Corporate Finance Part 2

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1.

Coupon rate = 7 percent

Average tax rate = 32%

Price of common stock = $80

Price of preferred stock = $50

Bond yield risk premium = 7%

Return of the market = 12%

Marginal tax rate = 35%

Common stock dividend (Do) = $6

Preferred stock dividend (Do) = $4

Growth rate of common stock dividend = 6%

Risk-free rate of return = 6%

Beta = 1.2

According to the information given, what is the cost of equity using the capital asset pricing model?

A. 14.4 percent

B. 12 percent

C. 13.95 percent

D. 13.2 percent

2. A firm should reject an investment if the internal rate of return on the investment is

A. less than the interest rate.

B. greater than the interest rate.

C. less than the cost of capital.

D. greater than the cost of capital.

3. Which of the following statements about retained earnings is correct?

A. Retained earnings are the firm’s cheapest source of funds.

B. Retained earnings have the same cost as new shares of stock.

C. Retained earnings are cheaper than the cost of new shares.

D. Retained earnings have no cost.

4. The internal rate of return and net present value methods of capital budgeting assume that the cash flows are reinvested at the

A. cost of capital for NPV and the internal rate of return for IRR.

B. cost of capital for IRR and the internal rate of return for NPV.

C. internal rate of return.

D. cost of capital.

5. NPV may be preferred to IRR because

A. NPV excludes salvage value.

B. IRR makes more conservative assumptions concerning reinvesting.

C. NPV makes more conservative assumptions concerning reinvesting.

D. IRR excludes salvage value.

6. A firm has two investment opportunities. Each investment costs $2,000, and the firm’s cost of capital is

8 percent. The cash flows of each investment are as follows:

Cash Flow of Investment A

Year 1: $1800

Year 2: $600

Year 3: $500

Year 4: $400

Cash Flow of Investment B

Year 1: $900

Year 2: $900

Year 3: $900

Year 4: $900

According to the information, the NPV for Investment B is

A. $1,600.

B. $2,980.

C. $980.

D. $3,600.

7. Which of the following statements about the cost of debt is correct?

A. The cost of debt is greater than the cost of preferred stock.

B. The cost of debt is greater than the cost of equity.

C. The cost of debt is less than the cost of equity.

D. The cost of debt is equal to the firm’s interest rate.

8.

Coupon rate = 7 percent

Average tax rate = 32%

Price of common stock = $80

Price of preferred stock = $50

Bond yield risk premium = 7%

Return of the market = 12%

Marginal tax rate = 35%

Common stock dividend (Do) = $6

Preferred stock dividend (Do) = $4

Growth rate of common stock dividend = 6%

Risk-free rate of return = 6%

Beta = 1.2

According to the information given, what is the cost of preferred stock?

A. 8 percent

B. 12 percent

C. 9 percent

D. 10 percent

9.

Coupon rate = 7 percent

Average tax rate = 32%

Price of common stock = $80

Price of preferred stock = $50

Bond yield risk premium = 7%

Return of the market = 12%

Marginal tax rate = 35%

Common stock dividend (Do) = $6

Preferred stock dividend (Do) = $4

Growth rate of common stock dividend = 6%

Risk-free rate of return = 6%

Beta = 1.2

According to the information given, what is the cost of equity using the bond yield plus risk premium

method?

A. 13.2 percent

B. 12 percent

C. 13.95 percent

D. 14 percent

10. Which of the following statements about the marginal cost of capital is correct?

A. The marginal cost of capital is a firm’s cost of debt and equity finance.

B. The marginal cost of capital refers to the cost of additional funds.

C. The marginal cost of capital declines as flotation costs alter equity financing.

D. The marginal cost of capital is constant once the optimal capital structure is determined.

11. The lower the debt ratio, the

A. lower is the use of financial leverage.

B. higher is the use of financial leverage.

C. higher are the firm’s total assets.

D. lower are the firm’s total assets.

12. If the net present values of two mutually exclusive investments are positive, a firm should select

A. both investments.

B. the investment with the higher net present value.

C. the investment with the higher present value.

D. neither investment.

13. A firm should make an investment if the present value of the cash inflows on the investment is

A. greater than zero.

B. less than zero.

C. greater than the cost of the investment.

D. less than the cost of the investment.

14. If the internal rates of return of two mutually exclusive investments exceed the firm’s cost of capital,

the firm should make

A. both investments.

B. the investment with the higher IRR.

C. the investment with the lower IRR.

D. neither investment.

15.

Coupon rate = 7 percent

Average tax rate = 32%

Price of common stock = $80

Price of preferred stock = $50

Bond yield risk premium = 7%

Return of the market = 12%

Marginal tax rate = 35%

Common stock dividend (Do) = $6

Preferred stock dividend (Do) = $4

Growth rate of common stock dividend = 6%

Risk-free rate of return = 6%

Beta = 1.2

According to the information given, what is the cost of equity using the expected growth method?

A. 13.95 percent

B. 14.4 percent

C. 12 percent

D. 13.2 percent

16. An increase of cost of capital will

A. increase an investment’s IRR.

B. Increase an investment’s NPV.

C. decrease an investment’s NPV.

D. decrease an investment’s IRR.

17. The net present value of an investment will be higher if

A. the cost of capital is higher.

B. there’s no salvage value.

C. the cost of the investment is lower.

D. a firm uses straight-line depreciation.

18.

Coupon rate = 7 percent

Average tax rate = 32%

Price of common stock = $80

Price of preferred stock = $50

Bond yield risk premium = 7%

Return of the market = 12%

Marginal tax rate = 35%

Common stock dividend (Do) = $6

Preferred stock dividend (Do) = $4

Growth rate of common stock dividend = 6%

Risk-free rate of return = 6%

Beta = 1.2

According to the information given, what is the cost of debt?

A. 2.45 percent

B. 7.0 percent

C. 4.55 percent

D. 6.25 percent

19. A firm has two investment opportunities. Each investment costs $2,000, and the firm’s cost of capital is

8 percent. The cash flows of each investment are as follows:

Cash Flow of Investment A

Year 1: $1800

Year 2: $600

Year 3: $500

Year 4: $400

Cash Flow of Investment B

Year 1: $900

Year 2: $900

Year 3: $900

Year 4: $900

Based on the information, if the investments are independent, the firm should select

A. all investments with an IRR that’s less than 8 percent.

B. all investments with an IRR that’s greater than 8 percent.

C. only one investment if the IRR is greater than 8 percent.

D. the higher IRR investment.

20. Which of the following statements best explains why a rising ratio of debt-to-total assets increases the

cost of debt?

A. As total assets decline in relation to a stable debt level, equity declines.

B. If debt remains constant while the ratio increases, rising assets must be finance with more expensive equity financing.

C. As the ratio increases, creditors require higher interest rates to compensate them for higher default risk.

D. As debt increases, the contribution of more expensive equity financing decreases.

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