# rca is considering two independent projects, x and y.

Question 1

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RCA is considering two independent projects, X and Y. Both projects have a cost of capital of 14%. The cash flows that the projects will produce are:

Year
0
1
2
3

Project X
\$(9,000)
4,000
4,000
4,000

Project Y
\$(10,334)
3,000
5,000
6,000

RCA uses the IRR method for project selection. Based on the above data, RCA should accept:

a. Both projects

b. Project X, but not Project Y

c. Project Y, but not Project X

d. Neither project

.

Question 2

Sibling Company’s common stock has a beta of 1.40. If the risk-free rate of return is 7% and the market offers a premium of 8% over the risk free rate, what is the expected return on Sibling’s stock?

a. 8.4%

b. 11.2%

c. 14.4%

d. 18.2%

.

Question 3

Which of the following investors incurs the least risk?

a. bondholders

b. preferred stockholders

c. common stockholders

d. all of the above bear equal risk

.

Question 4

Castle Corp. generated \$2 million in operating profits. The firm’s corporate tax rate was 40%. If the WACC was 12%, what was the value of the firm?

a. \$6.7 million

b. \$10 million

c. \$12.3 million

d. \$16.7 million

.

Question 5

If the market price of a bond increases, then:

a. the yield to maturity decreases

b. the coupon rate decreases

c. the yield to maturity increases

d. none of the above

.

Question 6

The Acme Company is analyzing a project that has a cost of capital of 10%. The project’s estimated cost is \$200,000. The cash flows that the project is expected to generate are as follows.

Year
1
2
3
4
5

Cash flow
\$75,000
\$85,000
\$95,000
\$65,000
\$15,000

The discounted payback period for this project is:

a. 2.42 years

b. 2.86 years

c. 3 years

d. 3.72 years

.

Question 7

Metals, Inc. has \$2,575,000 of debt, \$550,000 of preferred stock, and \$18,125,000 of common stock. The after-tax cost of debt is 5.25%, preferred stock has a required rate of return of 6.35%, and common stock has a required rate of return of 14.05%. What is Metals’ WACC?

a. 4.50%

b. 8.33%

c. 10.84%

d. 12.78%

.

Question 8

Wannabe a Brave, Inc. (WaB) is considering the purchase of a new machine which is expected to increase EBITDA by \$5,000 annually. Due to this increase, WaB expects that its working capital will increase \$3,000 for the project. The company will use the straight-line method to depreciate the \$20,000 purchase price over the project’s 5 year economic life. The salvage value will be zero. The firm has a marginal tax rate of 34 percent and a cost of capital of 12 percent.

The machine’s after-tax operating cash flows for years 1-5 are _________.

a. \$10,000

b. \$4,660

c. \$5,980

d. \$1,980

.

Question 9

RRR Co. has a debt ratio of 45%. What is its Debt-to-Equity ratio?

a. 45%

b. 55%

c. 82%

d. 122%

.

Question 10

A stock dividend and a stock split are similar in that _____.

a. cash is paid out and the number of shares outstanding increases

b. no cash is paid out and the number of shares outstanding increases

c. both changes affect only the common stock account

d. cash is paid out and the only other effect is on the retained earnings account

e. they are totally dissimilar

.

Question 11

Wannabe a Brave, Inc. (WaB) is considering the purchase of a new machine which is expected to increase EBITDA by \$5,000 annually. Due to this increase, WaB expects that its working capital will increase \$3,000 for the project. The company will use the straight-line method to depreciate the \$20,000 purchase price over the project’s 5 year economic life. The salvage value will be zero. The firm has a marginal tax rate of 34 percent and a cost of capital of 12 percent.

The machine’s initial cash outlay is ________.

a. \$23,000

b. \$21,000

c. \$20,000

d. \$17,000

.

Question 12

Katie’s Chocolates imports raw chocolate from Brazil. The current cost of chocolate in the spot market is \$2.38 per pound. The company’s total imports are 200,000 pounds per year. What would the cost savings be to the company from hedging, at the current spot rate, this year’s purchases if chocolate goes up in price to \$3.00 per pound?

a. \$124,000

b. \$200,000

c. \$476,000

d. \$600,000

.

Question 13

The intrinsic (exercise) value of a put option equals _____.

a. exercise price – stock price

b. stock price – exercise price

c. call premium – (exercise price – stock price)

d. put premium – (stock price – exercise price)

.

Question 14

A corporation with surplus cash flows may use the cash flows to:

a. pay special dividends

b. repurchase shares

c. pay interest

d. all of the above

.

Question 15

The optimal capital structure is

a. the mix of funds used by the firm in a manner that will maximize the firm’s common stock price

b. the mix of all items that appear on the right-hand side of the company’s balance sheet

c. the mix of funds that will minimize the firm’s beta

d. the mix of securities that will maximize the firm’s EPS

.

Question 16

An investor would buy a _____ if she believes that the price of the underlying stock will fall in the near future.

a. call option

b. convertible bond

c. put option

d. futures contract

.
Question 17

Last year, the sales for the Writing Room Stationery Company were \$20 million. The ratios for several balance sheet items relative to sales were calculated as follows:

Cash

Accounts Receivable

Inventory
Net Fixed Assets

Accounts Payable

Notes Payable

Other Accruals

Net Income

5%
15%
20%
50%
20%
10%
5%
8.5%

The firm wishes to maintain its 25% payout ratio. If sales were to increase 5%, what would the Additional Funds Needed be?

a. \$203,750

b. -\$725,000

c. -\$788,750

d. -\$688,750

.

Question 18

Villa Pizza had sales in 2012 of \$850,000. It expects sales to increase 10% this next year. The firm is operating at full capacity. If Asset/Sales = 55%, Liabilities/Sales = 20%, Profit Margin = 12% and the POR = 50%, what would be the Additional Funds Needed?

a. -\$26,350

b. \$24,650

c. \$58,650

d. \$246,500

.

Question 19

Target-Mart is planning a new store in Greenwich. The company will lease the needed space for 15 years. Equipment and fixtures for the store will cost \$2,500,000 and will be depreciated totally using the straight-line depreciation method. In addition, inventories valued at \$500,000 will also be needed to stock the store at the current time (before opening). Sales are expected to be \$5 million each year. Operating expenses, ignoring depreciation, will be \$2,500,000 each year. The firm will maintain the same inventory levels, and liquidate the inventory at the end of the 15-year period. The corporate tax rate is 34%. The WACC for Target-Mart is 11.75%.

What is the MIRR of this project?

a. 22.5%

b. 30.9%

c. 35.7%

d. 56.8%

.

Question 20

Speedy Growth Profitable Tech Company’s zero dividend policy may be explained by _____.

a. a dividend payment would indicate no more positive investment opportunities

b. Speedy has generated a greater return to shareholders than they can earn on the dividend

c. shareholders prefer growth and capital gains over dividends

d. all of the above

e. none of the above

.

Question 21

Which of the following statements regarding capital budgeting is most accurate?

a. The higher the discounted payback period, the higher a project should be ranked.

b. A project that is expected to generate a negative NPV will produce an IRR that is greater than the cost of capital required to justify the investment.

c. When analyzing two independent projects, the IRR method will produce the same decision that is obtained from evaluating projects using the NPV method.

d. The Profitability Index (PI) is a better method for ranking projects than the Payback Period (PBP) because PI used cash flows and PBP doesn’t.

.

Question 22

Healy, Inc. currently has a beta of 1.25 and a debt-equity ratio of 1. The corporate tax rate is 35%. If the company increases debt so that its debt-equity ratio is 1.75, what would the resulting beta be?

a. 0.76

b. 1.25

c. 1.62

d. 1.75

.

Question 23

A project with a WACC of 10% has a net present value of -\$175. The internal rate of return for this project will be:

a. Lower than 10%

b. Higher than 10%

c. Equal to 10%

d. Cannot be determined with the information given

.

Question 24

The South Bay Company manufactures computer chips for use in consumer electronics that are built to the specifications of major brand manufacturers. Company management is considering investing in a project to develop and produce its own line of electronic music storage and playback devices based on its own revolutionary and untested chip design. In analyzing the NPV of this project, a financial analyst should use ___.

a. the firm’s weighted average cost of capital as the discount rate

b. a discount rate that is higher than the firm’s WACC to reflect the additional risk of this project

c. very conservative estimates for the estimated cash flows and discount them at a rate that is lower than the firm’s WACC to reflect the additional risk of this project

d. the leveraged free cash flows of the project discounted at a higher risk-adjusted WACC

.

Question 25

If dividends are taxed, then investors in _____ tax brackets will tend to prefer high dividend payout stocks.

a. high

b. average

c. low

d. cannot tell from the information provided

.

Question 26

A company estimates that an average-risk project has a WACC of 9%, a below-average risk project has a 7% cost of capital, and an above-average risk project has an 11% cost of capital. Which of the following projects should the company accept?

a. Project A which has average risk and an IRR of 9.5%

b. Project B which has below-average risk and an IRR of 6.35%

c. Project C which has above-average risk and an IRR of 10.5%

d. All of the projects are acceptable

.

Question 27

Target-Mart is planning a new store in Greenwich. The company will lease the needed space for 15 years. Equipment and fixtures for the store will cost \$2,500,000 and will be depreciated totally using the straight-line depreciation method. In addition, inventories valued at \$500,000 will also be needed to stock the store at the current time (before opening). Sales are expected to be \$5 million each year. Operating expenses, ignoring depreciation, will be \$2,500,000 each year. The firm will maintain the same inventory levels, and liquidate the inventory at the end of the 15-year period. The corporate tax rate is 34%. The WACC for Target-Mart is 11.75%.

What is the NPV of this project?

a. \$8,256,937

b. \$8,829,179

c. \$8,389,579

d. \$8,875,198

.

Question 28

Treasury bonds currently earn 5.8%. The expected market rate of return is 13.4%. The corporate tax rate is 40%. Given the following information for PDG Corporation, what is the debt ratio that maximizes the firm’s value?

wd
we
D/E
rd
b
rs
WACC

.20
.80

8%
1.2
14.92%
12.9%

.40
.60

9%

.60
.40

10%

.80
.20

12%

a. 20%

b. 40%

c. 60%

d. 80%

.

Question 29

Why do common stocks tend to grow in value over long periods of time?

a. the fact that almost all shares of common stock are convertible

b. the growth rate in earnings per share

c. the growth in the number of shareholders

d. all of the above

.

Question 30

An analyst is interested in using the Black-Scholes model to value call options on the stock of QU, Inc. The analyst has accumulated the following information:

Stock price
\$15

Exercise price
\$18

Time until maturity
6 months

Standard deviation of the stock
20%

Risk free rate of return
4%

What is the value of the call option?

a. \$0.43

b. \$0.14

c. \$3.38

d. \$3.00

.

Question 31

What type of risk is a direct result of a firm’s capital structure decision?

b. financial risk

c. systematic risk

d. interest rate risk

.

Question 32

An analyst is interested in using the Black-Scholes model to value put options on the stock of QU, Inc. The analyst has accumulated the following information:

Stock price
\$40

Strike price
\$40

Time until maturity
6 months

Standard deviation of the stock
12%

Risk free rate of return
16%

Using the Black-Scholes model, what is the value of a put option?

a. \$1.94

b. \$0.30

c. \$3.76

d. \$3.38

e. \$2.12

.

Question 33

A discretionary form of financing would be:

a. Notes payable

b. Accounts payable

c. Accrued expenses

d. None of the above

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