Q&A Hero

Q: Use the following information to answer the following question(s). The following data concerning Grafton Computer Peripherals' capital structure is available. $ millions Book Values Market Values Accounts Payable & Accruals $100 Short-term notes 50 50 Long-term debt 150 200 Preferred Stock 25 50 Common Stock 200 500 Total $525 $800 The percentage of preferred stock in Grafton's weighted average cost of capital is: A) 5.9%. B) 6.25%. C) 4.76%. D) 62.5%.

Q: Use the following information to answer the following question(s). The following data concerning Grafton Computer Peripherals' capital structure is available. $ millions Book Values Market Values Accounts Payable & Accruals $100 Short-term notes 50 50 Long-term debt 150 200 Preferred Stock 25 50 Common Stock 200 500 Total $525 $800 The percentage of debt in Grafton's weighted average cost of capital is: A) 38.1%. B) 25%. C) 31.25%. D) 57.14%.

Q: Use the following information to answer the following question(s). The following data concerning Grafton Computer Peripherals' capital structure is available. $ millions Book Values Market Values Accounts Payable & Accruals $100 Short-term notes 50 50 Long-term debt 150 200 Preferred Stock 25 50 Common Stock 200 500 Total $525 $800 The percentage of common stock in Grafton's weighted average cost of capital is: A) 38.1%. B) 20%. C) 6.25%. D) 62.5%.

Q: Briefly identify and describe some important uses of a firm's weighted average cost of capital.

Q: Business risk reflects the added variability in earnings available to a firm's shareholders.

Q: The firm should continue to invest in new projects up to the point where the marginal rate of return earned on a new investment equals the marginal cost of new capital.

Q: When investors increase their required rate of return, the cost of capital increases simultaneously.

Q: The weighted average cost of capital is computed using before-tax costs of each of the sources of financing that a firm uses to finance a project.

Q: The minimum rate of return necessary to attract an investor to purchase or hold a security is called the cost of capital.

Q: Which of the following is a correct formula for calculating the cost of capital? A) WACC = weighted after-tax cost of debt + weighted cost of preferred stock + weighted cost of common stock B) WACC = weighted after-tax cost of debt + weighted after-tax cost of preferred stock + weighted after-tax cost of common stock C) WACC = (after-tax cost of debt + cost of preferred stock + cost of common stock )/3 D) WACC = weighted cost of debt + weighted cost of preferred stock + weighted cost of common stock

Q: Cost of capital is: A) the coupon rate of debt. B) a minimum rate of return set by the board of directors. C) the rate of return that must be earned on additional investment if firm value is to remain unchanged. D) the average cost of the firm's assets.

Q: The cost of capital is: A) the opportunity cost of using funds to invest in new projects. B) the rate of return the firm must earn on its investments in order to satisfy the required rate of return of the firm's investors. C) the required rate of return for new capital investments which have typical or average risk. D) all of the above.

Q: Which of the following reasons causes bonds to be a less expensive form of capital for a public firm than the issuance of common stock? Bondholders: A) bear less risk than common stockholders bear. B) have prior voting rights over common stockholders. C) receive greater returns than common stockholders. D) investors pay a lower tax rate on bond interest

Q: Which of the following would NOT be considered in calculating a firm's cost of capital? A) Bonds B) Accounts payable C) Preferred Stock D) common stock

Q: Which of the following must be adjusted for the firm's tax rate when estimating the weighted average cost of capital WACC? A) Cost of common equity B) Cost of preferred stock C) Cost of debt D) All of the above

Q: A firm's capital structure consists of which of the following? A) Common stock B) Preferred stock C) Bonds D) All of the above

Q: Which of the following best describes a firm's cost of capital? A) The average yield to maturity on debt B) The average cost of the firm's assets C) The rate of return that must be earned on its investments in order to satisfy the firm's investors D) The coupon rate on preferred stock

Q: The weights used to determine the relative importance of the firm's sources of capital should reflect: A) book values in accord with generally accepted accounting principles. B) current market values for bonds, common stock, and preferred stock and book values for retained earnings. C) current market values. D) subjective adjustments for firm risk.

Q: The investor's required rate of return differs from the firm's cost of capital due to the: A) firm's beta. B) tax deductibility of interest. C) CAPM. D) time value of money.

Q: In order to maximize firm value, management should invest in new assets when cash flows from the assets are discounted at the firm's ________ and result in a positive NPV. A) cost of capital B) cost of debt used to finance the project C) rate of return on equity D) internal rate of return

Q: Why is it important to consider real options in the capital budgeting process? Give two specific examples.

Q: The NPV of a project based on forecasted cash flows is $1,000,000. There is a 40% probability that cash flows from the project will be seriously reduced because competitors will enter the market. In this case, if the company did nothing, the NPV would be ($500,000). The project can also be abandoned after 2 years and NPV will be ($100,000). What is the expected NPV of the project when the option to abandon is considered. Should the projected be accepted?

Q: Briefly explain what is meant by a real option in capital budgeting. Give 2 concrete examples.

Q: The holder of the patent on a new energy efficient, long lived light bulb that gives off a warm yellow light and does not contain mercury intends to manufacture and market it over the internet. Which of the following possibilities represent real options? A) Sell the patent to a major manufacturer after 2 or 3 years. B) Expand production and sell the product through major retailers. C) Delay the launch of the website until energy prices rise. D) All of the above.

Q: One type of real option is to delay the beginning of a project until conditions are more favorable.

Q: When evaluating projects with real options, businesses must consider the probability that the option will be exercised.

Q: Real options can be either calls, options to buy the project, or calls, options to sell the project.

Q: Which of the following is NOT a typical real option in capital budgeting? A) The option to expand the project B) The option to abandon the project C) The option to reduce the scale of a project D) The option to discount the project at a lower rate of return

Q: Tennessee Fried Chicken is evaluating a proposal to open a fast food restaurant in Westphalia. The restaurant will cost $14.5 million to open. Expected cash flows are $4 million per year for the first five years. At the end of 5 years, the government of Westphalia will either revoke TFC's permit and the restaurant will close, or renew the permit indefinitely. In that case, assume that the $4 million turns into a perpetuity. There is a 30% chance the permit will be revoked and a 70% chance it will be renewed. Compute the expected NPV of the project. Use a discount rate of 12%. A) $18.83 million B) ($.08 million) C) $13.16 million D) $9.43 million

Q: Use the following information to answer the following question(s). Tropical Soft Drinks is evaluating a proposal to install solar panels on the roof of it's factory near San Juan. The panels will cost $150,000 per set. Depending on the price of electricity and the efficiency of the panels, the project will increase operating cash flows by either $50,000 per year or $75,000 per year. The useful life of the panels is 5 years. If early results indicate savings of $75,000 per year, four additional sets of panels will be installed immediately at the same cost with the same projected savings. The probability of either outcome is 50%. Use a discount rate of 10%. What is the expected NPV of the project if the option to expand is considered. A) $355,542 B) $671,545 C) $236,924 D) $711,084

Q: Use the following information to answer the following question(s). Tropical Soft Drinks is evaluating a proposal to install solar panels on the roof of it's factory near San Juan. The panels will cost $150,000 per set. Depending on the price of electricity and the efficiency of the panels, the project will increase operating cash flows by either $50,000 per year or $75,000 per year. The useful life of the panels is 5 years. If early results indicate savings of $75,000 per year, four additional sets of panels will be installed immediately at the same cost with the same projected savings. The probability of either outcome is 50%. Use a discount rate of 10%. What is the expected NPV of the project if the option to expand is not considered. A) $39,539 B) $86,924 C) $236,924 D) $134,309

Q: Use the following information to answer the following question(s). An alternative energy project will cost $300,000. Depending on the price of electricity, the project will create after-tax savings of either $100,000 per year for 5 years or $75,000 per year for 5 years. If first year savings are only $75,000, the project can be sold at the end of the first year for $250,000. Use a discount rate of 10%. What is the expected NPV of the project if the option to abandon is considered. A) ($4,545) B) $31,694 C) $37,267 D) $63,388

Q: Use the following information to answer the following question(s). An alternative energy project will cost $300,000. Depending on the price of electricity, the project will create after-tax savings of either $100,000 per year for 5 years or $75,000 per year for 5 years. If first year savings are only $75,000, the project can be sold at the end of the first year for $250,000. Use a discount rate of 10%. What is the expected NPV of the project if the option to abandon is not considered. A) ($4,545) B) $31,694 C) $37,267 D) $63,388

Q: Use the following information to answer the following question(s). An alternative energy project will cost $300,000. Depending on the price of electricity, the project will create after-tax savings of either $100,000 per year for 5 years or $75,000 per year for 5 years. If first year savings are only $75,000, the project can be sold at the end of the first year for $250,000. Use a discount rate of 10%. What is the NPV of the project if first year savings are only $75,000 and the project is sold. A) ($4,545) B) ($15,691) C) $15,691 D) $75,000

Q: Use the following information to answer the following question(s). An alternative energy project will cost $300,000. Depending on the price of electricity, the project will create after-tax savings of either $100,000 per year for 5 years or $75,000 per year for 5 years. If first year savings are only $75,000, the project can be sold at the end of the first year for $250,000. Use a discount rate of 10%. What is the NPV of the project if first year savings are only $75,000 and the project is not sold. A) ($4,545) B) ($15,691) C) $15,691 D) $75,000

Q: Use the following information to answer the following question(s). Enrico, the owner of a pizza parlor near a large university campus, is considering opening a shop specializing in quick, inexpensive take-out meals that are low in fat and calories. He will use a vacant space adjacent to the pizza parlor. Assume that the project requires an initial cash outlay of $100,000. Finance students from the university have taken on the project as a course assignment. They believe that there is a 50% chance that the project will have modest success and return $11,000 per year for the foreseeable future (a perpetuity). On the other hand, there is a 50% chance that the project will be highly successful and produce returns of $20,000 per year in perpetuity. If the restaurant is modestly successful, Enrico will keep it open, but not expand. If it is well received, he will immediately open 2 more shops at sites close to the sprawling campus. The additional shops would have approximately the same cash flow as the first. Cash flows will be discounted at 10%. What is the expected NPV of the project with the option to expand if the probability of modest success is revised to 70% and great success to 30%? A) $310,000 B) $155,00 (no change) C) $213,000 D) $97,000

Q: Use the following information to answer the following question(s). Enrico, the owner of a pizza parlor near a large university campus, is considering opening a shop specializing in quick, inexpensive take-out meals that are low in fat and calories. He will use a vacant space adjacent to the pizza parlor. Assume that the project requires an initial cash outlay of $100,000. Finance students from the university have taken on the project as a course assignment. They believe that there is a 50% chance that the project will have modest success and return $11,000 per year for the foreseeable future (a perpetuity). On the other hand, there is a 50% chance that the project will be highly successful and produce returns of $20,000 per year in perpetuity. If the restaurant is modestly successful, Enrico will keep it open, but not expand. If it is well received, he will immediately open 2 more shops at sites close to the sprawling campus. The additional shops would have approximately the same cash flow as the first. Cash flows will be discounted at 10%. What is the expected NPV of the project with the option to expand? A) $310,000 B) $155,000 C) $110,000 D) $300,000

Q: Use the following information to answer the following question(s). Enrico, the owner of a pizza parlor near a large university campus, is considering opening a shop specializing in quick, inexpensive take-out meals that are low in fat and calories. He will use a vacant space adjacent to the pizza parlor. Assume that the project requires an initial cash outlay of $100,000. Finance students from the university have taken on the project as a course assignment. They believe that there is a 50% chance that the project will have modest success and return $11,000 per year for the foreseeable future (a perpetuity). On the other hand, there is a 50% chance that the project will be highly successful and produce returns of $20,000 per year in perpetuity. If the restaurant is modestly successful, Enrico will keep it open, but not expand. If it is well received, he will immediately open 2 more shops at sites close to the sprawling campus. The additional shops would have approximately the same cash flow as the first. Cash flows will be discounted at 10%. What is the NPV of the project if it is expanded? A) $100,000 B) $500,000 C) $300,000 D) $600,000

Q: Use the following information to answer the following question(s). Enrico, the owner of a pizza parlor near a large university campus, is considering opening a shop specializing in quick, inexpensive take-out meals that are low in fat and calories. He will use a vacant space adjacent to the pizza parlor. Assume that the project requires an initial cash outlay of $100,000. Finance students from the university have taken on the project as a course assignment. They believe that there is a 50% chance that the project will have modest success and return $11,000 per year for the foreseeable future (a perpetuity). On the other hand, there is a 50% chance that the project will be highly successful and produce returns of $20,000 per year in perpetuity. If the restaurant is modestly successful, Enrico will keep it open, but not expand. If it is well received, he will immediately open 2 more shops at sites close to the sprawling campus. The additional shops would have approximately the same cash flow as the first. Cash flows will be discounted at 10%. What is the project's NPV if success is modest and it is not expanded? A) $10,000 B) ($10,000) C) $110,000 D) The present value of a perpetual cash flow cannot be determined.

Q: Real options can have the effect of: A) increasing a project's NPV. B) reducing a project's risk. C) gaining information about future opportunities. D) all of the above.

Q: Which of the following is a real option with respect to a capital budgeting decision? A) A call option on the company's stock. B) A put option on securities sold to finance the project. C) An option to expand the scale of the project. D) An option to purchase that will be used for the manufacturing facility.

Q: Year 0 Year 0 Year 1 Year 2 Revenue $15,000 $15,000 Variable Cost ($5,000) ($5,000) Depreciation ($200) ($200) Fixed Cost ($350) ($350) Operating Income $9,450 $9,450 Taxes at 30% ($2,835) ($2,835) NOPAT $6,615 $6,615 Capital Investment ($5,753) Free Cash Flow $6,815 $6,815 NPV $6,074.69 Forecasts for project ST are shown above. Using a discount rate of 10%, the project has a positive NPV of $6,074.69. Estimate within $100 the level of sales revenue that will result in an NPV of $0.00. No other variables will change.

Q: Actual 2010 figures and forecasted 2011 figures are shown below for HEMOPath Labs Actual 2011 Forecast 2011 Sales $6,000,000 $6,480,000 Total Variable Costs 3,600,000 3,888,000 Total Fixed Costs 2,000,000 2,000,000 NOI ? ? DOL Compute Compute HEMOPath's degree of operating leverage (DOL).

Q: For a line of snowblowers sold by Arctic Equipment, fixed costs, including depreciation of $1,000,000, total $2,400,000. The snowblowers sell for $800 each. Variable costs of a snowblower are $500. Compute a. accounting break-even. b. cash break-even

Q: If the worst case scenario for a project results in an NPV of zero, the project should be accepted.

Q: Accounting break-even means that the company is able to pay its interest expense and also the dividends shareholders were expecting.

Q: Dudster company's DOL is 2. If sales increase by 10%, NOI will increase by 5%.

Q: Break-even NPV means that the expected rate of return on a project is equal to the required rate of return.

Q: Gardner Furniture Co. has calculated its degree of operating leverage as 3.5. If Gardner can increase sales revenue by 5%, net operating income should increase by: A) 15%. B) 17.5%. C) 1.43%. D) 3.5%.

Q: Chevre Imported Cheese Inc. forecasts that if sales revenue for next year is $1,250,000, net operating income will be $100,000 and if sales revenue is $1,000,000, net operating income will be $80,000. Chevre's degree of operating leverage is: A) 2. B) 10. C) .5. D) 1.

Q: Charlestown Marina's forecasts indicate that if slip rentals equal $500,000, net operating income will be $25,000 and if rentals equal $525,000, net operating income will be $37,500. What is Charletown's degree of operating leverage? A) 2 B) 10 C) .05 D) .10

Q: If Untel Inc. decides to manufacture a new generation of computer chips with a brief 2 year product life cycle, it expects to sell 1 million units each year. Variable cost per unit will be $75, fixed costs $5 million, and depreciation $3 million. The initial investment will be $22.91 million. Untel uses a discount rate of 10%; its marginal tax rate is 40%. To reach break-even NPV, UNTEL must sell the chips for at least ________ each. A) $87 B) $105 C) $100 D) $1,000

Q: Project Zeta is expected to produce after-tax cash flows $30 million in year 1, $40 million in year 2, and $50 million in year 3. If the company uses a 12% required rate of return, what is the most it can invest in this project and break even with respect to NPV? A) $69.03 million B) $94.26 million C) $1,11 million D) $120 million

Q: Miller River Light that manufactures the project will require an initial investment of $350,000. Miller River uses a 12% discount rate for capital projects of this type. What level of operating cash flows over a period of 5 years will cause the project to reach break-even NPV? A) $70,000.00 B) $97,093.41 C) $92,329.12 D) $86,690.54

Q: Brookfield Heavy Equipment is considering a project that will produce after tax cash of $40,000 per year for 5 years. The project will require an initial investment of $144,191. At what discount rate will the project reach break-even NPV? A) 8% B) 10% C) 12% D) 11.11%

Q: DNATECH has developed a hair growth treatment at a cost of $10 million. They can license the technology to another company for a period of 10 years. What is the minimum annual free cash flow they could accept in order to reach break-even NPV on this product? Use a discount rate of 8%. A) $1,490,295 B) $1,639,324 C) $1,108,000 D) $1,000,000

Q: Garcia Developers will erect a small office building at a cost of $4,500,000. They have a client who will lease the space for 5 years at a price that will produce free cash flows of $150,000 per year. For approximately how much would they need to sell the building for at the end of the 5th year to reach break-even NPV? Garcia uses a discount rate of 10% for projects of this type. A) $3,750,000 B) $5,755,936 C) $6,331,530 D) $6,964,683

Q: Net present value break-even is reached: A) after the time period when NPV finally turns from negative to positive. B) at the discount rate that produces an NPV of $0.00. C) at the level of sales over the life of the project that results in free cash flow of $0.000 for a given period. D) at the level of sales over the life of the project that results in an NPV of $0.00.

Q: Miniature Molding is planning to introduce a valve for use in medical implants. Variable costs per unit are $250. The maximum price MM could charge is $325. Fixed costs associated with this product are $20,000,000. Depreciation expense of $2,500,000 are included in fixed costs. The worst case forecast calls for sales of 240,000 valves, the best case for $290,400. Will MM reach cash break-even in the worst case scenario? A) Sales will fall short of cash break even by $8,666,667. B) The product will exactly break even. C) Sales will fall short of cash break even by $2,000,025. D) Sales will exceed cash break even by $2,166,667.

Q: Miniature Molding is planning to introduce a valve for use in medical implants. Variable costs per unit are $250. The maximum price MM could charge is $325. Fixed costs associated with this product are $20,000,000. The worst case forecast calls for sales of 240,000 valves, the best case for $290,400. Will MM reach accounting break-even in the worst case scenario? A) Sales will fall short of break even by $8,666,667. B) The product will exactly break even. C) Sales will fall short of break even by $5,000,025. D) Sales will exceed break even $58,000,000.

Q: Jake's Tree farm is evaluating a proposal to plant 5,000 ornamental trees at an initial cost of $10,000. The trees will be sold in 5 years. What is the minimum after tax cash flow from selling the trees that will allow the tree planting project to reach break even NPV? Use a discount rate of 12%. A) $12,000.00 B) $5,674.26 C) $17,623.42 D) $17,958.56

Q: In the 4th year of project M, expected revenues will be $4,750,000, variable costs will be $4,000,000, depreciation expense $180,000, and fixed cash costs $570,000. Which of the following is true? A) Accounting income equals $0.00 B) Free cash flow equals $180,000 C) Free cash flow equals 0 D) Both A and B are true.

Q: Excom Fiberoptics sell micro test tubes for biotechnology research in sets of 10,000 tubes. Fixed costs associated with the project are $2,000,000, variable cost per set is $120. Excom expects to sell 25,000 sets. What is the minimum price must it can charge and reach the accounting break-even point? A) $80 B) $120 C) $240 D) $200

Q: Variable cost for Light.com's fluorescent tubes is $12.50, the tubes are sold over the internet to businesses and organizations for $20.00 each. Fixed costs are $7,500,000. $500,000 in depreciation expense is included in fixed costs. What is the cash break-even quantity for the fluorescent tubes? A) 933,333 B) 1,000,000 C) 375,000 D) 1,066,667

Q: Variable cost for Light.com's fluorescent tubes is $12.50, the tubes are sold over the internet to businesses and organizations for $20.00 each. Fixed costs are $7,500,000. What is the break-even quantity for the fluorescent tubes? A) 600,000 B) 1,000,000 C) 375,000 D) 7,500,000

Q: February sales for Ted's Variety Store equal $100,000, variable costs equal $60,000, fixed costs, including depreciation of $20,000, total $60,000. A) Teds' Variety Store broke even with respect to net income. B) Teds' Variety Store broke even with respect to cash. C) Ted's Variety fell $20,000 short of cash break-even. D) Teds' Variety Store broke even with a $20,000 surplus.

Q: Accounting break-even analysis uses: A) free cash flows over the entire life of a project. B) sales, variable costs and fixed costs over the entire life of a project. C) sales, variable costs and fixed costs for a single period. D) free cash flows for a single period.

Q: Accounting break-even analysis solves for the level of sales that will result in: A) IRR=Cost of Capital. B) net income = $0.00. C) Free cash flow = $0.00. D) NPV = $0.00.

Q: The Oviedo Thespians are planning to present performances of their Florida Revue on 2 consecutive nights in January. It will cost them $5,000 per night for theater rental, event insurance and professional musicians. The theater will also take 10% of gross ticket sales. How many tickets must they sell at $10.00 per ticket to raise $1,000 for their organization? A) 1000 tickets B) 1,112 tickets C) 1,223 tickets D) There is not enough information

Q: Klaus Nicholas plans to sell Christmas trees from a vacant lot in downtown Springfield. The trees will cost him $1200 per 100 tress. They can only be purchased in lots of 100. It will cost Klaus $1,500 to rent the lot from November 1 through December 30. If Klaus sells the trees for $20 each, how many trees must he sell to break even? Assume that he purchases makes an initial, non-refundable purchase of 300 trees. A) $1,500/($20-$12) = 188 trees with a very small profit on the last tree. B) All 300 trees because he must purchase them in lots of 100. C) At least 255 trees because all costs are fixed once the trees are purchased. D) The Christmas tree project can never break even.

Q: Klaus Nicholas plans to sell Christmas trees from a vacant lot in downtown Springfield. The trees will cost him $12 each. It will cost Klaus $1,500 to rent the lot from November 1 through December 30. If Klaus sells the trees for $20 each, how many trees must he sell to break even? Assume that he makes an initial, non-refundable purchase of 200 trees but can buy more trees in any quantity after that for $12 each. A) $1,500/($20-$12) = 188 trees with a very small profit on the last tree B) $3,900/$20 = 195 trees C) All 200 trees D) The Christmas tree project can never break even.

Q: The Oviedo Thespians are planning to present performances of their Florida Revue on 2 consecutive nights in January. It will cost them $5,000 per night for theater rental, event insurance and professional musicians. The theater will also take 10% of gross ticket sales. How many tickets must they sell at $10.00 per ticket to break even? A) 1000 tickets B) 1,112 tickets C) 1,223 tickets D) There is not enough information

Q: Which of the following costs is NOT covered in an accounting break-even analysis? A) Shareholders expected rate of return B) Variable production costs C) Interest expense D) Depreciation expense

Q: Angie's Sub Shop expects to sell 200,000 subs next year at an average price of $5.00. Variable cost of a sub is $3.00. Cash fixed costs are $85,000, depreciation $95,000 and the tax rate is 25%. If the price increases to $5.50 and all other variables remain the same, how much will free cash flow increase?

Q: Boulangerie Bouffard expects to sell 1 million croissants next year for $1.25 each. Variable cost of a croissant is $0.75. Fixed costs are $150,000, depreciation $200,000 and the tax rate is 25%. If the number of croissants sold increases by 10%, and all other variables remain the same, how much will free cash flow increase?

Q: Webster Footwear believes that a new line of foul weather footwear they are planning to introduce this year will result in an NPV of $500,000 if the winter weather is exceptionally cold and wet, $400,000 if weather is normal, and $200,000 if winter is relatively warm and dry. The probability of a hard winter is 30%, an average winter is 50%, and a mild winter 20%. Compute the project's expected NPV.

Q: List at least four typical value drivers that could seriously impact the outcome of a project.

Q: Briefly distinguish between sensitivity analysis, scenario analysis, and simulation.

Q: One advantage of simulation is that it can differentiate between unsystematic and systematic risk.

Q: Sensitivity analysis shows how the distribution of possible net present values is affected by a change in one input variable.