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1. a. b. c. d.

A bank that helps firms to acquire external capital is called a CH11 commercial bank savings bank investment bank credit union

ANS: C 2. a. b. c. d. Which of the following should not be considered a benefit to a firm that is issuing an IPO? CH11 access to additional capital provide an alternative to cash for future acquisitions have another source, other than cash for executive compensation limits the founders ownership dilution

ANS: D 3. If you are an investor that owns shares in a firm that you believe is about to issue additional equity, then you would expect the price of your shares to CH11 a. increase. b. be unaffected. c. decrease. d. all three of the above could happen with equal probability. ANS: C 4. Which of the following is NOT a benefit of going public for a private firm? CH11 New capital for the company. Publicly traded stock for acquisitions Personal wealth and liquidity Low managerial cost in issuing the IPO.

a. b. c. d.

ANS: D 5. The capital budgeting process involves a. identifying potential investments and estimating the incremental cash inflows and outflows of cash associated with each investment b. analyzing and prioritizing the investments utilizing various decision criteria c. implementing and monitoring the selected investment projects d. estimating a fair rate of return on each investment given its risk e. all of the above ANS: E Gamma Electronics Gamma Electronics is considering the purchase of testing equipment that will cost $500,000 to replace old equipment. Assume the new machine will generate after-tax savings of $250,000 per year over the next four years. 6. Refer to Gamma Electronics. Whats the payback period for the investment? a. 1.8 years b. 2.0 years

c. 2.5 years d. 2.8 years ANS: B 7. Refer to Gamma Electronics. If the firm has a 15% cost of capital, whats the discount payback period of the investment? a. 1.5 years b. 2.0 years c. 2.4 years d. 2.6 years ANS: D 8. a. b. c. d. If Gamma Electronics has a 15% cost of capital, whats the NPV of the investment? $213,745 $185,865 $713,745 $500,000

ANS: A Exhibit 8-1 The cash flows associated with an investment project are as follows: Cash Flows Initial Outflow Year 1 Year 2 Year 3 Year 4

-$70,000 $20,000 $30,000 $30,000 $30,000

9. Refer to Exhibit 8-1. Whats the payback period of the project? If a firms cutoff payback period is 3 years, should it accept the project? a. 2.7 years; reject the project b. 2.7 years; accept the project c. 3.6 years; reject the project d. 3.6 years; accept the project ANS: B NPV Profile The figure below shows the NPV profile for two investment projects.

10. a. b. c. d.

Refer to NPV Profile. Whats the IRR for project 2? 12% 14% 18% Cannot tell from the given information

ANS: C 11. You are given the following information. What is the initial cash outflow? $12,000 $ 4,000 $ 3,000 $ 2,000 $ 1,000 40%

Purchase and installation of new equipment Sale price of replaced equipment Book value of replaced equipment When the new equipment is installed: Inventory increase Accounts payable increase Tax rate a. b. c. d. $9,400 $9,000 $13,000 $10,600

ANS: A 12. A machine costs $3 million and has zero salvage value. The machine qualifies under the 3-year MARCS category. Assume a discount rate of 10% and a 40% tax rate. What is the present value of depreciation tax savings associated with this machine? (MARCS tax depreciation schedule of a 3-year class asset: 33.33% in year 1, 44.45% in year 2, 14.81% in year 3, and 7.41% in year 4) a. $1,090,900 b. $1,200,000 c. $994,741

d. $998,684 ANS: D 13. a. b. c. d. Everything else being equal a higher corporate tax rate... will increase the WACC of a firm with debt and equity in its capital structure will not affect the WACC of a firm with debt in its capital structure will decrease the WACC of a firm with some debt in its capital structure will decrease the WACC of a firm with only equity in its capital structure

ANS: C Bavarian Brewhouse Capital Structure Information for Bavarian Brewhouse Debt ( in million) Preferred Stock (in million) Common Stock (in million) Total Capital Cost of debt Annual Preferred Stock Dividend Preferred Stock Market Price Common Stock Beta Risk free rate Expected return on market portfolio What is Bavarian Brewhouses cost of preferred stock? 8.00% 15.5% 10.7% 12.6% $25 $ 5 $45 $75 8% $ 2.50 $16.13 0.85 3.75% 17.55%

14. a. b. c. d.

ANS: B What is Bavarian Brewhouses cost of common equity? 10.67% 12.55% 16.23% 15.48%

15. a. b. c. d.

ANS: D 16. a. b. c. d. The uncertainty caused by the variability of a firms cash flows is called . . . financial risk business risk financial leverage none of the above

ANS: B 17. a. b. c. d. Which statement is FALSE regarding empirical evidence of capital structures? Capital structures show strong industry patterns. Economy wide leverage ratios are consistent across countries. Leverage ratios are negatively related to the cost of financial distress. Within industries, the most profitable companies borrow the least.

ANS: B 18. Which of the following statements is true? a. The use of debt may lead to financial distress and bankruptcy, thus firms that sell expensive, durable products that may have warranties and ongoing service requirements tend to use less debt. b. The use of debt may lead to financial distress and bankruptcy, thus firms that sell expensive, durable products that may have warranties and ongoing service requirements tend to use more debt. c. Companies with a large proportion of tangible assets should be more willing to use debt than firms with mostly intangible assets. d. Companies with a large proportion of tangible assets should be less willing to use debt than firms with mostly intangible assets. e. Both (a) and (c) ANS: E Stone Cold Incorporated Balance Sheet: 12/31/04 Assets Cash and Marketable Securities Accounts Receivable Inventories Total Current Assets Net plant and equipment TOTAL ASSETS Liabilities and Equity Accounts Payable Notes Payable Accruals Total Current Liabilities Long Term Bonds TOTAL DEBT Preferred Stock Common Stock Retained earnings TOTAL COMMON EQUITY TOTAL LIABILITIES AND EQUITY Income Statement: 12/31/04

2004 10 375 615 1,000 1,000 2,000 2004 60 140 110 310 754 1,064 40 130 766 896 2,000 2004

2003 80 315 415 810 870 1,680 2003 40 60 130 230 580 810 40 130 700 830 1,680 2003

Net Sales Operating Costs (excludes Dep/Amortization) EBITDA Depreciation Amortization Depreciation and Amortization EBIT Less Interest EBT Taxes (40%) NET INCOME (before Preferred Dividends) Preferred Dividends NET INCOME Common Dividends Addition to Retained Earnings

3,200 2,700 500 100 0 100 400 88 312 124.8 187.2 4 183.2 117 66.2

2,850 2,497 353 90 0 90 263 60 203 81.2 121.8 4 117.8 53 64.8

19. a. b. c. d.

Refer to Stone Cold. For 2004, what was the return on assets? 9.16% 12.40% 15.60% 20.00%

ANS: A 20. A company has sales of $1,250,000, cost of goods sold of $750,000, depreciation expenses of $250,000 and interest expenses of $55,000. If the companys tax rate is 34% and the income statement is complete, what is this firms operating cash flow? a. $183,700 b. $433,700 c. $165,000 d. $415,000 ANS: B

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