is the discount rate applicable to division A?
A. 7.98 percent
B. 8.27 percent
C. 9.43 percent
D. 11.48 percent
E. 13.43 percent

C. 9.43 percent

83. Swizer Industries has two separate divisions. Division X has less risk so its projects are assigned a discount rate equal to the firm’s WACC minus 0.5 percent. Division Y has more risk and its projects are assigned a rate equal to the firm’s WACC plus 1 percent. The company has a debt-equity ratio of .45 and a tax rate of 35 percent. The cost of equity is 14.7 percent and the aftertax cost of debt is 5.1 percent. Presently, each division is considering a new project. Division Y’s project provides a 12.3 percent rate of return and division X’s project provides an 11.64 percent return. Which projects, if any, should the company accept?
A. Accept both X and Y
B. Accept X and reject Y
C. Reject X and accept Y
D. Reject both X and Y
E. The answer cannot be determined based on the information provided.83.

B. Accept X and reject Y

84. Beverly’s is a retail chain selling the latest fashions through its outlets located in various neighborhood malls. Clothing Galore is a wholesaler that buys from textile mills and sells to retail outlets. Beverly’s has a cost of capital of 13.6 percent, while Clothing Galore’s cost of capital is 17.8 percent. Both firms are considering opening a retail outlet in a gigantic new mall. Both proposals are quite similar in design and have basically the following financial features: an initial cash outlay of $2.7 million, a projected 5-year life with no salvage value, and cash inflows of $845,000 a year for the life of the project. Which firm or firms, if either, should open a retail outlet in the new mall?
A. Beverly’s only
B. Clothing Galore only
C. Both Beverly’s and Clothing Galore
D. Neither Beverly’s nor Clothing Galore
E. The answer cannot be determined based on the information provided

C. Both Beverly’s and Clothing Galore

85. Lester’s is a globally diverse company with multiple divisions and a cost of capital of 15.8 percent. Med, Inc. is a specialty firm in the medical equipment field with a cost of capital of 13.7 percent. With the aging of America, both firms recognize the opportunities that exist in the medical field and are considering expansion in this area. At present, there is an opportunity for multiple firms to be involved in a new medical devices project. Each project will require an initial investment of $8.4 million with annual returns of $2.2 million per year for 7 years. Which firm or firms, if either, should become involved in the new projects?
A. Lester’s only
B. Med, Inc. only
C. Both Lester’s and Med, Inc.
D. Neither Lester’s nor Med, Inc.
E. The answer cannot be determined based on the information provided

C. Both Lester’s and Med, Inc.

86. Bob’s is a retail chain of specialty hardware stores. The firm has 21,000 shares of stock outstanding that are currently valued at $68 a share and provide a 13.2 percent rate of return. The firm also has 500 bonds outstanding that have a face value of $1,000, a market price of $1,068, and a 7 percent coupon. These bonds mature in 6 years and pay interest semiannually. The tax rate is 35 percent. The firm is considering expanding by building a new superstore. The superstore will require an initial investment of $12.3 million and is expected to produce cash inflows of $1.1 million annually over its 10-year life. The risks associated with the superstore are comparable to the risks of the firm’s current operations. The initial investment will be depreciated on a straight line basis over the life of the project. At the end of the 10 years, the firm expects to sell the superstore for $6.7 million. Should the firm accept or reject the superstore project and why?
A. Accept; The project’s NPV is $1.27 million.
B. Accept; The NPV is $4.89 million.
C. Reject; The NPV is $1.06 million
D. Reject; The NPV -$3.27 million.
E. Reject; The NPV is -$5.71 million.

D. Reject; the NPV is -$3.27 million

87. Casper’s is analyzing a proposed expansion project that is much riskier than the firm’s current operations. Thus, the project will be assigned a discount rate equal to the firm’s cost of capital plus 3 percent. The proposed project has an initial cost of $17.2 million dollars that will be depreciated on a straight-line basis over 20 years. The project also requires additional inventory of $687,000 over the project’s life. Management estimates the facility will generate cash inflows of $2.78 million a year over its 20-year life. After 20 years, the company plans to sell the facility for an estimated $1.3 million. The company has 60,000 shares of common stock outstanding at a market price of $49 a share. This stock just paid an annual dividend of $1.84 a share. The dividend is expected to increase by 3.5 percent annually. The firm also has 10,000 shares of 12 percent preferred stock with a market value of $98 a share. The preferred stock has a par value of $100. The company has a 9 percent, semiannual coupon bond issue outstanding with a total face value of $1.1 million. The bonds are currently priced at 102 percent of face value and mature in 16 years. The tax rate is 33 percent. Should the firm pursue the expansion project at this point in time? Why or why not?
A. Accept; The NPV is $2.648 million.
B. Accept; The NPV is $4.507 million.
C. Reject; The NPV is -$3.241 million.
D. Reject; The NPV is -$3.027 million.
E. Reject; The NPV is -$1.040 million.

B. Accept; the NPV is $4.507million

92. Gray’s Tools just issued a dividend of $1.60 per share on its common stock. The company is expected to maintain a constant 4 percent growth rate in its dividends indefinitely. If the stock sells for $31 a share, what is the company’s cost of equity?
A. 8.81 percent
B. 9.37 percent
C. 9.94 percent
D. 10.32 percent
E. 11.46 percent

B. 9.37 percent

93. Stock in ABC Enterprises has a beta of 1.06. The market risk premium is 6.8 percent, and T-bills are currently yielding 3.2 percent. ABC’s most recent dividend was $1.56 per share, and dividends are expected to grow at a 4 percent annual rate indefinitely. If the stock sells for $43 a share, what is your best estimate of ABC’s cost of equity?
A. 7.78 percent
B. 8.82 percent
C. 9.09 percent
D. 9.41 percent
E. 9.69 percent

C. 9.09 percent

94. Upstate Bank has an issue of preferred stock with a $4.80 stated dividend that just sold for $86 a share. What is the bank’s cost of preferred stock?
A. 4.91 percent
B. 5.58 percent
C. 6.23 percent
D. 6.47 percent
E. 7.32 percent

B. 5.58 percent

95. Raceway Motors issued a 20-year, 8 percent semiannual bond 3 years ago. The bond currently sells for 98.6 percent of its face value. The company’s tax rate is 34 percent. What is the aftertax cost of debt?
A. 5.38 percent
B. 5.54 percent
C. 5.69 percent
D. 5.72 percent
E. 5.99 percent

A. 5.38 percent

96. Healthy Foods has a target capital structure of 55 percent common stock, 5 percent preferred stock, and 40 percent debt. Its cost of equity is 14.3 percent, the cost of preferred stock is 8.9 percent, and the pre-tax cost of debt is 8.1 percent. What is the company’s WACC if the applicable tax rate is 34 percent?
A. 9.29 percent
B. 9.61 percent
C. 10.02 percent
D. 10.45 percent
E. 10.83 percent

D. 10.45 percent

97. Precision Engineering has a target debt-equity ratio of 0.55. Its cost of equity is 15.4 percent, and its pre-tax cost of debt is 7.8 percent. If the tax rate is 34 percent, what is the company’s WACC?
A. 10.20 percent
B. 10.72 percent
C. 10.91 percent
D. 11.48 percent
E. 11.76 percent

E. 11.76 percent

98. Given the following information for Electric Transport, find the WACC. Assume the company’s tax rate is 34 percent. Debt: 7,500, 8.4 percent coupon bonds outstanding. $1,000 par value, 22 years to maturity, selling for 103 percent of par, the bonds make semiannual payments. Common stock: 195,000 shares outstanding, selling for $78 per share, beta is 1.21 Preferred stock: 11,000 shares of 6.35 percent preferred stock outstanding, currently selling for $76 per share. Market: 8 percent market risk premium and 5.1 percent risk-free rate.
A. 11.49 percent
B. 12.07 percent
C. 12.42 percent
D. 13.33 percent
E. 13.80 percent

A. 11.49 percent

99. You are given the following information concerning Around Town Tours: Debt: 8,500, 7.1 percent coupon bonds outstanding, with 14 years to maturity and a quoted price of 102.6. These bonds pay interest semiannually. Common stock: 265,000 shares of common stock selling for $76 per share. The stock has a beta of 0.92 and will pay a dividend of $2.48 next year. The dividend is expected to grow by 4 percent per year indefinitely. Preferred stock: 7,500 shares of 6 percent preferred stock selling at $88 per share. Market: A 13.2 percent expected return, a 4.5 percent risk-free rate, and a 34 percent tax rate. Calculate the WACC for this firm.
A. 8.22 percent B. 8.67 percent C. 9.29 percent D. 9.57 percent E.

10.08 percent

A. 8.22 percent

100. Stewart’s is considering a new project. The company has a debt-equity ratio of 0.72. The company’s cost of equity is 15.1 percent, and the aftertax cost of debt is 7.2 percent. The firm feels that the project is riskier than the company as a whole and that it should use an adjustment factor of +2 percent. What is the WACC it should use for the project? A. 12.53 percent B. 12.98 percent
C. 13.79 percent D. 14.14 percent E. 14.68 percent

c. 13.79 percent

1. The use of borrowing by an individual to adjust his or her overall exposure to financial leverage is referred to as:
A. M&M Proposition I.
B. capital restructuring.
C. homemade leverage.
D. M&M Proposition II.
E. financial risk management.

C. Homemade leverage

2. Which one of the following statements matches M&M Proposition I?
A. The cost of equity capital has a positive linear relationship with a firm’s capital structure.
B. The dividends paid by a firm determine the firm’s value.
C. The cost of equity capital varies in response to changes in a firm’s capital structure.
D. The value of a firm is independent of the firm’s capital structure.
E. The value of a firm is dependent on the firm’s capital structure.

D. The value of a firm is independent of the firm’s capital structure

3. Which one of the following states that a firm’s cost of equity capital is a positive linear function of the firm’s capital structure?
A. Static theory of capital structure
B. M&M Proposition I
C. M&M Proposition II
D. Homemade leverage theory
E. WACC

C. M&M Proposition II

4. Which one of the following is the equity risk arising from the daily operations of a firm?
A. Strategic risk
B. Financial risk
C. Liquidity risk
D. Industry risk
E. Business risk

E. Business Risk

5. Which one of the following is the equity risk arising from the capital structure selected by a firm?
A. Strategic risk
B. Financial risk
C. Liquidity risk
D. Industry risk
E. Business risk

B. Financial Risk

6. Paying interest reduces the taxes owed by a firm. Which one of the following terms applies to this relationship?
A. Static theory of interest rates
B. M&M Proposition I
C. Financial risk
D. Interest tax shield
E. Homemade leverage

D. Interest tax shield

7. Which one of the following is a direct bankruptcy cost?
A. Loss of customer goodwill resulting from a bankruptcy filing
B. Legal and accounting fees related to a bankruptcy proceeding
C. Management time spent on a bankruptcy proceeding
D. Any financial distress cost
E. Costs a firm spends trying to avoid bankruptcy

B. Legal and accounting fees related to a bankruptcy proceeding

8. Which one of the following terms applies to the costs incurred by a firm which is trying to avoid filing for bankruptcy?
A. Indirect bankruptcy costs
B. Direct bankruptcy costs C. Static theory cost
D. Optimal capital structure cost
E. Reorganization costs

A. Indirect bankruptcy costs

9. Which one of the following terms is inclusive of both direct and indirect bankruptcy costs?
A. Financial distress costs B. Capital structure costs C. Financial leverage
D. Homemade leverage
E. Cost of capital

A. Financial distress costs

10. Which one of the following is the theory that a firm should borrow up to the point where the additional tax benefit from an extra dollar of debt equals the additional costs associated with financial distress from that additional debt?
A. M&M Proposition I, with taxes
B. M&M Proposition II, with taxes
C. M&M Proposition I, without taxes
D. Homemade leverage proposition
E. Static theory of capital structure

E. Static theory of capital structure

11. Which one of the following best defines legal bankruptcy?
A. Negotiating new payment terms with a firm’s creditors
B. A temporary technical insolvency
C. A legal proceeding for liquidating or reorganizing a business
D. The internal process of revising the capital structure of a firm
E. The failure of a firm to meet its financial obligations in a timely manner

C. A legal proceeding for liquidating or reorganizing a business

12. Which one of the following terms refers to the termination of a firm as a going concern?
A. Insolvency
B. Reorganization
C. Chapter 11 bankruptcy D. Prepack
E. Liquidation

E. Liquidation

13. Greenwood Motels has filed a petition for bankruptcy but hopes to continue its operations both during and after the bankruptcy process. Which one of the following terms best applies to this situation?
A. Chapter 7 bankruptcy
B. Liquidation
C. Technical insolvency
D. Accounting insolvency
E. Reorganization

E. Reorganization

14. In the process of liquidation, some types of claims receive preference over other claims. Which one of the following determines which type of claim is paid first?
A. Technical insolvency definition
B. Absolute priority rule C. Accounting insolvency definition
D. Chapter 7 of the Federal Bankruptcy Reform Act of 1978
E. Securities and Exchange Commission

B. Absolute priority rule

15. Which one of the following is minimized when the value of a firm is maximized?
A. Return on equity
B. WACC
C. Debt
D. Taxes
E. Bankruptcy costs

B. WACC

16. Assume you are comparing two firms that are identical in every aspect, except one is levered and one is unlevered. Which one of the following statements is correct regarding these two firms?
A. The levered firm has higher EPS than the unlevered firm at the break-even point.
B. The levered firm will have higher EPS than the unlevered firm at all levels of EBIT.
C. The unlevered firm will have higher EPS than the levered firm at relatively high levels of EBIT.
D. The EPS for the unlevered firm will always exceed those of the levered firm.
E. The unlevered firm will have higher EPS at relatively low levels of EBIT.

E. The unleveled firm will have higher EPS at relatively low levels of EBIT

17. Which one of the following statements concerning financial leverage is correct?
A. Financial leverage increases profits and decreases losses.
B. Financial leverage has no effect on a firm’s return on equity.
C. Financial leverage refers to the use of common stock.
D. Financial leverage magnifies both profits and losses.
E. Increasing financial leverage will always decrease the earnings per share.

D. Financial leverage magnifies both profits and losses

18. You are comparing two possible capital structures for a firm. The first option is an all-equity firm. The second option involves the use of $3.8 million of debt. The break-even point between these two financing options occurs when the earnings before interest and taxes (EBIT) are $428,000. Given this, you know that leverage is beneficial to the firm:
A. whenever EBIT is less than $428,000.
B. only when EBIT is $428,000.
C. whenever EBIT exceeds $428,000.
D. only if the debt is decreased by $428,000.
E. only if the debt is increased by $428,000.

C. whenever EBIT exceeds $428,000

19. Which one of the following statements concerning financial leverage is correct?
A. The benefits of leverage are unaffected by the amount of a firm’s earnings.
B. The use of leverage will always increase a firm’s earnings per share.
C. The shareholders of a firm are exposed to less risk anytime a firm uses financial leverage.
D. Changes in the capital structure of a firm will generally change the firm’s earnings per share.
E. Financial leverage is beneficial to a firm only when the firm has negative earnings.

D. Changes in the capital structure of a firm will generally change the firm’s earnings per share

20. T.L. C. Enterprises just revised its capital structure from a debt-equity ratio of 0.30 to a debt-equity ratio of 0.45. The firm’s shareholders who prefer the old capital structure should:
A. sell some shares and hold the sale proceeds in cash.
B. sell all of their shares and loan out the entire sale proceeds.
C. do nothing.
D. sell some shares and loan out the sale proceeds. E. borrow funds and purchase more shares.

D. Sell some shares and loan out the sale proceeds

21. Which one of the following statements is the core principle of M&M Proposition I, without taxes?
A. A firm’s cost of equity is directly related to the firm’s debt-equity ratio.
B. A firm’s WACC is directly related to the firm’s debt-equity ratio.
C. The interest tax shield increases the value of a firm.
D. The capital structure of a firm is totally irrelevant. E. Levered firms have greater value than unlevered firms.

D. The capital structure of a firm is totally irrelevant

22. Which one of the following supports the theory that the value of a firm increases as the firm’s level of debt increases? A. M&M Proposition I, without taxes
B. M&M Proposition II, without taxes
C. M&M Proposition I, with taxes
D. Static theory of capital structure
E. No theory suggests this.

C. M&M Proposition I, with taxes

23. Which one of the following is an implication of M&M Proposition II, without taxes?
A. A firm’s optimal capital structure is 100 percent debt.
B. WACC is unaffected by the capital structure of a firm.
C. WACC decreases as the debt-equity ratio increases.
D. A firm’s capital structure is irrelevant.
E. The risk of equity depends on both the degree of financial leverage and the riskiness of the firm’s operations.

E. The risk of equity depends on both the degree of financial leverage and the riskiness of the firm’s operations

24. M&M Proposition II, without taxes, states that the:
A. capital structure of a firm is highly relevant.
B. weighted average cost of capital decreases as the debt-equity ratio decreases.
C. cost of equity increases as a firm increases its debt-equity ratio.
D. return on equity is equal to the return on assets multiplied by the debt-equity ratio.
E. return on equity remains constant as the debt-equity ratio increases.

C. cost of equity increases as a firm increases its debt-equity ratio.

25. The level of financial risk to which a firm is exposed is dependent upon the firm’s:
A. tax rate.
B. debt-equity ratio.
C. return on assets.
D. level of earnings before interest and taxes.
E. operational level of risk.

B. debt-equity ratio

26. Which one of the following represents the present value of the interest tax shield?
A. D x (1 – Tc)
B. D/(1 – Tc)
C. D/Tc
D. D – D(Tc)
E. TC x D

E. TC x D

27. Which of the following will increase the value of a levered firm according to M&M Proposition I, with taxes? I. decrease in the amount of the debt II. increase in the value of the unlevered firm III. decrease in the tax rate IV. increase in the interest rate on the debt
A. II only
B. I and IV only
C. II and III only
D. II and IV only
E. II, III, and IV only

A. II only

28. Which of the following statements correctly relate to M&M Proposition I, with taxes? I. Debt decreases the value of a firm. II. The levered value of a firm exceeds the firm’s unlevered value. III. The weighted average cost of capital (WACC) is constant. IV. The optimal capital structure is zero debt.
A. I only
B. II only
C. II and III only
D. I and IV only
E. I, III, and IV only

B. II only

29. Which one of the following is an example of a direct bankruptcy cost? A. Operating at a debt-equity ratio that is less than the optimal ratio
B. Reducing the dividend payout ratio as a means of increasing a firm’s equity C. Forgoing a positive net present value project to conserve current cash
D. Incurring legal fees for the preparation of bankruptcy filings
E. Losing a key customer due to concerns over a firm’s financial viability

D. Incurring legal fees for the preparation of bankruptcy filings

30. The static theory of capital structure assumes a firm:
A. maintains a constant debt-equity ratio.
B. has an all-equity structure.
C. is fixed in terms of its assets.
D. pays no taxes.
E. is operating at the point where financial distress costs are eliminated

C. is fixed in terms of its assets

31. Which one of the following conditions exists at the point where a firm maximizes its value?
A. The tax benefit from an additional dollar of debt is zero.
B. Financial distress costs are equal to zero.
C. The debt-equity ratio is 1.0.
D. WACC is minimized.
E. The cost of equity is minimized

D. WACC is minimized

32. Which one of the following statements related to the static theory of capital structure is correct?
A. A firm begins to lose value as soon as the first dollar of debt is incurred. B. The actual value of a firm continually rises in direct proportion to the increased use of debt.
C. The linear function of a firm’s value has a constant positive slope.
D. A firm’s value is maximized when a firm operates at its optimal debt level.
E. The value of a firm will automatically decrease whenever the debt-equity ratio is decreased

D. A firm’s value is maximized when a firm operates at its optimal debt level.

33. Which one of the following is correct based on the static theory of capital structure?
A. A firm receives the greatest benefit from debt financing when its tax rate is relatively low.
B. A debt-equity ratio of 1 is considered to be the optimal capital structure.
C. The costs of financial distress decrease the value of a firm.
D. The more debt a firm assumes, the greater the incentive to acquire even more debt until such time as the firm is financed with 100 percent debt.
E. At the optimal level of debt a firm also optimizes its tax shield on debt.

C. The costs of financial distress decrease the value of a firm

34. Assume both corporate taxes and financial distress costs apply to a firm. Given this, the static theory of capital structure illustrates that:
A. a firm’s value and its weighted average cost of capital are inversely related.
B. a firm’s value and its tax rate are inversely related. C. the maximum value of a firm is obtained when a firm is financed solely with debt.
D. the value of a firm rises as the interest rate on debt rises.
E. the value of a firm rises as both the interest rate on debt and the tax rate rise

A. a firm’s value and its weighted average cost of capital are inversely related

35. When is a firm insolvent from an accounting perspective? A. When the firm is unable to meet its financial obligations in a timely manner
B. When the firm’s debt exceeds the value of the firm’s equity
C. When the firm has a negative net worth
D. When the firm’s revenues cease
E. When the market value of the firm’s equity equals zero

C. When the firm has a negative net worth

36. Peterboro recently defaulted on a bank loan. To avoid a bankruptcy proceeding, the bank agreed to a composition. This composition would do which one of the following?
A. Forgive the loan payment in its entirety
B. Extend the due date on the missed loan payment
C. Reduce the amount of the loan payments so Peterboro can pay timely D. Transfer some of Peterboro’s assets to the bank in lieu of the loan payment
E. Transfer all the equity shares in Peterboro to the lending bank

C. Reduce the amount of the loan payments so Peterboro can pay timely

37. Which one of the following will generally receive the highest priority in a bankruptcy liquidation, assuming the absolute priority rule is followed?
A. Claims by unsecured creditors
B. Employee wages
C. Government tax claims D. Contributions to employee retirement plans
E. Bankruptcy administrative expenses

E. Bankruptcy administrative expenses

38. Which one of the following is a key provision of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005? A. Disallowance of bankruptcy prepacks
B. Right granted to creditors to file their own reorganization plan once a firm is in bankruptcy for 18 months
C. Disallowance of all management bonus payments while a firm is in bankruptcy
D. Requirement that only creditors can file reorganization plans for a bankrupt firm
E. Requirement for all Chapter 11 bankruptcies to be converted to Chapter 7 bankruptcies after 18 months

B. Right granted to creditors to file their own reorganization plan once a firm is in bankruptcy for 18 months

39. Which one of the following statements is correct?
A. A prepack is a plan of liquidation used to distribute a firm’s assets.
B. Bankruptcy courts have "cram-down" powers.
C. The absolute priority rule must be strictly followed in all bankruptcy proceedings.
D. Creditors cannot force a firm into bankruptcy even though they might like to do so.
E. A reorganization plan can only be approved if the firm’s creditors all agree with the plan.

B. Bankruptcy courts have "cram-down" powers

40. A prepack:
A. guarantees full payment to all creditors but lengthens the time span of the debt.
B. is the joint filing of both a bankruptcy filing and a creditor-approved reorganization plan.
C. protects the interests of both the current creditors and the existing shareholders.
D. applies only if a firm files under Chapter 7 of the bankruptcy code.
E. extends the time that a firm is protected by the bankruptcy process.

B. is the joint filing of both a bankruptcy filing and a creditor-approved reorganization plan

41. Which one of the following statements is correct?
A. All Chapter 7 bankruptcy filings must include a "workout" agreement.
B. Firms must remain in bankruptcy for at least 18 months.
C. Key employee retention plans (KERPS) are no longer legal.
D. Labor contracts cannot be modified through the bankruptcy process.
E. A firm can file for Chapter 11 bankruptcy even if the firm is solvent

E. A firm can file for Chapter 11 bankruptcy every if the firm is solvent

42. Glass Ornaments, Inc. is an all-equity firm with a total market value of $386,000 and 15,000 shares of stock outstanding. Management is considering issuing $75,000 of debt at an interest rate of 8 percent and using the proceeds on a stock repurchase. As an all-equity firm, management believes the earnings before interest and taxes (EBIT) will be $31,000 if the economy is normal, $11,000 if it is in a recession, and $37,000 if the economy booms. Ignore taxes. What will the earnings per share (EPS) be if the economy falls into a recession and the firm maintains its all-equity status?
A. $0.68
B. $0.73
C. $1.21
D. $1.67 E. $2.07

B. $0.73

43. The Green Briar is an all-equity firm with a total market value of $418,000 and 20,000 shares of stock outstanding. Management is considering issuing $120,000 of debt at an interest rate of 9 percent and using the proceeds on a stock repurchase. Ignore taxes. How many shares will the firm repurchase if it issues the debt securities?
A. 2,871 shares
B. 3,516 shares
C. 3,921 shares
D. 4,607 shares
E. 5,742 shares

E. 5,742 shares

44. Charleston Mills is an all-equity firm with a total market value of $221,000. The firm has 8,000 shares of stock outstanding. Management is considering issuing $50,000 of debt at an interest rate of 7 percent and using the proceeds on a stock repurchase. Ignore taxes. How many shares can the firm repurchase if it issues the debt securities?
A. 1,810 shares
B. 1,818 shares
C. 1,847 shares
D. 1,856 shares
E. 1,899 shares

A. 1,810 shares

45. Northern Wood Products is an all-equity firm with 16,000 shares of stock outstanding and a total market value of $352,000. Based on its current capital structure, the firm is expected to have earnings before interest and taxes of $26,000 if the economy is normal, $3,000 if the economy is in a recession, and $33,000 if the economy booms. Ignore taxes. Management is considering issuing $88,000 of debt with a 6 percent coupon rate. If the firm issues the debt, the proceeds will be used to repurchase stock. What will the earnings per share be if the debt is issued and the economy is in a recession?
A. -$0.27
B. -$0.19
C. $0.03
D. $0.26
E. $0.31

B. -$0.19

46. Cross Town Cookies is an all-equity firm with a total market value of $720,000. The firm has 150,000 shares of stock outstanding. Management is considering issuing $200,000 of debt at an interest rate of 7 percent and using the proceeds to repurchase shares. The projected earnings before interest and taxes are $58,600. What are the anticipated earnings per share if the debt is issued? Ignore taxes.
A. $0.25 B. $0.33 C. $0.38
D. $0.41 E. $0.47

D. $0.41

47. Ernst Electrical has 9,000 shares of stock outstanding and no debt. The new CFO is considering issuing $80,000 of debt and using the proceeds to retire 1,500 shares of stock. The coupon rate on the debt is 7.5 percent. What is the break-even level of earnings before interest and taxes between these two capital structure options?
A. $18,500 B. $21,000
C. $24,000 D. $32,500
E. $36,000

E. $36,000

48. Northwestern Lumber Products currently has 15,000 shares of stock outstanding. Patricia, the financial manager, is considering issuing $120,000 of debt at an interest rate of 6.75 percent. Given this, how many shares of stock will be outstanding once the debt is issued if the break-even level of EBIT between these two capital structure options is $60,000? Ignore taxes.
A. 12,975 shares
B. 13,650 shares
C. 14,025 shares
D. 14,550 shares
E.15,000 shares

A. 12,975 shares

49. Chick ‘N Fish is considering two different capital structures. The first option consists of 25,000 shares of stock. The second option consists of 15,000 shares of stock plus $150,000 of debt at an interest rate of 7.5 percent. Ignore taxes. What is the break-even level of earnings before interest and taxes (EBIT) between these two options?
A. $2,813
B. $3,134
C. $16,410
D. $28,125
E. $31,338

D. $28,125

50. A firm is considering two different capital structures. The first option is an all-equity firm with 32,000 shares of stock. The second option is 20,000 shares of stock plus some debt. Ignoring taxes, the breakeven level of earnings before interest and taxes between these two options is $48,000. How much money is the firm considering borrowing if the interest rate is 8 percent?
A. $175,000
B. $225,000
C. $250,000
D. $275,000
E. $300,000

B. $225,000

51. Room and Board has determined that $36,000 is the breakeven level of earnings before interest and taxes for the two capital structures it is considering. The one structure consists of all equity with 14,000 shares of stock. The second structure consists of 10,000 shares of stock and $80,000 of debt. What is the interest rate on the debt?
A. 7.72 percent
B. 8.19 percent
C. 9.97 percent
D. 11.43 percent
E. 12.86 percent

E. 12.86 percent

52. Shoe Box Stores is currently an all-equity firm with 28,000 shares of stock outstanding. Management is considering changing the capital structure to 40 percent debt. The interest rate on the debt would be 9 percent. Ignore taxes. Jamie owns 300 shares of Shoe Box Stores stock that is priced at $17 a share. What should Jamie do if she prefers the all-equity structure but Shoe Box Stores adopts the new capital structure?
A. Borrow money and buy an additional 120 shares. B. Borrow money and buy an additional 180 shares. C. Keep her shares but loan out all of the dividend income at 9 percent.
D. Sell 120 shares and loan out the proceeds at 9 percent.
E. Sell 180 shares and loan out the proceeds at 9 percent

D. Sell 120 shares and loan out the proceeds at 9 percent

53. Katz is an all-equity development company that has 36,000 shares of stock outstanding at a market price of $25 a share. The firm’s earnings before interest and taxes are $29,000. Katz has decided to issue $200,000 of debt at a rate of 6 percent and use the proceeds to repurchase shares. What should Faith do if she owns 500 shares of Katz stock and wants to use homemade leverage to offset the leverage being assumed by the firm?
A. Borrow money and buy an additional 22 shares
B. Borrow money and buy an additional 111 shares C. Sell 22 shares and loan out the proceeds
D. Sell 56 shares and loan out the proceeds
E. Sell 111 shares and loan out the proceeds

E. Sell 111 shares and loan out the proceeds

54. Gabella’s is an all-equity firm that has 21,000 shares of stock outstanding at a market price of $40 a share. The firm has earnings before interest and taxes of $84,000 and has a 100 percent dividend payout ratio. Ignore taxes. Gabella’s has decided to issue $160,000 of debt at a rate of 12 percent and use the proceeds to repurchase shares. Travis owns 500 shares of Gabella’s stock and has decided to continue holding those shares. How will Gabella’s debt issue affect Travis’ annual dividend income?
A. Decrease from $2,400 to $1,840
B. Increase from $2,400 to $2,160
C. Decrease from $2,000 to $1,906
D. Increase from $2,000 to $2,094
E. No change

C. Decrease from $2,000 to $1,906

55. Henderson’s is an all-equity firm that has 135,000 shares of stock outstanding. Neal, the financial vice-president, is considering borrowing $220,000 at 7.25 percent interest to repurchase 20,000 shares. Ignoring taxes, what is the value of the firm?
A. $1,260,000
B. $1,400,000
C. $1,485,000
D. $1,620,000
E. $1,750,000

C. $1,485,000

56. Tree Farms, Inc. currently has 45,000 shares of stock outstanding and no debt. The price per share is $17.50. The firm is considering borrowing funds at 7.5 percent interest and using the proceeds to repurchase 3,000 shares of stock. Ignore taxes. How much is the firm borrowing?
A. $52,500
B. $75,000
C. $110,500
D. $125,000
E. $135,000

A. $52,500

57. The Gable Inn is an all-equity firm with 16,000 shares outstanding at a value per share of $14.50. The firm is issuing $50,000 of debt and using the proceeds to reduce the number of outstanding shares. How many shares of stock will be outstanding once the debt is issued? Ignore taxes.
A. 11,970 shares
B. 12,552 shares
C. 12,846 shares
D. 13,030 shares
E. 13,561 shares

B. 12,552 shares

58. Western Shores is comparing two separate capital structures. The first structure consists of 260,000 shares of stock and no debt. The second structure consists of 210,000 shares of stock and $1.5 million of debt. What is the price per share of equity?
A. $18
B. $22
C. $27
D. $30
E. $33

D. $30

59. The Doll House has a pre-tax cost of debt of 7.9 percent and a return on assets of 11.7 percent. The debt-equity ratio 0.45. Ignore taxes. What is the cost of equity?
A. 11.87 percent
B. 12.03 percent
C. 12.47 percent
D. 12.98 percent
E. 13.41 percent

E. 13.41 percent

60. The Outlet has a cost of equity of 16.8 percent, a pre-tax cost of debt of 8.1 percent, and a return on assets of 14.5 percent. Ignore taxes. What is the debt-equity ratio?
A. 0.28
B. 0.36
C. 0.44
D. 0.52
E. 0.57

B. 0.36

61. Weston Mines has a cost of equity of 19.8 percent, a pre-tax cost of debt of 9.4 percent, and a return on assets of 17.1 percent. Ignore taxes. What is the debt-equity ratio?
A. 0.35
B. 0.41
C. 0.47
D. 0.56
E. 0.62

A. 0.35

62. Clark’s Cookies has a return on assets of 15.3 percent and a cost of equity of 17.6 percent. What is the pre-tax cost of debt if the debt-equity ratio is 0.54? Ignore taxes. A. 8.87 percent
B. 9.29 percent
C. 9.64 percent
D. 10.31 percent
E. 11.04 percent

E. 11.04 percent

63. The Water Works has a return on assets of 13.7 percent, a cost of equity of 18.6 percent, and a pre-tax cost of debt of 7.1 percent. What is the debt-equity ratio? Ignore taxes. A. 0.44
B. 0.47
C. 0.61
D. 0.68
E. 0.74

E. 0.74 percent

64. An all-equity firm has a return on assets of 15.3 percent. The firm is considering converting to a debt-equity ratio of 0.30. The pre-tax cost of debt is 8.1 percent. Ignoring taxes, what will the cost of equity be if the firm switches to the levered capital structure? A. 15.57 percent
B. 16.28 percent
C. 16.67 percent
D. 17.46 percent
E. 18.19 percent

D. 17.46 percent

65. Stone House Cafe has a 30 percent tax rate and total taxes of $35,280. What is the value of the interest tax shield if the interest expense is $16,700?
A. $4,887
B. $5,010
C. $5,395
D. $5,708
E. $6,023

B. $5,010

66. Aaron’s Tea House has a 32 percent tax rate and an interest tax shield valued at $6,728 for the year. How much did the firm pay in annual interest?
A. $2,153
B. $2,304
C. $2,468
D. $20,507
E. $21,025

E. $21,025

67. Kelner’s Nursery has 8,000 bonds outstanding with a face value of $1,000 each. The coupon rate is 6.5 percent and the tax rate is 34 percent. What is the present value of the interest tax shield?
A. $2.72 million
B. $2.83 million
C. $3.09 million
D. $3.13 million
E. $3.26 million

A. $2.72 million

68. Southern Fried Foods has a $12 million bond issue outstanding with a coupon rate of 6.75 percent and a yield-to-maturity of 7.27 percent. What is the present value of the tax shield if the tax rate is 35 percent?
A. $283,500
B. $305,340
C. $3,053,400
D. $3,560,000
E. $4,200,000

E. $4,200,000

69. Liz’s Home Remedy has a $24 million bond issue outstanding with a coupon rate of 7.75 percent and a current yield of 7.67 percent. What is the present value of the tax shield if the tax rate is 34 percent?
A. $632,400
B. $625,872
C. $6.28 million
D. $8.16 million
E. $8.68 million

$8.16 million

70. Tropical Fruit Extracts expects its earnings before interest and taxes to be $218,000 a year forever. Currently, the firm has no debt. The cost of equity is 16.3 percent and the tax rate is 35 percent. The company is in the process of issuing $2 million of bonds at par that carry a 6.5 percent annual coupon. What is the unlevered value of the firm?
A. $371,429
B. $431,971
C. $747,485
D. $869,325
E. $988,315

$869,325

71. Kline Construction is an all-equity firm that has projected perpetual earnings before interest and taxes of $879,000. The current cost of equity is 18.3 percent and the tax rate is 34 percent. The company is in the process of issuing $6.2 million of 8.5 percent annual coupon bonds at par. What is the levered value of the firm?
A. $5,278,164
B. $5,541,085
C. $6,422,225
D. $6,713,185
E. $7,385,695

A. $5,278,164

72. Stevenson’s Bakery is an all-equity firm that has projected perpetual earnings before interest and taxes of $138,000 a year. The cost of equity is 13.7 percent and the tax rate is 32 percent. The firm can borrow money at 6.75 percent. Currently, the firm is considering converting to a debt-equity ratio of 0.45. What is the firm’s levered value? A. $527,613
B. $689,919
C. $752,987
D. $829,507
E. $903,682

C. $752,987

73. Hot To Go is an all-equity firm specializing in hot ready-to-eat meals. Management has estimated the firm’s earnings before interest and taxes will be $167,000 annually forever. The present cost of equity is 15.1 percent. Currently, the firm has no debt but is considering borrowing $750,000 at 9 percent interest. The tax rate is 34 percent. What is the value of the unlevered firm?
A. $623,017
B. $646,511
C. $704,141
D. $729,934
E. $755,200

D. $729,934

74. Great Lakes Shipping is an all-equity firm with anticipated earnings before interest and taxes of $439,000 annually forever. The present cost of equity is 16.4 percent. Currently, the firm has no debt but is considering borrowing $1.25 million at 8.5 percent interest. The tax rate is 36 percent. What is the value of the levered firm?
A. $2,163,171
B. $2,406,519
C. $2,588,547
D. $2,666,667
E. $2,818,181

A. $2,173,171

75. Jericho Snacks is an all-equity firm with estimated earnings before interest and taxes of $826,000 annually forever. Currently, the firm has no debt but is considering borrowing $650,000 at 6.75 percent interest. The tax rate is 34 percent and the current cost of equity is 17.2 percent. What is the value of the levered firm?
A. $3,187,271
B. $3,169,535
C. $3,307,271
D. $3,390,535
E. $3,506,418

D. $3,390,535

76. The Gift Mart is an all-equity firm with a current cost of equity of 19.6 percent. The estimated earnings before interest and taxes are $239,000 annually forever. Currently, the firm has no debt but is in the process of borrowing $400,000 at 9.5 percent interest. The tax rate is 30 percent. What is the value of the unlevered firm?
A. $849,207
B. $853,571
C. $856,411
D. $919,307
E. $926,667

B. $853,571

77. Coaster’s has a cost of equity of 15.4 percent, a return on assets of 10.2 percent, and a cost of debt of 7.3 percent. There are no taxes. What is the firm’s weighted average cost of capital?
A. 7.30 percent
B. 10.20 percent
C. 10.97 percent
D. 15.40 percent
E. Cannot be determined from the information provided

B. 10.20 percent

78. A firm has a cost of debt of 7.5 percent and a cost of equity of 16.2 percent. The debt-equity ratio is 0.45. There are no taxes. What is the firm’s weighted average cost of capital?
A. 11.75 percent
B. 12.29 percent
C. 13.50 percent
D. 14.47 percent
E. 16.20 percent

C. 13.50 percent

79. A firm has a weighted average cost of capital of 11.68 percent and a cost of equity of 15.5 percent. The debt-equity ratio is 0.65. There are no taxes. What is the firm’s cost of debt?
A. 5.80 percent
B. 6.27 percent
C. 6.44 percent
D. 7.23 percent
E. 7.81 percent

A. 5.80 percent

85. Jasper Industrial has no debt outstanding and a total market value of $110,000. Earnings before interest and taxes, EBIT, are projected to be $12,000 if economic conditions are normal. If there is strong expansion in the economy, then EBIT will be 15 percent higher. If there is a recession, then EBIT will be 20 percent lower. Jasper Industrial is considering a $35,000 debt issue with a 7 percent interest rate. The proceeds will be used to repurchase shares of stock. There are currently 7,500 shares outstanding. Ignore taxes for this problem. What is the percentage change in EPS when a normal economy slips into recession?
A. -33 percent
B. -25 percent
C. -20 percent
D. -16 percent
E. -10 percent

C. -20 percent

86. Gabe’s Market is comparing two different capital structures. Plan I would result in 11,000 shares of stock and $225,000 in debt. Plan II would result in 14,000 shares of stock and $150,000 in debt. The interest rate on the debt is 8 percent. Ignoring taxes, compare both of these plans to an all-equity plan assuming that EBIT will be $45,000. The all-equity plan would result in 20,000 shares of stock outstanding. Of the three plans, the firm will have the highest EPS with _____ and the lowest EPS with _____.
A. Plan I; Plan II
B. Plan I; all-equity plan
C. Plan II; Plan I
D. Plan II; all-equity plan E. all-equity plan; Plan I

B. Plan I; all-equity plan

87. Uptown Construction is comparing two different capital structures. Plan I would result in 23,000 shares of stock and $320,000 in debt. Plan II would result in 17,000 shares of stock and $260,000 in debt. The interest rate on the debt is 10 percent. Ignoring taxes, EPS will be identical for Plans I and II when EBIT equals which one of the following?
A. $8,550
B. $9,000
C. $9,600
D. $10,400
E. $10,750

B. $9,000

88. Bruno’s is considering a change from its current capital structure. Bruno’s currently has an all-equity capital structure and is considering a capital structure with 30 percent debt. There are currently 6,500 shares outstanding at a price per share of $46. EBIT is expected to remain constant at $43,000. The interest rate on new debt is 8.5 percent and there are no taxes. Tracie owns $20,700 worth of stock in the company. The firm has a 100 percent payout. What would Tracie’s cash flow be under the new capital structure assuming that she keeps all of her shares?
A. $1,998
B. $2,227
C. $2,815
D. $3,027
E. $3,499

E. $3,499

89. Delta Mowers has a debt-equity ratio of 1.2. Its WACC is 10.1 percent, and its cost of debt is 7.5 percent. There is no corporate tax. What is the firm’s cost of equity capital?
A. 12.60 percent
B. 13.22 percent
C. 13.83 percent
D. 14.29 percent
E. 14.80 percent

B. 13.22 percent

90. Triangle Enterprises has no debt but can borrow at 9 percent. The firm’s WACC is currently 14.7 percent, and there is no corporate tax. If the firm converts to 70 percent debt, what will its cost of equity be?
A. 20.67 percent
B. 22.95 percent
C. 24.47 percent
D. 26.39 percent
E. 28.00 percent

E. 28.00 percent

91. M.G. Movers can borrow at 7.5 percent. The firm currently has no debt, and the cost of equity is 16 percent. The current value of the firm is $540,000. What will the value be if the firm borrows $160,000 and uses the proceeds to repurchase shares? The corporate tax rate is 34 percent.
A. $528,000
B. $540,000
C. $552,000
D. $571,000
E. $594,400

E. $594,400

92. Snow Mountain Resort has a 33 percent tax rate. Its total interest payment for the year just ended was $6.8 million. What is the interest tax shield?
A. $2,006,500
B. $2,244,000
C. $2,410,600
D. $2,525,000
E. $2,618,000

B. $2,244,000

93. Marcos & Sons has no debt. Its current total value is $58 million. What will the company’s value be if it sells $21 million in debt and has a tax rate of 34 percent? Assume debt proceeds are used to repurchase equity.
A. $58,220,000
B. $60,370,000
C. $62,330,000
D. $64,560,000
E. $65,140,000

E. $65,140,000

94. Glass Growers has no debt. Its cost of capital is 8.7 percent. Suppose the firm converts to a debt-equity ratio of 0.65. The interest rate on the debt is 6.9 percent. What is its new WACC?
A. 7.99 percent
B. 8.13 percent
C. 8.36 percent
D. 8.44 percent
E. 8.61 percent

A. 7.99 percent

95. One year ago, you purchased a 5 percent coupon bond with a face value of $1,000 when it was selling for 101.2 percent of par. Today, you sold this bond for 99.8 percent of par. What is your total dollar return on this investment? .
A. $36
B. $74
C. $82
D. $64
E. $60

A. $36

96. You own a portfolio that has $1,900 invested in Stock A and $2,700 invested in Stock B. If the expected returns on these stocks are 9 percent and 15 percent, respectively, what is the expected return on the portfolio? .
A. 11.96 percent
B. 12.52 percent
C. 11.14 percent
D. 13.07 percent
E. 10.57 percent

B. 12.52 percent

97. Which one of the following is the slope of the security market line? .
A. Market rate of return
B. Risk-free rate
C. Market risk premium
D. Risk premium on an individual asset
E. Beta coefficient

A. Market risk premium

98. Q: Based on the capital asset pricing model, investors are compensated based on which of the following?.I. Market risk premium.II. Portfolio standard deviation.III. Portfolio beta.IV. Risk-free rate .
A. II and IV only
B. I, III, and IV only
C. I, II, and III only
D. I, II, III, and IV
E. I and III only

B. I, III and IV only

99. Semistrong form market efficiency states that the value of a security is based on:.
A. historical information only
B. all public and private information
C. all publicly available information
D. all publicly available information plus any data that can be gathered from insider trading
E. random information with no clear distinction as to the source of that information

C. All publicly available information

100. The stock of Wiley United has a beta of 0.92. The market risk premium is 8.4 percent and the risk-free rate is 3.2 percent. What is the expected return on this stock? .
A. 10.93 percent
B. 11.52 percent
C. 12.01 percent
D. 8.87 percent
E. 10.69 percent

101. A stock has a beta of 1.56 and an expected return of 17.3 percent. A risk-free asset currently earns 5.1 percent. If a portfolio of the two assets has a beta of 1.06, what are the portfolio weights? .
A. Stock weight = 0.28; risk-free weight = 0.72
B. Stock weight = 0.72; risk-free weight = 0.28
C. Stock weight = 0.032;risk-free weight = 0.68
D. Stock weight = 0.68; risk-free weight = 0.32
E. Stock weight = 0.44; risk-free weight = 0.56

D. Stock weight = 0.68; risk-free weight = 0.32

102. Your portfolio has provided you with returns of 8.6 percent, 14.2 percent, -3.7 percent, and 12.0 percent over the past four years, respectively. What is the geometric average return for this period? .
A. 7.54 percent
B. 7.57 percent
C. 7.25 percent
D. 9.55 percent
E. 7.63 percent

A. 7.54 percent

103. You earned 26.3 percent on your investments for a time period when the risk-free rate was 3.8 percent and the inflation rate was 4.0 percent. What was your real rate of return for the period? .
A. 21.44 percent
B. 19.12 percent
C. 21.67 percent
D. 20.06 percent
E. 21.08 percent

A. 21.44 percent Website: http://www.calculatorpro.com/calculator/real-rate-of-return-calculator/

104. Which one of the following is the best example of systematic risk? .
A. Increase in agricultural exports.
B. Decrease in textile imports.
C. Decrease in gross domestic product.
D. Decrease in management bonuses for banking executives.
E. Discovery of a major gas field.

C. Decrease in gross domestic product

105. Which one of the following statements is correct?
A. A portfolio that contains at least 30 diverse individual securities that will have a beta of 1.0.
B. A risk-free security plots at the origin on a security market line graph.
C. An underpriced security will plot above the security market line.
D. A portfolio that has a beta of 1.12 will lie to the left of the market portfolio on a security market line graph
E. Any portfolio that is correctly valued will have a beta of 1.0.

106. The systematic risk principle states that the expected return on a risky asset depends only on which one of the following?
A. Diversifiable risk
B. Asset-specific risk
C. Unique risk
D. Market risk
E. Unsystematic risk

D. Market risk

107.You would like to create a portfolio that is equally invested in a risk-free asset and two stocks. One stock has a beta of 1.15. What does the beta of the second stock have to be if you want the portfolio to be equally as risky as the overall market? .
A. 1.23.
B. 1.85.
C. 1.55.
D. 0.97.
E. 0.78.

B. 1.85.

108. One year ago, Peyton purchased 3,600 shares of Broncos stock for $101,124. Today, he sold those shares for $26.60 a share. What is the total return on this investment if the dividend yield is 1.9 percent? .
A. -3.40 percent
B. -3.98 percent
C. 1.10 percent
D. 3.40 percent
E. -2.29 percent

A. -3.40 percent

109. What is the probability associated with a return that lies in the upper tail when the mean plus two standard deviations is graphed? .
A. 0.05 percent.
B. 1.0 percent.
C. 0.5 percent.
D. 2.5 percent.
E. 5.0 percent.

D. 2.5 percent.

110. A $36,000 portfolio is invested in a risk-free security and two stocks. The beta of Stock A is 1.29 while the beta of Stock B is 0.90. One-half of the portfolio is invested in the risk-free security. How much is invested in Stock A if the beta of the portfolio is 0.58?.
A. $6,000.
B. $18,000.
C. $15,000.
D. $9,000.
E. $12,000.

E. $12,000.

111. Investors require a 4 percent return on risk-free investments. On a particular risky investment, investors require an excess return of 7 percent in addition to the risk-free rate of 4 percent. What is this excess return called? .
A. Risk premium
B. Real return
C. Required return
D. Average return
E. Inflation premium

A. Risk Premium

112. Diversifying a portfolio across various sectors and industries might do more than one of the following. However, this diversification must do which one of the following? .
A. Increase the security’s risk premium
B. Reduce the portfolio’s systematic risk level
C. Increase the expected risk premium
D. Reduce the portfolio’s unique risks
E. Reduce the beta of the portfolio to zero

D. Reduce the portfolio’s unique risks

113. A stock has returns for five years of 23 percent, -17 percent, 8 percent, 22 percent, and 3 percent, respectively. The stock has an average return of ______ percent and a standard deviation of _____ percent.
A. 7.80; 14.63.
B. 7.80; 16.36.
C. 14.60; 14.63.
D. 14.60; 16.36.
E. 7.80; 13.54.

B. 7.80; 16.36.

114. You expect the inflation rate to be 3.8 percent and the U.S. Treasury bill yield to be 3.9 percent for the next year. The risk premium on small-company stocks is 12.6 percent. What nominal rate of return do you expect to earn on small-company stocks next year? .
A. 15.5 percent.
B. 9.2 percent.
C.16.8 percent.
D.16.5 percent.
E. 8.8 percent.

D. 16.5 percent.

115. Which one of the following statements is accurate for a levered firm? .
A. A firm’s WACC will decrease whenever the firm’s tax rate decreases.
B. The subjective approach totally ignores a firm’s own WACC.
C. WACC should be used as the required return for all proposed investments.
D. An increase in the market risk premium will decrease a firm’s WACC.
E. A reduction in the risk level of a firm will tend to decrease the firm’s WACC.

E. A reduction in the risk level of a firm will tend to decrease the firm’s WACC.

116. Aaron’s Rentals has 58,000 shares of common stock outstanding at a market price of $36 a share. The common stock just paid a $1.64 annual dividend and has a dividend growth rate of 2.8 percent. There are 12,000 shares of 6 percent preferred stock outstanding at a market price of $51 a share. The preferred stock has a par value of $100. The outstanding bonds mature in 17 years, have a total face value of $750,000, a face value per bond of $1,000, and a market price of $1,011 each. The bonds pay 8 percent interest, semiannually. The tax rate is 34 percent. What is the firm’s weighted average cost of capital? .
A. 9.97 percent.
B. 8.68 percent.
C. 10.30 percent.
D. 9.29 percent.
E. 7.74 percent.

E. 7.74 percent

117. A firm wants to create a WACC of 10.4 percent. The firm’s cost of equity is 14.5 percent and its pretax cost of debt is 8.5 percent. The tax rate is 34 percent. What does the debt-equity ratio need to be for the firm to achieve its target WACC? .
A. 0.70.
B. 0.51.
C. 0.62.
D. 0.86.
E. 0.57.

D. 0.86.

118. All else constant, the weighted average cost of capital for a risky, levered firm will decrease if: .
A. the firm’s bonds start selling at a premium rather than at a discount.
B. the market risk premium increases.
C. corporate taxes are eliminated.
D. the dividend yield on the common stock increases.
E. the firm replaces some of its debt with preferred stock.

A. the firm’s bonds start selling at a premium rather than at a discount.

119. The Cracker Barrel has a beta of 0.98, a dividend growth rate of 3.2 percent, a stock price of $33 a share, and an expected annual dividend of $1.06 per share next year. The market rate of return is 11.2 percent and the risk-free rate is 3.7 percent. What is the firm’s cost of equity? .
A. 7.74 percent.
B. 17.46 percent.
C. 9.72 percent.
D. 9.30 percent.
E. 8.73 percent.

E. 8.73 percent.

120. Stock in ABC Enterprises has a beta of 1.06. The market risk premium is 6.8 percent, and T-bills are currently yielding 3.2 percent. ABC’s most recent dividend was $1.56 per share, and dividends are expected to grow at a 4 percent annual rate indefinitely. If the stock sells for $43 a share, what is your best estimate of ABC’s cost of equity? .
A. 9.09 percent.
B. 8.82 percent.
C. 9.41 percent
D. 7.78 percent.
E. 9.69 percent.

A. 9.09 percent.

121. Healthy Snacks, Inc. has a target capital structure of 55 percent common stock, 5 percent preferred stock, and 40 percent debt. Its cost of equity is 14.3 percent, the cost of preferred stock is 8.9 percent, and the pretax cost of debt is 8.1 percent. What is the company’s WACC if the applicable tax rate is 35 percent? .
A. 10.83 percent.
B. 10.34 percent.
C. 9.61 percent.
D. 9.29 percent.
E. 10.43 percent.

E. 10.43 percent.

122. USA Manufacturing issued 30-year, 8.5 percent semiannual bonds 6 years ago. The bonds currently sell at 101 percent of face value. What is the firm’s aftertax cost of debt if the tax rate is 30 percent? .
A. 6.59 percent.
B. 5.76 percent.
C. 5.62 percent.
D. 8.40 percent.
E. 5.88 percent.

E. 5.88 percent.

123. A firm has a return on equity of 12.4 percent according to the dividend growth model and a return of 18.7 percent according to the capital asset pricing model. The market rate of return is 13.5 percent. What rate should the firm use as the cost of equity when computing the firm’s weighted average cost of capital (WACC)? .
A. 13.5 percent.
B. The arithmetic average of 12.4 percent, 13.5 percent, and 18.7 percent.
C. 12.4 percent because it is lower than 18.7 percent.
D. The arithmetic average of 12.4 percent and 18.7 percent.
E. 18.7 percent because it is higher than 12.4 percent.

D. The arithmetic average of 12.4 percent and 18.7 percent.

124. Titans, Inc. has 6 percent bonds outstanding that mature in 14 years. The bonds pay interest semiannually and have a face value of $1,000. Currently, the bonds are selling for $993 each. What is the firm’s pretax cost of debt? .
A. 6.08 percent.
B. 5.97 percent.
C. 6.40 percent.
D. 6.14 percent.
E. 6 31 percent.

A. 6.08 percent.

125. Madison Square Stores has a $20 million bond issue outstanding that currently has a market value of $18.6 million. The bonds mature in 6.5 years and pay semiannual interest payments of $35 each. What is the firm’s pretax cost of debt? .
A. 7.58 percent.
B. 7.74 percent.
C. 8.42 percent.
D. 4.21 percent.
E. 7.80 percent.

C. 8.42 percent.

126. Ted is trying to decide what cost of capital he should assign to a project. Which one of the following should be his primary consideration in this decision? .
A. Use, or lack, or preferred stock to finance the project.
B. Mix of funds used to finance the project.
C. Amount of debt used to finance the project.
D. Risk level of the project.
E. Length of the project’s life.

D. Risk level of the project.

127. The 7.5 percent preferred stock of Rock Bottom Floors is selling for $60 a share. What is the firm’s cost of preferred stock if the tax rate is 35 percent and the par value per share is $100? .
A. 13.79 percent.
B. 14.14 percent.
C. 12.50 percent.
D. 8.13 percent.
E. 7.50 percent.

C. 12.50 percent.

128. Which one of the following statements is correct? Assume the pretax cost of debt is less than the cost of equity.
A. A firm may change its capital structure if the government changes its tax policies.
B. A decrease in the dividend growth rate increases the cost of equity.
C. A decrease in the systematic risk of a firm will increase the firm’s cost of capital.
D. A decrease in a firm’s debt-equity ratio will decrease the firm’s cost of capital.
E. The cost of preferred stock decreases when the tax rate increases.

A. A firm may change its capital structure if the government changes its tax policies.

129. Tennessee Valley Antiques would like to issue new equity shares if its cost of equity declines to 10.5 percent. The company pays a constant annual dividend of $1.80 per share. What does the market price of the stock need to be for the firm to issue the new shares? .
A. $14.83.
B. $18.80.
C. $17.92.
D. $17.14.
E. $14.48.

D. $17.14.

130. Orchard Farms has a pretax cost of debt of 7.68 percent and a cost of equity of 15.2 percent. The firm uses the subjective approach to determine project discount rates. Currently, the firm is considering a project to which it has assigned an adjustment factor of -0.5 percent. The firm’s tax rate is 34 percent and its debt-equity ratio is 0.45. The project has an initial cost of $4.3 million and produces cash inflows of $1.27 million a year for 5 years. What is the net present value of the project?.
A. $628,721
B. $514,370.
C. $328,895
D. $561,027
E. $121,619

C. $328,895

131. The 7.5 percent preferred stock of Home Town Brewers is selling for $45 a share. What is the firm’s cost of preferred stock if the tax rate is 35 percent and the par value per share is $100? .
A. 16.52 percent.
B. 7.50 percent.
C. 16.17 percent.
D. 15.92 percent.
E. 16.67 percent.

E. 16.67 percent.

132. International Exchange has three divisions: A, B, and C. Division A has the least risk and Division C has the most risk. The firm has an aftertax cost of debt of 6.1 percent and a cost of equity of 14.3 percent. The firm is financed with 35 percent debt and 65 percent equity. Division A’s projects are assigned a discount rate that is 3 percent less than the firm’s weighted average cost of capital. What is the discount rate applicable to Division A? .
A. 9.48 percent.
B. 13.43 percent.
C. 8.27 percent.
D. 8.44 percent.
E. 7.98 percent.

D. 8.44 percent.

133. Farm Equipment, Inc. announced this morning that its next annual dividend will be decreased to $1.80 a share and that all future dividends will be decreased by an additional 1.5 percent annually. What is the current value per share of this stock if the required return is 16.5 percent? .
A. $8.
B. $16.
C. $12.
D. $10.
E. $14.

D. $10.

134. Kurt, who is a divisional manager, continually brags that his division’s required return for its projects is 1 percent lower than the return required for any other division of the firm. Which one of the following most likely contributes the most to the lower rate requirement for Kurt’s division? .
A. Kurt tends to underestimate the variable costs of his projects.
B. Kurt’s division is less risky than the other divisions.
C. Kurt has the most efficiently managed division.
D. Kurt’s projects are generally financed with debt while the other divisions’ projects are financed with equity.
E. Kurt tends to overestimate the projected cash inflows on his projects.

B. Kurt’s division is less risky than the other divisions.

135. Which one of the following is the equity risk arising from the daily operations of a firm? .
A. Strategic Risk
B. Financial Risk
C. Liquidity Risk
D. Industry Risk
E. Business Risk

E. Business Risk

136. Paying interest reduces the taxes owed by a firm. Which one of the following terms applies to this relationship? .
A. Static theory of interest rates.
B. M&M Proposition I.
C. Financial risk.
D. Interest tax shield.
E. Homemade leverage.

D. Interest tax shield.

137. Which one of the following is the theory that a firm should borrow up to the point where the additional tax benefit from an extra dollar of debt equals the additional costs associated with financial distress from that additional debt? .
A. M&M Proposition I, with taxes.
B. M&M Proposition II, with taxes.
C. M&M Proposition I, without taxes.
D. Homemade leverage proposition.
E. Static theory of capital structure

E. Static theory of capital structure

138. Which one of the following best defines legal bankruptcy? .
A. Negotiating new payment terms with a firm’s creditors.
B. A temporary technical insolvency.
C. A legal proceeding for liquidating or reorganizing a business.
D. The internal process of revising the capital structure of a firm.
E. The failure of a firm to meet its financial obligations in a timely manner.

C. A legal proceeding for liquidating or reorganizing a business.

139. In the process of liquidation, some types of claims receive preference over other claims. Which one of the following determines which type of claim is paid first? .
A. Technical insolvency definition.
B. Absolute priority rule.
C. Accounting insolvency definition.
D. Chapter 7 of the Federal Bankruptcy Reform Act of 1978.
E. Securities and Exchange Commission

B. Absolute priority rule.

140. Assume you are comparing two firms that are identical in every aspect, except one is levered and one is unlevered. Which one of the following statements is correct regarding these two firms? .
A. The levered firm has higher EPS (earnings per share) than the unlevered firm at the break-even point.
B. The levered firm will have higher EPS than the unlevered firm at all levels of EBIT.
C. The unlevered firm will have higher EPS than the levered firm at relatively high levels of EBIT.
D. The EPS for the unlevered firm will always exceed those of the levered firm.
E. The unlevered firm will have higher EPS at relatively low levels of EBIT.

141. The level of financial risk to which a firm is exposed is dependent on the firm’s:.
A. tax rate.
B. debt-equity ratio.
C. return on assets.
D. level of earnings before interest and taxes.
E. operation level of risk.

B. debt-equity ratio.

142. Which one of the following is an example of a direct bankruptcy cost?.
A. Operating at a debt-equity ratio that is less than the optimal ratio.
B. Reducing the dividend payout ratio as a means of increasing a firm’s equity.
C. Forgoing a positive net present value project to conserve current cash.
D. Incurring legal fees for the preparation of bankruptcy filings.
E. Losing a key customer due to concerns over a firm’s financial viability.

D. Incurring legal fees for the preparation of bankruptcy filings.

143. Christmas Ornaments, Inc. is an all-equity firm with a total market value of $386,000 and 15,000 shares of stock outstanding. Management is considering issuing $75,000 of debt at an interest rate of 8 percent and using the proceeds on a stock repurchase. As an all-equity firm, management believes the earnings before interest and taxes (EBIT) will be $31,000 if the economy is normal, $12,000 if it is in a recession, and $37,000 if the economy booms. Ignore taxes. What will the EPS be if the economy falls into a recession and the firm maintains its all-equity status? .
A. $0.78.
B. $0.80.
C. $1.21.
D. $1.67.
E. $2.07.

B. $0.80.

144. Northern Wood Products is an all-equity firm with 16,000 shares of stock outstanding and a total market value of $352,000. Based on its current capital structure, the firm is expected to have earnings before interest and taxes of $26,000 if the economy is normal, $3,000 if the economy is in a recession, and $33,000 if the economy booms. Ignore taxes. Management is considering issuing $88,000 of debt with a 6 percent coupon rate. If the firm issues the debt, the proceeds will be used to repurchase stock. What will the earnings per share be if the debt is issued and the economy is in a recession? .
A. -$0.27.
B. -$0.19.
C. $0.03
D. $0.26
E. $0.31.

B. -$0.19.

145. Ernst Electrical has 9,000 shares of stock outstanding and no debt. The new CFO is considering issuing $80,000 of debt and using the proceeds to retire 1,500 shares of stock. The coupon rate on the debt is 7.5 percent. What is the break-even level of earnings before interest and taxes between these two capital structure options? .
A. $18,500.
B. $21,000.
C. $24,000.
D. $32,500.
E. $36,000.

E. $36,000.

146. Weston Mines has a cost of equity of 20.8 percent, a pretax cost of debt of 9.4 percent, and a return on assets of 17.1 percent. Ignore taxes. What is the debt-equity ratio? .
A. 0.39.
B. 0.41.
C. 0.48.
D. 0.56.
E. 0.62.

C. 0.48.

147. Granny’s Home Remedy has a $30 million bond issue outstanding with a coupon rate of 7.75 percent and a current yield of 7.67 percent. What is the present value of the tax shield if the tax rate is 34 percent? .
A. $632,400
B. $625,872
C. $1.20 million.
D. $8.16 million.
E. $10.2 million.

E. $10.2 million.

148. Forbidden Fruit Extracts expects its earnings before interest and taxes to be $325,000 a year forever. Currently, the firm has no debt. The cost of equity is 16.3 percent and the tax rate is 35 percent. The company is in the process of issuing $2 million of bonds at par that carry a 6.5 percent annual coupon. What is the unlevered value of the firm? .
A. $371,429
B. $431,971
C. $747,485
D. $949,325
E. $1,296.012

E. $1,296.012

149. Kline Construction is an all-equity firm that has projected perpetual earnings before interest and taxes of $879,000. The current cost of equity is 18.3 percent and the tax rate is 34 percent. The company is in the process of issuing $6.2 million of 8.5 percent annual coupon bonds at par. What is the levered value of the firm? .
A. $5,278,164.
B. $5,541,085.
C. $6,422,225.
D. $6,713,185.
E. $7,385,695.

A. $5,278,164.

150. Great Lakes Shipping is an all-equity firm with anticipated earnings before interest and taxes of $439,000 annually forever. The present cost of equity is 16.4 percent. Currently, the firm has no debt but is considering borrowing $1.25 million at 8.5 percent interest. The tax rate is 36 percent. What is the value of the levered firm? .
A. $2,163,171.
B. $2,406,519.
C. $2,588,547.
D. $2,666,667.
E. $2,818,181

A. $2,163,171.

151. Roller Coaster’s has a cost of equity of 15.4 percent, a return on assets of 11.3 percent, and a cost of debt of 7.3 percent. There are no taxes. What is the firm’s weighted average cost of capital? .
A. 7.30 percent.
B. 11.20 percent.
C. 12.97 percent.
D. 15.40 percent.
E. Cannot be determined from the information provided.

B. 11.20 percent.

152. A firm has a weighted average cost of capital of 11.68 percent and a cost of equity of 15.5 percent. The debt-equity ratio is 0.65. There are no taxes. What is the firm’s cost of debt? .
A. 5.80 percent.
B. 6.27 percent.
C. 6.44 percent.
D. 7.23 percent.
E. 7.81 percent.

A. 5.80 percent.

153. Delta Mowers has a debt-equity ratio of 1.2. Its WACC is 10.1 percent, and its cost of debt is 7.5 percent. There is no corporate tax. What is the firm’s cost of equity capital? .
A. 12.60 percent.
B. 13.22 percent.
C. 13.83 percent.
D. 14.29 percent.
E. 14.80 percent.

B. 13.22 percent.

154. The Piano Movers can borrow at 7.5 percent. The firm currently has no debt, and the cost of equity is 16 percent. The current value of the firm is $540,000. What will the value be if the firm borrows $160,000 and uses the proceeds to repurchase shares? The corporate tax rate is 40 percent.
A. $528,000
B. $540,000.
C. $552,000.
D. $571,000.
E. $604,000.

E. $604,000.

155. Kyle Electric has three positive net present value opportunities. Unfortunately, the firm has not been able to find financing for any of these projects. Which one of the following terms best describes the firm’s situation? .
A. Contingency planning.
B. Sensitivity analysis.
C. Soft rationing.
D. Sunk cost.
E. Capital rationing.

E. Capital rationing.

156. Rock Haven has a proposed project that will generate sales of 1,680 units annually at a selling price of $22 each. The fixed costs are $12,700 and the variable costs per unit are $5.95. The project requires $28,000 of fixed assets that will be depreciated on a straight-line basis to a zero book value over the four-year life of the project. The salvage value of the fixed assets is $6,900 and the tax rate is 34 percent. What is the operating cash flow for year 4? .
A. $12,417.
B. $11,794.
C. $16,971.
D. $16,348.
E. $14,258.

B. $11,794.

157. The opportunities that a manager has to modify a project once it has started are called: .
A. scenario adjustments.
B. restructuring options.
C. managerial options.
D. erosion control measures.
E. sensitivity choices.

C. managerial options.

158. A cost that should be ignored when evaluating a project because that cost has already been incurred and cannot be recouped is referred to as which type of cost? .
A. Fixed.
B. Variable.
C. Forgotten.
D. Opportunity.
E. Sunk.

E. Sunk.

Hunter’s Lodge purchased $578,000 of equipment four years ago. The equipment is seven-year MACRS property. The firm is selling this equipment today for $199,500. What is the aftertax cash flow from this sale if the tax rate is 35 percent? The MACRS allowance percentages are as follows, commencing with year 1: 14.29, 24.49, 17.49, 12.49, 8.93, 8.92, 8.93, and 4.46 percent.
A. $209,740.81.
B. $198,410.18.
C. $192,873.52
D. $216,610.81.
E. $153,869.81.

158,114.81?

A project has annual depreciation of $16,200, costs of $87,100, and sales of $123,000. The applicable tax rate is 40 percent. What is the operating cash flow according to the tax shield approach? .
A. $29,878.
B. $28,020.
C. $27,458.
D. $27,667.
E. $21,540.

B. $28,020.

Six years ago, China Exporters paid cash for a new packaging machine that cost $287,000. Three years ago, the firm spent $3,900 on repairs and modifications to the machine. The machine is now fully depreciated and has just sat idly in a back corner of the shop for the past seven months. The estimated value of the machine today is $125,500. The firm is considering using this machine in a new project. If it does so, what value should be assigned to this machine and included in the initial costs of the new project? .
A. $3,900
B. $143,500
C. $0
D. $125,500
E. $127,400

D. $125,500

A cost-cutting project will decrease costs by $58,500 a year. The annual depreciation on the project’s fixed assets will be $10,300 and the tax rate is 34 percent. What is the amount of the change in the firm’s operating cash flow resulting from this project? .
A. $25,805. NO
B. $24,552. NO
C. $42,112.
D. $29,791. NO
E. $38,610.

Any changes to a firm’s projected future cash flows that are caused by adding a new project are referred to as which one of the following? .
A. Deviated projections.
B. Eroded cash flows.
C. Directly impacted flows.
D. Incremental cash flows.
E. Assumed flows.

D. Incremental cash flows.

Valley Forge and Metal purchased a truck five years ago for local deliveries. Which one of the following costs related to this truck is the best example of a sunk cost? Assume the truck has a usable life of eight years.
A. Money spent last month repairing a damaged front fender.
B. New tires that will be purchased this winter.
C. Cost for a truck driver for the remainder of the truck’s useful life.
D. Engine tune-up that is scheduled for this afternoon.
E. Costs of repairs needed so the truck can pass inspection next month.

A. Money spent last month repairing a damaged front fender.

Assume a firm has positive net earnings. The operating cash flow of this firm: .
A. ignores both depreciation and taxes.
B. is equal to net income minus depreciation.
C. is unaffected by the depreciation expense.
D. increases when tax rates decrease.
E. must be negative.

D. increases when tax rates decrease.

Scenario analysis asks questions such as: .
A. How will the operating cash flow change if the depreciation method is changed?.
B. What is the best outcome that should reasonably be expected?.
C. How much will a $1 increase in the variable cost per unit change the net present value?.
D. How will changing the number of units sold affect the outcome of this project?.
E. Will the net present value increase or decrease if the quantity sold increases by 100 units?.

B. What is the best outcome that should reasonably be expected?.

A project has an initial requirement of $261,000 for fixed assets and $27,000 for net working capital. The fixed assets will be depreciated to a zero book value over the four-year life of the project and have an estimated salvage value of $78,000. All of the net working capital will be recouped at the end of the project. The annual operating cash flow is $96,200 and the discount rate is 13 percent. What is the project’s net present value if the tax rate is 35 percent? .
A. $45,799.
B. $47,919.
C. $47,880.
D. $43,333.
E. $42,011.

A. $45,799.

Mike’s Fish Market is implementing a project that will initially increase accounts payable by $4,600, increase inventory by $4,800, and decrease accounts receivable by $800. All net working capital will be recouped when the project terminates. What is the cash flow related to the net working capital for the last year of the project? .
A. -$2,000
B. $2,000
C. -$600
D. $200
E. -$400

C. -$600

One year ago, you purchased a 5 percent coupon bond with a face value of $1,000 when it was selling for 101.2 percent of par. Today, you sold this bond for 99.8 percent of par. What is your total dollar return on this investment? .
A. $36
B. $74
C. $82
D. $64
E. $60

A. $36

You own a portfolio that has $1,900 invested in Stock A and $2,700 invested in Stock B. If the expected returns on these stocks are 9 percent and 15 percent, respectively, what is the expected return on the portfolio? .
A. 11.96 percent
B. 12.52 percent
C. 11.14 percent
D. 13.07 percent
E. 10.57 percent

B. 12.52 percent $1,900 multiply by (1.09) = $2071 $2,700 multiply by 1.15 = $3105 Ending portfolio balance= 2071+3105 = $5176 Beginning balance= 1,900+$2,700 = $4600 Ending balance/ Beginning 5176/4600= 1.1252-1= .1252 = 12.52% is expected return on portfolio

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